The market has started 2018 much the way it did 2017, with three straight positive sessions. The Dow Jones Industrial Average has cleared 25,000. Any worries that the New Year would lead to heightened volatility or profit-taking so far have been shrugged off.
But the year’s first test begins next week, as two major U.S. financial companies report fourth-quarter earnings. The sector as a whole had a strong 2017 and an impressive finish to the year. Most big banks are at post-crisis if not all-time highs, as is the Financial Select Sector SPDR Fund (NYSEARCA:XLF).
Those reports could set the tone for earnings season later this month, with results likely to echo across the market. Earlier in the week, one of the S&P 500’s biggest laggards will try and reset its own narrative with first-quarter fiscal 2018 results. The heart of earnings season is still a couple of weeks away, but there’s plenty to keep a close eye on next week.
Earnings Reports to Watch: Acuity Brands (AYI)
It would seem like Acuity Brands, Inc. (NYSE:AYI) should be performing well, particularly in this bull market. The company manufactures lighting equipment, the majority of which uses LED and OLED technology. Given increasing adoption of LEDs, in particular — spurred in part by government mandates — one would think that Acuity Brands would be growing, and AYI stock would be gaining.
But in fact, AYI stock is struggling, declining by roughly one-third just since the middle of 2016 and it is moving in the opposite direction of the broad markets. A series of earnings misses and concerns about competition from Chinese manufacturers have undercut the company’s growth story with both investors and the Street.
Ahead of its fiscal Q1 release on Tuesday morning, AYI might look tempting. For all the pessimism surrounding the stock, revenue did grow 6.5% in fiscal 2017, with adjusted EPS increasing 8%. AYI trades right at 20x Street consensus EPS for FY18. Tax reform should benefit Acuity earnings, and corporate demand should help 2018 results.
But AYI doesn’t look quite like a solid trade ahead of the report. The company’s track record in meeting analyst expectations is mixed. Guidance for FY18 issued with Q4 results was tepid. Acuity cited labor shortages in the construction industry and likely weak demand through the first half of calendar 2018.
There is potential for a turnaround here, but with AYI already up 10%+ from last month’s lows and the good news not likely to come until later this year, the risk/reward simply doesn’t look attractive enough. The market’s concerns about the stock — short interest is nearly 14% — simply aren’t going to be answered by the results from a single quarter.
Earnings Reports to Watch: JPMorgan Chase (JPM)
JPMorgan Chase & Co. (NYSE:JPM) is one of the two major financials to report next week, on Friday morning. And recent history suggests two likely outcomes.
First, JPM is likely to come in ahead of Street expectations. The company has beat on the top and bottom lines for eight consecutive quarters. And, second, investors are likely to shrug off any beat.
Indeed, while JPM stock has been a solid performer, gaining 25% over the past year and 56% since the U.S. presidential election, its post-earnings moves have been rather meager. In fact, the stock’s biggest move of 2017 came not after one of its four earnings beats, but after incoming Fed chairman Jay Powell testified that financial sector regulation was “tough enough,” sending the entire sector higher.
I’d expect that pattern to again play out on Friday. JPMorgan Chase continues to look like the best-capitalized of the big banks, and its on-the-ground performance is impressive. But to some degree, both those attributes are priced in by a stock at an all-time high. And there simply isn’t going to be much, if anything, in the report relative to the yield curve, Fed moves and other factors to have a huge impact on the Street’s opinion.
JPM very well may have more upside in 2018, but investors expecting fireworks in Friday’s trading are likely to be disappointed.
Earnings Reports to Watch: Wells Fargo (WFC)
On the other hand, Wells Fargo & Co (NYSE:WFC) has managed to reach an all-time high of its own despite disappointing at earnings time. WFC has missed consensus revenue estimates for four consecutive quarters, as the brand damage done by its ‘fake account’ scandal continues to be larger than the Street projects.
Yet investors have shrugged off that bad news — for the most part. WFC does trade at an all-time high. But over the last year, it has lagged not only JPM, but fellow big banks Bank of America Corp (NYSE:BAC) and Citigroup Inc (NYSE:C), among others. And the stock looks reasonably dangerous heading into its own Q4 report, also released on Friday morning.
For one, WFC has soared of late, gaining 15% just since late November. Financials have risen as a whole, and WFC’s gains have outpaced those of other big banks. But those peers don’t have a scandal hanging over their heads.
Wells Fargo will still likely face billions of dollars in fines for not only the fake accounts, but issues with auto insurance refunds and small business banking. Lending activity was notably weak in Q3, which implies some level of ongoing damage to the bank’s reputation with customers. And there’s the obvious risk that there might yet be more problems that so far haven’t been discovered … or disclosed.
With WFC in line with JPM from a valuation standpoint, the risks don’t seem to match the rewards. The banking sector at this point is for value investors, not growth investors. And finding value requires protecting downside. WFC simply doesn’t offer that protection, particularly given its valuation and recent track record.
Hilary Kramer is the editor of GameChangers, Breakout Stocks, High Octane Trader, Absolute Capital Return and Value Authority. She is an accomplished investment specialist and market strategist with more than 25 years of experience in portfolio management, equity research, trading, and risk management. She has extensive expertise in global financial management, asset allocation, investment banking and private equity ventures, and is regularly sought after to provide her analysis on Bloomberg, CNBC, Fox Business Network and other media.