Why bank stocks could make a comeback

Investors are digesting a mixed bag of results from the US earlier today, with Lockheed Martin and Johnson and Johnson delivering some much needed good news, while the banks sold off after Bank of America and Goldman Sachs failed to deliver all of the goods with their Q2 earnings reports.

Interestingly, both Goldman and BOA reported Earnings per Share that were above market estimates, however, the detail in the reports spooked the market as Goldman reported trading revenue that was down 40%, while Bank of America’s interest income declined, even though interest rates have been rising in the US.

US banks: and the good news…

There were pockets of good news, for example, BOA saw revenues rise in all areas of its business, and Goldman’s equities business saw revenues increase by 8%, boosted by the global equity market rally over the second quarter. On balance, you could argue that Goldman Sachs has been the most disappointing bank in the sector, as its trading revenues fell significantly more than JP Morgan’s, Citi’s and Bank of America’s, this is reflected in the underperformance of its share price relative to its peers in recent weeks, as you can see in figure 1 below.

What is Goldman’s problem?

Goldman relies on its investment banking revenues a lot more than its peers as its retail lending business, Marcus, was only started in 2016. It has attempted to rebalance away from investment banking by boosting its investment management business, which saw revenues rise to $1.53 billion, an increase of 13%, however this is still not enough to make up for the slump in bond trading.

Goldman’s weakest performance in bond trading for 9 years’ was blamed on the challenging market environment and low levels of client activity. The worrying part for investors is that the bank didn’t offer any strategic plans for how to get itself out of its trading hole, neither did the bank dwell on its other businesses, including its new lending business and investment management where it saw revenues actually rise. If the market takes the view that Goldman isn’t in control of its own destiny then its share price may continue to lag its peers.

Why there’s hope for the banking sector, even Goldman…

Goldman’s share price gapped lower at the open, and Tuesday’s low so far has been $226.25, key trend support going back to May. If the stock doesn’t manage to close the gap and get above $228.50 today then we could see further weakness, the overall technical view will turn bearish if Goldman breaks below $226.50, the base of trend support since June. Below here opens the way for a move back to $210.

Bank of America hasn’t performed as badly, and is making attempts to retrace the gap at the market open, although it needs to get above $24 to be out of the danger zone. Finance is one of the weakest sectors in the Dow Jones and the S&P 500, and is down approx. 0.35% so far on Tuesday. Interestingly, JP Morgan has staged a decent recovery after initially falling at the open. This suggests that the market may be warming to JPM again after Friday’s sell off and weakness in bank shares could be used as a fresh buying opportunity. This suggests that banks, including Goldman, may not be out of favour for too long.

Although stocks have fallen this week, both the Dow and the S&P 500 made record highs in recent days and the sell off looks fairly tepid even if there are pockets of weakness in the US indices. Netflix is helping to support US markets, and is up nearly 10% at the open after it reported encouraging earnings for last quarter, which may bode well for the rest of the all-important tech sector who reports earnings in the coming weeks.

A weak dollar and low US yields, 10-year yields are testing the 200-day sma at 2.27%, are also supportive of US indices, and may be enough to overcome the disappointing political backdrop where businesses are still waiting for deregulation and tax cuts from the Trump administration. If our view is correct, then banking stocks and the indices should be able to overcome the disappointment with the Trump administration and continue to thrive. As a bonus, if banks do receive the financial deregulation and tax cuts that they crave down the line then the rally could be extended even further.

Chart 1:

Source: City Index and Bloomberg