There’s really nothing wrong with the shares of Capital One Financial (COF) that a stronger U.S. economy, a more confident U.S.consumer, and an interest rate increase–or two–from the Federal Reserve wouldn’t fix.
It’s just that I don’t see any of these in the cards in the near term–December at the earliest for a move by the Federal Reserve. And the Fed seems to be deep into holding the course until it can collect some evidence that inflation is a real danger (especially with an election looming.)
I bought shares of Capital One for my Jubak Picks portfolio back on December 10, 2015, when it looked like the Fed might actually deliver not just a December interest rate increase but two more increases in 2016. That would have given banks a big boost toward higher net interest margins on their capital and would have been a sign that the Fed was optimistic about the U.S. economy.
If those interest rate increases aren’t pending and if faith in the economy seems increasingly a matter of faith and not data, I think it’s time to call this buy “premature” and sell these shares. Shares of Capital One are up 18% from the June 27 low as of the close today, August 18. (But my position in these shares is still down 13.66% since that December purchase.) That recent gain brings them pushing up against the 200-day moving average at $69.57 and to a position near the top of their recent volatility range as sketched by the Bollinger Bands indicator. The stock has shown a recent pattern of lower highs with the shares failing to reach the April 26 high of $75.91 or the May 27 high of $73.83. The July 14 high was $68.85. By all these measures Capital One is starting to look, if not expensive, at least stretched.
The bank’s second quarter results fed into my decision to sell because they show a bank that is itself acting as if it sees dangers in the economy. For the second quarter, Capital One reported operating earnings of $1.76 a share, slightly below the Wall Street consensus at $1.86.
The miss was largely the result of a build in reserves as the bank added $465 million to the money it has put aside for troubled loans and credit card accounts. $298 million went toward reserves for the bank’s big U.S. credit card business, but the bank also set aside $58 million largely for its subprime auto loan portfolio.
The caution evidenced in the results as of the end of June looked well founded when the bank reported on July operations recently. Credit losses in its international credit card business rose 12 basis points to 3.64%. Credit losses were down 12 basis points from June but up 76 basis points year over year. Dollar delinquencies rose 18 basis points as percentage of loans from June. Credit card loss rates historically improve in the second quarter at Capital One and then increase again in the fourth quarter.
In its second quarter earnings call bank management said that it expects to see margin compression in the second half of the year driven by declining margins on auto loans and by the current and continuing low level of interest rates. (In July credit losses from auto loans increased by 25 basis points to 1.71% from June. That’s only a tick higher than the 1.70% rate of credit losses in June 2015.
Wall Street analysts have been lowering their earnings estimates for the third and fourth quarters of 2016. The consensus estimate of $2.08 for the third quarter 30 days ago is now down to 1.96 a share. For the fourth quarter the consensus estimate of 30 days ago at $1.70 has crept lower to $1.66 a share.
I still like the bank’s credit card business as a driver of future revenue growth but I just think the current interest rate environment makes it very hard for the bank to generate earnings growth from this business.
Time to review these shares when Fed policy clearly turns toward higher interest rates.
Second quarter earnings results announced this morning by JPMorgan Chase (JPM) held solidly good news for the U.S. economy. Not as much good news for the bank and the banking sector in general, though. JPMorgan Chase is the first of the big banks to report with Citigroup (C) and Wells Fargo (WFC) on deck tomorrow.
Loans of all kinds extended by JPMorgan Chase rose $106 billion from the second quarter of 2015. That’s a 16% increase. “We had broad-based demand for loans pretty much across categories, whether it was auto, business banking, cards, so I would say that speaks well for the U.S. economy and the consumer in particular,” Chief Financial Officer Marianne Lake said.
Figuring out how the bank itself did in the quarter is harder. As reported earnings were $1.55 a share, up from $1.54 a share in the second quarter of 2015, and ahead of the $1.43 a share estimated by analysts. (Net income was down year to year from $6.29 billion in 2015 to $6.2 billion on a lower share count because of share buybacks.)
But that as reported earnings figure included all kinds of one-time charges and credits including an accounting gain and a legal benefit plus a gain from the sale of the bank’s stake in Visa Europe and a loss on the bank’s investment in Square. Adjusting for all those one-time gains and losses earnings came to $1.50 a share, down from $1.54 in the second quarter of 2015 but still above Wall Street estimates of $1.43 a share.
Revenue growth wasn’t as robust as you might expect from growth in the bank’s loan portfolio or those earnings per share figures. Revenue climbed just 2.8% year over year to $25.2 billion powered by a big 35% jump in revenue from fixed income trading. Revenue from equity trading rose just 1.5%.
Earnings grow was so much stronger than revenue growth because JPMorgan Chase continued to cut costs. Non-interest expenses fell 6%. Compensation costs at the corporate and investment bank fell 6% in the first six months of 2016.
I’d look to see if consumer units at Citigroup and at Wells Fargo tomorrow report that same strong picture. (Pay special attention to Wells Fargo’s big mortgage unit.) If consumer lending is as strong tomorrow at those banks as at JPMorgan Chase today that’s good news for the economy as a whole. Make sure to pay special attention to provisions for credit losses. That item rose to $1.4 billion at JPMorgan Chase, an increase of $467 million, from the second quarter of 2015. The bank said that was a result of the increase in the loan portfolio and not a sign of a deterioration in credit quality. See if other banks echo that comment.
On my paid site–China weakens the yuan, Japan looks to stimulus, why bargain hunting is so hard on this dip, and my take on bank stocks
On my paid site JubakAM.com I aim for a mix of posts on macro trends and on individual stock picks. It’s a strategy I call tactical stock picking.
Over the last few days on this free site and on my paid site, I’ve posted my views on the short-term and medium-term effects of the Brexit vote.
In addition to those posts on my paid site I’ve tried to remember that not everything is about the U.K. and European markets and economy.
For example, today the People’s Bank of China lowered the dollar/yuan reference rate. The last two times the People’s Bank did this–in January and last August–it contributed to an emerging markets sell off. The fears in those markets were that a strong dollar and increasing competition from lower priced Chinese goods would make it tougher for companies from Brazil to India to sell their goods.
Today’s rally, June 28, looks to be based on hope that global central banks will start new stimulus packages. First one up I note in a post today on JubakAM.com, looks to be Japan where the government has proposed new stimulus to weaken a yen that has soared on the flight for safe havens after Brexit.
I’ve also posted, twice, on why the Brexit crisis is so tough on bargain hunters. The first, more general piece, looks at how this is likely to be a very extended crisis–which means that the markets will have time to vacillate between hope and fear a number of times over the next two years. The second, a more specific piece, applies this logic to the banking sector. The tough thing about finding bargain investments among bank stocks is that the sector is undergoing so much change that its hard to know what stocks are selling off because they should and what stocks are bargains because this crisis hasn’t changed favorable fundamentals. I end with a list of stocks to watch as trends in the banking sector develop.
That’s what I’m working on at my subscription JubakAM.com site. (I’m still, yes still, at work on what’s turned out to be a very complicated post on the robotics sector and on one about water stocks that should go up on JubakAM.com in the next day or two. Before those get posted, though, I be putting up a post 0n Brett bargain hunting in the technology sector and the timing of any search for bargains..) I think there’s some value to you in passing on the direction of my thinking about the market on that site. Hope so anyway.
Of course, there’s an ulterior motive to sharing this with you: If you decide that you’d like more of my thoughts on the market in my JubakAM.com posts, I’m hoping that you’ll subscribe to my site at JubakAM.com for $199 a year. (By the way, you can get a full refund during the first seven days if you change your mind for any reason.)
Welcome back to December! Remember when the financial markets thought the Federal Reserve was going to raise interest rates three times or maybe even four times in 2016 and suddenly bank stocks were the thing to own? (At least until January when the Fed pulled back from its three or four times language and the market decided that one or none was more like it for interest rate increases in 2016 and sent the sector into a dumpster.)
Well, the positioning was back today–even if just for a day. After last week’s minutes from the April meeting of the Federal Reserve and after jawboning by half the Fed board of governors (it seems), financial markets have decided that a June interest rate increase could be back on the table–odds are now up to 36% from 4% before the release of the Fed minutes–and if not June then quite likely July–odds for a July increase climbed to 54% today.
That was more than enough to help the Standard & Poor’s 500 stock index to a gain of 1.4% as the index tacked on 28.02 points to hit 2076.06, comfortably, again, above the 2050 level that triggers worry that the S&P 500 is going to break through the bottom of its recent trading range.
The way upward was led by, you guessed it, banks as the SPDR S&P Bank ETF (KBE) climbed 1.86% led by stocks such as Morgan Stanley (MS) up 2.16%, JPMorgan Chase (JPM) up 1.7%, Bank of America (BAC), up 1.45%, and Capital One Financial (COF), up 1.37%. (Capital One is a member of my Jubak Picks Portfolio.)
The logic here is that bank earnings will climb if the Federal Reserve raises interest rates since that would increase the interest rate that banks can charge on their loans.
Of course, the growing conviction that the Fed will raise interest rates sooner rather than later (just two weeks ago you had to go out to February 2017 (and not July 2016) to find a Fed meeting that got better than 50% odds for an interest rate increase) took its toll on other sectors today. Gold fell another 1.8% to $1232 an ounce to set its longest losing streak since November. The dollar held near its recent two-month high against the euro.
There’s been precious little staying power to any market trend recently and today’s love affair with banks may prove to be short-lived as well. At an investor day event today Wells Fargo (WFC) lowered its projections for its 2016 return on assets to 1.1% to 1.4% from the 1.3% to 1.6% it projected at its 2014 investor day. For the full 2016 year the bank is now looking for a return on equity of 11% to 14%, down from 12% to 15%.
The big culprit is the bank’s large portfolio of energy loans and the company told investors it was taking steps to reduce the size of its portfolio of those loans. Wells Fargo said it had cut credit lines on 68% of the energy companies it had reviewed.
But it’s what the bank said about its net interest margin that might have the most impact on a continued bank stock rally. Because Wells Fargo, like many banks, has moved to reduce risk in its portfolio, it now expects that a 100 basis point upward shift in the yield curve after a Federal Reserve interest rate increase would add 5 to 15 basis points to its net interest margin. Previously the bank had estimated that a 100 basis point shift in the yield curve would add 10 to 30 basis points to its net interest margin. (100 basis points equal one percentage point.)
So here’s how this earnings season is playing out so far in the banking sector.
Beat really grim forecasts for earnings and revenue in the first quarter, shares go up–see JPMorgan Chase (JPM) yesterday.
Come close to those grim estimates, and shares go up–see Bank of America (BAC) today.
Beat grim projections, but show trouble in a core business, and shares move down, slightly–see Wells Fargo (WFC) today.
What we haven’t seen to date is the market’s reaction to a high-flying growth stock missing forecasts. That’s still to come.
Back to banking.
Adjusted earnings per share at Bank of America fell to 20 cents for the first quarter. That’s down from 25 cents a share in the first quarter of 2015, but only a penny short of the average estimate among Wall Street analysts.
Revenue dropped by 6.7%, falling below the $20.4 billion estimate on Wall Street, as revenue from trading operations dropped 16%. Investment banking fees fell, leading to a 22% retreat in the global banking division.
The one bright spot was consumer banking were profit rose 22% on a cut in expenses Profit at the wealth management division, which includes Merrill Lynch, rose 13% as lower expenses offset a drop in revenue.
And, as at JPMorgan Chase yesterday, Bank of America put aside another $525 million in loan loss provisions for its energy portfolio. That brought the loan loss provision for energy loans to $1 billion as of March 31. At the same time the bank reduced the size of its energy loan portfolio by $325 million from the first quarter of 2015.
Wells Fargo showed better results than Bank of America or JPMorgan Chase–except in its energy loan portfolio. Which is a big deal since Wells Fargo is Wall Street’s top oil and natural gas lender.
Earnings per share slid to 99 cents a share from $1.04 a share in the first quarter of 2015. That was 2 cents a share above Wall Street estimates. Revenue grew by 3.8% to $22.2 billion, beating analyst estimates for $21.6 billion in revenue.
The big red flag, completely expected, came in energy lending where the bank set aside another $500 million (a popular figure, no?) in provisions against bad loans in its portfolio of energy loans. Wells Fargo had $17.8 billion in outstanding loans to the energy industry, about 2% of its loan portfolio, at the end of the first quarter. (In addition Wells Fargo paid $1.2 billion in February to resolve government claims related to its mortgage practices from 2001 to 2010.)
In other, but very related news JPMorgan Chase, Bank of America, and Wells Fargo were all among the too-big-to-fail big U.S. banks to have their living wills rejected by the Federal Reserve and the Federal Deposit Insurance Corp. The banks, along with State Street and Bank of New York Mellon were told that their plans for entering bankruptcy in the next financial crisis were not credible. The banks have until October 1 to rewrite their plans or face the possibility of higher capital requirements. Among the eight too-big-to-fail banks only Citigroup’s plan earned a grudging pass from both regulators although even Citigroup was told it needed to improve its plan. Goldman Sachs and Morgan Stanley received a pass from only one of the two regulators.
Citigroup (C) is scheduled to report on Friday; Morgan Stanley (MS) and Goldman Sachs (GS) will release results next week.