Big banks kicked off Q1 earnings season with a bang. Firms reporting this week in the S&P 500’s banks and capital markets categories announced Q1 earnings growth topped 200% y/y, trouncing expectations for more pedestrian double-digit growth rates.[i] This has headlines claiming more gangbusters growth is in store and set to deliver a big positive surprise to stocks. Apologies for raining on a parade, but we think they are in for some disappointment. Not the bull-market-ending kind, but the kind that doesn’t fuel lasting outperformance in more cyclical stocks.
Banks’ blowout growth is wonderful news, but it is backward looking—and has questionable staying power. Simply, markets pre-priced all the economic activity that drove these earnings. Thinking they are predictive is backward. After last year’s March 23 low, the S&P 500 hit new highs in August, preceding economic recovery well in advance. The latest Q4 GDP figure still stands -2.4% below its Q4 2019 pre-pandemic high.[ii] While economists expect expansion this year, that—and its impact on bank earnings along the way—is old news to stocks.
The drivers behind Q1’s bank earnings are well known at this point—and they don’t look sustainable to us. For one, base effects from last year dominated. During Q1 2020, as lockdowns took effect, Financials’ earnings fell -40.6% y/y.[iii] That set up a low base, which alone virtually assured triple-digit growth rates as earnings return toward—and exceed—pre-pandemic levels. With 15 of 65 S&P 500 Financials reporting so far, their blended aggregate Q1 2021 earnings per share (EPS)—combining actual results with remaining consensus expectations—stand at $11.92, which would be 116% y/y over last year’s $5.53.[iv] But pre-pandemic, Financials’ quarterly EPS averaged $9.16 in 2019.[v] In this light, Q1 EPS more than doubling year over year seems much less extraordinary. Growth now has more to do with 2020’s devastation than anything in 2021, besides normalcy resuming.
Then too, this quarter’s earnings had some one-off padding. That includes record M&A and SPAC deals, big trading volumes courtesy of the meme-stock frenzy, and banks’ further release of loan loss reserves. While deal volume may remain elevated, the other two don’t seem likely to maintain their frenetic pace over the next year, much less accelerate. Equity trading tends to ebb and flow, with pretty wide swings. Furthermore, as we detailed last quarter, banks’ reserve releases are an accounting treatment, not new money coming in the door. Will deal activity or lending offset these should trading and reserve releases dry up? We have our doubts. Without that force, this quarter’s pop seems likely to fade.
Many now take banks’ one-off earnings bump and their executives’ related commentary as a sign that a long economic boom—a new “roaring 20s”—lies ahead. The evidence? Households’ amassed savings and pent-up demand, not to mention abundant capital and low rates—supposedly fuel for a big credit boom. Instead of a return-to-normal V-shaped recovery, they foresee a check mark with a wall of money driving growth skyward. Then, to reinforce such views, they cite trillions of dollars’ worth of fiscal and monetary support, as well as banks’ allegedly abundant lending firepower.
But banks’ earnings releases themselves undercut this. Notably weak? Loan growth—banks’ primary long-term earnings driver.[vi] Even after long rates’ recent climb, the yield curve remains flattish relative to its long history, which probably still weighs on banks’ lending. Many popular expectations hinge on stimulus money fueling big growth, but that looks more likely to disappoint than positively surprise amid grinding gridlock. Meanwhile, there are already signs inflation will subside after a brief, base-effect driven uptick. Circling back, banks don’t seem particularly keen on using their burgeoning deposits to back new loans when they expect less creditworthy borrowers to struggle and aren’t compensated for taking the extra risk. We think this cocktail underscores what is likely beyond the reopening bounce: a return to slower growth, not a lasting boom.
Buoyant sentiment today already reflects Q1 earnings. Probably Q2 and beyond, too. While analysts are seemingly playing catch up this earnings season, they have been ratcheting up their forecasts for a big 2021 earnings recovery since last spring. The details may still be fuzzy, but stocks penciled in the rebound’s broad outlines a while ago. Markets typically look 3 – 30 months ahead, in our view. Economic activity and the earnings it generated last quarter—and will probably keep fueling in the near term—don’t matter as much as what 2022 is shaping up to look like. In our view, it behooves investors to focus on that window—and whether expectations are running too hot.
Q1 is past. Don’t look to it—or forthcoming earnings announcements—for where stocks go next. The reopening bounce they confirm is baked in. Investors should look beyond that to whether sentiment now reflects the likely reality then—and keep expectations in check.
[i] Source: FactSet Earnings Scorecard, as of 4/15/2021.
[ii] Source: Federal Reserve Bank of St. Louis, as of 4/15/2021. Real GDP, Q4 2019 – Q4 2020.
[iii] See note i.
[vi] “Big U.S. Banks Cut Loans to Record Low, Again, as Deposits Jump,” Shahien Nasiripour, Bloomberg, 4/12/2021.
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