What to expect from US banks as Q4 earnings season kicks off

Our City expert considers Wall Street's big banking stocks as interest rates near a peak and with the prospect of a global recession looming large.

America’s biggest banks get the fourth-quarter results season under way on Friday, with Wall Street braced for overall S&P 500 earnings to show their first decline since autumn 2020.

Concern over how higher interest rates are impacting corporate America means that analysts have cut their estimates for the final quarter of 2022 by a larger than usual margin.

• Invest with ii: US Earnings Season | Buying US Shares in UK ISA | Cashback Offers

The revisions since the end of September have reversed an estimate for earnings growth of 3.5% to a position where Wall Street is now braced for a decline in earnings of 4.1%.

FactSet said this would mark the first time the index has reported a year-over-year earnings fall since the Covid-hit third quarter of 2020 revealed a 5.7% decline.

Analysts also decreased their estimates for this year by 4.4% between October and December, led by stocks in the communications services and consumer discretionary sectors.

• See our US results season calendar here
• Visit our YouTube channel to view our experts’ tips for 2023
• US stock market outlook 2023: American shares become attractive to Brits

These downgrades and a stock market recovery since October means that the S&P 500 index now trades with an improved price/earnings multiple of 16.5 times, compared with 15.2 times at the end of the third quarter. However, FactSet notes that this is still below the five-year average of 18.5 times and the 10-year average of 17.2 times.

The first chance for investors to gauge whether the red-pen revisions have gone too far will come on Friday, when Bank of America Corp (NYSE:BAC), BlackRock Inc (NYSE:BLK), Citigroup Inc (NYSE:C), JPMorgan Chase & Co (NYSE:JPM) and Wells Fargo & Co (NYSE:WFC) post their figures before Wall Street’s opening bell.

Their levels of profitability should have been sustained by the impact of much higher interest rates on the margin spanning what they charge for loans and pay on deposits.

However, the upside for net interest income will have been offset by a much quieter period for corporate deal-making activity across investment banking operations.

• This former hot stock is ready to rise again
• 11 ways to invest your ISA like Warren Buffett

There’s now the prospect of rising default levels as the US heads towards a probable recession, although Wall Street’s big banks showed in third-quarter results that they are well capitalised and that consumer balance sheets have so far remained solid.

Despite signs that the Federal Reserve is near its peak on interest rates, recent sessions have seen investors turn more positive on banking stocks.

Bank of America’s clients have been net sellers of US equities for three weeks in a row, but one of the exceptions has been financials after inflows second only to technology stocks.

Its analysts recommend that financials may be a good spot to park assets as the sector continues to trade at a relative discount to its average market multiples.

The bank said: “We are overweight and see it as a higher-quality sector, with better earnings stability than the S&P 500, cleaner balance sheets thanks to US regulators, and less recession risk than other more crowded and expensive cyclical sectors like info tech.”

The bank believes that the S&P 500 overall still screens as statistically expensive versus history, but given the recent drop in sentiment and positioning it warns that one of the biggest risks might be that of being under-invested in stocks.