Bank of America (BAC) reported strong beats on both its top and bottom lines this morning. However, shares struggled out of the gate and did not turn positive until the afternoon, as the S&P 500 (^GSPC) broke to new highs for April. The price action is best understood in conjunction with the events that unfolded last week.
In a perverse turn of events last week, large-cap banks reported Q1 results on Friday morning and largely beat consensus expectations for EPS and revenue growth, but fell victim to a dramatic selloff after markets opened. Three of the largest banks reporting, JPMorgan Chase (JPM), Citigroup (C) and Wells Fargo (WFC) all lost meaningful ground on the session, and in the process weighed down the financial sector and broader market. Solid earnings results, coupled with revenue growth and constructive guidance, “should” lead to rising prices, but that was not the case on Friday. In the case of the banks that have reported so far, and the sector, generally speaking, investors have been very optimistic in regards to performance expectations for several quarters — if not years. Even though Q1 results on Friday did justify further price appreciation, investors moved on from the trade.
Several tailwinds have fueled the positive expectations for the sector: Scaled back costly and redundant regulations, rising interest rates, increasing net interest margin, tax reform, and a resurgent economy. Investor consensus on the space is that though Q1 results have thus far been solid, how much further can prices and valuations rise in the near term?
Additionally, it appears as those tailwinds are being at least partially offset by rising expenses. Those expenses may be the result of M&A activity, consolidation, a competitive marketplace, strategic growth and investment, or any number of factors, including increased costs associated with inflation and wage gains. That said, the tide is, in fact, rising for banks. All of those factors that investors have expected to push prices and performance over the past several years have been playing an increasingly positive role in the significant rise in prices enjoyed by the banking sector recently. In fact, banking stocks have largely outperformed the broader market by a wide margin over the same period.
The reason for the counter-intuitive weakness witnessed on Friday has more to do with the fact that the banking sector has become relatively stretched in comparison to the broader market. Friday was a case of buy on the rumor, sell on the news. The banking sector will continue to provide investors with an ideal vehicle with which to price in continued economic acceleration and growth. The sector simply needs to digest a degree of rotation into other sectors of the market that sport less stretched valuations.
The results of last week’s economic calendar, though largely in-channel, did not provide much meaningful lift to the broader market. The NFIB Small Business Optimism Index for March slipped from February’s 107 to 104.7. March’s PPI-FD was 0.3%, less food and energy Y/Y, was 2.9%. Interestingly, the CPI for March was -0.1% versus the prior reading of 0.2%. The FOMC minutes for 4/11 had one significant takeaway in that the Fed is expecting inflation to achieve its 2% target later in the year, but that is not news and does not materially impact the current expectations for timeline tightening. Crude inventories rose 3.3M barrels in the previous week, but given the recent tightness in supply and the ongoing concern over military action in the Middle East, crude prices held their ground. In fact, it would appear as though another leg up in prices is in the offing. Finally, the import and export price data for March was flat: zero. February’s revised reading was 0.3%. In short, the week’s economic data was, if anything, a tad less dramatic than the Street was expecting. Additionally, the economic calendar was overshadowed by both earnings and tensions in the middle east.
This week, equity markets will again be dominated by Q1 results. This week’s economic calendar will feature nine Fed officials speaking. On Monday we receive retail sales and the Housing Market Index; on Tuesday, housing starts and industrial production; on Wednesday, the Fed’s Beige Book. And leading indicators, the Philly Fed Business Outlook Survey and weekly jobless claims, round out the week.
It will be a busy week for earnings. BAC, CE, MTB, NFLX, and PNFP take the spotlight today. On Tuesday, CMA, CSX, GS, IBKR, IBM, ISRG, and UAL will drive the narrative as we move away from banks and into transports and logistics. ABT, AA, AXP, and CCI will provide investors with a broader view of how corporate America and the US economy faired in Q1. On Thursday and Friday, we hear from ABB, BK, BBT, DHR, NVS, and BHGE. Further details may be found here.
I continue to expect to see volatility decrease while equity markets post additional, though uneven gains this week. The best case scenario for the bulls remains ongoing and constructive Q1 corporate results and constructive economic data. Both themes should provide soft support for the market’s attempt to move higher — away from our double bottom, which was confirmed on April 2. That said, markets remain vulnerable in the near term. As evidenced by the chart above, since the double bottom formed by the February and April lows, the rebound staged by the S&P 500 has been relatively anemic. Volume has tapered off, and price gains have been uneven. Additionally, the 50 DMA is beginning to move dangerously close to the 200 DMA — sure to generate headlines of “death cross” should they cross over. We have not yet received confirmation that the worst of the correction is over.
Commentary by Sam Stovall, CFRA chief investment strategist
The decision by Speaker of the House of Representatives Paul Ryan not to seek reelection adds to the already lengthy list of uncertainties to be dealt with by investors. We believe it increases the likelihood that the Republicans will lose control of the House of Representatives in the midterm elections, thereby reducing the possibility of dangling additional economic carrots (such as tax reform) in front of investors to push share prices higher. Future advances will likely be driven by EPS growth and interest rates. Yet 2018 is not too dissimilar to prior midterm election years, which have traditionally experienced higher volatility and lower returns. Indeed, during the second and third quarters of mid-term election years, the S&P 500 saw 12.5% and 23.6% increases in average daily volatility relative to all years since 1945. In addition, the 500 recorded the two worst average quarterly price returns in Q2 and Q3 of mid-term election years, falling more than half of the time in that six-month stretch. Yet this uncertainty tends to dissipate after the elections. In the 12 months following mid-term elections, the S&P 500 rose in 18 of 18 years by an average 16.6%.