Better-Than-Expected Bank Earnings Fail to Inspire Rally

Friday, October 16, 2020 4:28 PM | Bobby Raines

Oct. 16, 2020 - Stocks didn't go very far this week, even as earnings season kicked off with better-than-expected results from most of the country's biggest banks.

On the plus side, the market seems to have taken the fact that a new stimulus bill isn't coming before the election pretty well. Talks between Treasury Secretary Mnuchin and House Speaker Nancy Pelosi are reportedly still happening, but in the Senate, Majority Leader Mitch McConnell seems to be planning to bring a $500 billion bill to the floor without considering the much larger package being worked on by Mnuchin and Pelosi.

It's hard to imagine President Trump and the Senate deciding they need a new economic stimulus package if former Vice President Biden wins the election, which seems to be the most likely outcome based on recent polling. This probably means a new stimulus bill wouldn't be signed until late January, with the new money not reaching the economy until February and March.

Even then, the future path of fiscal policy hinges not just on the presidential race, but also on Senate races. A Biden administration would likely be hamstrung to some degree by a Republican-held Senate, where it seems a pivot back to fiscal conservatism is in the works, particularly if Trump loses as expected.

The will-they-or-won't-they stimulus dance is likely to continue until Congress adjourns for the election, even though very few people expect anything to get passed at this point, although the effect on markets will probably remain muted unless it starts to look like something might actually happen.

Meanwhile, earnings season, which began this week, is most likely to move individual stocks around, although thus far, reactions have been muted.

The calendar was heavy on banks this week, and most (Wells Fargo (WFC) continues to struggle.) did better than expected.

Big earnings beats from big companies should push stocks in that sector, and maybe across the market higher, but the Financial Sector ETF actually lost ground this week, so what gives?

Banks, particularly the big ones, live at the intersection of accounting as science and accounting as art. These institutions have massive balance sheets with trillions of dollars in assets, mostly offset by trillions of dollars in liabilities. Most of the time, bank earnings are largely driven by changes in the values to these two buckets, which contain a lot of things that are hard to put a price on.

This is not to say that there's anything fishy going on with the banks, just that bank earnings are lot more complicated than the traditional model of earnings equals revenue minus expenses.

It turns out that banks largely did well in two places. Retail banks, like JP Morgan (JPM) and Citigroup (C) exceeded expectations largely because they set aside less money than expected to cover bad loans. This is a positive, but on the order of "less bad than expected" as opposed to actually "better than expected".

Investment banks, like Goldman Sachs (GS) and Morgan Stanley (MS) did well in asset management and trading. This makes sense as financial markets were relatively stable and stocks prices rose during the quarter. Neither bank provided a particularly rosy forecast for the economy, which as we've mentioned before, is what giant banks really need to see significant increases in earnings.

Next week's calendar is a lot more full, with reports from big companies in a lot of different industries. This is where we'll get a better feel for which parts of the economy are doing better than others, and in cases where companies outperform, or underperform their industries, see the value of good management.

All told this week, the S&P 500 gained 0.19%, while the Nasdaq added 0.79% and the Dow Jones Industrial Average rose 0.07%.

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