Macro: Sandcastle economics
Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.
Summary: Earnings season kicks off this week with US financials dominating the initial releases. Last earnings season the financials were index laggards reporting disappointing results as the COVID crisis raged. This 3Q earnings season will no doubt confirm the sector remains under pressure, and very much in the eye of the COVID storm, but low expectations and falling loan loss provisions, alongside FICC revenues bolstering results could see the bigger banks in particular meeting and beating the lowered bar.
3Q earnings season begins this week, with the big US banks kicking off the show. Citigroup and JPMorgan Chase are first up on Tuesday, followed by Bank of America, Goldman Sachs Group, and Wells Fargo on Wednesday. Morgan Stanley reports on Thursday.
More broadly this earnings season will provide investors with an update on company fundamentals which is likely to cement the picture of the “K-shaped recovery” that we see represented in the stark divides between COVID winners and losers. The divergence visible not only at an index level when we look at the divergent recovery trajectories for technology stocks vs. for example, energy or travel and leisure stocks, but also throughout the economy as a whole. Large vs. small companies, white collar worker vs. frontline, automation vs. human contact, asset rich vs. otherwise. Although with financial markets settled into the present liquidity driven paradigm, these dynamics matter more for the real economy and its social fabric.
However, as earnings kick off risky assets are more focused on the ongoing fiscal stalemate, paused vaccine trials and the upcoming election, where increased odds of a “blue wave” and substantial stimulus spend in the new year is supporting sentiment. We are just 3 weeks out from the election and although investors seem comfortable with the prospect that another round of fiscal spending may not eventuate prior to the election, remaining focused on the prospect stimulus is coming at some point, whoever wins, there remains a lot of noise with respect to news flow. This supports the notion of choppy, rangebound markets until the election is out of the way. It is true that the trajectory of both fiscal and monetary policy, alongside the economic recovery path and the prospects of a vaccine will outweigh the election result, but there remains some ground to cover until we get there with a potentially noisy period for news flow to traverse in between.
What to watch as banks kick of 3Q earnings this week:
In recent weeks US banks have outperformed the broader index in tandem with the reflation narrative that has driven risky assets. 3Q earnings should confirm this momentum given the lowered bar to meet and beat expectations.
However the earnings themselves are less important in the current environment. What matters more for the share prices is:
The reflationary narrative that has gripped market sentiment, bolstered by the increased probability of a democratic sweep, supports a steeper yield curve and could be positive for the US banks into 2021/2022. A steepening yield curve means widening profit margins for banks, who borrow short and lend long, although more broadly lower yields relative to cycle highs will still constrain interest margins.
The US desperately needs the next round of fiscal stimulus – stimulus gap may emerge in Q4 economic data with no deal on Capitol Hill prior to the election. US 3Q financial sector reports are likely to highlight the fact that unprecedented government and central bank stimulus has been critical.
Better 3Q results for the big US banks aside, it is stimulus that has driven the economy in recent months, and has been critical in averting the worst case scenario for the economy. In many ways bridging the gap between crisis and the post pandemic return to normalcy. The present gridlock in Washington increases the risk of economic scarring with unnecessary layoffs and business closures that may occur with the stimulus gap in play. A concerning dynamic which will be negative for consumption down the track, the recovery momentum is too fragile to go without and monetary policy is pushing on a string.