Market Confronts the First Earnings Season of Rate Cut Cycle: How Will Big Banks Perform?

Moomoo News Global wrote a column · Oct 8, 2024 18:55

As the stock market navigates its first earnings season amid a rate-cut cycle, U.S. investors will in on the banking sector. Major players such as $JPMorgan (JPM.US)$, $Wells Fargo & Co (WFC.US)$, and $Bank of New York Mellon (BK.US)$ are preparing to disclose their financial results. Investors are particularly focused on the potential for a soft economic landing, Federal Reserve rate cuts, and the impact these factors could have on bank valuations.

Market Confronts the First Earnings Season of Rate Cut Cycle: How Will Big Banks Perform?

According to data compiled by FactSet, the banks industry is the only industry in the financial sector that is expected to report a year-over-year decline in earnings at -12% this quarter.

Bank of America analysts, led by Ebrahim H. Poonawala, maintain a cautiously optimistic stance on bank stocks, suggesting that a soft-landing scenario could revive customer activity, enhance loan growth, and ultimately result in higher price-to-earnings (P/E) multiples for the sector. However, macroeconomic uncertainties, including potential Fed policy shifts and the upcoming U.S. elections, present significant challenges that could temper this outlook.

Net Interest Income, the Key Metric

As U.S. banks gear up for their earnings reports, the focus is on net interest margins (NIM) amid the Federal Reserve's rate-cutting cycle. The anticipated rate cuts could pressure banks' net interest income (NII), which has already seen a decline for four straight quarters. While the easing of rates might eventually boost loan growth, the immediate impact could be challenging for NII.

A quicker reset in deposit costs compared to loan rates could offer some cushion to NII in the near term. Additionally, the decline in rates may facilitate loan growth, but tangible evidence of a recovery in lending demand remains to be seen.

Last quarter, overall loan balances increased by just 2%, with consumer loans continuing to soften for the second consecutive quarter. Investors are keenly observing any signs of a significant pick-up in loan demand, which would be crucial for ensuring that declines in net interest income occur at a more gradual pace.

Stephen Biggar from Argus Research notes that while higher interest rates historically benefit banks' net interest margins, the recent rate cuts could relieve some of the pressures banks face, particularly regarding deposit costs and loss provisions. This triple benefit could be a boon for the lending business, provided lower rates continue to materialize.

Noninterest Revenues

Noninterest revenues will likely present a mixed picture this earnings season. Investment banking revenues may still be constrained due to ongoing weakness in mergers and acquisitions (M&A), though there are early signs of a pickup in sponsor monetizations that could stimulate activity. Mortgage banking revenues are expected to remain sluggish despite declining interest rates. However, wealth and asset management sectors may experience a positive impact, buoyed by a 5.5% gain in the S&P 500 during the quarter, slightly higher than the previous quarter's growth.

Consumer Health/Credit

The health of the consumer remains a focal point for investors, especially after Ally Financial's recent cautionary update and concerns about a potential spending slowdown as pandemic savings diminish.

"It will be important to keep a close eye on what the banks say about credit delinquencies and loan quality, along with the retail-focused firms and what they see in consumer spending behavior. GDP-related data shows strong trends here but more timely and granular views will be in focus," Horizon Investments head of research Michael Dickson said.

While credit card defaults remain within normal levels, there are emerging signs of financial stress among lower-income groups, which could impact overall consumer spending. Earnings guidance from banks and retail-focused firms will be pivotal in assessing consumer trends heading into the holiday season and 2025.

Warren Buffett Cutting Stakes

One thing bank investors should note is that Warren Buffett's $Berkshire Hathaway-A (BRK.A.US)$ has significantly reduced its stake in Bank of America over the course of last month, shedding about 239 million shares, or roughly 23% of its holding, generating approximately $10 billion in proceeds. While Buffett has not publicly explained the rationale behind this decision, possible reasons include profit-taking after a 50% rise in the stock over the past year, concerns about higher capital-gains taxes, a strategic rebalancing of Berkshire's $300 billion stock portfolio, or pessimistic about the stock price movement. This reduction in Bank of America's stake follows similar exits from peers like JPMorgan and $Goldman Sachs (GS.US)$ in recent years.

Option Market Expectation

Over the past 13 quarters, the options market has consistently overestimated the earnings-related movements of $Bank of America (BAC.US)$ stock, doing so 69% of the time. While the options price forecast a ±5.2% move following earnings announcements now, the actual movements on earnings day averaged only ±2.8% for the past 12 quarters.

In terms of extreme stock movement during regular trading hours post-earnings, BAC stock saw its highest increase at +8.2% and its largest drop at -7.7%. Despite these fluctuations, the average one-day return for an long options straddle was notably negative at -14.1%.

Historically, BAC shares have usually climbed in the immediate aftermath of earnings, rising in 10 out of the last 12 reports with an average first-day post-earnings gain of 2.1%.

Overall, mixed results are expected for banks in the third quarter, but there are a number of indicators that the market should be considering both the short-term negatives and the possibility of better conditions (and outcomes) in 2025.

Source: Business Insider, Bloomberg, Fact Set, Market Chameleon
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