Financials Kick Off Q1 Earnings

Banks Beat Estimates 

There were puts and takes to the big six banks’ earnings – we would argue more good than bad – but against high expectations, there was a mixed reaction to the stock prices. We believe in the big banks, especially as they take market share and we begin a new capital markets recovery. On this theme, Morgan Stanley (MS) and Goldman Sachs (GS) posted the strongest results as capital markets are showing a significant bounce. Wealth management surprised to the upside in net new assets with MS, and Charles Schwab (SCHW) the notable standouts. Net interest income is troughing and expected to recover in the second half of the year, with Bank of America (BAC) and JP Morgan (JPM) both posting notable results. Fees were impressive across the board. On the other hand, the yield curve continues to be a headwind for bond portfolios and higher deposit costs. Overall, we are encouraged by the results and even more impressed with the company commentary. 

Chart 1: Financials Have Performed Well in the Last Year, and Are Up 25% Since October¹ 

Capital Markets Boost Earnings 

As we have mentioned, M&A activity has started to see a comeback this year, and the firms that have reported thus far are echoing this theme. Earnings releases from the major banks have shown mid-double-digit growth in investment banking, M&A and capital market fees and revenues. With interest rate cuts on the horizon, firms are eager to raise new capital and acquire competition to grow market share. M&A activity bottomed out in late 2022 with inflation at its peak and interest rates on the rise. Now that companies have a clearer economic picture, some are looking to capital markets as an avenue to grow their businesses. Total M&A deal value in the first quarter of 2024 increased 35% y/y.² 

Chart 2: Deal Activity Bottomed in Early 2023 and Spiked in Q4 2023³ 

GS reported Q1 earnings Monday morning, beating nearly all estimates. The bank’s profit increased 28% y/y, “thanks to a rebound in capital markets activity.”⁴ Investment banking fees jumped 32% y/y, with equity and debt underwriting revenues up 45% and 38% y/y, respectively. This is similar to the earnings reports from last week where all three banks had extremely strong M&A numbers. Citi’s investment banking revenue increased 35% y/y, JPM’s grew 21% y/y and WFC’s surged 70% y/y. 

On the GS conference call, CEO Daivd Solomon noted that the historically depressed levels of activity in the M&A markets would not last forever, and that, “it’s clear that we’re in the early stages of a reopening of the capital markets.”⁵ The firm collected over $2 billion in investment banking fees for the quarter, over $300 million above estimates.  

The strengthening U.S. economic outlook is enticing companies to begin thinking about M&A activity and raising capital. Although the timing of interest rate easing is being pushed out later this year, firms see the light at the end of the tunnel, which is ultimately encouraging for capital activity. 

Consumer activity has remained strong as well, which has provided a healthy sentiment in financial markets. GS lowered its provision for credit losses by 39% q/q to $244 million, hinting at a strong consumer and less of a need for a backstop in case of loan losses. Moreover, Charles Schwab (SCHW) saw a record $14 billion of net flows into its advisory solutions group in Q1 and $4.4 billion of net flows into its Schwab Wealth Advisory unit, also a record in a single quarter. Clients are active in markets and looking for investment solutions, a positive for wealth management businesses.  

CEOs Allude to AI Themes 

On top of M&A activity, recent CEO commentary has reflected the themes in AI and electrification we have been discussing. As mentioned in our Weekly Wisdom titled “The Cyclical Rebound” on March 20, technological advancements are going to need vast amounts of energy to produce. Electricity consumption from data centers, AI and cryptocurrencies are expected to reach 1,000 terawatt-hours by 2026, which is roughly equivalent to the total electricity consumption in all of Japan.⁶ This is up from 460 terawatt-hours hours of electricity today.  

Blackrock CEO Larry Fink stated Friday that, “AI cannot happen unless there is a huge investment in infrastructure.” Fink believes the amount of energy and power generation needed for AI will cause the world to run out of electricity in the case that AI is fully adopted and infrastructure is not expanded. Continuing, Fink mentioned that the buildout for an AI integrated world will stimulate the economy in the form of trillions of dollars of investments into datacenters and infrastructure. These are comments we have discussed for some time and continue to implement.  

Goldman Sachs CEO David Solomon, also discussed AI developments in the GS earnings call, mentioning that the topic comes up in nearly every client conversation he has. Solomon stated that there will be, “significant demand for AI-related infrastructure,” which will be a tailwind for GS in the form of financing. He stated that the firm has a dedicated team of engineers focused on machine learning and artificial intelligence looking to enhance productivity for the firm. Furthermore, Goldman’s focus on scaling AI is a long-term project over the next 5-10 years, not just a few quarters. The investment into AI goes beyond just companies – governments are making investments into infrastructure as well to boost productivity.  

Energy infrastructure and electrification are ways to gain exposure to the energy transition that will be needed to support AI. Eaton Corp (ETN) and Quanta Services (PWR) are two companies to benefit from this transition. ETN’s electrical and aerospace megaproject backlogs are both up +10% y/y and the company’s backlog has doubled since Q4 2020. PWR has an extensive pipeline of infrastructure projects with a backlog of $30 billion, 1.5x its trailing 12-month revenues. Both companies stand to gain from the investments that are going to be needed for AI expansion.  

Charles Schwab Talks Economic Turnaround 

Charles Schwab’s Q1 revenue and earnings beat analyst expectations. Core net new assets grew by $100 billion in the quarter, up 6% y/y, with March alone bringing in $45 billion. The company added one million new brokerage accounts in the quarter, the most in the previous three quarters.  

Management noted in the earnings call that they expect the net interest margin to expand through 2024 and 2025 and approach 3% by the end of 2025, driven by paydowns of higher interest debt. They stated that interest rates remaining higher for longer also benefit the company, as more than one-third of its assets are floating. If interest rates do not fall by the 150 bps the Fed estimates by 2025, its net interest margin may exceed 3%. 

Importantly, the company saw improved client engagement and sentiment. Daily average trading was up 15% q/q, client borrowing (margin balances) up 9% q/q and total client interactions up 17%. Furthermore, net flows to its investment advisory solutions were up nearly 70% q/q, showing greater client interest in advisory services. Management stated they are noticing a “turnaround” in the environment, positively impacting all parts of the company: investor engagement, net new assets, client assets focused on capital building, revenue and earnings. 

Stephanie Link’s TV Schedule: 

Sources

1. FactSet (Chart). As of April 15, 2024.
2. WSJ. As of April 15, 2024.
3. McKinsey. As of February 20, 2024.
4. CNBC. As of April 15, 2024.
5. WSJ. As of April 15, 2024.
6. IEA. AS of January 2024.

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