Lost amidst the international headlines this week are the earnings results from the first full week of Q2 earnings season. In the financials sector, the stock reactions were clearly much more a result of divergent expectations rather than the results themselves. There might be a lesson there for stock investors looking at the broader market as well.
First, the weakest reactions were actually from the pure commercial banks. WFC, USB, and PNC have all fallen substantially in the past week. Their earnings reports were actually better than the headline consensus estimates (WFC was in line, but all three beat on revenues). Despite those results, however, all three stocks sold off after earnings, giving up a good portion of their year-to-date gains. PNC is trading within 3% of its 200 day ma for the first time since December:
On the other hand, the investment banking stocks had very low expectations among investors. In fact, analysts had likely moved the bar too low (with management’s urging in the past couple of months), as every bank with a major investment banking operation beat expectations (though BAC fell after the results, especially since its reserve release looked unduly large). That occurred even with continuing poor results in the trading businesses. However, analysts’ had cut expectations to a 20-30% drop for those businesses, and the drop was more like 10-15%, leading to beats. In addition, the corporate finance divisions did quite well with the M&A and IPO boom.
So what about going forward?
First off, we still view BAC as the weakest bank of the lot. While BAC’s headline number did beat, the company still has major legal issues outstanding. Meanwhile, consensus expectations for 2015 EPS growth are at 22%, which seems like a stretch given that they don’t have much room left on reserve releases (the allowance for loan losses is already near a decade low).
Speaking of legal issues, that remains a major overhang for these large financial companies. Aside from the DoJ’s many fines though, Elizabeth Warren’s severe questioning of Janet Yellen with regards to more stringent Dodd Frank regulation (specifically with regards to possibly breaking up the large banks like JPM since they are still too big to fail), could lead to even more regulatory restrictions for the banks in the year to come.
If there is one bright spot, it is likely MS, where James Gorman and the management team have done a stellar job of transitioning the business more towards wealth management, where regulatory and legal issues are less onerous. However, MS has been unable to get through the $33-$34 resistance area, so we’ll likely stay away on the long side unless it breaks out:
Overall, the important lesson from the financials sector is that expectations might be more important than the actual results. My hunch is that holds true for the sectors left to report as well.