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The US first quarter earnings season, which starts this week, is expected to record a 25% growth in earnings for S&P 500 listed companies. US financials, which contributed to the strong uptick in earnings expectations over the quarter, are the first to announce their earnings results this week, primarily the US largest banks. This includes JP Morgan Chase, Wells Fargo, Goldman Sachs and Bank of America.
Overall, the financial sector has managed to record a strong rebound since the start of the pandemic. After initially underperforming when the market corrected initially, the banking sector, particularly, has managed to outperform the broad market index as the positive cyclical momentum started taking shape.
Since the start of the year, US banks returned over 26% compared to the broad market return of 10%. Similarly in Europe, banks notched approximately a 19% gain compared to the 12% return by the general European equity market. In fact, the strong recovery across the European banking sector and the larger weighting of banks within the broad market index, has contributed to the stronger year-to-date gains across European equities when compared to the US.
The strong rally across the banking sector was largely driven by an uptick in earnings expectations, supported by a strong macro-economic backdrop and the consequent rise in bond yields. As a result, the banks’ earnings releases this week are expected to feature three key themes that are shaping financial results: the impact of a zero interest rate environment, the required level of loan loss provisions and the contribution of fees from the investment banking arm.
Primarily, this quarter’s US banks earnings is expected to deliver a series of reserve reversal on the back of an improving economic outlook. Just last week, the International Monetary Fund (IMF) announced that little lasting damage from the pandemic is expected across advanced economies, particularly in the US, following the unprecedented level of stimulus injected in the economy and the fast pace of the covid-19 vaccine roll-out.
The IMF upgraded the expected growth rate for the US economy, from the 5.5% announced in January to 6.1%. It is also expected that the US economy exceeds its-pandemic GDP level by this year, one year ahead of its peers. Given the stronger economic recovery, reserves are expected to be released, boosting the banks’ underlying capital. This in turn increase the ability for banks to add shareholder value by resuming dividend payments and share buybacks.
Secondly, the low interest rate environment will undoubtedly feature as a detriment to the bank’s bottom line. Nonetheless, interest rate sensitivity varies across the banks and the ongoing yield curve steepening bodes well for less pressure on Net Interest Margin (NIM) in the future. A steepening yield curve acts as a strong indicator for an improving economic outlook and rising inflationary pressures, which will eventually trigger future interest rate hikes. Implicitly, the US banks’ NIM is expected to fully benefit in a rising interest rate environment, which the market is expecting to begin in 2023.
The third major theme for this week’s banks’ earnings is the contribution from fee income. Given the current compression on Net Interest Margins, banks have shifted focus on fee income, primarily returns from trading activity and wealth management. Investment banks are expected to benefit from merger and acquisition activity and strength in equity initial public offerings strength. This trend is expected to normalise towards the end of the year, as volatility continues to fall.
This article was written by Rachel Meilak, CFA, Equity Analyst at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd which is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.
For more information visit https://cc.com.mt/ The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.
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