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Worried about the economy? Watch bank earnings

1. Bank earnings: As the global economic outlook darkens, American banks have an unenviable...

Posted: Jan 14, 2019 1:57 PM
Updated: Jan 14, 2019 1:58 PM

1. Bank earnings: As the global economic outlook darkens, American banks have an unenviable job: Convincing a jittery public that the US economy remains strong and can keep growing.

Concerns about whether the economy can continue expanding have gripped investors in recent weeks, and spurred erratic swings in global markets. Such fears threaten to weigh on banks this year, because their performance is closely tied to the health of the economy.

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Bank profits suffer when the economy stumbles and businesses are scared to borrow. They become especially vulnerable when a recession hits and some customers aren't able to pay back loans.

Whether a recession looms will be a key topic of discussion this week, when JPMorgan Chase (JPM), Citigroup (C), Bank of America (BAC), Wells Fargo (WFC), Goldman Sachs (GS) and Morgan Stanley (MS) report earnings from the final three months of 2018. (Update: Citi reported earnings that topped forecasts, but its revenues were lower than what Wall Street was expecting.)

Wall Street executives almost certainly will be asked to prognosticate about the state of the economy — and what it could mean for businesses if growth falters after a lengthy run.

"We're in a mature stage of economic growth in the US," said Fred Cannon, director of research at Keefe, Bruyette & Woods. "It's hard to find a real expansion area [for banks] right now."

Last year, bank stocks diverged from the actual business performance.

Banks brought in record profits, according to data from the Federal Deposit Insurance Corporation. In the third quarter of 2018, FDIC-insured banks reported $62 billion in profit, an all-time high and up nearly 30% compared to the previous year. Both President Donald Trump's corporate tax cuts and the buzzing economy played a role.

But bank shares sagged, trailing the market amid apprehension about what could be coming down the pike. The financial sector (XLF) fell almost 15% in 2018. Comparatively, the Dow fell 5.6%, and the S&P 500 was down 6.2%. JPMorgan Chase, a top performer, dropped about 9% last year.

One reason for worry has been the shrinking difference between short-term and long-term bond yields. Before almost every recent recession, the so-called yield curve has inverted, meaning short-term rates are higher than long-term ones. That indicates investors are not enthusiastic about long-term growth.

The flattening yield curve affects the income banks collect from lending, since banks pay interest on short-term rates and lend at long-term rates. They make money off the difference.

When the banks report this week, Wall Street will likely pay close attention to consumer and business loans. Analysts predict solid loan growth for last quarter. But the segments will be keenly monitored as barometers of economic health.

Steve Biggar, an analyst at Argus Research, noted in a December memo that loan growth has been increasingly "sluggish" as interest rates have gone up, particularly for auto loans and home loans. Businesses have also cut back on borrowing, he said.

"We don't see another surge in commercial real estate that would encourage a lot of borrowing," Cannon said. "We see concerns about leveraged lending, which is an area that has grown rapidly." Businesses already have high debt loads, he added.

Last quarter's market volatility could also lead to questions about the pace of mergers and acquisitions and public offerings. Activity in the capital markets can dwindle when they're choppy, which causes banks to lose out on advisory fees. Banks' asset management divisions are also sensitive to market behavior.

While there's plenty of reason to scrutinize bank performance, market watchers aren't exactly worried about their survival.

Regulators have gone to great lengths since the 2008 financial crisis to ensure banks would be on solid footing in the event of another recession. They now mandate that banks maintain certain levels of liquid assets, which can be easily converted to cash to pay off obligations.

Since the financial crisis, liquid assets in the banking system have increased by more than $3 trillion, according to a November report from the Federal Reserve Board of Governors. Banks have also maintained solid capital levels to cushion any losses, and have largely tried to avoid the sort of risky lending that got them in trouble before.

"You don't see the excesses in lending on bank balance sheets that you saw going into the last recession," Cannon said.

2. Germany GDP: The German economy is in trouble, and economists are worried Germany may be entering a recession.

On Tuesday, Germany's statistics office will release its preliminary estimate of fourth-quarter GDP. Recent economic indicators suggest the number won't be pretty: German industrial production fell in November, the worst decline since 2009.

Economists typically consider a recession to begin after two consecutive quarters of shrinking economic output. The German economy shrunk 0.2% in the third quarter, so this would mark the second straight quarter of economic declines.

3. Shutdown slowdown: The stock market has mostly ignored the partial US government shutdown. The economic impact of a multi-week shutdown so far has been minimal, though it's certainly been painful for hundreds of thousands of government employees who aren't receiving their paychecks.

Yet the shutdown could start to drag down the economy if it continues. Credit rating agency Standard & Poor's said Friday that the US economy has already lost $3.6 billion and it will lop $1.2 billion off US GDP for every week the shutdown drags on.

Eventually, indirect economic harm could pile up: People will cancel vacations to parks and museums, and government contractors may have to lay off employees. If the shutdown continues, it could have a real impact on first-quarter GDP.

4. Airlines: Delta Air Lines (DAL) and United Continental Holdings (UAL) will report earnings on Tuesday.

Last Thursday, American Airlines (AAL) warned investors that the end of last year wasn't as good as it hoped. A week earlier, Delta cut its guidance on fourth-quarter fare revenue.

Lower-than-expected fuel prices have helped boost airline profits, but that wasn't enough to satisfy investors who are worried about a slowing global economy.

5. Detroit Auto Show: The United States' preeminent auto show will announce its 2019 Car, Truck and SUV of the Year award Monday.

Ford (F) and Volkswagen are also expected to formalize their widely expected partnership at the show on Tuesday. Ford has said it plans to spend $11 billion on new technologies and reshaping the focus of the company in the next three to five years. Finding someone to share those kinds of costs with will be crucial to its success.

6. Coming this week:

Monday — Citigroup earnings

Tuesday — JPMorgan, Wells Fargo, Delta and United earnings

Wednesday — Goldman Sachs, Bank of America and BlackRock (BLK) earnings

Thursday — American Express (AXP) and Netflix (NFLX) report earnings

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A hot week will transform into an even hotter weekend over northern California as high pressure stays in control of our weather. No rain is in the forecast, but it will cool a bit by late next week.
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