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Three things to watch as the big US banks turn in their quarterly results

Tellers serve customers at the Wells Fargo bank in downtown Denver.
Rick Wilking | Reuters
Tellers serve customers at the Wells Fargo bank in downtown Denver.

There's a big difference coming into the fourth quarter of 2016 earnings for banks compared with the prior three — both share prices and sentiment have improved drastically for the sector, so there's more room for disappointment than there was for all of 2016.

Before the election, the average valuation for the big five banks with both investment and commercial businesses was 1 times price to tangible book — or the banks' market price in relation to the value reported on their balance sheets. That same measure now stands at 1.3 times. Over the coming quarters, banks need to deliver stronger earnings to justify that higher multiple, and Friday is the first major test of investors' elevated enthusiasm toward the sector.

On that note, the key things to watch are:

  1. Strong trading revenue anticipated again: Indications during the quarter are positive. As with the third quarter, the expectation is that trading in fixed income, currency and commodities will outpace that of equities, although stronger markets and higher volatility postelection will support the latter, too. This plays better to the strengths of investment banks like Goldman Sachs and Morgan Stanley than pure retail banks like Wells Fargo.
  2. Rates: Look out for commentary on precisely how positive the increase in rates has been. JPMorgan Chase CEO Jamie Dimon suggested in December that sensitivity to rates could in fact be better than expected. On the flip side, to what extent have higher rates hurt revenue; that is, are loan volumes struggling? Expect net interest margins to rise, and watch for revenue impact.
  3. Credit risks: We are in a far better position than this time last year, but it is a potential wildcard to keep an eye on what could derail the current positive sentiment. Investors will be looking for reassurance that credit risks remain benign.

Given the extraordinary change in sentiment since the presidential election, there will be a disproportionate focus on management commentary, not least in terms of what they expect from a Donald Trump presidency in terms of deregulation and tax changes, but also more broadly because most banks will be announcing their 2017 guidance. (Next week from World Economic Forum in Davos, CNBC will broadcast interviews with the CEOs JPMorgan, Goldman Sachs, Morgan Stanley, Bank of America and Citigroup.)

Broadly speaking, the analyst community remains positive on banks, though they expect more steady share price appreciation based on earnings growth, as opposed to the huge gains due to multiple expansion that investors saw in November and early December. But there now appears to be preference for commercial banks based on the fact that markets have already seen rates improve over investment banks, which stand to benefit from deregulation and tax changes that are yet to arrive.

Bank of America, JPMorgan Chase and Wells Fargo kick off earnings on Friday, with Morgan Stanley, Goldman Sachs and Citigroup following next week.