Wells Fargo kicks off our bank earnings Friday. Rate cuts and dealmaking will be in focus this season

Published Thu, Apr 11 20244:28 PM EDT

What a difference a year makes. Club holding Wells Fargo will post quarterly results on Friday, followed by our other financial holding, Morgan Stanley, on Tuesday. The industry's first-quarter results will come against a more pleasant backdrop than last year, when the March 2023 collapse of Silicon Valley Bank sent shockwaves throughout the sector. The major banks are also beyond last quarter's messy numbers as they paid for the FDIC's regional bank rescue efforts. Meanwhile, the Federal Reserve's stance on interest rate hikes has also changed from a year ago when central bankers were increasing rates to the current talk about how many rate cuts to expect in 2024. The impact of higher-for-longer interest rates is in focus again this earnings season. Some analysts believe it's a positive for a key financial gauge for Wells Fargo. We're also optimistic but want to temper expectations because several factors play into the firm's performance. Expectations for Fed rate cuts have continued to come down since the start of 2024 when the market ambitiously priced in six reductions. With some recent data signaling an uptick in inflation, including Wednesday's consumer price index for March, market odds are now in the two-cut neighborhood for this year, with the first projected one to arrive in September. Jim Cramer has been saying repeatedly that the resilient economy could re-ignite inflation and that the Fed should not cut rates anytime soon, if at all, this year. A higher rate environment could lead Wells Fargo to boost full-year net interest income (NII) guidance, which we saw as conservative when it was delivered alongside fourth-quarter 2023 results . At the time, its NII outlook, which assumed five Fed rate cuts this year, hit the stock. WFC YTD mountain Wells Fargo (WFC) year-to-date performance NII is the revenue generated from loans, securities, and other interest-earning assets minus the interest expenses paid on its liabilities like customer deposits. Higher rates can be seen as a positive for Wells Fargo's NII because the firm relies heavily on its consumer banking and lending segment. It accounted for roughly 44% of overall revenue in 2023. In theory, higher borrowing costs mean Wells Fargo can generate more money from those interest-earning assets, but it's not that simple. Rates are one of many factors that play into a firm's interest income, including potentially sluggish loan growth, which was a factor in the fourth quarter. It's hard to say with the fluid inflation and rate expectations whether Wells Fargo might change its NII outlook when it reports on Friday. During a UBS financial services conference in February, Wells Fargo CFO Mike Santomassimo said the bank is "still very comfortable" with its NII guidance. "When you look at rates in isolation, higher rates, [for a] modestly asset-sensitive business [like Wells] is a positive," Santomassimo said at the Feb. 26 event. However, he added it's only "one factor that you sort of have to look at across the whole balance sheet." Wells Fargo's expense guidance will also be in focus after the bank barely hit estimates last quarter. Expense control is crucial for Wells Fargo to continue improving its efficiency ratio , a profitability measurement in the banking industry. In the fourth quarter, management indicated that the firm met its multiyear goal to cut expenses by $10 billion. We don't predict any thesis-changing events in Friday's release and remain bullish long-term on the bank stock. During Wednesday's Morning Meeting , Jim said, "I like Wells. Let Wells sell off $3 [per share], and then you buy it." The stock was above $56 apiece when Jim made his statement, and it traded modestly lower on Thursday. Wells Fargo also has a key long-term growth prospect in the potential removal of its $1.9 trillion Fed-imposed asset cap. This is a big part of our investment thesis and why we have continued to own the stock, though we trimmed some earlier this year when its outperformance resulted in it becoming our largest position. Once the bank gets its growth cap lifted, which we expect next year, Wells Fargo will be able to grow its balance sheet again. Wells Fargo has also been making noise about getting into the investment banking business in a bigger way. In February, Wells Fargo cleared a big regulatory hurdle tied to past misdeeds, which gave us more optimism around CEO Charlie Scharf and the rest of management's strides to get the growth cap lifted. "Charlie's got a great handle on things," Jim said earlier this week. "He's also a great risk manager." Shares of Wells Fargo have gained more than 15% year to date — due in part to February's regulatory victory — but in recent weeks, the financial name has cooled off. Over the past month, the stock was down slightly while the S & P 500 was up more than 1 percent. Morgan Stanley has generally been hurt by higher interest rates over the past two years because they have injected uncertainty into the economic landscape, limiting dealmaking activity for its investment banking division to partake in. Investment banking came back "strongly" in the first quarter of 2024, JPMorgan analysts said in a note to clients this month. Industrywide fees rose 21% quarter over quarter and 10% on an annual basis, the firm said, reaching their highest levels since the first quarter of 2022 — coinciding with the start of the Fed's rate-hiking campaign . Although these JPMorgan analysts don't cover Morgan Stanley directly, the improved dealmaking backdrop is encouraging for our financial holding's once-lucrative investment banking business. After booming during the early parts of the Covid pandemic, the segment has lagged for over a year amid muted mergers & acquisitions (M & A) activity and a weaker initial public offering (IPO) market. In a note to clients last week, Jefferies analysts similarly said investment banking activity has "begun to rebound," adding that an increase in M & A announcements "bodes well" for Morgan Stanley's advisory revenues during the second half of 2024. Morgan Stanley served as a financial advisor to Discover in Capital One's $35 billion acquisition of the credit-card issuer, which was one of the biggest deals announced in the first quarter of the year. MS YTD mountain Morgan Stanley (MS) year-to-date performance The Club agrees with the Wall Street firms, considering the many signs we've seen that indicate the dealmaking environment is improving. In addition to increased acquisitions, there's been a slew of big-name IPOs already in 2024. Morgan Stanley's investment banking services were tapped for big public debuts from the likes of Wilson tennis racket maker Amer Sports and chip firm Astera Labs , both of which are in the top five IPOs so far this year based on money raised, according to Jefferies. Perhaps most notably, Morgan Stanley was a lead underwriter for Reddit's multibillion-dollar IPO in March. The stock debuted at around $34 per share and is trading around $45 per share Thursday. Reddit's successful debut on the New York Stock Exchange can be viewed as a positive for both investors' current appetite and the future dealmaking environment. And our hope is private companies that want to go public will choose Morgan Stanley as a facilitator for their future offerings. Morgan Stanley earns a fee based on the size of the IPO and for selling the stock to investors. Elsewhere, margins in Morgan Stanley's wealth management division will be under scrutiny after leaving plenty to be desired in the fourth quarter. One factor that weighed on profitability in the segment, which houses online brokerage E-Trade, was that clients were moving their deposits into higher-yield accounts in a process sometimes called "cash sorting." However, deposit trends generally seem to have stabilized, according to Jefferies analysts. And a more supportive market should help Morgan Stanley's margins, analysts suggested. We want to see the firm get back on track toward its previously issued goal of 30% operating margins for the segment down the line. Under recently departed CEO James Gorman, Morgan Stanley embarked on an aggressive push into asset and wealth management, in a bid to become less reliant on the boom-and-bust nature of its traditional investment banking operations. The firm bought E-Trade in 2020 as part of that transformation, but the brokerage has become "sleepy," Jim said, during the Club's most recent Monthly Meeting, alongside a plea for management to improve the bank's overall performance. "New CEO Ted Pick has to come out swinging on this next conference call about how he's going to grow revenues in a faster, less-complacent pace," Jim said. "He's got a better IPO market to crow about, but this company has been a big disappointment versus some others in the industry." Shares of Morgan Stanley tumbled 5% on Thursday after The Wall Street Journal reported that multiple federal regulators are probing the bank for its wealth management practices. To be sure, the report cited people familiar with the matter and has not been confirmed yet. With the information the Club has now, though, we think the stock decline was a market overreaction. Still, Thursday's losses add on to an overall lackluster 2024 performance for the stock. Morgan Stanley shares have now lost nearly 7% year to date, compared with a roughly 8% gain for the S & P 500 financials sector. (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. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . 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A woman walks past Wells Fargo bank in New York City, U.S., March 17, 2020.

Jeenah Moon | Reuters

What a difference a year makes.