After a solid new-year rally, top US banks begin reporting their fourth-quarter earnings on Friday. Investors remain optimistic that higher interest rates and improving demand for credit will fuel further profit growth.
The benchmark KBW Bank Index, which tracks 24 of the largest US lenders, is off to its best yearly start in more than a decade, surging more than 11%. This enviable performance comes on top of 35% gains that the index delivered last year.
As inflation rises to its highest level in about four decades, we believe that the Fed’s growing hawkish stance will continue to benefit bank shares.
Higher interest rates bode well for the sector as banks can charge wider margins on their lending products, which include credit cards, lines of credit, and credit cards.
As a note to clients last week from Raymond James pointed out:
“Rising rates and acceleration of loan growth are the two biggest catalysts for investors to become more bullish on bank stocks.”
Further Upside Potential For Sector
Among the largest US banks, Wells Fargo (NYSE:WFC), JPMorgan Chase (NYSE:JPM), and Citigroup (NYSE:C) will report their Q4 earnings tomorrow, Friday, Jan. 14 ahead of the US session open. Expectations are that growth momentum has more room to run.
One of our favorite picks from this group, JPMorgan, is forecast to report $29.87 billion in revenue and earnings per share of three cents. In Q3, JPM turned in record quarterly revenue for advising on deals and one of the best results ever for total investment banking fees.
Its shares closed on Wednesday at $168.44 after gaining about 6% this year. According to InvestingPro’s trading model, the stock’s average fair value is $181.88.
Source: InvestingPro
That implies another 9% upside potential.
Push From Consumer Spending
Combined with the government’s massive infrastructure spending and gradual tapering of monetary stimulus, banks could see demand for credit increase substantially this year as companies and individuals use up the liquidity accumulated during the pandemic.
This trend was visible during the third quarter when customer spending eclipsed pre-pandemic levels, a trend many bank executives saw continuing into the holidays. For example, spending on Citigroup's credit cards jumped 20% from a year ago to a record.
While most analysts agree that banks will deliver on expectations for accelerating loan growth, the spread of the Omicron variant may dampen the lending business in the short run.
According to a recent note by Wedbush in a Bloomberg report:
“Loan growth in the first quarter may hit a speedbump from the impact of the Omicron variant, but we expect growth to resume an upward trajectory throughout the rest of 2022.”
Bottom Line
After their impressive start in 2022, bank stocks continue to look attractive, with many macro trends remaining favorable for their businesses.
JPM remains our favorite financial sector pick due to its diversified portfolios and stronger balance sheets. In our view, any post-earnings weakness should be considered a buying opportunity for long-term investors.