First-quarter earnings season kicked off with the latest reports from the big banks. So far, the bank earnings and revenue “headline numbers” have been excellent and mostly above expectations. However, the market reaction has been much more muted.
As you can see in the chart below, the SPDR Bank ETF (NYSEARCA:KBE) is still stuck at support near $47 per share. Often, we can attribute the lack of positive movement following an earnings surprise to a “buy the rumor, sell the news” situation, but that seems like a stretch considering that the last time investors pushed bank stocks higher was in January.
SPDR Bank ETF (KBE) — Chart source: TradingView
Earnings for this quarter are expected to grow 16% over the same quarter last year. That is a faster growth rate than we have seen in seven years. So far, the financial sector is living up to the hype if you only look at the bottom-line numbers, but the forward outlook is what seems to be tripping up investors.
Last week’s earnings report from Morgan Stanley (NYSE:MS) is representative of what we have been seeing across the sector. The company posted 40% profit growth, and revenue hit an all-time high, which crushed analysts’ estimates. However, as you can see in the next chart, the reaction in the stock was extremely mild.
Morgan Stanley (MS) — Chart source: TradingView
Why Aren’t Bank Earnings Moving Stocks?
There are likely two problems creating issues for the banking sector, which may wind up hurting the market as well.
First, the banks seem to be talking out of both sides of their mouths. While Morgan Stanley’s CEO is touting its results, the bank’s own analysts are predicting that the U.S. markets are at a cyclical top. Who should investors believe? Analysts claim that fiscal stimulus (tax cuts) and economic growth are already “in the price,” which indicates increased risk to the downside. MS isn’t the only bank to be saying one thing to their shareholders while delivering a more negative outlook to their research clients lately.
Second, despite excellent earnings growth, investors are concerned about the fact that the yield curve is getting flatter. A completely flat or inverted yield curve is often a precursor to a negative downturn in the market.
Geopolitical concerns could be part of the problem, but it doesn’t seem to fully explain why the yield curve is as flat as it was before the tax cuts. Regardless of the cause, profit growth is likely to slow if the yield curve continues its present trend.
To be fair, this is not the first time since 2008 that bank analysts have called a top in the market, and it probably won’t be the last. By definition, we are getting closer to the end of the current bull market, but that could still mean that there are years to go before a serious decline. However, investors will still act jumpy if the outlook this earnings season continues to be less rosy than current performance.
The Bottom Line for Bank Stocks
In our opinion, there does seem to be mounting evidence that the current channel of the major indices could persist for longer than normal, but a true bear market seems unlikely.
In the past, even when the earnings outlook dipped, positive earnings growth prevented the market from a serious decline. What seems more likely is that investors are worried that the market is priced for the best-case, short-term scenario and that current levels of volatility will be extended.
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