Investors poured money into banks before earnings, then got burned

Key Points
  • The Financial Select SPDR ETF took in nearly $900 million in July before earnings season, but fell after the first big names reported Friday.
  • Analysts remain generally supportive of bank stocks, though they face obstacles from interest rates and low economic growth.
Banks turn lower despite earnings beats

As earnings seasons approached, investors flocked to financial stocks on anticipation that the high hopes for the sector would come true. So far, it's been an expensive losing bet.

Bank shares slumped Friday in an early but important round of profit reports. JPMorgan Chase, Wells Fargo and Citigroup — Nos. 1, 3 and 4 in terms of assets — each disappointed the market for various reasons.

Financials broadly fell more than 1 percent by midday, and the KBW Nasdaq Bank Index specifically was off 1.2 percent. Wells Fargo dropped about 2 percent.

That comes as investors have been pumping cash into an exchange-traded fund that tracks the industry, the Financial Select Sector SDPR. The ETF has hauled in just shy of $900 million in July — about a 3.6 percent gain in assets just for the period — as investors bet big on the banks.

Despite the decline Friday, no one is panicking yet. Indeed, ratings firm CFRA kept its buy recommendation on both JPMorgan and Wells Fargo and raised its price target $2 on each of the stocks.

"A lot of the environment around them is still pretty good just fundamentally," said Jim Paulsen, chief investment strategist at The Leuthold Group. "There's borrowing and lending going on again. With the stock market going to new highs, I think it's going to stoke a little new activity."

Bank stocks immediately fell in premarket trading after the three big institutions released their earnings reports. They stayed negative through the trading day as investors digested the positions of the Wall Street leaders, and after weak inflation data sent government bond yields lower.

Joseba Etxaburu | Reuters

Indeed, Paulsen said the direction of yields will be a critical metric by which to gauge bank performance.

Should the benchmark 10-year Treasury note break above 2.6 percent, the sector stands to benefit, he said. The road will be different under lower bond yields, in which case earnings will take more prominence.

"I think we break out [on yields]. If we do, they'll be OK," Paulsen said. "Some of the sales have been weak, but that would be helped if you can raise the yield structure and steepen the curve again."

That yield dynamic has created some uncertainty in the market lately. While Federal Reserve officials have indicated their desire to bring interest rates back to levels closer to historical norms, the inflation numbers have not been cooperating.

Consumer price index data Friday showed surprisingly weak pricing pressures, with June prices unchanged. The Fed is determined to bring inflation back up to 2 percent annualized, but the CPI now points to just a 1.6 percent reading.

However, Kevin Quigg, chief strategist at ACSI Funds, said the sector has other factors in its favor.

"The industry as a whole is in very good shape. Everyone passed the stress test for the first time in seven years," Quigg said, referencing the exams banks must pass to show that they can withstand another financial crisis. Each bank involved in the tests received approval for their plans to distribute capital to shareholders.

"There's also deregulation. There certainly will be a look into regulations. That's a real tail wind for the industry," added Quigg, whose fund has positions in Citi, JPMorgan and Wells Fargo.

To be sure, not everyone is a fan.

Kevin O'Leary, who runs the O'Shares ETF family and is a judge on ABC"s "Shark Tank," a program that also is syndicated on CNBC, believes the big bank stock run is at least taking a break for a while.

"This is the pause that refreshes going forward," O'Leary said on "Fast Money Halftime Report." He pointed to comments from JPMorgan CEO Jamie Dimon earlier in the day expressing frustration with the slow pace of fiscal reforms in Congress.

"In his words are caution," O'Leary said. "I think if you're looking for what's going to make things work in financials, you don't have to own banks."

WATCH: O'Leary explains why he doesn't like banks.

Kevin O'Leary: Financials will not lead the market