Will Banks Vault? Earnings Season Likely To Disappoint, But Investors Hope To Hear 2021 Optimism

This is a nice lead-in to earnings.

The new week kicks off right where the old one ended, with lots of optimism lifting stocks tied to reopening the economy. 

Early strength came despite unrelenting spikes in coronavirus cases over the weekend, especially in Florida. Investors seem primed to look past this, especially with headlines this morning about vaccine progress from Pfizer Inc. (NYSE:PFE) and  German biotech BioNTech SE, which both received “fast-track” designation from the U.S. Food and Drug Administration (FDA). 

Meanwhile, earnings season starts tomorrow (see more below) as the largest banks prepare to open their books, and the S&P 500 Index (SPX) looks like it could be ready to start testing post-crisis highs after a June swoon that kept it stuck in a trading range.

Risk meters still flash concern, however. The 10-year Treasury yield has been stuck in the middle of a low range between 0.6% and 0.7%, and gold continues hanging out near $1,800 an ounce. Crude oil did crack above $40 a barrel early Monday, but isn’t exactly putting on a July fireworks show. It would be nice to see if the 10-year yield can hold onto 0.65% after dipping to really low levels for a while last week. 

The SPX has been pretty range-bound itself, between roughly 3000 and 3200 for a few weeks now. Monday begins with the index looking like it’s going to open right at 3200, and it would be good to see it hold that level on the close. If earnings come in better than expected, maybe that could help nudge stocks even higher. Another helpful factor? More strength in China’s stock market earlier Monday (see more below). 

On the other side of the equation, many sectors—especially Technology—have come so far from the lows that they might be in Missouri “show me” territory as earnings get underway. Meaning that if stocks haven’t completely divorced themselves from fundamentals, companies could be under pressure to deliver strong quarters or potentially get punished. 

’Tis The Season

Today’s empty calendar shouldn’t fool anyone. The busy times start tomorrow when JPMorgan Chase & Co. (NYSE:JPM), Citigroup Inc (NYSE:C), and Wells Fargo & Co (NYSE:WFC)  step to the plate for Q2 earnings. That kicks off an earnings season that might be unlike any since the financial crisis of 2008. Analysts are expecting average S&P 500 earnings across all sectors to fall about 45% from a year ago. 

When we last heard from the big banks in mid-April, they’d only had a few weeks of dealing with COVID-19 shutdowns. Now they’ve had an entire quarter. The Financials sector is expected to report the fourth largest year-over-year earnings decline of all 11 sectors in the S&P 500 at negative-51.5%, according to research firm FactSet.

The suffering isn’t necessarily spread through the Financial sector equally. Although all five industries in this sector are predicted to report a decline, FactSet predicts three of these five industries will report declines of more than 25%. These include Consumer Finance (-106%), Banks (-69%), and Insurance (-27%). 

That puts banks right near the bottom, though the bank part of Financials isn’t monolithic. There’s mega-banks like JPM and BAC, and also smaller regional banks. The regionals have been hammered in trading lately, though a better mortgage environment might be helping ease the pain a little. 

Two other big banks reporting later this week—Goldman Sachs Group Inc (NYSE:GS) and Morgan Stanley (NYSE:MS)—stick out from the rest because their business is more reliant on the capital markets. When markets rallied sharply from the late-March lows, it likely increased all sorts of market activity, including hedging and “buying the dip.” Several times in June, markets took a brief dive, only to see a flood of new buyers come in before any major damage could be done.

There was amazing trading volume early in the rally for both fixed income and stocks, noted research firm Briefing.com, part of a “reflation trade” across capital markets. That, along with a lot of mortgage refinancing that accompanied lower rates, could have helped business for many big banks, especially MS and GS. 

The overriding question heading into this earnings season is whether the banks add substantially to provisions for possible credit losses or start reducing them a bit. Their action could say a lot about how they see the reopening taking shape. Even if these provisions ease in Q2, they’re likely to continue to weigh on banks’ profitability. 

Other key reporting companies later this week include Johnson & Johnson (NYSE:JNJ) and Netflix Inc (NASDAQ:NFLX).

The broad question is whether we’ll get guidance from companies this time around. Everybody pretty much got a free pass last earnings season in terms of sharing guidance. People could demand more this time, at least some color on plans and expectations until the end of the year, if not concrete numbers. It would definitely be nice to hear companies say it’s a rough 2020 but they hope for a better 2021. 

Overall, it’s probably best to understand that earnings are going to look pretty disappointing. We’ll have to see what companies are doing to cut expenses. You never want to see people lose jobs, but we’ve already heard about potential layoffs from some major firms.

Shades Of Spring

For a while there late last week, it felt like early June again. The Information Technology heavyweights retreated a bit and some of the “value” sectors like Financials and Energy—not to mention travel— emerged from the sidelines where they’d been hiding out for a while. Carnival Corp (NYSE:CCL) jumped 10% as excitement stirred about what appears to be decent booking demand for 2021.

Energy and Financials led the market Friday in a rally that was good to see going into the weekend. These Friday rallies tend to show there’s still confidence in not only the market, but perhaps in the economy, too. Investors worried about the pandemic rushed to sell ahead of the weekend on a bunch of Fridays earlier this year. 

News about treatment success from Gilead Sciences, Inc. (NASDAQ:GILD) and possible progress on a vaccine from Pfizer Inc. (NYSE:PFE) got things going Friday as once again, the market quickly rebounded from a bad day the day before. Progress in treatment could be a big step. If people feel like they’re not taking their lives in their hands potentially by going out to restaurants, traveling on planes, and generally living life more normally, it could have a really big impact on consumer sentiment. 

There’s no need to get carried away, because the other side of the coin is that cases keep rising dramatically across lots of the country and travel restrictions and store closings are coming back in some places. That said, Walt Disney Co (NYSE:DIS) reopened over the weekend and Major League baseball is only about a week away from getting started again.

Another good thing to see late last week was the Cboe Volatility Index (VIX) cooling down. It ended Friday well below 28, and has generally trended lower since March. There were a couple of hiccups last month that drove volatility higher, and more of that can’t be ruled out in these headline-sensitive times. However, having the anchor of earnings season in place over the next few weeks does have a chance of keeping things a little steadier.

CHART OF THE DAY: NO WALL FOR SHANGHAI INDEX: The Shanghai Composite, represented here by the Dow Jones Shanghai NDX ($DJSH—candlestick) has simply exploded this month after spending most of the recently-ended quarter trailing the Nasdaq Composite (COMP—purple line). The recent China rally could reflect investors worrying about the virus caseload growth here in the U.S. Data Sources: Dow Jones, Nasdaq. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

Bulls in a China Shop: If there’s any other index that’s starting to resemble the Nasdaq (COMP) as far as looking like a hockey stick pointing straight up on the right, maybe it’s the Shanghai Composite (see chart above). After puttering slowly but steadily higher through April, May, and June, it’s just exploded in July. At its intraday peak last week, the Shanghai index was up 14% since the end of June, or less than two weeks earlier. What gives, and what could this mean for U.S. stocks? One idea floating around is that investors who feel there’s no place else to be but in stocks (with yields so low on fixed income) are trying to find places outside the U.S. to park their money that they feel might offer strong returns. With the U.S. market up more than 40% since its March low, the sense could be that there might be more room to grow overseas. 

There’s some logic to that, considering Chinese stocks had come much less far through the end of June from their lows than stocks in the U.S. Another thought is that money is heading out of the U.S. because the growing caseload of COVID-19 here has some people worried about possible economic pullback. China has generally been six to nine weeks ahead of the U.S. throughout the virus pandemic, and at this point seems to be in decent shape compared with the U.S. on that front. Recent weakness in the dollar vs. the Chinese currency also could speak to investors looking across the Pacific on worries about the U.S. economy.  The dollar index was near one-month lows by the end of last week.

Also, China’s government actively began encouraging people to start buying stocks. That’s kind of what’s been happening here, too, if you think about it. The Fed has made the stock market look more attractive to many through its efforts to push borrowing prices down. It just didn’t say, “Go buy stocks,” in so many words. 

China Strength and U.S. Markets: The China rally isn’t necessarily something market bulls here need to worry about in regards of possible impact on the U.S. There’s still plenty of money on the sidelines to be invested, probably enough to keep U.S. and overseas markets heading higher if investors remain optimistic. It’s not like money is running out, and the dovish monetary policy on both sides of the Pacific could arguably lead one to believe there’s more potential upside. 

However, U.S. investors tempted to start investing in China need to do their homework. It’s not the same market, obviously, and has its own set of fundamentals. Nearly all investors in mainland China stock markets are individual traders. You have to be aware that many of these traders tend to be highly leveraged, one analyst told CNN Business last week, meaning they could bail out quickly if things start to go south—something that happened in 2015. Another analyst said China’s stocks are now the most “overbought” they’ve been since 2014. Also, the two countries are still flexing their trade muscles, something that could depress major Chinese stocks if tensions get worse. Stocks of Chinese companies that are popular here with U.S. investors, like Alibaba Group Holding Ltd (NYSE:BABA) and Baidu Inc (NASDAQ:BIDU) could be among those that suffer in any trade war flare-up. 

Don’t Forget the Data: There’s plenty to keep investors busy besides earnings this week. Tomorrow brings the June Consumer Price Index (CPI), which analysts expect to rise 0.5% following a retreat in May, according to research firm Briefing.com. That sounds high, but probably reflects fluctuating energy and food prices. The core CPI is expected to go up just 0.1%. 

Other data to consider looking out for as the week continues include University of Michigan July sentiment, June industrial production, the July homebuilders index, and, perhaps most importantly, June retail sales due Thursday morning. We’ll preview retail sales tomorrow.

TD Ameritrade® commentary for educational purposes only. Member SIPC.

Photo by Etienne Martin on Unsplash