In The Thick Of It: Bank Results Highlight Morning, With NFLX At Center Screen Late

Today’s session starts with banks and ends with a FAANG.

Bank of America Corp BAC and several other banking firms highlight the earnings picture this morning, while anticipation builds ahead of Netflix Inc. NFLX results after the close. Remember that for NFLX, the first FAANG company to report this quarter, subscriber numbers are arguably more important than its quarterly financial performance because they provide an indicator of where the company is heading, especially as competition heats up.

Also, there seems to be some risk aversion creeping back into the picture after President Trump’s comments about the China trade situation yesterday (see more below). Small-caps out-performed large-caps yesterday, maybe a sign of some investors seeking names less exposed to trade battles.

This morning, BAC became the latest big bank to surpass Wall Street’s earnings estimates as interest income rose, but shares edged lower in pre-market trading. Revenue looked like it was just shy of the average Wall Street estimate, which could explain the red numbers.

Like several other banks that reported earlier this week, BAC’s earnings in Q2 reflected strong consumer demand, with spending by customers up 5%, BAC said in a press release. Profit in consumer banking rose 13% in Q2 to lead all of BAC’s businesses, the company said. This reflected strength in deposits and loans.

Also, in a sign that maybe corporate America isn’t as shy about spending as some recent data seem to indicate, BAC reported that it saw “consistent borrowing and activity from our commercial and corporate clients.”

BAC wasn’t the only bank reporting early Wednesday. Others included U.S. Bancorp. USB and PNC Financial Services Group PNC, and both of those came in better than expected.

Getting out of the teller line and up into the sky, United Continental Holdings UAL results after the close yesterday also looked very solid, with earnings and revenue both beating third-party consensus and the company raising guidance. One analyst raised the price target for UAL, citing strong earnings momentum, but shares are up just a sliver in pre-market trading early Wednesday. The stock’s gains this year are way behind the broader market.

On the downside, railroad company CSX CSX saw shares crumble more than 7% in pre-market trading after the company cut its outlook and cited weak shipping volumes. It looks like trade tensions with China could be taking a toll for CSX. Earnings and revenue both missed Wall Street’s projections.

Besides NFLX, this afternoon brings earnings from IBM Common Stock IBM and eBay Inc EBAY. Microsoft Corporation MSFT bows tomorrow, along with Morgan Stanley (MS). 

On the data side, news from the housing market continues to be less than stellar. Both housing starts and building permits fell in June, both coming up short of analysts’ estimates. On the plus side, single-family home building did increase. Consider keeping in mind that home building is a factor in gross domestic product (GDP) growth, so we might see some analysts lower their already soft Q2 GDP projections based partly on this news.

China Worries Back in Picture

Stocks began Tuesday by marching to new record highs, only to pull back late morning after President Trump said “there’s a long way to go” on China trade talks. While it’s arguable that most investors probably already knew this, hearing it straight from a presidential tweet helped bring the matter into sharper focus.

Though the U.S. threat to raise tariffs further was temporarily withdrawn when the two countries’ presidents met last month, it still looms in the background if talks go south. With this situation still such an elephant in the room, it’s hard to imagine stocks really pushing out of the current range. 

Where is that range? In the S&P 500 Index (SPX), there appears to be a band of support between 2940 and 2954, according to research firm CFRA. Below that, there’s the 50-day moving average of 2894, which has often been a support point in the recent past. The top of the range would probably be around all-time highs near 3015.

Anyway, the SPX was coming off five days in a row of being higher, and it’s just hard to continue that momentum. Tuesday’s slow, low-energy performance might be because people just couldn’t find fresh reasons to buy.

Bank Results Unspectacular, but Underneath, Something to Watch

Banks had a mixed day Tuesday following earnings that weren’t bad but not overwhelmingly good from three of the big names. JPMorgan Chase & Co JPM and Goldman Sachs Group Inc GS finished with 1% or better gains, while Wells Fargo & Co WFC slipped.

On the surface, the bank earnings didn’t look too spectacular. Underneath, however, they told a story about the consumer. In fact, you might want to call Tuesday, “the day of the consumer.”

First of all, the bank earnings showed mortgage applications up across the board. Also, credit card spending was up significantly. Debit card spending was down, but credit cards were up. Additionally, balances were up. Those are big numbers calling out the solidity of the U.S. consumer. 

It goes beyond the banks, as transportation companies are reporting full trucks and trains—though CSX earnings were a notable exception. To reinforce it more, retail sales for June were better than analysts had expected, helping back up what bank earnings indicated about consumers.

Another less positive way to look at bank earnings is to say maybe the consumer is getting a bit over-leveraged. This would be more of an issue in a rising rate environment, but not so much with the Fed expected to chop rates later this month. 

That said, Treasury yields briefly hit one-month highs above 2.14% for the 10-year Treasury note Tuesday after the strong retail sales data. The dollar also appeared to get a boost from the data, and rose to two-year highs vs. the British pound as Brexit worries continued to flare.

This week’s big bank earnings showing consumer strength could make it even more interesting to see what regional banks report. They face a strong headwind from low rates eating into their profit margins, but the question is whether they might be able to make up for it with more mortgage loans. Also, the big banks reporting this week aren’t too focused on auto loans, but regional banks have a big market with those and might see a bounce if people start buying more cars. 

Does this mean the retail sector might also do well when it comes to earnings? Yes, but with a caveat. The retail sector can’t really be seen as a single entity, because every major business is so different. Some brick-and-mortar retailers likely will continue to struggle with the same online competitive forces that have been hitting them for years. Others, especially some of the “big boxes,” seem primed to continue doing well. The heart of retail earnings is still a few weeks away, but Amazon.com, Inc. AMZN is due next week.

Another thing worth noting about Tuesday was a midday plunge in crude oil after the Trump administration said Iran might be ready to negotiate about its missile program. The quick drop in crude on this news does seem to point up how geopolitics played a big role in the commodity’s recent run higher, though falling U.S. stockpiles also get some credit.

Catalysts, Anyone?

If you’re looking for a potential catalyst that could give this rally more legs, earnings seem like the place to focus, especially since a rate cut this month is pretty much baked into prices already. Unfortunately for anyone who wants to see stocks move higher, most analysts expect earnings to fall 1% to 3% this quarter from a year ago. According to some calculations, that would be the second-straight quarter of falling earnings, or what’s often called an “earnings recession.” If that’s how things turn out, it’s probably not much of a base for additional stock market gains.

However, in many recent quarters, the trend has been for companies to do better overall than analysts initially had thought, with evidence of that building as earnings season advances.  So each week as we fill in the boxes for S&P 500 earnings reports, it could be important to watch whether earnings to that point are outpacing estimates. If strength starts to build, it might become that catalyst. 

Or maybe not, because in one way, the bar moves a bit higher this quarter. With all the recent stock buyback activity—which hit an all-time record in 2018 and is currently on pace to exceed that total this year—there’s a sense that some people want to see how “organic” earnings did. That means they might look at how strong a company’s earnings might have been if it hadn’t been buying back stock. Other one-time events like tax credits or sales of a business that temporarily boost results could receive a fish eye from some.

This issue came up with Citigroup Inc.’s C earnings earlier this week. The quarterly results received an assist from C’s investment in Tradeweb, an electronic trading platform. That helped offset declines in the company’s Investment Banking and Fixed Income and Equity Markets revenues.  However, some analysts pointed out that the company’s 14-cent earnings beat would have been just two cents without that investment, and the stock couldn’t generate much momentum.

JP Morgan Chase found itself in a similar boat on Tuesday, when analysts pointed out that 23 cents of the quarterly earnings beat came from tax credits. JPM still surpassed expectations even with the tax situation factored out, but by a whole lot less. This skepticism about companies getting an “assist” on their results from one-time impacts appears to be a growing theme this time around, so investors might want to stay on the watch for more of the same as earnings season rolls along.

Figure 1: YIELDS, DOLLAR ON UPSWING: After falling sharply at times over the last month as the market built in 100% chances of a Fed rate cut by the end of July, both the 10-year Treasury yield (candlestick) and the dollar (purple line) began to climb back this week on stronger U.S. retail sales data and a bigger-than-expected rise in June inflation. Data Source: Cboe Global Markets, ICE. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Two Sides to Earnings Equation: One metric people often look at during earnings season is earnings “beats,” which measure whether a company surpassed third-party consensus estimates for earnings per share and revenue. The fact that many analysts already predict weak earnings for Q2 means companies might not get all that much credit for beating low estimates, but could get punished harshly for missing. Also, there’s a sense that with 70% or more of S&P 500 companies tending to beat earnings expectations every quarter, some firms might be adjusting their numbers to do better than Wall Street expects. If you feel this way, consider looking at revenue and revenue growth, the other side of the coin, because revenue simply is what it is and can’t be tinkered with to emphasize what companies might want you to see.

Since we’re on the topic of revenue, one complaint heard on Wall Street after three of the big banks reported yesterday was that revenue didn’t surpass analysts’ projections by as much as earnings per share. If this complaint persists in coming weeks, it could signal dissatisfaction with company performance and raise new worries about economic health even if earnings per share continue to beat.

Going Away for the Holidays? Let’s hope your travel plans don’t get hampered by continued problems with Boeing Co’s BA 737 MAX, because concerns are growing that the troubled jet might not be back in the skies until next year, USA Today reported. Two major U.S. airlines are pushing back their expectations on when the plane might be ready again, and now target November. We’ll see if they stick to that. While the airlines have done a pretty good job keeping people moving despite the MAX issue, travel volume tends to rise in December, meaning lack of these airplanes could slow the “flow,” to borrow an airline term. Airline shares, as measured by the New York Stock Exchange’s Arca Airline Index, are roughly flat over the last year, but up sharply from late May. It might be a good idea to consider monitoring any impact on the airline names as we approach late summer to see if BA’s issues start to bring pressure. The index took a pounding in March when the MAX planes got grounded.

On the Home Front: Today’s housing starts and building permits for June follow Tuesday’s fair but unimpressive Housing Market Index from the National Association of Home Builders (NAHB). The July index headline came in at 65, which is well into positive territory (anything above 50) and up from 64 in May. That said, it was down from 68 a year ago, hurt by weakness in the Midwest market. It’s interesting that despite all the headlines about lower mortgage rates, there hasn’t been much of a lift for the NAHB Index the last three months, and the NAHB said that might partly reflect lack of affordability. 

Labor shortages and rising construction costs—some of which reflect more expensive materials from China due to tariffs—play into high home prices. While prices are near all-time highs, they’ve actually moderated slightly from a year ago, but anything above $300,000 probably doesn’t sound cheap to most people. We’ve been saying for a while that the consumer seems healthy when it comes to the little things, which could help explain why fast food chains like McDonald’s Corp MCD and Chipotle Mexican Grill, Inc. CMG are doing well. When it comes to big items like homes and cars, however, the jury is still out.

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