Why Bank Stocks Could Be About to Face 9% Slide
A slowdown in lending is sending warning signs about bank earnings as the biggest names in the business get set to reveal their quarterly profits and expectations for the future.
Though big-bank stocks have gained about 9 percent this year and served as leadership during the first-quarter market rally, they've trailed over the past month, with the KBW Bank Index losing nearly 3 percent.
A note out Tuesday from Goldman Sachs helps explain some of the group's problems and throws up a warning signal: Banks that gain more than 10 percent in the first quarter historically have given nearly all those profits back when future earnings estimates begin falling as well.
Goldman took down earnings forecasts for some of the industry's biggest players, cutting Morgan Stanley by 17 percent, Bank of America by 15 percent and dropping Citigroup, which it actually says it still likes, by 13 percent.
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"The past few years have shown that bank stocks gain over 10 percent in 1Q only to lose 9 percent in 2Q when out-year estimates start to decline," Goldman said. "With 1Q earnings likely to be weak, we see the risk that history repeats itself with the start of another negative (earnings) revision cycle."
There are three primary culprits for the bank slide: Loan growth contracting 2 percent for the quarter after growing 3 percent in the fourth quarter; slower activity in capital markets including a March dropoff in mergers and acquisitions as well as initial public offerings, and declining confidence in the economy.
A report Friday indicating the economy added just 88,000 jobs in March stoked fears of another springtime slowdown.
(Read More: US Job Creation Plunges, but Rate Drops to 7.6%)
In the meantime, companies across the spectrum have been warning of weakening conditions, with the number of negative revisions outnumbering positive in Standard & Poor's 500 companies by nearly 3 to 1.
Overall M&A activity in the first quarter surged in dollar volume to $347 billion, more than double the same period in 2012, though the amount of deals fell 19 percent and was the lowest in two years, according to Dealogic.
"The biggest concern we have heading into 1Q earnings is that lackluster fundamentals could lead to a negative EPS revision cycle (which has been the trend the past few years)," Goldman said. "While we believe 1Q EPS expectations have been lowered, in an uncertain revenue environment we would avoid names trading at a premium multiple on expectations for outsized EPS growth."
In addition to Citi, Goldman favors JPMorgan Chase among the mega-caps. In regionals, the picks are Regions Financial and First Niagara Financial Group, while those not in favor are Comerica and First Horizon National.
Banks have acted as leadership in 2012 and again this year, with the KBW Bank Index still up 9.7 percent despite the recent pullback.
Any underperformance by the banks could generate substantial effects on the broader market, which has been due for a pullback following the S&P 500's 10 percent rally this year.
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The earnings outlook looks fairly glum to begin with, as most analysts have first-quarter EPS growth for the S&P 500 up less than 1 percent, or in the case of Citi economists, declining 0.6 percent. Expectations for future quarters rise significantly.
Piper Jaffray, which has been strongly bullish, cautioned clients that the time ahead will be a period of "backing and filling" in which the S&P 500 is likely to sustain a 5 to 10 percent decline. That, in turn, "may represent the single best buying opportunity this year."
Banking analyst Dick Bove, who sees the sector in the early stages of a 14-year bull run, believes banks will outlast any near-term weakness.
"The outlook for the second quarter dims when recent figures are assessed. If this trend continues it will result in a major slowdown in bank earnings growth," he said in a note to clients. "Our view is that there will be an upward shift due to the expected economic recovery."