Banks: A Bright Spot Amid Earnings Gloom

Expect third-quarter fireworks out of the financial sector

By Dan Burrows, InvestorPlace Feature Writer

The third-quarter earnings reporting period is just around the corner and, based on Wall Street’s forecasts, banks’ bottom lines won’t spoil the party for financial stocks.

The general market melt-up and return to risk-on trading in wake of European and U.S. central bank easing has goosed shares in banks and the financial sector in general. But the fact that sector profits are expected to be a bright spot amid a broader drop in third-quarter earnings isn’t hurting matters, either.

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The financial sector of the S&P 500 is up more than 8% for the quarter-to-date, beating the broader market by about 150 basis points. Indeed, only fellow risk-on bets like energy and tech stocks have put up better returns.

Drilling down to some of the biggest names in banking reveals even more astounding gains. The nation’s largest banks by assets, JPMorgan Chase (NYSE:JPM), and Bank of America (NYSE:BAC) are each up 14% for the quarter-to-date. JPMorgan has sloughed off the London Whale trading fiasco, while BofA has been quietly enjoying improvement in its business and its balance sheet.

More impressively, beaten-down investment banks have staged a remarkable run. Goldman Sachs (NYSE: GS) has gained more than 20% in the third quarter, and rival Morgan Stanley (NYSE:MS) is up 16%.

Meanwhile, outshining them all is Citigroup (NYSE:C). Yes, the original too-big-too-fail financial supermarket has seen its stock rise about 22% for the quarter-to-date.

True, some of the gains are just part of a risk-on rally lifting all boats — but future earnings actually support optimism on the part of investors.

As we saw when second-quarter results came out, the banking business and its balance sheets are indeed on the mend. More borrowers are paying their loans on time, meaning banks are setting aside less money for loan-losses, with attendant benefits to the bottom line. And although a dearth of deal activity and turbulent markets are still weighing on investment banking, a healthier housing market is boosting mortgages and refinancing activity.

So, even as third-quarter earnings for the S&P 500 are expected to decline for the first time in 11 straight quarters, financials are looking up.

Last time around, they posted decent year-over-year profit growth, but that was essentially only because of easy comparisons against last year’s second quarter. This time around, yes, there are a couple names with easy comparisons, but there also are a couple coming up against tough comparisons.

When all is said and done, we’ll call it a wash — one that doesn’t detract from the fact that financials, with expected profit growth of 9.9% according to data from FactSet, are going to be the best-performing sector this earnings season.

Indeed, if you exclude financial-sector earnings from the S&P 500, the index’s profits would decline by 5%, or almost twice as steep a drop as the 2.7% currently expected. After excluding unusual year-over-year comparisons (both easy and tough) for Goldman, Morgan Stanley, BofA and AIG (NYSE:AIG), the financial sector is forecast to produce not just broad-based earnings gains, but handsome growth to boot.

Heck, strip out those four firms, and financials are seen posting third-quarter earnings growth of 11.7%, FactSet says. That should help investors in financial stocks breathe easier.

Yes, the market has rallied in large part thanks to a risk-on party ignited by more monetary easing, and you’ve got to wonder how long that can last.

But at least the financials are rallying into some better bottom-line results — which is more than you can say of the market as a whole.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

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