Big banks to set second-quarter earnings tune
Alcoa will kick off earnings, but J.P. Morgan, Wells Fargo to set tempo
By William L. Watts, MarketWatch
NEW YORK (MarketWatch) — Earnings season unofficially starts after Monday’s closing bell with Alcoa Inc., but it is the results from the big beasts of the banking world, starting with J.P. Morgan Chase & Co. on Friday, that will likely set the tune in coming weeks.
In past quarters, corporate earnings have often played second fiddle to broader macroeconomic concerns, particularly the Federal Reserve’s aggressive bond-buying plan, the centerpiece of its quantitative easing strategy.
With investors convinced, however, that the Fed is set to begin scaling back asset purchaseswithin months, corporate fundamentals will play an increasingly important role in setting the tone, strategists said.
And financial firms are a particularly important bellwether, given that the sector’s stock performance has long been closely correlated to the overall performance of the market, said Adam Sarhan, chief executive of Sarhan Capital.
“It’s not just the numbers, but how the market reacts to the numbers,” he said. “Reaction to the earnings is a subtle but yet a very important signal for how the market will react to the rest of earnings season.”
The S&P 500 (SNC:SPX) and the Dow Jones Industrial Average (DJI:DJIA) each rose about 1.5% this week, following up on the S&P’s 2.4% advance and the Dow’s 2.3% gain in the second quarter. The Nasdaq Composite (NASDAQ:COMP) gained 2.2%.
Alcoa (NYSE:AA) , the world’s largest aluminum producer, is expected to report earnings of six cents a share on revenue of $5.85 billion, according to a FactSet survey of Wall Street analysts.
J.P. Morgan (NYSE:JPM) , reporting ahead of Friday’s opening bell, is expected to deliver a profit of $1.42 a share on revenue of $24.9 billion.
Wells Fargo & Co. (NYSE:WFC) , also slated to report Friday, is forecast to report earnings of 92 cents a share on revenues of $21.17 billion.Read more on what investors are expecting from bank earnings.
Equities remain off the nominal highs set in late May before Federal Reserve Chairman Ben Bernanke offered the first, clear indication the central bank was prepared to begin taking its foot off the accelerator as soon as this year.
In a note published earlier this week, Morgan Stanley equity strategist Adam Parker laid out the case for why the coming earnings season will be “more critical than normal.”
“Because unlike earlier this year, we now think ‘good is good and bad is bad,’ meaning the fundamentals will be in focus,” he said.
That is a reference to the previous tendency of risk-sensitive assets, such as equities, to sell off on stronger economic data because it tended to reinforce expectations that the Fed would move to slow the stimulus flow. Conversely, risky assets would often rally on lackluster data.
U.S. equities posted strong gains Friday, albeit in a choppy trading session, after a stronger-than-expected rise in June nonfarm payrolls further stoked expectations the Fed will begin to taper, perhaps as early as September.
Some big banks, including J.P. Morgan and Bank of America Corp. (NYSE:BAC) are expected to report a significant revenue boost from higher long-term bond yields and a steeper yield curve, noted analysts at Citibank in a note this week. Yields have risen significantly as the Fed has signaled it could begin to slow the pace of bond purchases in coming months.
Meanwhile, investors in the coming week will sift through mostly second-tier economic data until Friday, with the release of June wholesale inflation data and the University of Michigan’s latest consumer sentiment data. Weekly jobless claims on Thursday will, of course, be closely watched for further clues to the employment picture.
The economic highlight of the week, however, will likely be a speech by Bernanke in Boston on Wednesday, the same day the Fed releases the minutes of the June 18-19 meeting of the rate-setting Federal Open Market Committee.
For earnings, the bar has been set low.
Heading into reporting season, 87 companies in the S&P 500 have issued negative guidance on earnings per share while 21 have issued positive guidance, according to John Butters, senior earnings analyst at FactSet. Of the 23 companies that have already reported second-quarter earnings, 70% have beat the mean earnings estimate, while 48% have topped the mean revenue estimate, he said.
Strategists note that firms have made a habit of lowering guidance into earnings season over the last several quarters.
Moreover, investors have tended to punish companies that offer below-consensus expectations, while rewarding those that exceed estimates, noted Parker at Morgan Stanley.
The market reaction to corporate guidance in the first two weeks of earnings season will be a key focal point, Parker said.
“Our current guess is that negative guidance will be punished more during [earnings] season this time than it was in prior quarters” as the Fed’s expected tapering leaves investors to focus more on corporate fundamentals.
Such a shift is logical given that the goal of the Fed’s quantitative-easing program was to provide the economy with sufficient momentum to stand on its own, said Sarhan at Sarhan Capital. It’s worth remembering, he added, that equities tumbled sharply when the Fed’s initial round of quantitative easing came to an end and fell hard again when the second round — QE2 — came to an end in mid-2011.
“If we don’t see strong earnings consistency in the near future and the Fed starts to taper, that’s a recipe for disaster,” he said.