Tag Archives: Earnings

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Banks in the spotlight for next week

With the start of Q3 earnings next week and a light reporting schedule, banks look set to be in the spotlight all week particularly on Friday when pair of big box gambling houses, JP Morgan (JPM) and Wells Fargo (WFC), come out with their earnings before the market opens.

JPM is expected to report $1.21 while WFC $0.87 per share but it may be a combination of several factors that folks may want to know out of their earnings report and the conference… things like the profits source (trading or lending), loan growth, issue of declining revenue, QE3 impact, legacy lawsuits costs and projections…

Whatever these two would have to say will, by implication, affect the other big box gambling houses, particularly Bank of America (BAC) who has tentacles of JPMs trading house as well as WFCs mega-sized mortgage portfolio.

Both JPM and WFC have been in a slow rally mode for the last 3 months so the earnings reports and forward statements would be critical not just to confirm this rally but to move the whole market ahead where financials are still laggards.

Some of these banking names mentioned so far have hit some important technical levels on Friday but gave a negative signal later in the day when they reversed.

With an exception of JPM whose technicals favor a shot at $44, WFC and BAC are bumping against ceiling resistance. The space between Monday and Friday’s earnings would seem like a logical time horizon for these names to clear out some of the technical ambiguities and set a stage for a more clear move on Friday one way or another.

One other, less known, bank earnings report on Thursday may give us not just some regional flavor in this space but also a trading opportunity for those with stomach for excitement.

Bank of the Ozarks (OZRK) is suppose to report sometime on Thursday with expectations $0.55. With about $1.5 billion in value, OZRK operates mainly in Arkansas, some in Georgia and few branches in other southern states. The bank is looking to expand there as the region is experiencing population growth hence business opportunity.

OZRK has a low non-performing loan ratio of 0.5%, loan growth of 10%, net interest margin (difference what it costs them to get money and what they lend it at) at 5.84% and deposit base expansion in double digits which may grow more as they keep announcing small deals here and there.

In July, OZRK popped over 8% in one day after it reported its Q2 earnings and the shares, somewhat pricey, have been sideways since and has, on the technicals, bounced off the initial July gap up.

It is currently building up a 3-week bullish flag but inside this flag, the price action on September 14 is particularly worrisome because it is a failed attempt at a break through $35 as well as a top in the MACD momentum read which is at a lower high then the one in July.

With such technical set up, OZRK could move about $4.50 one way or another giving it a possible price range of circa $30.50 to circa $39.50.

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Earnings & the Japanese Trap

The latest earnings season produced a significant number of profit beats but also a noticeable drop in revenues suggesting sluggish demand and with the elevated share buybacks some say that this scenario is suggestive of a so-called Japanese Trap.

“Of the 119 companies that have reported earnings thus far, 68% have beat estimates, higher than the historical norm of 62%. While this may seem positive, it’s important to note that only 42% of companies are beating revenue estimates, causing investors to question the health of U.S. corporations,” says S&P in its latest report.

“The current earnings surprise ratio stands at a positive 6.4%, higher than the 10-year average of only 3%. On the other hand, companies are actually missing revenue estimates by an average of 0.4%,” notes S&P.

These earnings gains, says S&P, are a result of corporations being still able to find places where they can cut their expenses – an occurrence which is deemed to be finite.

S&P also says that many of the earning beats are a result of “implementing clever but unsustainable accounting methods.”

One therefore presumes that at some point corporations will no longer be able to find things to cut while, at the same time, exhaust the “creative” accounting that inflates their earnings.

At the same time, corporate buybacks are on an upward momentum which results in a net decrease in equity.

Sluggish demand (left chart) and anemic business investment (chart on right)

In a recent note, Natixis puts these 3 developments – rising earnings and buy backs against weakening corporate revenue – and suggests to their clients that these are the symptoms of a Japanese trap.

“By consequence, the components of the “Japanese trap” are taking shape: profits are not invested, waged income is weak, and corporate savings are used inefficiently (deleveraging in the euro zone and in the United Kingdom; share buybacks in the United States; increase in financial assets held). Can we already see signs that potential growth is weakening in these countries? The answer is undoubtedly yes,” says Natixis report.

Increase in corporate buybacks is reflected in a negative net equity issuance as percent of GDP (left chart) which, as an investment, does nothing to increase productivity (chart on right)

They say that the flat to decreasing consumer demand will shrink corporate revenue over time (chart 7B) which will flatten the business investment as percent of GDP (chart 8A) while savings (corporate profits) would increasingly go into removing equity shares out of the market (chart 9B) as labor productivity sinks (9D).

“Therefore, we have excessively high corporate savings, weak domestic demand overall, reduction in potential growth due to the decline in the investment rate and the inefficient utilisation of savings. We fear that the Japanese trap, pulling out from which is difficult, is also under way in the United States, the euro zone (apart from France where profitability is poor) and the United Kingdom,” concludes Natixis.

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Earnings, equities diverging

From Wells Fargo Advisors:

This week’s chart on the next page looks at an overlay of the S&P 500 and the trailing four quarter operating earnings of the companies that make up the S&P 500, adjusted to the period when the earnings were being reported. In 2008, earnings dropped sharply and so did the market. This year, earnings advanced while the market declined. Of course, past performance does not guarantee similar results. Nevertheless, this year’s market weakness at the same time that operating earnings were hitting new all time highs, created a good value in the stock market. Unfortunately, many risk-adverse investors were looking for safety this past year, not attractive valuations. Consequently, the stock market still had a substantial correction even though the economy and profits were rising.

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Earnings seen as possible lift to stocks

There is a great divergence between corporate profits and economic indicators with the indicators currently in the driver seat of stock prices.

These economic indicators have been heading lower as many have underestimated the negative impact of the disaster in Japan.

So, some are arguing that the corporate earnings will eventually catch up to these lower indicators citing that the corporate profits as percent of GDP are at an all time high.

From SmartMoney:

History suggests today’s corporate earnings are unsustainably high relative to the size of the economy. The real price-to-earnings ratio, based on a more normal level of earnings, is well over 20.

The SmartMoney writer, Jack Hough, notes that corporate profits were this size only twice in the US history – 1929 and 2006 – all years that ushered in nasty economic depressions.

Based on this argument then, any lack of GDP growth shrinks corporate profits just so to keep up with their GDP share.

However, as the chart on the left shows, change in corporate profits does correlate with the changes in the GDP, so any GDP shrinkage has dire consequence for corporate profits and if they are at the all time high like now the path of lowest resistance is down.

Then there are those who dispute any relationship of GDP to stock prices.

From Vitrus Mutual Funds:

Common wisdom is that countries with strong long-term economic growth prospects are more likely to provide attractive stock market returns than countries with slower growth expectations. Interestingly enough, the historical data does not back up this belief.

Vitrus cites Dimson, Marsh, and Staunton’s Triumph of the Optimists: 101 Years of Global Investment Returns and Professor Jay Ritter’s paper Economic Growth and Equity Returns who show that there is not much relationship between real GDP and real equity returns.

Hm? Real huh. Swell even though stocks move on the reported nominal EPS with “real” one best left to academicians.

Anyway, with lack of positive market catalysts as of late some are pinning hopes on corporate earnings as the bright star that can move the market higher.

There are 14 notable earnings releases this week whose earnings, guidance and prospects could help swing the market.

These names report on various dates this week. The number next to symbol is the expected EPS.

Business activity & manufacturing:

FDX 1.72
CMC 0.20
KMX 0.67
DFS 0.67

Consumer spending:

BBBY 0.62
WAG 0.62
RAD -0.12
KMX 0.67
DFS 0.67

Technology:

ADBE 0.51
JBL 0.57
RHT 0.22
SONC 0.18
MU 0.16
ORCL 0.71
TIBX 0.18