Investors’ buoyant outlook on US banks, which propelled stocks higher at the close of 2024, is about to face a rigorous test as earnings season kicks off this week.
The performance reports of the largest US lenders will reveal whether the recent rally is sustainable or if the sector is poised for a more turbulent year.
Post-election rally and the need to justify fundamentals
The stocks of major US banks had rallied following Donald Trump’s election victory, driven by expectations of deregulation and a more lenient approach to corporate mergers.
However, as these banks prepare to report their fourth-quarter and full-year 2024 results this Wednesday and Thursday, investors are now looking for concrete evidence to back up these optimistic valuations.
“Any sector, any stock that comes a long way in a short period of time, had better deliver the fundamentals to justify that type of move,” Interactive Brokers chief strategist Steve Sosnick told Yahoo Finance.
Record profits expected, but quarterly dips anticipated
JPMorgan Chase, the nation’s largest bank, is expected to announce its second consecutive year of record profits, with fourth-quarter earnings showing an increase compared to the same period last year.
Analysts also anticipate that Bank of America, Wells Fargo, Citigroup, Goldman Sachs, and Morgan Stanley will report profit increases for both 2024 and the fourth quarter, compared to the same periods in 2023.
However, these positive results are expected to be tempered by a decline in fourth-quarter profits compared to the third quarter of 2024.
Focus shifts to 2025 outlook amid economic uncertainty
The primary focus of investors will likely be the banks’ outlooks for the coming year, particularly given the volatility surrounding inflation, the US economy, the policies of the incoming administration, and future interest rate decisions.
A strong December jobs report, signs of persistent inflation, and potential shifts in trade policy under the new administration have led many Wall Street strategists to believe that the Federal Reserve will hold off on further interest rate cuts for now, and that the door has been cracked open for possible rate hikes in 2025.
A bullish scenario for banks, but risks remain
There is an argument to be made for how banks will fare this year, particularly after a full percentage point of rate cuts from the Fed in 2024.
Interest rates, while still high enough for banks to earn robust lending margins, have also come down far enough to give some bank borrowers a measure of relief.
Furthermore, dealmaking is picking up, with companies issuing debt at a record pace and initial public offerings (IPOs) increasing, while the Trump administration is expected to scrap a set of proposed capital rules that would have limited future profits.
“I don’t want to be like Pollyanna-ish, you know, there are certainly some wild cards out there but the outlook overall is pretty good,” Piper Sandler bank analyst Scott Siefers told Yahoo Finance.
The “wild card” of interest rates
The direction of interest rates remains a key uncertainty, and a major wild card for the year ahead, Siefers noted.
Even as the Fed has reduced its benchmark rate, longer-term rates have increased due to concerns about inflationary pressures.
These higher long-term rates could have a double-edged effect on banks, potentially creating higher unrealized losses on their bond portfolios and decreasing fixed income trading revenue, while also posing risks for corporate customers.
Conversely, these higher rates could also allow banks to charge more for their loans.
“We make a lot of money if that happens,” PNC Financial Services Group CEO Bill Demchak said at a Goldman Sachs conference last month.
However, Demchak also expressed concern that such an outcome could hurt the economy.
Net interest income key to bank performance
Bank analyst Mike Mayo predicts that if long-term, 10-year rates do not exceed 5% to 6%, a key revenue source known as net interest income will “inflect” across most US banks after the first quarter.
Net interest income represents the difference between what banks charge on their loans and pay on their deposits.
“Choo choo, the train is taking off but mind the gap so you don’t break a leg or anything,” Mayo, who works for Wells Fargo, told Yahoo Finance, underscoring both the potential and the risks ahead for the banking sector.
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