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Curatia Analysis for Thu, Jul 11

Q2 2019 Earnings Preview: Second Verse Same as the First for Scuffling Banks, Asset Managers

Following predictions of a “soul destroying” Q1, large-cap banks defied early 2019 analyst pessimism in registering a 23% YTD rally.

They’ll need to fight uphill to repeat that feat in Q2 against a backdrop of projected rate cuts, analyst downgrades, and the Deutsche Bank Effect even as markets touch all-time highs.

Macro Headwinds

Q2 earnings season in the financial world kicks off next week with Citigroup reporting Monday. JPMorgan, Goldman, and Wells Fargo post results Tuesday, followed by BAML Wednesday, Morgan Stanley Thursday, and BlackRock Friday. Danske Bank and Nordea get a jump on earnings season in Europe Thursday before things begin in earnest next week.

After seeing profit levels jump 8.7% YoY in Q1, banks are in for a much grimmer Q2 if prognosticators are to be believed. Across sectors, 82% of companies revising earnings estimates have slashed them — the second-highest proportion in nearly four years.

With stocks collectively touching all-time highs as traders roll around in the cotton-candy cloud of anticipated rate cuts, analysts are concerned investors have overlooked earnings’ first forecast contraction (-2.5%) since 2016.

Rate cuts buoy markets generally but create headwinds for banks by paring interest income. Morgan Stanley downgraded large-cap bank stocks Monday, citing prospective rate cuts, peaking US job growth, and limited room to cut expenses. In mid-June, State Street predicted an 8% decline in interest income QoQ in Q2.

Deutsche Bank has also weighed on the financial sector, although its pledge to exit equity sales and trading and lay off a small town by 2022 may offer a silver lining by allowing other banks to gain market share.

Collectively, those macro headwinds have banks trading at just 9.4x estimated 2020 earnings — an 11% discount to their average forward-year multiple over the last five years.

Worrisome Trading Signals

Banks themselves have also signaled they’re bracing for a third consecutive quarter of trading revenue declines. JPMorgan, Citigroup, and BAML have all indicated trading revenue could fall 5% YoY in Q2.

Banks expect those struggles to continue amid investor reluctance to place big bets on a market many see as cresting. Average daily stock trading volumes slipped in Q2 versus Q1, and average daily options volume had fallen 8% YoY through May.

With investors increasingly watching from the sidelines, volatility has cratered 39% YTD — a dynamic that has hindered brokerages and exchange operators despite market buoyancy.

While the S&P 500 (+7.2%) scored its best June performance since 1955, Charles Schwab (-2.4%) and TD Ameritrade (+0.5%) scuffled. Cboe (-1.9%), CME (+2.8%), and ICE (+5.5%) also lagged broader markets.

Glimmers of Hope

That crucible of concerns is encouraging financial firms to pursue adaptation with renewed vigor in hopes of exceling estimates — and competitors.

While Citigroup projected Q2 investment banking revenue would be down in the mid-teens YoY, it said results would “‘likely [be] better than what we’re seeing in the industry overall’” — a sign the bank could snatch market share following a significant restructuring that allocated more authority to execs with backgrounds in fixed income.

With faltering European markets offering no succor, firms have turned to Asian markets in hopes of jump-starting growth. Industry bellwether Jefferies reported a 29% YoY gain in trading revenue as it aggressively expands its trading footprint into Asia. Morgan Stanley is likewise looking to Asia as the “main growth opportunity for its global wealth business.”

Firms have also doubled down on initiatives aimed at “serving clients’ data and advisory needs through technology offerings.” The goal of such efforts is to wean financial firms off of business lines overly sensitive to fluctuations in trading volumes and volatility.

Ironically, the firms that succeed in pivoting away from market-sensitive operations may be those that generate growth capital by outperforming their competitors in exactly those areas today.

Administrative note: There will be no Curatia Analysis tomorrow as we continue working on product enhancements. We’ll be back on Monday.