As The Economy Recovers, Banks Shine Through
Banks are back, baby.
Bank earnings tend to establish the tone for the season and serve as a barometer of the overall economy. After salting away billions for possible loan losses in 2020, banks are expressing confidence in their ability to cope with defaults, a clear indication that stronger economic growth lies ahead in 2021.
This past week, 15 of the 22 companies in the S&P 500 that reported actual earnings for the first quarter of 2021 were in the financials sector. Most of these companies were in the banking segment, including the big leaders JPMorgan Chase (NYSE: JPM), Wells Fargo (NYSE: WFC), Bank of America (NYSE: BAC), and Citigroup (NYSE: C).
For Q1, the banking segment so far has posted the largest year-over-year earnings per share (EPS) growth rate (248%) of all five industries in the financials sector, according to research firm FactSet. Banks are the largest contributor to earnings growth for the sector.
Hence the recent outperformance of the financials sector. The benchmark Financial Select Sector SPDR Fund (XLF) has generated a year-to-date total return of 19.7%, compared to a total return of 11.5% for the SPDR S&P 500 ETF Trust (SPY), as of market close April 22.
And yet, bank stocks as a whole remain reasonably valued in light of projected earnings growth. They’re unlikely to stay cheap for long.
Bank stocks were among the worst performing stocks during the nadir of the pandemic in 2020, but they’ve bounced back this year amid the economic recovery. The rally in bank stocks will likely continue this year, as consumers and businesses get back on their feet.
Another positive for banks has been rising long-term yields, as shorter-term yields hover near zero. This so-called “steepening of the yield curve” typically helps banks because they prefer to borrow short-term money and lend it out long.
The recovery of banking is a major pillar shoring up the bull market; another is resurgent consumer spending.
That said, stocks swooned Thursday when news broke that President Biden wants to increase the capital gains tax for wealthy Americans. The Dow Jones Industrial Average fell 321.41 points (-0.94%), the S&P 500 slipped 38.44 points (-0.92%), and the tech-heavy NASDAQ declined 131.81 points (-0.94%). If there’s anything that Wall Street hates, it’s the threat of higher taxes.
In pre-market futures contracts Friday, all three U.S. indices were trading in the green as investor nerves calmed down and the focus returned to strong projections for Q1 earnings.
Loan loss provisions tell the story…
In Q1 earnings results, if the banking segment were excluded, the blended EPS growth rate for the financials sector would fall to 58.8% from 118.8%. “Blended” combines actual results for companies that have reported and estimated results for companies yet to report.
Here’s the seeming anomaly: the blended revenue growth rate for the banking industry for Q1 is only 3%. How can an industry report EPS growth of almost 250% and revenue growth of a paltry 3%? For the answer, let’s turn to loan loss provisions.
Banks are reporting, or are projected to report, substantially lower provisions for loan losses in Q1 2021 versus Q1 2020. Loan loss provisions don’t affect top-line growth, but they significantly affect bottom-line growth.
Banks sharply boosted their provisions for loan losses in the first half of 2020, in response to economic damage from the coronavirus pandemic. Now that lockdowns are getting lifted and the economy is recovering, banks are reducing loan loss provisions. Thanks to aggressive monetary and fiscal stimulus, many feared economic scenarios didn’t happen.
FactSet tracks the metric of loan loss provisions for all 18 companies in the banking industry in the S&P 500. All 18 of these companies have reported or are projected to report a year-over-year decline in provisions for loan losses for Q1 2021 relative to Q1 2020.
The average year-over-year decline in provisions for loan losses for these 18 companies is -109%, representing -$40.7 billion (-$10.2 billion vs. $30.5 billion). Take a look at the chart:
As of this writing, the banking industry is projected to report year-over-year earnings growth in Q2 of a whopping 295%, largely thanks to lower loan loss provisions.
The upshot: Key indicators are increasingly optimistic and the bulls remain in charge. If you’re looking for a way to stay bullish but at the same time minimize risk, you should keep an eye out for an exciting offer from Investing Daily. It’s “the next big thing” from our colleague Robert Rapier: a new trading service called Rapier’s Income Accelerator.
Robert Rapier’s trading methodology works in up or down markets, in economic expansions or recessions…in normal times or during pandemics. Robert is currently setting up his next trades. Want to join the action? Click here now.