US Q4 bank earnings guide

Having seen a dramatic drop in bank shares over the past few months, the question is now whether the sector is good value. Upcoming earnings provide a chance to test that idea.

Volatility: after the quiet of 2017, much of 2018 was a rollercoaster ride.

Volatility is both good and bad for banks. Good, in that it boosts trading activity and revenue from spreads and commissions, but the higher risk can hurt performance. Jefferies reported results last Thursday, and this saw an 11% fall in trading revenues, and the average ‘value at risk’ level (which looks at how much money could be lost on any given day) rose 81% compared to results for a year earlier.

Funding costs: these might be on the up, as banks have to pay out more due to short-term interest rates going up. So far, interest margins have not been too hard hit, but this may begin to change. Smaller banks are already offering higher rates, so the big banks may have to follow suit.

Loan growth: this remains weak, despite the strength of the US economy. At Bank of America, total loan growth in the third quarter (Q3) was up just 1.4%. The US Federal Reserve (Fed) data suggests business loan growth at large banks has accelerated in the last few months of the year, but this has not been replicated in commercial real estate.

Dealmaking: Mergers and aquisations (M&A) picked up in 2018, after a difficult 2017, but the volume of new deals was weak in the final quarter (Q4).

Reserves: US banks have been running down reserves over the past few years, helping to improve earnings. But as the US economy starts to slow, banks may start to bolster their cash piles in order to provide a greater margin of safety.

Government shutdown: with 800,000 Federal employees currently going unpaid, the shutdown will start to have an effect on the broader economy, and bank earnings will be one area where this might show up, or if not in the actual earnings, then in the outlook. In addition, the initial public offering (IPO) activity grinds to a halt while the Security Exchange Commission (SEC) is on enforced leave, further hurting potential revenues.

XLF: financial sector ETF chart

Like the rest of the market, XLF shares have rallied hard since Christmas. But they are struggling to move much higher. 2457 is the first level to watch, and a breakout from here would challenge 2502 and then the 50-day simple moving average (SMA) at 2534.

If the rally has already priced in decent earnings then a fresh drop is possible, and a close back below 2400 would be the first sign of this. Longer-term, any rally faces hurdles at 2750 and then 2905, the December and September highs respectively.