Inside Markets — Earnings Season

Large cap diversified banks always kick off earnings season, and the market reaction to good/bad results often sets the tone for the quarter.  The Q2 earnings bar for the large cap diversified banks is high, and the group already trades at a valuation premium to long-term historical averages.  Wall Street uses different valuation methodologies for each equity group, and banks are generally valued on a price to tangible book value (P/TBV) basis.  Large-cap diversified banks now trade at 1.7x P/TBV vs. their long-term historical average of 1.3x.  Valuation metrics matter more for equity groups with slower earnings growth potential.  Large cap banks don’t usually generate a lot of earnings growth, so they tend to stay in a valuation range between 0.9x and 2xTBV.  Banks are a cyclical equity group and the best time to add cyclical equity exposure is when valuations are low.  This usually happens in the late innings of a recession as the yield curve steepens in anticipation of policy easing.  A good portion of the current valuation premium is likely due to a more favorable regulatory environment, but the rally over the last month (outperformed SPX by 2x) was on increased expectations for rate cuts.  Maybe the most important takeaway from these early reports is the degree to which disappointing results (WFC) are punished, and better results (C) are rewarded.

Overall, the Q2 SPX earnings bar is low with expected revenue growth of +4.2% and EPS growth of 5% with 12.3% profit margins.  Notwithstanding a spike in implied volatility (VIX>22 on growth shock), an in line or better Q2 earnings season should keep the SPX above technical support in the 6025-6060 zone until NVDA reports on 8/27.  All bets are off after Labor Day when sell-side industry conference season usually results in downside year-ahead estimate revisions.