Sell first, ask questions later.
That's been investors' approach to Wall Street banks of late, and it poses a challenge for the companies as they report fourth-quarter earnings next week. Bank chiefs' bullish views and near-record profits in their previous round of results couldn't stop an 18% plunge in their stocks last quarter. Now they're going into the season with weaker earnings expectations as they contend with a pileup of share downgrades.
"The risk is for a negative-feedback loop" if bank heads acknowledge expectations for slowing growth or a recession, said Wells Fargo & Co. analyst Mike Mayo. "By having a desire to not appear tone-deaf, they go out of their way to say there's risk, that makes people worry, and that causes less activity.''
Mr. Mayo himself has a positive view on big banks, which he expects to benefit from cost cuts and high credit quality.
Citigroup will be the first to report results on Monday, followed by JPMorgan Chase & Co. and Wells Fargo & Co. Tuesday, and others later in the week. While lenders were buoyed by a strong U.S. economy and rising interest rates for much of 2018, they're now facing investor concerns over risks including the timing of the next recession and U.S.-China trade tensions. As a stock sell-off roiled financial markets in December, banks may have missed out on opportunities to profit as their clients moved to the sidelines.
The KBW Bank Index has rebounded 4.8% this year after dropping almost 16% in December.
Here are some things to watch as banks report earnings:
The four largest U.S. banks posted loan growth of just 1.5% in the third quarter. While fourth-quarter results are likely to include some bright spots, including strong credit quality and efficiency, gains in lending have remained modest. Wells Fargo reported a decline in average loans in the third quarter from a year earlier, while Bank of America Corp., JPMorgan and Citigroup had increases.
Deepak Puri, Americas chief investment officer for Deutsche Bank's wealth management unit, is expecting a rebound.
"We like banks" in the U.S., Mr. Puri said. "After a long time, deposits are making a comeback — we expect banks to start generating deposits, which means they'll be able to lend more." Deutsche Bank Wealth Management oversees 211 billion euros ($243 billion) globally.
Mr. Puri's not the only optimist. Billionaire Warren Buffett's Berkshire Hathaway is betting big on banks, piling more than $13 billion into their stocks in the third quarter, regulatory filings showed in November.
The equity market sell-off last quarter posed a challenge for banks as they struggled to capitalize on extreme, but short-lived, bouts of volatility across financial markets.
"December was unlike any other that we remember in our 34 years on the street," Chris Kotowski, an analyst at Oppenheimer & Co., wrote in a note to clients. "There were volatile and mostly downward markets right up to New Year's." That will probably translate to a poor quarter for capital markets businesses, which may persist through the first half of this year, he wrote.
Last month, Bank of America and Citigroup executives signaled that trading revenue would be slightly lower in the fourth quarter, while JPMorgan CEO Jamie Dimon said his company was on track to be "roughly equivalent" to a year earlier. Given the recent market turmoil, investors will be watching closely to see how those predictions panned out.
Another pain point is the stubbornly flat yield curve, which has made it tougher for banks to profit by using short-term borrowing to finance long-term loans. A sustained inversion of the yield curve could also signal a recession is on the way, dimming the outlook for banks.
"Sluggish loan growth, fierce deposit competition and a difficult yield-curve environment will likely pressure earning asset growth" and net interest margins, Laurie Hunsicker, an analyst at Compass Point Research & Trading, wrote in a note to clients.
Still, lenders should be able to navigate the flat-curve environment and make money, Morgan Stanley analyst Betsy Graseck said in a Bloomberg television interview.
"You can still earn a good spread," she said. Morgan Stanley reduced its median price targets for large banks by 6%, citing lower market-based revenue and slower growth in net interest margins. The bar for fourth-quarter results "has moved significantly lower," Ms. Graseck wrote in a report Tuesday.
The fallout from equity markets is also likely to show up in wealth management businesses, according to Jim Shanahan, an analyst at Edward Jones, who expects bank executives to set lower expectations for their divisions that oversee holdings for the affluent.
Lower fees and a decline in the value of assets under management will be a drag on wealth units, according to Marty Mosby, an analyst at broker-dealer Vining Sparks. Despite that weakness, he's broadly optimistic on the banking sector, citing improving margins and capital deployment.
"Are the banks broken?" Mr. Mosby said. "They're anything but broken."
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