Banks Kickoff Earnings: Interest Income Driving Headline Profits, Credit Losses Not Yet Substantial 

1.Consumer Sentiment Stumbles. The University of Michigan’s October Sentiment Index fell -7.5% from the prior month, a larger fall than expected. This is the preliminary report, and sentiment is still above 2022 levels, but consumer sentiment tends to be a leading indicator for the demand elasticity of consumer purchasing. 

The sentiment report capped a week of stable inflation and wage data, accompanied by dovish Fed comments.  

Chart 1: Falling Wage Inflation and CPI¹ 

A tight labor market, supported by low weekly initial unemployment claims, plus falling inflation data and higher long-term treasury yields that support the Fed’s ongoing restrictive policy, is a balanced mix that should allow slow growth to proceed. 

On Friday, gold reacted to the lower consumer sentiment by rising +3.2%. The U.S. dollar also strengthened during the back-half of last week. Companies report Q3 earnings over the next few weeks.  

2. Social Security Benefits Increase, Reflecting Higher Cost of Living. Social Security benefits will increase +3.2% next year, a much smaller increase than the 8.7% increase for retirees in 2023, but still above the historic average.² This much smaller increase reflects slowing inflation and steady economic growth, compared to last year. 

The cost-of-living adjustment (COLA) goes into effect on January 1. Retirees will also be impacted by higher Medicare premiums and deductibles in 2024. Medicare and Medicaid memberships represent one-third of UnitedHealth’s (UNH) health insurance business. UnitedHealth reported better-than-expected profit growth and raised its 2023 forecast, but higher costs are weighing on its longer-term outlook.  

3. Earnings Season Lookout: Winding Down Inventories, Testing Price Elasticity and Housing Cost Pressure. JP Morgan (JPM) reported a large Q3 earnings beat, citing robust economic growth and higher profits from higher interest rates. Revenue increased +21% y/y, driven by +30% y/y net interest income and lower-than-expected credit provisions. 

Higher rates on loans are outpacing higher payouts on deposits, but CEOs are realizing that dynamic may likely be unsustainable if the economy slows and consumer loans experience more defaults. Jamie Dimon, CEO of JP Morgan, acknowledged the bank is “over earning” on net interest income and “below normal” credit costs will normalize over time. 

Credit card spending increased at JP Morgan, Citigroup (C) and PNC (PNC), while mortgage originations are down -9% y/y at JP Morgan and -17% y/y at Citigroup. 

It is now more expensive to own than to rent a home. Across the U.S., August monthly rent was cheaper than the average mortgage payment – the biggest gap nationally, with data going back to 2015.³ The cost-benefit analysis for potential homeowners now favors renting until affordability returns. 

Chart 2: National Average Mortgage Costs Are Above Rental Costs⁴ 

Corporations are searching for ways to cut costs, targeting lower inventories and store closures. Meanwhile price action for more elastic products are proving uncompetitive, as noted by Walgreen’s (WBA). Sell-side analysts currently expect S&P 500 third quarter earnings growth to be +1.3% y/y, better than -2.8% y/y in the second quarter. 

4. Yield Curve Shifts Lower Amid International Conflict. U.S. bond prices increased last week, despite Thursday’s CPI data (3.7% y/y vs. 3.6% estimated) as turmoil in the Middle East caused a flight to quality; the 2-year treasury yield fell 4 bps, while the 10- and 30-year maturities saw yields fall 18 bps. 

The 2/10-year inversion widened back to -43 bps but remains much tighter than the summer 2/10-year inversion that peaked at -106 bps in July. The yield curve is flattening. Market participants have priced in just a 33% chance for a rate hike by end of year, despite Fed minutes indicating one more is likely this year. High yield spreads stayed relatively flat this week at +455 bps. Muni yields continued to follow Treasuries, decreasing 7-12 bps across the curve. 

5. The Week Ahead. 

Earnings – Tuesday: BAC, JNJ, GS, JBHT; Wednesday: MS, UAL, LRCX, TSLA, NFLX; Thursday: AAL, UNP; Friday: SLB, AXP.  

Economics – Tuesday: Retail Sales (September), Industrial and Manufacturing Production (September), NAHB Housing Market Index (October); Wednesday: Building Permits and Housing Starts (September); Thursday: Philadelphia Fed Index (October). 

Stephanie Link: CNBC TV Schedule 

Return for Selected Indices⁵ 

Sources

1. FactSet (chart). As of October 14, 2023.
2. Yahoo! Finance. As of October 12, 2023.
3. Bloomberg. As of October 13, 2023.
4. Bloomberg, Zillow. As of October 13, 2023.
5. Bloomberg. As of October 9, 2023.

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