US bank share prices: what to expect from earnings

US banks take their traditional place at the head of earnings season, and with Federal Reserve (Fed) rate cuts on the agenda and talk of economic slowdown in the air, the outlook from the sector will set the tone for the weeks to come.

The US economy continues to storm ahead, as demonstrated by the recent monthly non-farm payrolls (NFP) figures, which beat expectations, but there are signs of weakness in manufacturing and construction. Mortgage applications recently hit their highest level since September 2016, a sign of strong consumer confidence in the economy.

US banks in better shape than European counterparts

US banks also find themselves in a much better condition than their European counterparts. Credit quality in the US is much better than in Europe, and they also possess plenty of capital, along with a more benign regulatory environment. Overall, the financial sector is expected to see earnings rise 4.3% for the second quarter (Q2) compared to a year earlier, which is much better than the expected 1.7% decline for the S&P 500 as a whole.

The Fed is expected to cut rates in July, and forecasts of further cuts have put downward pressure on long-term rates, boosting loan refinancing activity and increasing bank fee income. However, lower rates also result in unfavourable repricing for commercial loans, offsetting some of the increased profitability.

Interestingly, as Marketwatch notes, the valuation discount for US banks has increased versus the broader index, with the forward price-to-earnings (P/E) ratio for banks 60% of that for the overall index, at 10 versus 18 for the S&P 500. Thus the sector, by comparison with the S&P 500, looks cheap.

Data compiled by Factset suggests that the major US banks will report the following earnings:

US banks earnings forecasts

In a world of lower interest rates, and a steady rise in the number of negative-yielding bonds, this means that the current yields on offer in the US financial sector are quite attractive. The US 10-year Treasury yields 1.98%, while financials overall yield 6.3%. Further diversification in business activities has included new wealth management and investment banking operations, which have helped boost performance and reduce dependence on trading operations. Thus even while interest rates fall, banks continue to pay out solid dividends, boosting the attractiveness of the stocks.

Compared to other sectors facing hits from trade wars, or weaker oil prices, bank stocks remain attractive. While they have not enjoyed the strongest returns, and have lagged behind the S&P 500, the sector seems well-placed to weather the potential storms of lower rates and possible weaker economic growth.

US banks: technical analysis

The benchmark SPDR KBW bank exchange traded fund (ETF) has seen lower highs since last May, although dips in March and May found buyers in the short term. Rallies to 4600 in February and May ran out of steam, but the following pullbacks dipped to the 4100-4000 area before bouncing. Crucially, the latest rally appears to be running out of steam at 4400, potentially leading to a retest of rising trendline support from the December low. A move above 4400 would open the way to a test of descending trendline resistance from the May 2018 highs, around 4500, and then from there 4600 comes into view, key resistance in February and May.