The first week of the summer earnings season has offered plenty of excitement, but so far has failed to give the markets direction heading into the second half of the year. Some industrial companies such as Alcoa (NYSE:AA) have posted solid numbers, while the tech sector was relatively mixed; Intel (NASDAQ:INTC) beat estimates but Google (NASDAQ:GOOG) failed to meet expectations. These trends put the much-maligned banking sector into focus as industry bellwether JP Morgan (NYSE:JPM) reported earnings yesterday. The company handily beat expectations by posting second-quarter earnings of $1.09 a share. Analysts surveyed by Bloomberg had estimated profit of 71 cents on average. However, investors did not react all that positively, due to the fact that a large part of the earnings came from a $1.5 billion reduction in the bank’s loan-loss reserves. Additionally, JP Morgan reported a 25% drop in investment banking revenues and a 33% drop in trading revenues, which helped to push total profits down 6% from a year earlier for the banking giant. “Investors were surprised by J.P. Morgan’s weak investment banking results,” said Peter Andersen, portfolio manager of Congress Asset Management. “While it’s reasonable to expect that merger activity and general trading has not recovered yet, the market was surprised about the extent of the hit. So most see J.P. Morgan as the bellwether for banks and the whole banking peer group has traded down.”
This news puts two of America’s weakest (and largest) banks in focus, as investor turn their attention to institutions that have managed to hang on despite deep loan losses and broad weakness in the economy. Bank of America (NYSE:BAC) and Citigroup (NYSE:C) both report earnings today, and look to keep financials in focus for the end of the trading week. Analysts polled by FactSet Research expect Bank of America to see a drop in profit to 22 cents a share from 33 cents. Citi is expected to report a drop in profit to 5 cents a share from 51 cents.
Investors will focus in on these banking giants to see if the issues that JP Morgan introduced are trends for the other large banks or just company-specific problems. Among the biggest issues that analysts will be focusing on is the impact that the new credit card rules will have on the two banks. JP Morgan reported that the impact of the loss of overdraft fees was likely to be $200 million more than initially projected, while the impact rules limiting interest rate hikes when a customer misses a payment is now more likely to be closer to the top end of its estimate, costing the company close to $750 million. Investment banking revenues will also be a key indicator, especially for Bank of America and its relatively new Merrill Lynch acquisition. While these revenues are expected to decline, it will be interesting to see if the two can do better than the 33% plunge in investment banking revenues that has been predicted for the industry.
With these earnings reports on the docket, the SPDR KBW Bank ETF (NYSEARCA:KBE) is Friday’s ETF to watch. The fund tracks the KBE Bank Index, a float adjusted modified-market capitalization-weighted index that seeks to reflect the performance of publicly traded companies that do business as banks or thrifts. KBE holds about 25 stocks in total and its top two holdings are Bank of America and Citigroup, which both make up about 9% of the total assets. Rounding out the top five is JP Morgan (8%), Wells Fargo (7%), and Minneapolis based U.S. Bancorp (6%). KBE, like many funds in the Financial Equities ETFdb Category, has outperformed the market so far in 2010 posting a gain of more than 15% since the beginning of the year. The fund could continue these gains if today’s important earnings reports impress.
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Disclosure: No positions at time of writing.
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