Flipping The Financial Playbook: Earnings Seen Firming For JP Morgan, Wells Fargo, Goldman Sachs

After years of standing on the sidelines while other sectors ran the ball downfield, banks are finally back under center approaching the kickoff of Q1 reporting season. Sure, bank earnings were generally pretty good in Q4, but arguably all the fundamental elements really didn’t join the huddle until the quarter that just ended.

This is starting to show up on Wall Street. So-called “value stocks,” which include banks, outplayed growth sectors like Tech early this year, a major turnaround from the recent past. This week, the biggest U.S. financial institutions open the books and investors will see if their newfound enthusiasm was justified.

JPMorgan Chase & Co. JPM, Goldman Sachs Group Inc. GS, and Wells Fargo & Co WFC—which kick off earnings season Wednesday ahead of Citigroup Inc C, Bank of America Corp BAC, and Morgan Stanley MS later this week—look like they came through the quarter mostly with flying colors. 

It would be surprising if they didn’t, considering that the benchmark 10-year U.S. Treasury yield nearly doubled during the quarter, though it’s still low by historic standards at a recent level near 1.67%. Back in March, it hit a 13-month high of 1.78%, way up from last August’s depths near 0.5%.

The rising yield curve we’ve seen this year—where longer-dated bond yields rise faster than shorter-term ones—is like catnip for the banking industry, allowing banks to borrow (and pay deposits) at low rates and lend out at higher ones. The premium of the 10-year yield to the two-year yield recently hit its highest level since mid-2017 as investors built more inflation and economic growth into their outlooks. 

This happened with the Fed keeping its benchmark short-term borrowing rate at zero and pledging to leave it there long-term, regardless of inflation. It also coincided with almost unprecedented amounts of fiscal stimulus.

You could hardly dream up a better scenario for the banking industry, which for a long time had to make its own luck, even before Covid. The yield curve actually inverted (went negative) at one point a couple years back, and the low interest rates and credit risks that came along with the pandemic put huge pressure on all the big banks. 

Fundamentals Finally Favoring Financials

Now, for the first time in a while, the big banks have a tailwind and investors can focus more on traditional bank functions and less on the industry’s efforts to bail out the floodwaters. The 10-year yield is much higher than it was six months ago, so they can make more on the spread and that should go right to the bottom line. 

Beyond that, trading is an important part of many bank businesses (especially some of the big Wall Street sluggers like JPM and GS), and they possibly saw benefits in their bond trading during Q1 thanks to opportunities there. As always, investors should consider focusing on the separate fortunes of equities and fixed income trading, where there’s often bifurcation. 

A sizzling housing market and signs of upticks in the U.S. manufacturing and services sectors mean more households and businesses might have been out there borrowing last quarter, another potential boost for banks. This could go especially for big banks with major consumer-facing businesses like credit cards and home mortgages. 

Most of the major banks put large amounts of capital into “loan loss provisions” over the last year as a shield in case of default from clients, but began pulling those back recently. These protective measures weighed on earnings in 2020, but may be less of a factor in Q1 and beyond. One interesting thing to look for as banks report is what they say about rolling back some of this caution, because it could potentially flow back into profit margins.

“Credit risk should improve from the abyss of 2020,” research firm CFRA said in a recent note previewing bank earnings.

To make things even rosier, some of the measures banks took to protect themselves in the down years, including cost cutting and higher fees, aren’t going away and could continue to provide traction. 

On the less rosy side, some analysts worry about higher corporate taxes possibly coming later this year if the Biden administration gets its infrastructure plan through, and say certain industries like commercial real estate remain on the watch list for potential loan loss provisions.

Despite those worries, Financials are the second best-performing sector year-to-date, up more than 18% through early April. Only Energy (another downtrodden sector until recently) gained more Q1 ground.

We’ll examine MS, BAC, and C in a subsequent report, but for now let’s focus on the first big banks to report, led by JPM on Wednesday. 

FIGURE 1: SOLID Q1 SEEN FOR FINANCIALS. The S&P Financial Sector (IXM—candlestick) has outpaced the broader market as represented by the S&P 500 Index (SPX—purple line) so far this year. Data source: S&P Dow Jones Indices.Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

JPMorgan Chase Earnings And Options Activity

When JPMorgan Chase releases results, it’s expected to report adjusted EPS of $3.08, up from $0.78 the prior-year quarter, on revenue of $30.52 billion, according to third-party consensus analyst estimates. Revenue is expected to rise 5% year-over-year. 

Options traders have priced in a 2.4% stock move in either direction around the upcoming earnings release, according to the Market Maker Move indicator on the thinkorswim® platform. Implied volatility was at pretty much its low point of the past 52 weeks—at the 2nd percentile as of Tuesday morning.  Looking at the April 16 options expiration, put options have seen the most activity at the 150 strike, but there’s been more activity to the upside, with the largest concentration in the 160-strike calls.

Note: Call options represent the right, but not the obligation, to buy the underlying security at a predetermined price over a set period of time. Put options represent the right, but not the obligation to sell the underlying security at a predetermined price over a set period of time.

JP Morgan Chase Sounds Optimistic Note Heading In

JPM shares have been solid all year, and got another boost last week when CEO Jamie Dimon released an optimistic letter to shareholders saying he thinks a “boom” in the U.S. economy could stretch into 2023. The bank is considered an industry leader thanks to what it calls its “fortress” balance sheet, and as the U.S. bank with the most assets. Also, Dimon tends to be influential, with the market sometimes moving on his words in the company’s earnings calls.

Last time out, JPM demolished analysts’ earnings projections for its Q4, but the stock retreated after the company reported, thanks in part to what appeared to be “whisper numbers” that suggested the chance of even better results. That’s been a problem for companies in lots of industries lately, so don’t be surprised if JPM or the other big banks beat but don’t get rewarded immediately by the Street.

By the way, if any of the big banks come up short, it wouldn’t be surprising to see them get slapped around by investors, who may feel like if you can’t hit expectations in this environment, when can you?

Dimon’s letter last week outlined a long list of challenges facing the banking industry and the country in general, but didn’t comment specifically on JPM’s Q1 performance. 

On the earnings call, Dimon is likely to face questions that go well beyond JPM’s own books and into the state of the economy. It will be interesting to get his take on the Fed’s most recent minutes released last week, which showed a central bank that’s willing to be more patient about allowing inflation than we’ve seen in the past. Does Dimon see any risk in that policy, particularly for the dollar and yields? One reason Treasury yields grew from around 0.9% in early January to 1.7% by March had to do with investors not necessarily being convinced the Fed could fend off inflation if it keeps such a dovish policy.

All the big banks, including JPM, are under a microscope to see how much they plan to release from those piles of cash they put aside against potential loan defaults during the initial Covid outbreak last year. In Q4, JPM released $2.9 billion, which gave its earnings per share for that quarter a boost. How much it removes this quarter from its remaining credit reserves could have a major impact on its earnings number. 

However, as an investor, remember to look at whatever that amount is as separate from overall earnings per share, since it’s more a reflection on the bank’s internal policies than on how their business grew during the quarter. In Q4, JPM would have beaten analysts’ estimates even without that boost from the trim in reserves, but Dimon said he didn’t consider the reserve release part of the bank’s core operating results.

Q4 2020 was a record quarter for trading at JPM, and it looks like trading should probably have helped the bank in Q1, as well. That amazing rally in Treasury yields and strength in the stock market probably kept trading volume robust, though stock market volatility did trend lower most of the quarter. One stretch in late February and early March when the Tech sector briefly went into correction did send volatility briefly soaring, possibly a boost for JPM’s trading desk.

Goldman Sachs Earnings And Options Activity

Goldman Sachs is expected to report adjusted EPS of $10.22 vs. $3.11 in the prior-year quarter, on revenue of $12.39 billion, according to third-party consensus analyst estimates. Revenue is expected to rise 41.7% year-over-year.

Options traders have priced in a 3% stock move in either direction around the coming earnings release, according to the Market Maker Move indicator. Implied volatility is at the 2nd percentile as of Tuesday morning.

Looking at the Apr 16 expiration, options volume has been light overall, with some activity in the 300-strike puts and the 335-strike calls. 

M&A, IPOs In Focus As Goldman Sachs Reports

Goldman Sachs is the big bank that gets the largest chunk of its revenue from Wall Street trading and activity. That means the energetic trading environment of Q1 probably gave its business a lift. Remember that in Q4, GS trounced analysts’ expectations, partly by an amazing performance with equity trading. Fixed income trading lagged a bit, however, so we’ll see if that changed at all in Q1.

Over on the initial public offering (IPO) side, the second half of 2020 featured several closely followed initial public offerings, some of which GS played a big role in. The excitement continued in Q1, but was dominated by special purpose acquisition companies (SPACS), not the traditional IPOs that have been bread and butter for big investment banks like GS over the years.

In its Q4 earnings call back in January, GS CEO David Solomon warned that the boom in equity issuance by SPACs isn’t sustainable.

“There will be something that will in some way, shape or form bring the activity levels down over a period of time,” Solomon said. “Like many innovations, there is a point in time as they start where they have a tendency maybe to go a little bit too far and they need to be pulled back or rebalanced in some way.” 

Goldman wasn’t one of the early leaders in underwriting SPAC IPOs but it’s caught up: It ranked third last year behind Credit Suisse Group AG CS and Citigroup Inc C in terms of the amount raised, Bloomberg reported. It wouldn’t be surprising if Solomon is asked on this week’s call to give more observations on SPACS, as well as how the traditional IPO market is shaping up for GS this year.

Usually a market featuring plenty of IPO and M&A activity means healthy times for big investment banks, and GS has a huge exposure here. Tech has been a leader in IPOs so far this year, and that could continue if you look at some of the companies planning to go public later in 2021. 

In Q4, GS reported strength in its Investment Banking and Global Markets businesses, with underwriting providing a big chunk of the Investment Banking growth. Financial advising also grew nicely. Those are areas to watch for potential continued strength when GS reports Q1 results. 

None of this is being ignored on Wall Street, where GS shares were already up 24% for the year through early April. As Barron’s recently noted, “Goldman Sachs has fared well over the last year thanks to a surge in trading and deal-making activity. Given its smaller loan book, the bank has also avoided having to boost its reserves by billions last year to protect against potential credit losses as peers did. The bank is also less exposed to negative impacts from low interest rates.”

Also look for the company to potentially use the earnings call to provide updates on its plans to grow wealth management and consumer banking.

Wells Fargo Earnings And Options Activity 

Wells Fargo is expected to report adjusted earnings of $0.69, vs. $0.01 in the prior-year quarter, on revenue of $17.5 billion, according to third-party consensus analyst estimates. Revenue is expected to be down 1.2% year-over-year.

Options traders have priced in a 3.3% stock move in either direction around the coming earnings release, according to the Market Maker Move indicator. Implied volatility was at the 4th percentile as of Tuesday morning. 

Looking at the April 16 expiration, put options have been more active, with concentrations at the 35 and 40 strikes. Calls have seen activity at the 42.5 and 45 strikes. 

WFC Still Dragged By Its Past

Old issues with corporate governance (the “fake account scandal” from a few years ago) continue to be a drag for WFC, with analysts expecting revenue to fall in Q1 from a year earlier. Earnings, however, are seen rising substantially.

“The Fed’s consent order against WFC continues for systemic consumer fraud,” CFRA said in a recent note. “Restructuring by new management is taking longer than we expected. WFC has substantial work to streamline its processes and enhance risk and control infrastructure that satisfies U.S. bank regulators. 

“We expect investments in compliance platforms to be done in the next two years,” CFRA continued. “This risk and control build-out is necessary, but it only enables WFC to catch up with its large bank rivals.”

In spite of all that, WFC shares have done very well this year, up about one-third since the end of 2020. The company is the biggest mortgage lender in the U.S., and a sizzling housing market might be one thing helping its shares. Mortgage rates rose in Q1 and housing supplies fell, which may be trends WFC management gets asked to address during its call.

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