Opinion: Bank earnings a bellwether for strong economy

Richard Baker

I read recently that a young Australian Shepherd dog was missing after a traffic accident, and everyone was to be on the lookout. Though he was a pet, his breed’s original job was to herd sheep. Another great shepherding tool was the use of a bellwether, where the farmer put a bell around the neck of the lead sheep, causing the rest of the flock to stay grouped around him.

Investment-wise, big banks are often the first to report earnings each quarter and are considered bellwethers for investors. In this case, the big banks serve as a bellwether for the overall performance of the economy during the quarter.

With the government shutdown stopping the release of normal economic data, earnings have become an even more important gauge of the U.S. economy.

This month, we’ve had the first wave of big bank and investment broker results, and so far, their earnings have been great. Most mentioned in their earnings calls that they benefited from a pickup in deal activity after the Federal Reserve rate cut, which especially helped their investment banking divisions.

We saw Citigroup, JPMorgan Chase, Wells Fargo and Bank of America all beat their third-quarter earnings expectations. The average upside earnings surprise for these big banks that reported was over 7%. For the investment broker companies that reported, including Goldman Sachs, BlackRock and Morgan Stanley, the average upside earnings surprise was over 18%, showing ongoing strength in trading and wealth management.

So far, early in this earnings reporting season, we are seeing a lot of good news. Overall, it seems that even a small Fed rate cut spurred a lot of business transactions when looking at new stock listings and mergers and acquisitions activity.

Bank of America beat earnings estimates with a 43% increase in investment banking revenue as business-to-business dealmaking sped up after the Fed rate cut.

Similarly, Morgan Stanley also beat their earnings estimate through an increase in trading revenue and a huge 44% increase in investment banking revenue after business activity picked up post rate cut.

The pent-up demand for business activity was evident, and investors took the first rate cut as a signal to make moves if their deals were going to get done before year-end. The financials sector is on track for a 17% increase in earnings year over year in Q3, second only to the technology sector, which is expected to rise 21% based on LPL estimates.

Investors are counting on continued Fed cuts in November and December but are also keeping a watchful eye on the China/U.S. tit-for-tat trade drama. The unresolved geopolitical risks are impossible to predict, and forecasting their financial consequences if something were to go sideways is even more difficult. The markets are strong, and though there could be a short-term pullback, the markets should end the year well and keep riding this three-year-old bull market.

These banks produced huge profits this quarter and seem to be signaling that they anticipate a boom if rate cuts continue.

If this bellwether is an early indication of a strong earnings reporting season, then it might not be too early to say the S&P 500 is well on its way to low-teens earnings per share growth for the quarter. Investors sure hope so.

The Australian Shepherd dog that had been lost during the traffic accident was found a few days later at a sheep farm, herding sheep. That dog got ejected out of car straight into his dream job! I don’t know if he was herding the sheep in the right direction, but I bet he was having a great time doing it.

Hopefully, the big banks’ strong bellwether is leading us all in the right direction.

Richard Baker, an accredited investment fiduciary, is the founder and executive wealth adviser at Fervent Wealth Management LLC in Springfield. He can be reached at richard@ferventwm.com.