What to expect from Wells Fargo earnings Friday — and the banking sector in 2024

Published Thu, Jan 11 20244:46 PM ESTUpdated Thu, Jan 11 20245:31 PM EST

This year is shaping up to be a better time for bank stocks than in 2023. But, investors shouldn't get too excited ahead of earnings season. Club name Wells Fargo will deliver fourth-quarter results before the opening bell on Friday. Our other financial holding, Morgan Stanley , will report on Tuesday. As important as the quarterly numbers are, investors will also focus closely on forward guidance as companies deliver their first looks at how they see business going in 2024. Wall Street's biggest banks look better positioned in 2024, with the Federal Reserve expected to cut interest rates later in the year. Last year's sharp rise in rates, as good as they can be for traditional lenders, sparked the collapse of Silicon Valley Bank in March 2023 and led to other regional institution failures. While the fallout did not impact big banks like Wells Fargo and Morgan Stanley directly, all bank stocks were painted with the same brush. A tumultuous year ensued as the industry grappled with a crisis of confidence. But in the final couple of months of 2023, banks took a sharp turn higher. Wells Fargo gained about 6%, and Morgan Stanley surged more than 9% over the past month. Widening that out to a three month period, Wells Fargo and Morgan Stanley rose 23% and over 16%, respectively. With rallies of those magnitudes, we don't think investors should jump the gun on earnings even if the prospects of an economic soft landing seem more likely. "The market may be a little bit too optimistic about how many [Fed] cuts are in place this year," Jeff Marks, the Investing Club's director of portfolio analysis, said recently, urging near-term caution around banks. While Morgan Stanley and Wells Fargo have solid underlying fundamentals, we prefer to see expectations lower rather than higher heading into the prints. "The number one risk to the banking sector going forward is still a relatively high level of interest rates," Columbia Business School Professor Tomasz Piskorski told CNBC. "If interest rates continue to go down, as some market participants expect, I think it will remove a lot of pressure from the banks." Jim Cramer recently said the banking sector is looking more attractive this year as investors look for other high-quality pockets of the market to invest in after last year's outsized gains in the Magnificent Seven stocks. In deference to those huge 2023 runs, we started the new year on Jan. 2 with some small sales in our Big Tech holdings. "It's okay to find something that's cheaper" than those mega-cap tech stocks, Jim said. He recommended bank stocks — specifically top-grade names with lower multiples as well as those with stabilizing deposit trends and anticipated loan growth. Wells Fargo and Morgan Stanley fit the bill. WFC 1Y mountain Wells Fargo (WFC) 1 year On Wells Fargo, analysts seem to be turning more cautious. Deutsche Bank cut the stock to hold from buy Tuesday, citing limited upside for valuation and management's potentially softer net interest income (NII) guidance. To be sure, Wells Fargo as a traditional lender reported an 8% year-over-year jump in NII during the third quarter, benefiting from the higher level of rates. For Wells, any sell-the-news risk could be circumvented by management's comments around expenses and improvements to its efficiency ratio — a measure of the bank's costs relative to its revenue. Cost-cutting has been a major priority for Wells. The bank conducted layoffs and aggressively scaled back its U.S. mortgage business in 2023. Wells Fargo is a multi-year play for the Club — so barring anything terrible in the quarter or the guidance, any immediate stock reaction probably won't change our view. If the stock were to dip on fiscal results, there are still long-term growth prospects for the firm. Wells, for example, has been forced to keep a lid on its asset growth since financial regulators implemented a $1.95 trillion cap in 2018. Its balance sheet could grow and rake in larger profits once the cap is lifted. We still think it's just a matter of when (not if) the cap will be removed, but this catalyst likely won't materialize until 2025. Wells Fargo's exposure to the ailing commercial real estate market will be a headwind in 2024. The sector has struggled in recent years due to higher office vacancies, tightening credit conditions and surging rates. Wells Fargo has one of the biggest CRE portfolios in the U.S. The bank reported more than $942 billion in loans outstanding as of the third quarter, with $152 billion in commercial real estate. That's about 16% of the bank's entire loan book. To be sure, management has said that significant loan losses have not been observed so far. If the U.S. economy avoids a recession, which we think will be the case, then the loan book will look much better moving forward. We'll be watching out for what management has to say about its CRE exposure. MS 1Y mountain Morgan Stanley (MS) 1 year For Morgan Stanley, 2024 could see much-needed relief for the firm's investment banking business, which has lagged for several quarters amid a dearth of mergers and acquisitions and CEOs looking to take their companies public. Macro uncertainty had been a major factor as prospective clients sought to protect capital in case of a steep economic downturn. "Higher cost of capital is related to higher interest rates. A lot of projects [have been] less likely to be financed, especially the growth companies," said Piskorski, a research associate at the National Bureau of Economic Research. The NBER is the arbiter of business cycle recessions and expansions. "As there's less capital raised, there are less IPOs down the road [and then] less IPO activity." However, the initial public offering and M & A pipelines should pick up in a lower-rate environment. We're already seeing this happen, with a handful of big acquisition announcements. Hewlett Packard Enterprise , for example, recently agreed to buy networking gear vendor Juniper Networks for roughly $14 billion. HSBC on Tuesday lowered its Morgan Stanley rating to hold from buy. Analysts see a softening outlook for Morgan Stanley's wealth management segment that could weigh on the firm's overall business. Under its previous CEO James Gorman, who retired at the start of 2024, Morgan Stanley has been building out its wealth management operations. The idea was to grow steadier revenue streams so the company could rely less on the volatile IB and trading businesses. Heading into Tuesday's earnings, Morgan Stanley remains well-capitalized — as we saw with the Fed's stress tests last June . The firm has solid fundamentals and better investment banking prospects. The C-suite transition promises to be a smooth one as new CEO Ted Pick looks to build on Gorman's legacy. Pick is a long-time Morgan Stanley executive who is well-equipped to manage through all kinds of business environments, Gorman told CNBC in October. (Jim Cramer's Charitable Trust is long WFC, MS . See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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A combination file photo shows Wells Fargo, Citibank, Morgan Stanley, JPMorgan Chase, Bank of America and Goldman Sachs.

Reuters

This year is shaping up to be a better time for bank stocks than in 2023. But, investors shouldn't get too excited ahead of earnings season.