Garnet Capital Advisors Blog

Major banks are expected to experience strong earnings growth in the third quarter – growth significantly over that of the entire S&P 500, in fact. But a number of issues, including slow loan growth, are likely to hold back bank stock performance despite the forecast strong earnings.

On October 26, big U.S. banks will begin their quarterly reporting periods. They are widely forecast to report third-quarter earnings growth higher than the broader market, at a forecast 26.5% for the S&P banks versus an expected 21.4% for the entire S&P 500.

Despite expected strong earnings growth in the third quarter, bank stocks may not benefit.

Higher Than Average Earnings Growth May Not Move Bank Stocks…

As a general rule, higher than average earnings will propel above-average stock returns for the companies enjoying them. But that might not be the case this time. Investors have been casting a lackluster eye on banks’ performance throughout 2018.

Bank stocks are underperforming in the broader market. The S&P 500 Banks Index (SPXBK) has turned in a 3.7% drop in 2018 so far, versus the 3.6% rise for the S&P 500 (SPX) over the same period. 

…Because of Potential Challenges

Why? Because despite the good news on earnings, banks face a number of risks in their ongoing business, and few to no positive news events. 

Loan growth is slowing, deposit costs are rising due to climbing interest rates, and credit quality is eroding. Banks had been very hopeful that President Trump’s cuts in corporate taxes would spur business loan activity, but they have not witnessed the anticipated activity in the ensuing months.

In addition, the United States Federal Reserve has hiked interest rates eight times since the final months of 2015. More importantly, perhaps, it has signaled that several rate hikes are likely for 2019 as well. As a result, banks will be under pressure to increase the interest rates customers receive on their deposits, and bank costs are likely to increase.

Slowing loan growth and rising interest rates are challenges for banks.

In terms of credit, banks are currently in a sweet spot, with comparatively low cost of funds, though observers worry that costs have nowhere to go but up. The economy is currently very strong, but that could change. If it does, rising funding costs could further impact banks’ performance.

Additionally, banks face a host of potentially challenging economic conditions, from possible slowing economic growth to United States trade sanctions on China.

Finally, banks are also not benefiting from rising yields in U.S. Treasury instruments. A yield curve that is steepening (seeing a wider gap between short- and long-term bonds) is often good news for bank stocks, because steepening yield curves can increase net interest income for banks. It appears, though, that stock investors are looking out past the steepening curve — and not appreciating what they see. What they see may not be enough to drive bank stocks down, but it’s unlikely to propel them up, either.

How a Whole Loan Broker Helps Banks Weather Business Conditions

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