Financial Review

Superstitious

…Banks kick off earnings season with beats, but fail to reflect a strong economy. TPP on the table again. Scooter Libby pardon. No pot crackdown. Amazon v. White House continued. Arizona to hike teacher pay.

Financial Review by Sinclair Noe for 04-13-2018

DOW – 122 = 24,360
SPX – 7 = 2656
NAS – 33 = 7106
RUT – 7 = 1549
10Y – .01 = 2.83%
OIL + .23 = 67.30
GOLD + 11.10 = 1346.40

 

Despite today’s decline, the major averages posted strong gains for the week. The Dow and S&P 500 rose 1.8 percent and 2 percent this week, respectively, while the Nasdaq advanced 2.8 percent.

 

JPMorgan Chase kicked off earnings season for the big banks, reporting earnings per share of $2.37 versus analysts’ estimates of $2.27 per share. The bank reported net revenue of $28.5 billion, compared to $25.8 billion the bank posted in the same period a year ago.

 

Citigroup reported a higher-than-expected quarterly profit, driven by strength in its consumer banking business and a surge in equities trading. Citi’s net income rose 13 percent in the first quarter. On a per share basis, Citi earned $1.68, topping analysts’ average estimate of $1.61. Total revenue rose about 3 percent to $18.87 billion, while operating expenses rose 2 percent to $10.92 billion. Global consumer banking revenue increased 7 percent. Equity markets revenue jumped 38 percent, gaining from increased volatility in the quarter. Citi reported a 10 percent drop in revenue from its investment banking business.

 

JPMorgan and Citigroup both beat estimates solidly. The two banks also posted gains in markets revenue, with JPMorgan’s markets revenue up 7% on an underlying basis and Citigroup’s total markets and securities revenue up 3%. But it wasn’t enough: JPMorgan shares lost 2.7%, Citi shares dropped 1.5%.

 

Wells Fargo shares dropped 3.4%. Despite its ongoing woes, Wells Fargo reported a 6 percent jump in profit, saying net income applicable to common stock rose to $5.53 billion, or $1.12 per share in the quarter ended March 31, from $5.23 billion, or $1.03 per share a year ago. Analysts on average expected $1.06 per share.

 

Two U.S. regulators have proposed Wells Fargo pay $1 billion in penalties to resolve probes into auto insurance and mortgage lending abuses. Many of the problems for Wells started with the scandal involving bogus accounts, various banking accounts conjured out of thin air to artificially inflate sales figures. Wells Fargo was also accused of steering minority borrowers into loans they could not afford, resulting in higher fees, defaults and foreclosures than for white borrowers, and rewarding employees with bonuses for offering such loans. As recently as last month, the bank also said it was examining its wealth and investment management business for possible customer abuse, including overcharging and inappropriate referrals, after inquiries from government agencies.

 

To appease investors and regulators, the bank overhauled its operational structure, shook up its board and hired a new compliance officer. But this failed to impress the U.S. Federal Reserve, which imposed restrictions in February on the bank’s growth, forbidding it to expand its balance sheet beyond 2017 levels until it makes internal changes that addressed risk management.

 

For the big three banks, the earnings were good, but just not good enough. The S&P banks index fell around 2.6 percent and the broader S&P financial index lost 1.4 percent, the most among the 11 major S&P sectors.

 

Interest rates are rising and the money should be rolling in. But the story isn’t playing out like the bank executives said it would, and investors are taking notice. The banks don’t seem to be getting the benefit from higher interest rates that investors once imagined they would. Yes, interest income rose more than 10 percent in the quarter for JPMorgan and Citigroup, but interest expenses were up in the 50 percent range.

 

Loan growth was disappointing. Now that interest rates are rising, there’s no great demand for borrowing. The banks’ mortgage businesses weakened during the quarter. Low unemployment and a continued rising economy and stock market, especially in an expansion as long as this one, should produce a surge of lending. The tax cut was supposed to amplify that jump. Instead, lending at the largest bank, JPMorgan, rose just 0.2 percent in the first quarter from the previous three months. Wells Fargo’s loans dropped by 1 percent, though some of that can be attributed to the bank’s particular problems. Citigroup’s lending was up 1 percent, but that stemmed largely from a push to expand its credit card business, which hasn’t been going so well. In the first quarter, the bank had to increase its provision for losses in it retail-branded cards by 16 percent.

 

Higher interest rates were supposed to translate into much higher lending profits. That isn’t the case, either. Part of the explanation is that long-term interest rates haven’t risen as much as short ones, compressing the lending profit spread. But banks also appear unable to hold onto as much of the benefit of higher short-term rates as expected. They have had to pass along some to consumers, who are their lenders. Net interest margins, which used to be in the 5 percent range, are still stuck in the 3 percent range.

 

Higher interest rates were also supposed to lead to more profits in the buying and selling of bonds, which used to be a chief driver of the big banks’ profits. Volatility was up in the first quarter, and many expected that would translate into big trading profits. But it didn’t, at least on the bond-trading side. Equity trading was a bright spot, but that’s never been a big profit center.

 

Bank stocks have traded up on the idea that the improving economy would produce more borrowing. It has not. So perhaps the problem is that the economy is not as good as people think. Next week brings earnings from Bank of America, Goldman Sachs, US Bancorp and Morgan Stanley.

 

The University of Michigan’s consumer sentiment index in April fell to a reading of 97.8, down from 101.4 in March. There is a familiar sentiment that things are pretty good right now, but it will get worse in the future. The index of current economic conditions fell to 115 from 121.2, while the expectations index declined to 86.8 from 88.8. Major concerns for respondents included possible trade wars and rising interest rates.

 

Yesterday, Trump told his economic advisors to look at getting back into the Trans-Pacific Partnership, or TPP. He tweeted: “Would only join TPP if the deal were substantially better…” Today, ministers from Japan, Australia and Malaysia welcomed the idea of the US returning to the Trans-Pacific Partnership but said they opposed renegotiating the deal.

 

While much of the White House focus today centered around a new book by former FBI director James Comey, the White House announced that “Scooter” Lewis Libby, the former chief of staff to Vice President Dick Cheney, has been pardoned. Libby had been convicted of perjury, obstruction of justice and lying to investigators in the investigation into who leaked the identity of a CIA officer. Libby had his sentenced commuted by President George W. Bush but had paid a $250,000 fine, performed community service and served two years of probation.

 

Colorado Sen. Cory Gardner issued a statement saying that Trump has promised him that he’ll support congressional efforts to protect states that have legalized marijuana. There had been a standoff between Gardner, a Colorado Republican, and the administration over Justice Department nominees. Gardner said in January he would block all DOJ nominations after Attorney General Jeff Sessions issued a memo that heightened the prospect of a federal marijuana crackdown on states that had legalized it. Recreational marijuana has been legal in Colorado since 2014. Gardner said Trump told him the marijuana industry in Colorado won’t be targeted. Marijuana is legal for medicinal use in 29 states and for recreational use in eight. Marijuana stocks surged on the news. Canada’s Canopy Growth, the largest cannabis producer by market value, jumped as much as 11 percent. Medical-marijuana supplier Aphria climbed as much as 21 percent in Toronto trading.

 

Amazon versus the White House takes a new turn with Trump ordering an investigation of the U.S Post Office. In the order, Trump calls on the task force to examine various parts of the Postal Service’s business, including ones that appear to directly involve large parts of Amazon’s business, although the order does not mention Amazon by name. The investigation includes the “expansion and pricing” of the package delivery market and the service’s role in competing with other, private delivery companies. The task force should look at the decline in mail volume and the implications for the service. The order also calls for the task force to look at the service’s “universal service obligation,” which requires the service to deliver to everyone in the United States.

 

Arizona Gov. Doug Ducey announced his plan to give teachers 20% pay raises by the beginning of the 2020 school year. Under his proposal, teachers’ pay would increase 9% in the 2018 school year, then another 5% for the next two years, which would boost the average salary to $58,130 from the current $48,372 by 2020. Arizona ranks 43rd in the nation in terms of how much it pays its teachers, according to the National Education Association. For weeks, educators have been holding rallies in Arizona. On Wednesday, they participated in “walk-ins” before class, part of a series of escalating actions sponsored by the Arizona Educators United coalition. Ducey also proposed to restore education funding from recession-era cuts with $371 million phased in over the next five years “without raising taxes”. The funding would be to support school resources such as infrastructure, textbooks, technology, curriculum and school buses. Ducey was vague about where the cash would come from, only saying a growing economy and lower spending in other areas unexpectedly freed up $274 million this year.

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