Is It Time To Buy Beaten Down Bank Stocks?

By Bryan Rich 

July 19, 2016, 2:15pm EST

We’ve talked about the reasons markets and economies are set-up nicely for positive surprises. Surprises create changes in outlooks.  And “change” is the primary catalyst that moves/reprices markets.

On that note, today we want to focus on earnings.

Last earnings season, 72% of the companies in the S&P 500 beat expectations.  Still, companies dialed down expectations coming into the second quarter.  Of course, then Wall Street lowers its bar.  And companies are now beating estimate again.

Like it or not, that’s how Wall Street works and has always worked.  FACTSET says on average (the five-year average) 67% of companies in the S&P 500 beat their analyst expectations.  And they beat by an average of 4%.

That begs the question:  Why aren’t analysts adjusting up their expectations on average, by 4%, given the history?  As we know, better than expected earnings are fuel for stocks.

Now, in the current earnings cycle, over the past week, we’ve had 35 companies report in the S&P 500, as of the close of last week. And the positive surprises are, again, running close to 70%.

The biggest surprise has been in bank earnings.  We’ve heard all of the warnings over the flattening yield curve. Historically, a flattening yield curve, is a drag on bank earnings (banks earn less on the spread between what they pay on deposits or borrowing and what they earn by lending).

But as we know, overtime, banks have become very different animals. In the 80s this spread or the “net interest margin” was king.  For big banks, interest income was about 90% on their income.  In the recent era, it’s about 75%.  These days, what’s tipping the balance is non-interest income.  And the banks seem to be finding ways to improve that number, whether it’s through costs cuts, or better trading profits.

Overall, the health of the banks is as good as it’s been in a long time. Last quarter loan balances grew at the fastest 12-month rate since 2008, the share of unprofitable banks fell to an 18-year low, and the number of ‘problem banks’ continued to decline.

Still, the S&P 500 bank index is down 5% year-to-date, underperforming the broader index by more than 10 percentage points.  Financials are the only sector in the S&P 500 in the red year-to-date.  If you think the worst blow to global economic sentiment might be behind us, the banks should offer some of the best upside in stocks.

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