Banks underperform in final week before earnings season. The KBW Bank Index (BKX) fell 2.82% last week, while the KBW Regional Bank Index (KRX) declined by a comparatively modest 0.80%—but both underperformed the S&P 500 by 330bps and 128bps, respectively. We take no view on the market, but those who make their living doing so will need to discern whether this underperformance into earnings is properly discounting weak results and weaker guidance revisions, or if it reflects expectations having dropped to the point that banks will clear the hurdle despite the many well-known headwinds they face.
Figure 1: The KBW Bank Index
Source: FactSet
Figure 2: The KBW Regional Bank Index
Source: FactSet
Earnings season begins on Friday the 13th; will guidance get slashed? Bank earnings kick off on Friday the 13th, which may prove all too appropriate. The primary foci are likely to be 1) the effect of the 76bps Q3 increase in the 10-year Treasury yield on capital levels, and 2) the degree of stabilization in deposits. We would anticipate some deceleration in the flow of demand deposits to money market accounts and CDs, which carries implications not just for banks but for brokers as well. Deposit betas will grind higher, pressuring NIMs, but if the Fed Funds futures market is to be believed then this is more of a lagging indicator at this point. As consumers have largely dissipated the above-trend savings accumulated during COVID, it will be interesting to see whether overdraft fee revenue begins to pick up. Overall loan growth should remain very sluggish—though loan loss provisions should continue rising—reflecting both current and prospective credit quality deterioration.
Among non-interest revenues, mortgage volumes will of course be very weak, reflecting low purchase volume and de minimis refinancing activity. Credit card spend seems to be holding up though credit is worsening, particularly in the private label segment. Investment banking revenues should see a bounce from Q2 levels. Advisory fees will remain depressed, but last quarter several managements remained positive on the medium-term outlook; it will be interesting to see whether that persists. Asset management revenues will reflect the market driven decline in AUM in equities and fixed income, while flows will likely continue to reflect shifts from equity to fixed income, and into alternatives.
On expenses, while we would anticipate some continued opportunistic hiring, we would also anticipate more draconian cost control programs, since that is among the few levers bank managements can control with much certainty at the moment. Overall, in light of the constellation of negative trends confronting banks, perhaps the most positive thing one might say about the upcoming earnings season is that it may not take much for banks to produce an upside surprise.
Imminent return of the McRib™ offers investors hope. Amid market turbulence and ominous economic conditions, investors could take solace last week from the announcement that McDonald’s will bring back the McRib sandwich on November 1. Whatever one’s feelings about the McRib sandwich, market performance during its windows of availability is a matter of public record; From 2010 through 2022, the average daily S&P return when the McRib was available was double the return when it was not available. It is left as an exercise for the reader to discern the causal mechanism.
Figure 3: McRib availability and daily stock market returns
Source: @dollarsanddata
Insider buying dropped off in Q3. While not shocking, it seems noteworthy that insider purchases at listed banks fell back to pre-crisis levels in 3Q23. In fact, the Q3 volume of open market purchases was slightly lower than the recent non-crisis average, likely reflecting a pull-forward of activity during the crisis.
Figure 4: Open market stock purchases by bank insiders dropped back in 3Q23
Source: FactSet
Bear steepener steepens bearishly. The bear steepener sustained its momentum last week as the 10-year yield climbed another 22bps to 4.79%. The 2 year – 10 year spread narrowed by another 18bps to 29bps. The recent increase in long rates is a positive for reinvestment rates and lending spreads, but that benefit is more than offset by the effect of rising long rates on capital levels, loan demand, and credit quality.
Figure 5: The bear steepener continues to flatten the curve
Source: FactSet
Figure 6: The 2-10 spread narrowed by 19bps last week to -47bps
Source: FactSet
Fed Funds futures reverse last week’s dovish turn. Fed Funds futures didn’t move much last week, but directionally they did resume the drift toward higher-longer, reversing the previous week’s move. The implied timing of the first rate cut remains the June 12 FOMC meeting.
Figure 7: Fed Funds futures took a slight dovish turn last week
Source: FactSet
Figure 8: Fed Funds futures imply the first rate cut has moved up to the June 12, 2024, FOMC meeting
Source: FactSet
Federal Reserve borrowings resume dip. Total bank borrowings (BTFP combined with the Discount Window) declined by 0.4% last week to $110.4 billion, effectively falling back to the level of August 30. Money market fund balances rose 114bps to a new high of $5.7 trillion.
Figure 9: Federal Reserve balances
Source: FactSet
Figure 10: Bank Term Funding Program usage reached another new peak last week
Source: FactSet
Figure 11: Money Market Fund assets rose by 114 bps last week
Source: FactSet
Figure 12: Large cap bank performance and valuation
Source: FactSet
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