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Banks’ earnings: a gauge for the US economic recovery

13102020

The third quarter earnings season kicks off this week and provides a key opportunity to investors to further digest the impact of the covid-19 pandemic on economic fundamentals.

Despite that weak sales growth and profit margins are still expected to weigh down on the quarterly results, aggregate earnings expectations began to move higher since the end of June. Bottom up full year earnings per share estimates for companies listed in the S&P 500 have increased over 6% over the past four weeks. Similarly, earnings expectations in Europe have also improved, albeit to a lesser extent than the US, with more than a 3% four week change in full year earnings per share estimates for the Euro Stoxx 600 Index.

As usual, the first week of earnings season is dominated by the financial results of the US largest banks. This includes JP Morgan, Wells Fargo, Bank of America and Goldman Sachs, whose earnings results are largely dependent on the strength of the US economy. On this basis, the banks’ earnings announcements provide key insights to assess how the US economic recovery is progressing.

While the general US market Index, the S&P 500, holds a 9% year-to-date return, the US banking sector still lags far behind. The industry focused index is sitting on a 30% decline since the start of the year, marking a stark underperformance to the general equity market.

Despite the solid second quarter investment banking results, on the back of increased market volatility, the impact of covid-19 pandemic on the banking sector was largely twofold. US banks have been negatively impacted by the decline in net interest margins, as interest rates fell to zero, and by the hit from additional provisions for expected loan losses.

Given that the positive attribution from the investment banking side is expected to normalise in the second half of the year, the key catalyst going forward depends on whether the level of provisions was either insufficient or excessive.

The extent of loan losses and therefore banking results, are therefore largely dependent on two key factors: the sustained economic recovery and further fiscal stimulus. Notwithstanding the unprecedent level and speed at which stimulus was deployed, from a global perspective, the rate of fiscal easing has slowed down. In the US, for instance, despite that further fiscal action was on the table, the possibility of a pre-election fiscal deal has diminished and is more likely to depend on the election outcome.

Meanwhile, although the level of new US covid-19 cases has declined from mid-summer peaks, case growth continues to trend higher. European countries are also once again battling the spread after the second surge in covid-19 cases. Despite that so far, governments have been reluctant to go back to full nation-wide emergency lockdowns, talks of stricter measures to contain the spread are on the rise.

Having said that, while fiscal policy is expected to continue to support the slowing economic recovery, the turnaround in the US banking sector performance is closely dependent on the cyclical recovery.

Disclaimer:

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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