U.S. banks: Smaller and restrained

By David Andrews | January 20, 2012 | Last updated on January 20, 2012
4 min read

U.S. earnings season kicked into high gear last week, and with many of the U.S. investment banks reporting weak results, Wall Street is wondering if this is a temporary slump or if they will soon get back to their high flying days.

Some of the forces that weighed on earnings last year, like Europe’s government debt crisis and a sluggish U.S. economy, could go away but the business still faces permanent pressures on its profitability, particularly from the stricter regulations aimed at making the financial system safer. Despite generally disappointing results and poor performance in 2011, the financials are up almost 8% on the month, the second best performing sector on the S&P500.

To date, earnings season is best described as very mixed. Measured against what we have seen over the past few years where companies beat expectations 70% of the time, thus far only half are beating analyst expectations. Quarterly results aside, stock markets are continuing to have their best start to a year in the past 15 years.

Economic data out this week continues to show signs of recovery with manufacturing and factory production in the United States at their highest levels in a year. As well, jobless claims fell by 50,000 as fewer Americans filed for unemployment benefits this week. Jobless claims are now at the lowest level since 2008. Inflation data also showed there was little upward pressure on prices. Even the housing market showed improvement as low mortgage rates and improved job prospects may be giving Americans the confidence to purchase homes that have fallen in value.

At home, the Bank of Canada held it benchmark interest rate a 1.00% for the 11th consecutive time citing an economy that would be hobbled by a slowdown in China, Europe, and the United States. The consensus expectation is for the Bank to hold rates at the current level until late in 2012 and possibly into 2013. The Canadian dollar strengthened to above US$0.99 before slipping back to the $0.9850 on the soft Canadian inflation data released at the end of the week.

The Trading Week Ahead

The Federal Reserve’s Interest rate policy meeting and the continuation of Earnings Season will likely be the catalysts for investors in the coming week. Markets look to continue to build on their noteworthy rise so far in 2012. On balance, the 2012 Federal Open Market Committee (FOMC) promises to have a more dovish bent than the 2011 Committee. That would be due primarily to the departure of three vocal hawks from voting seats. By the way, as if it needs to be said, no change to U.S. interest rate policy is expected.

Tuesday’s 2012 State of the Union address by President Obama will essentially launch his re-election campaign, just as Republicans vote on which nominee they want to oust him from his job. As tradition requires, House Speaker John Boehner invited the President to speak to a joint session of Congress and outline his new ideas on how he plans to work with congress in the coming year.

In Canada, the key economic data will be November’s retail sales, which should post the smallest gain in four months. A price decline in gasoline sales should limit the headline number and from a technical perspective, the normal ebb and flow of Canadian retail spending favors a more modest showing in November. As for U.S. data, new home sales are set to reach the highest level in a year. This is suggested by the 4.4% rise in single-family housing starts. The housing sector continues to remain depressed, as demand for new homes has hovered in the low, but recoveries have to start somewhere though.

Q4 real GDP is expected to grow at 3.1% for the quarter –or at the fastest rate of growth since Q22010.

Stock market investors will return to a tug of war between signs of domestic strength and overseas concerns as a batch of critical earnings reports look to add credence to the idea the North American economy is improving, while credit rating downgrades in Europe will keep that region’s difficulties in view.

Question of the week: Is a Greek debt default imminent?

In recent weeks, talk has emerged that Greece may be on the verge of an outright default. It has long been speculated that the country would eventually default, although aggressive actions taken by the European Union have managed to avert that event thus far. There is a proposed deal which would see creditors “volunteer” to accept a 50% haircut on their Greek bond holdings. While a voluntary cut may be beneficial to Europe as a whole, individual investors would suffer as they take massive losses. Some investors bought credit default swap (CDS) contracts as insurance on their investments, but officials have resisted letting Greece default outright because the extent of the CDS contract exposure is unknown. After the market closed on Tuesday, Bloomberg reported that Greece and its creditors were close to a new deal which sees even more of a haircut—to the tune of Greece paying out 32 cents on the euro. Officials seem bent on pushing for a “technical default’ (which does not trigger the CDS contracts) and not allowing an official default right now.

David Andrews is the Director, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @David_RGMP

David Andrews