Taking the Pulse of The U.S. Economy
Earnings Season is Back
Hi everyone, Markets again. I’m sure you’re all absolutely morose over the distinct lack of a Sunday Read this week. That’s totally my bad, but in the interest of transparency, I wanted to give an explanation (promise it’ll be brief).
Basically, I’m moving soon and spent the whole weekend apartment searching out of state. Unfortunately, I have a room-temperature IQ when it comes to planning these things out, but I promise you won’t go another week without one again.
If you’re still salty, maybe this rundown on “bank” earnings will help. Thanks, DYD team!
It’s the most wonderful time of year.
No, not because spring is springing here up north. Nor is it because Red Sox opening day is today. In fact, it’s not even because tax season is almost over.
No. We’re talking about the moment we finance hardos cherish more than any other. It’s officially earnings season again, and as usual, the festivities have been kicked off with the latest quarterly drops from the U.S.’s largest banks and financial service firms.
First, I have to confess - bank earnings might just be my all-time favorite economic indicator. Huge proportions of Americans have relationships with at least one of these banks and, at the same time, their earnings show a practical measure of how well the institutions greasing the nation’s economic wheels are performing. It’s the perfect combination of economic depth and breadth (lol, Deep Breadth) and for sure is a helluva better than something like the CPI, where over a quarter of the metric is derived from a survey.
For a bird’s eye view of bank earnings, take a look at this table. We won’t hit on all of these names, but the goal here is to provide a high-level overview of the U.S. economy through the big dawgs of the financial landscape. To do so, we’ll focus on firms that have at least a mild differentiation from the rest of the pack, especially if that differentiation was shown this quarter.
Anyway, we have a lot to talk about. To celebrate this sacred event, let’s dive into the most relevant specifics from a few of the biggest banks, then generalize to a broader economic view and speculate wildly while we’re at it. Sound fun? Sweet, obviously we have to go in order of market cap, so let’s start with…
J.P. Morgan Chase & Co. ($JPM)
The numbers are in. JPM reported earnings of $2.63/sh on $31.59bn in sales vs expectations of $2.74 on $31.44bn. That’s a revenue beat of almost 0.5%, but a sorry 4.01% miss on EPS, making JPM the only firm in the set we’re looking at today to miss on the bottom line.
That’s kinda sad, but you wouldn’t know it listening to the Banking King Jamie Dimon on the firm’s conference call. Not really sure how he fit both of these statements in the same sentence but Dimon hinted that JP “remain[s] optimistic” while following that with “but see significant geopolitical and economic challenges ahead due to high inflation, supply chain issues, and the war in Ukraine.”
Whether you call it skeptical optimism or gullible pessimism, it doesn’t really matter. It seems like JP doesn’t really know either. From an investor perspective, I guess that indecision is fine? I mean, I’d rather hear them say “we don’t know but we’re prepared for whatever” as opposed to “well, we think X is definitely happening so as a result, we’re doing Y.”
Still, the pessimism around Ukraine seems warranted. Actually, it definitely is because last quarter, the firm reported a $524mn loss related to the war already. Only about a month ago, our boy Mr. Dimon claimed in his annual letter that JP’s max potential loss related to the conflict would be $1bn. Something tells me running up more than half of that “max” loss only ~7 weeks into the conflict wasn’t part of the plan…
That $524mn also contributed to the building of a $902mn balance in credit loss provisions, marking the first instance that JP has had to build this line item in almost 2-years.
From a markets perspective, however, traders were firing on all cylinders. Combined, fixed income and equity trading revenue ran up to $8.8bn, way past expectations. But, despite beating on Wall Street’s guesstimates, that figure’s got nothing on the over $9.5bn raked in from this segment in Q1 of 2021. Then again, the $GME fiasco and other mind-numbing ridiculousness of 2021 helped pad last year’s stats a good bit.
So while things weren’t great last quarter, they could’ve been a whole lot worse. Shares tumbled for the rest of the week following the report, which seems unwarranted from a fundamentals perspective, but this was also a prime week for sparking inflation fears once again. CPI clocked in at 8.5%, yet another multidecade record, and PPI saw that and said: “hold my beer”, setting an all-time record with an 11.2% annual surge.
But we’ll get more into that later. Now, we have to take a peek at…
Bank of America ($BAC)
The straggler of the group. Bank of America, per us, is just a little bit behind the rest of the gang, delivering quarterly results on a fashionably late basis earlier today. Unlike JPM, BofA’s earnings give us a lens more focused on the financial health of Main Street, meaning that from an economic indicator perspective, this straggler could be the most important of all. So, was the wait worth it? Did we go good??
In short - yes.
In long, yes, but…
Revenue growth came in just barely lighter than estimates, with analysts taking the $23.33bn raked in as roughly “in-line” with the $23.24bn expected. Earnings, on the other hand, beat with ease, clocking in per-share income of $0.80 vs expectations for $0.76.
That’s a win for Main Street as BofA winning generally = Main Street winning, too. The bank has a much larger consumer division than the likes of JPM or MS, making them basically the equivalent of a small-town credit union but for the world’s largest economy in a nation of 330mn people.
Diving into the drivers of BofA’s results, let’s start with the similarities between them and JPM. Most notably, BofA and their much-smaller-than-peers trading desk managed to kill it last quarter, dancing the night away as volatility kept the music going (shoutout Margin Call). Obviously like its rivals, revenue in this department was down compared to the GameStop & AMC-induced market equivalent of giving a chimpanzee crack-cocaine that we saw in Q1’21. Still, the $4.72bn they did manage to gouge out was just 7.1% lower than last year - aka, not bad at all.
They can largely thank Putin and his three-quarter-life crisis in the form of a war in Ukraine for that. Fixed-income trading was the primary culprit, with revenues approaching $2.6bn, a $1bn spike from the previous quarter.
But the fun didn’t end there. Lending activities seem to be performing far better for the Charlotte, NC-based titan of consumer credit. Loan balances accelerated over 10% from a year ago, crushing estimates and reaching nearly $1tn. According to CFO Alastair Borthwhich, “strong loan and deposit growth” supported this and the ~13% growth seen in net interest income, registering $11.6bn on that front.
Lastly, the true shining star of BofA’s report was mortgage originations. With average fixed 30-year rates skyrocketing to now over 5%, most banks - including JPM and Citi - are seeing huge declines in this line item. Bank of America, on the other hand, saw a 7% jump in originations.
Still, overall net profit was down 12%, so despite BofA’s 3.41% rise on Monday, investors remain somewhat skeptical about jumping into financial names for now. From a macro perspective, that’s somewhat counterintuitive as rising rate environments are generally conducive to widening the spread in which banks derive their net interest income, however the decline in regular bank operations like IPO underwriting and IB advisory fees is apparently outweighing any positives JPow is trying to throw their way.
Still, there are plenty more hoods to be looked under and industries within the financial realm we haven’t touched on. So to do that, let’s check out…
Morgan Stanley ($MS)
Similar to Bank of America (but not really to JPM), Morgan Stanley is a certified big wealth management guy. I mean, just look at Barron’s freshly released 2022 ranking of the Top 100 PWM Teams in the U.S. Notice anyone that kinda dominates?
In addition to making up 5 of the top 7 teams on this list, MS PWM hoarded 50% of the top 20 spots in 2022. I mean, in fairness we have to shout out UBS and Merrill (aka BofA) for also dominating, but they had nothing on Morgan Stanley last year.
So, with that mild differentiation, let’s see how the 87-year-old stalwart held up.
For the quarter, MS posted a revenue beat of over 4%, pulling in $14.80bn in top-line vs $14.19bn expected. Meanwhile, EPS beat estimates like they owed it money, soaking up $2.06/sh when the Street only wanted $1.93/sh.
Mind you those results come amid a quarter that saw IB revenues plummet 37% from the same period last year. Even wilder, within the “investment banking revenues” segment, advisory fees nearly doubled from $480mn in Q1’21 to $944mn last quarter. Much of last year’s M&A boom continues to linger in 2022, with a plethora of deals yet to be completed, driving the surprising growth here. On the other hand, IPO underwriting saw revenues jump off the Brooklyn Bridge, falling 82% from over $1.5bn 12-months ago to just $258mn. In case you still weren’t sure, safe to say the IPO and SPAC boom are laying on their deathbeds.
But obviously, as shares jumped nearly 3% following the release, it wasn’t all bad. Like its bulge-bracket brethren, trading revenues saw a fat boost. Well, really only equity trading, because, unlike peers, fixed-income trading at MS was basically flat from a year ago (down around 1.4%). Thankfully, equities saw a 10% jump, lifting the desk’s revenue to a point where trader bonuses will still clear.
Now for the fun stuff. In total, revenue derived from wealth management fell just under half a percent. Profitability dropped slightly as well, but it’s the breakdown of this segment that’s worth looking at.
For starters, transaction-based revenues fell off a cliff. It wasn’t as bad as the disgusting drop in IPO revenues, but a 48% decline is still pretty bad. Excluding losses from mark-to-market impacts, revenues were down “just” 20%, suggesting that reduced trading activity from clients was the primary culprit here. It’s not just the retail side that’s taking a breather from last year, but even institutional investors are taking their feet off the pedal for now.
Meanwhile, asset management revenues grew a respectable 14%. This is really the first time we get a true annual comp of Morgan Stanley’s asset management business since the E*Trade acquisition, and given the blend of institutional and retail investors that came with that acquisition, this line item could be the optimal pulse for measuring broad-scale investor sentiment. That 14% growth certainly has the S&P 500’s mild appreciation from a year ago to thank in part, but continued positive flows and the fees derived therein was the main driver of growth, suggesting that investors largely remain confident in U.S. stocks despite recent blowups.
But, if we really want to gauge investor sentiment from a flows perspective, we’re gonna have to go a helluva lot bigger. To do so, let’s check out the king of all financial kings, which of course is…
Given that every time we wake up the world seems collectively bleaker, you might think investors would catch on to that and maybe chill out with the buying for the time being. In fact, the exact opposite of that happened. It seems now that everyone and their mother knows to “be greedy when others are fearful” and vice versa, but damn I did not think we knew it this well.
If there’s one number you remember from this section, let it be this: $114bn. $114bn is the amount of long-term net flows that investors poured into BlackRock funds last quarter. In case it’s not obvious, that is a ton of money.
Of that $114bn, ETFs soaked up the majority, raking in $56bn, continuing their multi-decade quest to eviscerate mutual funds and all other forms of investment. Within those ETFs, Core Equity was the prevailing strategy, giving reason to believe that under the constant shouting of economic fears and growth stock tears, investors still can’t get enough equity market exposure.
The resilience of investors is on full display, from both institutional and retail perspectives. Both groups saw massive inflows last quarter, with institutions soaking up $47bn of BLK funds while retail managed to buy up $10bn. For institutions, index funds dominated active, pulling in nearly 2x that of the former. Meanwhile, retail bros were all about U.S.-focused funds, putting 80% of their net flows into that category, but, when we break it down by region and account for all kinds of investors, EMEA and APAC absolutely dominated Americas-focused funds.
BlackRock investors, which can be viewed as a microcosm for the general investing public, are telling us a few things here, including:
We’re super bullish
But we’re less bullish on the U.S. and
We just have so much money we don’t know what to do with it
It’s kinda weird that investors poured much more money into Europe than the Americas last quarter, but then again, by the time Putin invaded Ukraine, the quarter was basically two-thirds over. Much of those flows could very well be early 2022 dollars that saw the E.U. as being slightly less hawkish on inflation and thus less willing to jack up rates in the way that JPow has very vocally planned to do. Something tells me regional flows look a lot different in March than in January.
But regardless, by the end of the quarter, total assets sat around $9.57tn, down from the $10tn surpassed at the end of 2021. Investors weren’t too shaken by the 2% revenue miss, delivering a nice $4.69bn while the Street wanted $4.8bn, but that’s likely because EPS still managed to beat, pocketing $9.35/sh vs $8.67 expected.
All Together Now
So there we have it. The numbers are (mostly) in when it comes to big dawgs of the financial world. Through their mixed messages, conflicting guidance, and classic bullsh*ttery, observers like us are left somewhat dazed and mildly confused. So, let’s try to synthesize.
For starters, consumers are doing great. Both lending and deposits were broadly up, albeit across different metrics and varied by institutions. Main Street balance sheets being kept in good condition despite price pressures and literal war in Europe is impressive, but I guess $10tn in pandemic-related spending will help with that. Still, the lesson is that there’s no reason to think consumers are going to throw us into a recession anytime soon.
Trading revenues keep killing it, but you can pretty much guarantee any period that sees the VIX break 30 at some point will be great for trading desks. Not bad, but I’m not impressed.
Institutional services continue to fall from their pandemic heights, largely as market frothiness dissipates and deal makers slowly regain their brain cells. Odds are we’ll be back at 2019 trend levels within the next 12-18 months, barring any hissy fits the markets throws as JPow raises rates and lowers the balance sheet.
Finally, investors are killing it. From the UHNWIs at Morgan Stanley’s WM business to casual Robinhood traders buying $IYW, everyone appears cautiously optimistic, as we should be. We can also consider the fact that maybe investors have finally learned that inflation is lowkey good for stocks, as long as the economy doesn’t crumble.
All in all, not a bad quarter for financial names. At time of writing, State Street’s flagship financials ETF, $XLF, sits down just over 6% for the year. But as investors digest the new, non-pandemic-induced conditions of the financial landscape, particularly in a policy tightening environment, it’s hard not to be bullish for the rest of 2022.
Disagree? Tell me why. As always, thanks for reading and let me know where I’m wrong!
- Markets Aurelius