Banks Kickoff Earnings Season

1.Bank Earnings Boost Sector Outperformance. A handful of companies in the financials sector reported earnings last week, and we are impressed with the group’s execution on higher interest revenues. Financials outperformed the broader market due to the better net interest income and net interest margins, supported by higher interest rates. As examples, net interest margin was +39% y/y for Wells Fargo (WFC) and +22% y/y for J.P. Morgan (JPM). Fixed income fees were also a highlight, while corporate and investment banking revenues were weak, as expected. While CEOs, including Jamie Dimon, did sound measured in their view of the economy, loan loss reserves are growing for most banks – expecting tightening conditions for businesses and households in 2023. More banks report this week, including BAC and GS.

Chart 1: Financials Outperform in First Week of Earnings Season¹ 

2. Inflation Acceleration. Inflation remained elevated in September, according to CPI and PPI data released last week. Core CPI was +6.7% y/y, the highest level since 1982. Rent of shelter, which represents 32% of CPI, was also up +6.7% y/y. PPI accelerated at its fastest monthly pace since June and is up +8.5% y/y.

Chart 2: CPI and PPI Highlights Peak Levels Staying Sticky²

The Fed’s latest dot plot indicates the fed funds rates will reach 4.4% by the end of the year, and the average 30-year mortgage rate has surged to above 6.9% – its highest level since 2006. While housing is slowing, there is a lag until that impact is felt on sticky costs like rents.

Chart 3: Fed Rate Hikes³

Retail sales were flat m/m in September but remain well-above the average historical annual rate (+7.8% y/y vs. +5.3% y/y 10-year average). The Cass Freight Index highlighted an acceleration in September shipments due to temporary factors and noted, “considerable cost relief highly probable for 2023.”

Even though demand trends are softening and certain sectors are pausing hiring programs or cutting jobs, the labor market remains tight overall, with a 3.5% unemployment rate at pre-pandemic low. Last week, Fed Vice Chair Lael Brainard suggested, “businesses that experienced unprecedented challenges restoring or expanding their work forces following the pandemic may be more inclined to make greater efforts to retain their employees than they normally would when facing a slowdown in economic activity. This may mean that slowing aggregate demand will lead to a smaller increase in unemployment than we have seen in previous recessions.”

3. U.S. Commerce Department Imposes China Export Restriction. The U.S. imposed new export restrictions for U.S. chipmakers, requiring U.S. companies to obtain a special license to export certain chips that could be used for advanced artificial intelligence and supercomputing, which can accelerate Chinese military power. Applied Materials (AMAT) forecasts this restriction will reduce quarterly profit by up to 20%. This coincides with Taiwan Semiconductors Manufacturing Company (TSMC) slashing capex spending by roughly 10%. Intel (INTC) is reportedly planning thousands of job cuts in the face of PC demand slowdown. While the new restriction is expected to hobble China’s tech industry, U.S. semiconductor companies are now dealt another blow to a key point of demand as excess inventory challenges emerge.

4. Energy Challenges Leave Uncertainty. Energy supply remains uncertain as OPEC+ announced cuts to their target production and U.S. crude inventories remain below their 5-year average. U.S. gasoline and distillate fuel production has also slowed, as refineries remain operating near 90% capacity. Chevron (CVX) CEO Mike Wirth shared comments that blamed the “unintended consequences” of energy supply problems on a premature transition to green energy. Wirth said that green energy policies will only cause “more volatility, more unpredictability and more chaos.” This winter, the U.S. Energy Information Agency (EIA) projects heating bills to be up +28% y/y, based on higher natural gas prices.

­5. Futures Imply Rates Moving Above Fed’s Dot Plot Predictions. The hot inflation figures led the market to price in a 100% chance of a fourth-consecutive 75 bps rate hike during the November FOMC meeting and a 64% chance of 75 bps in December. Futures are implying a 4.9% fed funds rate by June 2023.

Following the release, the 2- and 10-year Treasury yields spiked by 25 and 22 bps, respectively, before partially receding to end the week. Investment grade spreads widened to +194 bps Friday, a new high-water mark for the year, while high yield, at +526 bps, remains tighter than its July peak of +610 bps. Municipal yields lagged Treasuries’ move higher, rising 1-2 bps across the curve; the 2-year muni-to-Treasury ratio fell to 67%.

Chart 4: 2-Year Muni and Treasury Yields⁴

6. The Week Ahead.

Earnings – Monday: BAC. Tuesday: JNJ, GS, NFLX, LMT. Wednesday: UAL, BKR, LVS, LRCX, IBM, PG. Thursday: DOW, AAL, T, UNP. Friday: SLB, VZ, AXP.

Economics – Tuesday: Industrial Production (September). Wednesday: Housing Starts, Building Permits (September). Thursday: Philadelphia Fed Index (October)

Stephanie Link: CNBC TV Schedule 

Return for Selected Indices⁵ 

Sources

1. FactSet (Chart)
2. FactSet (Chart)
3. Bloomberg (Chart)
4. Bloomberg (Chart)
5. Bloomberg

Disclosure 

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