Will financial institution shares’ wild rally proceed? Listed below are the numbers to look at in subsequent week’s earnings outcomes

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The fate of this year’s wild bank equity rally may depend on whether major US banks manage to show signs of increased credit activity in their third quarter results starting next week.

With the prospect that rising interest rates will help banks widen their net interest margin – the profits they make from lending – bank stocks have overtaken the broader market year-round.

Source: fact set

As of Wednesday’s close of trading, JPMorgan Chase JPM is + 0.08% year-to-date, up 33% while Bank of America BAC, + 0.50%, is up 46%, Goldman Sachs GS, + 0.56% is up 47 % up, Morgan Stanley MS, + 1.26% is up nearly 45%, Wells Fargo & Co. WFC, + 0.50% has recovered nearly 59%, and Citigroup C, + 0.22% has a more moderate Increase of almost 18% posted. In contrast, the S&P 500 is up 16.2% this year.

However, signs of a rate hike remain patchy as the Fed continues to signal a tightening cycle at some point, while economists predict it could happen sooner rather than later. But as the economy rebounded year-on-year, banks were relative favorites on Wall Street as they rebounded from their 2020 losses during the COVID lockdown. However, investor optimism about banking and other stocks has been under scrutiny recently, with large sell-offs occurring in a few sessions.

Wall Street targets for banks

With megabank earnings now available, as shown in the graph above, investors should carefully examine earnings per share as banks moved down the credit risk reserves they built up in the early days of the COVID pandemic as the economy has improved. This practice allows banks to operate within regulatory limits on credit risk reserves while exceeding their quarterly EPS estimates.

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“Last year they booked a large number for credit risk reserves and this year they expect the economy to skyrocket. “This in turn is reflected in a large EPS figure.

Analysts and investors seem to be aware of this development, however, as the share prices of the major banks did not rise significantly after the results for the second quarter were released three months ago.

A major challenge for banks is whether or not they have seen an increase in lending activity as they lose market share to non-bank lenders while consumers avoid additional debt outside of the buoyant car buying activity.

“So far this year banks have not increased their lending to businesses or even the home mortgage market,” Bove said. “Their holdings in these two loan portfolios, which account for 44.4% of their total loans, are declining in both cases. In the consumer credit sector, history is more positive due to the surge in auto loans. However, if you look at all portfolios, bank loans are lower today than they were a year ago. “

On the positive side, however, banks that are more focused on capital markets underwriting and advisory services on mergers and acquisitions remain in a stronger position against the backdrop of record-breaking deals. That trend is helping banks like JPMorgan Chase, Morgan Stanley, and Goldman Sachs as the dominant names in these arenas, with Bank of America’s Merrill Lynch unit also exposed, Bove said.

See: Global M&A activity hits $ 3.6 trillion in just eight months, beating the 2020 full year record and previous record

For his part, Edward Jones has three bank stocks on his focus list: Bank of America, JP Morgan Chase and the regional bank Truist TFC, + 0.51%.

Edward Jones’ banking analyst James P. Shanahan said BAC was more attractive because it was well positioned to benefit from rising interest rates. JPMorgan Chase is known for its diversification, including strong contributions from market related activities, while Truist offers value compared to its peers.

“We believe that the biggest catalyst for banks is credit growth, particularly business credit growth, followed by rising interest rates,” Shanahan said. “One of the biggest challenges for the banks is that they had borrowing costs due to the pandemic and have settled them so that the reserves were not needed. When we got into the recovery later, the focus shifted to deposit growth and excess liquidity. “

As companies issue bonds instead of borrowing and consumers use stimulus money to pay off credit cards, banks are facing downward pressure on credit growth.

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“Banks would do better if they could convert low-cost deposits they took out during the pandemic into higher-interest loans,” Shanahan said.

However, large companies may be nervous about borrowing and investing in plant equipment because of uncertainty about the Delta option, concerns about rising interest rates, and possible tax law changes by Congress.

Households remain cautious as they face high unemployment compared to pre-2020, but it is possible that consumers are using their credit capacity on credit cards and businesses will borrow at a healthier pace in late 2021 or next year.

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Of the six megabanks, analysts continue to assign the most buy ratings to Goldman Sachs and Morgan Stanley with 17 buy ratings each, followed by 16 buy ratings for Citi, 15 buy ratings for JP Morgan Chase and 11 for Wells Fargo, which is plagued by most of the regulatory problems of the big banks.

Citigroup stands out as the cheapest bank stock, trading at 0.8 times its book value, according to FactSet Data, the lowest multiple among the six megabanks. Its price / earnings ratio of 9.7 is also the lowest, followed by a 9.8 for Goldman Sachs at close of trading on Monday. Bank of America’s P / E ratio of 15.3 is the highest in the group.

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Oppenheimer analyst Chris Kotowski said the company’s recommended list for banks includes Bank of America, Citigroup, Goldman Sachs, Jefferies JEF, + 1.55% and US Bancorp USB, + 0.73%.

The major banks covered by Oppenheimer returned an average of 2.4% versus 1.3% for the S&P 500, he said. Looking back either 10 years, 5 years, or 3 years, banks have increased their dividends about three times as fast as the S&P.

Kotowksi raised Oppenheimer’s 2022 profit estimates for banks by around 1% to 2% on September 29, as credit quality was expected to surprise on the uptrend.

“The most important thing in this and upcoming earnings reports is the resumption of net interest income growth,” he said. “While it probably won’t happen sensibly this quarter, it should be another stall
Quarter after net interest income bottomed out in Q3 20. “

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