Some of the largest financial institutions in the US will unofficially kickstart the second quarter earnings parade, with JP Morgan Chase, Wells Fargo and Citigroup reporting their financial results on Friday before Wall Street’s opening bell. The banking sector came under pressure in March following the collapse of four regional US banks, but recently regained investors’ trust after most US banking giants aced the Fed’s annual stress tests. Can the financial sector display healthy fundamentals and fend off any macro concerns?

Harsh first half but fears subside

The banking sector started the year on the front foot as analysts were anticipating that banks could continue to capitalize on higher net interest margins, which are essentially the difference between the interest income generated by long-term assets such as loans and the interest expense paid to short-term liabilities such as deposits. Moreover, even though the global economy was slowing down, the probability of a severe recession that would spark an apocalypse of non-performing loans (NPLs) had been minimal.

However, this euphoria got disrupted by the collapse of few US regional banks, which were driven by mass deposit withdrawals as they failed to pass on higher interest rates to depositors. These failures triggered speculation that even bigger financial institutions could go under, resulting in a brutal sell-off for bank stocks, which have been severely underperforming major US indices so far in the year.

For this earnings season, the S&P 500 financial sector is set to report a 5.4% earnings growth on an annual basis, substantially lower than the 7.7% reported last quarter. Moreover, as has been the case in the last few quarters, financial institutions with larger exposure to traditional banking will probably outperform those whose business relies more on investment banking and deal-making.

Loans and provisions under the spotlight

This earnings season is likely to garner a lot of attention as investors keep grappling with a wide variety of risks within the banking sector. Firstly, we are going to get an updated view on whether banks will keep increasing their gains from loan businesses.

On the one hand, large banks saw huge inflows of cash during the US regional banking crisis, which bolstered their ability to hand out loans. Nevertheless, there might soon be a fresh wave of defaults as borrowers continue to get squeezed from inflation at a time when the pandemic stimulus has evaporated, and the economy is slowing down. Furthermore, demand for mortgages is subsiding due to the high level of interest rates, while commercial real estate remains under pressure.

For all the above, the level of loan provisions will be of particular interest as it will reflect the banks’ outlook on how deep they expect any upcoming recession to be. Will the latest success in the Fed’s annual stress tests enable them to set aside less capital and improve their profits?

In other news, markets are expecting investment banking and trading activities to continue to struggle, but this is more likely to be reflected in investment banks such as Goldman Sachs and Morgan Stanley, which will report next week.

Valuations remain attractive

The March sell-off compressed even further the examined banks’ low valuations, suggesting that investors still see some downside risks surrounding the financial industry. This is more than evident by the fact that banks’ forward 12-month price-to-earnings (P/E) ratios are on a steady decline in a period when the S&P 500’s is continuously increasing.

Overall, someone could argue that bank shares are currently in a ‘buy the dip’ zone from a historical comparison perspective, especially if they deliver better than expected results.

JP Morgan and Wells Fargo shine, Citigroup struggles

JPMorgan has been the best performer among the major banks in 2023 as its credible status helped to attract a large number of deposits from the endangered smaller US regional banks. The firm is anticipated to record revenue of $38.87 billion, according to consensus estimates by Refinitiv IBES, which would represent a year-on-year increase of 22.90%. Additionally, Earnings per share (EPS) are estimated to increase by 44.72% on an annual basis to $3.99.

For Wells Fargo the fundamental picture remains extremely positive given that it is one of the biggest lenders in the US. The leading financial institution is on track for a 14.02% annual increase in its revenue figure, which could reach $20.07 billion. Meanwhile, EPS is expected to decline from $1.23 last quarter to $1.16 but mark a 41.38% increase in annual terms.

Citigroup will likely face a tough earnings season, exhibiting major underperformance compared to the other two examined banks. The major investment bank is set to post an annual revenue decrease of 1.86% to $19.27 billion. Also, its EPS is projected at $1.30, a 43.46% decrease relative to the same quarter last year.

Will the recovery persist for JP Morgan?

Taking a technical look at JP Morgan, we can see that the stock price has erased its March slump, while posting a fresh 17-month high of $147.50 in early July before paring some gains.

For the uptrend to extend further, the price needs to reclaim its recent 17-month high of $147.50. However, a break below the June support of $138.00 could spark a sustained downtrend.