Earnings season: five stocks on Goldman’s radar

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Investments

Earnings season is underway. Now’s the time to take a look at some stocks that could provide investors with more than the Wall Street consensus would tell you.

US earnings season Q3 2021

Goldman reviews earnings season stocks

Sometimes investors like to break away from the pack. To dare is to do.

It’s all about spotting opportunities from stocks that may be overlooked by Wall Street.

As reported by CNBC, Goldman Sachs has been scanning Wall Street for stocks it believes hold promise for investors looking for something different this earnings season.

Earnings season began in earnest this week with major US banks leading the charge as always. You can use our earnings season calendar to see which megacaps are reporting this quarter and when.

In a note to investors published on Wednesday, Goldman said it expects stocks to rise 6% this quarter. Its spotlighted stocks, however, could offer upsides of 14%.

The investment bank deployed a fairly complex methodology when analysing Q3 2021 earnings season stocks. 1,000 companies in Goldman Sachs’ coverage universe were scanned at the 25 best opportunities were selected when considering EPS of $5 per share over the next four quarters.

After this, the results were filtered through analysts which were above or below Thomson Reuters’ consensus for the upcoming quarter, and the year ahead, “on a key financial metric.”

“Single stock put-call skew is at its highest level in over a year,” Goldman said, encouraging investors to make out-of-money calls on its out-of-consensus stock picks. “Given investors are well hedged, even modest earnings beats are likely to drive a relief rally in specific stocks (on earnings day) and the broad index (over the next three months).”

The out-of-consensus stocks to pick

Please note these are only Goldman Sachs’ recommendations – not hard and fast must-buys. Only invest if you are comfortable with the risk of potential capital loss.

The top five stocks Goldman has selected to watch this earnings season are:

  • Uber
  • Signature Bank
  • Yeti
  • Bank of America Corp
  • Lowe’s

Let’s start with Uber. The ride-hailing service burst onto the scene several years ago as a taxi industry disruptor. Goldman’s Eric Sheridan thinks the app can deliver a 37% upside over the coming year. Sheridan’s earnings estimates put Uber 20% higher than Wall Street consensus right now too.

The idea is that if Uber can close the supply/demand gap, then this should lead to normalised ride pricing, higher demand in general, and thus pre-pandemic profits.

Outdoor retailers Yeti could offer even better upsides than Uber. Goldman considers Yeti a “growth compounder with best in class authentic brand positioning.” It could deliver upsides of 44% if Goldman is on the money. In terms of EPS, Yeti’s could be 8% higher than analysts think in the third quarter and 3% higher in the next.

Investment banks are usually amongst the first to start reporting on Wall Street come earnings season. It’s certainly true this year. Of these, Goldman flags Bank of America as the one to keep an eye on. Goldman’s analysis puts BoA’s upside at 7% – some 10% higher than consensus.

Bank of America’s potential has been pegged to “significant remixing of cash into securities” by Goldman.

Smaller banks are represented by Signature Bank. Ryan Nash, a Goldman stock analyst, forecasts earnings-per-shares to come it at 7% higher than Wall Street forecasts this quarter and 5% for the next four. Signature is on course for a revenue-beating Q3, driven by an acceleration in loan growth.

Rounding off Goldman’s section of potentially consensus-beating stocks is Lowe’s. The DIY probably benefitted more than most from the pandemic last year, but this quarter it could offer investors an upside of 12%.

Goldman’s Kate McShane said Lowe’s position is stronger now than in the last 6-12 months, thanks to bringing forward its seasonal inventory purchases.

10 stocks that make Goldman’s conviction list

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Investments

Goldman Sachs’ list of conviction stocks has just been updated. Here are some choice selections for you to keep an eye on.

Goldman Sachs conviction stocks

The conviction list is Goldman’s selection of equities it believes will overperform this year. All of the stocks that make the grade hold a buy rating.

As ever with these things, the companies Goldman highlights come from a mixture of different sectors. A slew of new equities have been added to the list for 2021, from tech, energy and beyond.

Let’s take a look at some standout picks.

Energy stocks

Houston, Texas-based NRG Energy made the list in June and currently holds a $53 target price. The bank cites elevated cash flows in 2022 and a compelling valuation as reasons why the gas & electricity supplier is a conviction stock. NRG stock could jump 25% in the coming months, according to Goldman.

Elsewhere, Targa Resources, another North American energy supplier, cemented its place on Goldman’s conviction list in March. In an investment note, the bank dubbed Targa “one of the most compelling companies in our midstream energy coverage.”

Targa’s “significant” buyback programme and double dividend attracted Goldman’s eye, suggesting the energy supplier’s profits and cash flows are on the up.

Another midstream firm, Michigan’s DTE Energy, also makes the list, with Goldman Sachs liking the oil transporter/processor’s decarbonisation efforts.

FMCG & consumer-focussed stocks

Switching to a more consumer-bent, a number of companies are fresh additions to the conviction list.

Let’s start with Chipotle. The Mexican fast-food joint has been called a “clear digital leader” by the bank. An easy-to-use app, strong online presence, new menu items, and a solid loyalty programme all underpin Chipotle’s fundamentals. Development of new drive-thru “Chipotlanes” also help the stock’s favourable rating.

Sportswear retailer Lululemon gained conviction status in July. Post-pandemic growth opportunities help the stock on its way, as well as the nature of its direct-to-customer online business which cuts out the middleman.

Constellation Brands, which owns Corona and Modelo beers, was a February conviction addition. When added to the list, Goldman praised Constellation’s strong fundamentals.

“We believe Constellation Brands remains one of the best growth stories across the U.S. Staples universe and is advantageously levered to the most attractive opportunities in alcoholic beverages – premium import beer, hard seltzers, and premium wines and spirits,” the bank stated in an investment note.

Technology stocks

Goldman joins Jeffries in signalling a number of different tech equities that could perform well for investors.

“Microsoft stands out very uniquely in the technology world given its strong presence across all layers of the cloud stack including applications platforms and infrastructure,” a Goldman investment note said.

With the bank believing the Seattle computing giant will post a strong fourth quarter, Microsoft makes its conviction list.

Salesforce also makes it. Goldman was attracted to Salesforce’s commitments to aiding worldwide digital transformation – something which greatly picked up during the pandemic – naming the brand as one of the standouts in the $1 trillion global cloud technical account management market.

Financial equities

Finally, let’s look at two financial stocks Goldman likes.

The first is investment firm Evercore Partners. Goldman believes Evercore is about to benefit greatly from upcoming M&A activity and continued profits from fees generated through advising special-purpose acquisition vehicles (SPACs).

“We see potential upside surprise vs. consensus on capital distributions, due to the stronger earnings we forecast, coupled with a robust cash position,” Goldman said.

Fifth Third Bank could also benefit from rising interest rates once the Fed ups its current historically-low cash rate.

“We believe it will see top quartile performance when rates rise and it leverages the benefits of medium term cost cuts,” said Goldman.

Goldman flags UK & European recovery stocks

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Investments

Goldman Sachs is keeping a close eye on which equities could perform well as the UK and European economies head towards post-COVID recovery. Here are some of the bank’s top picks.

Goldman Sachs’ UK &European equities to watch

The current state of play

As reported by CNBC, a fair few stocks are on Goldman’s list, but it’s worth contextualising why they’ve been picked.

Every week, Goldman publishes its “Reopening for Europe report”. It contains analysis across various sectors to gauge how quickly British and European economies are rebounding from historic COVID-related declines.

Included in Goldman’s calculations are metrics such as retail sales, job advertisements and employment numbers, airline ticket sales and flights data, and so on. In its report for the week ending July 30th, the bank noted activity was 20% below pre-pandemic levels – an increase of 2% week-on-week.

In the UK’s case, a lot of factors are at play helping its economy get back on its feet. Lower COVID cases, lower hospitalisations, and the higher level of antibodies in the general public have helped, alongside a near full removal of pandemic restrictions.

Inbound travel is back on the cards too. UK authorities recently removed quarantine requirements for two-jab vaccinated travellers coming from the EU and the US into England. They will still need to take a test before they travel here and get a PCR test on their second day in the country, but other than that, there is no need to quarantine.

We’ve also seen EU services and manufacturing accelerate at the fastest rate for months.

The stocks on Goldman’s radar

Now we know the background, let’s look at the stocks. According to Goldman Sachs’ analysis, the below equities could offer upsides above 20% during this period of economic recovery.

“Looking at domestic categories, some leisure-driven categories are at or above pre-Covid levels (motorway traffic, eating out), while others continue to lag (use of cash, office return), potentially indicative of structural changes,” Goldman’s analysts led by Patrick Creuset stated.

Let’s start with the UK. Hotel and restaurant group Whitbread has been identified as offering 24% upsides. Many British holidaymakers are choosing to take their holidays the old-fashioned way this year by staying in domestic hotspots. Whitbread could be poised to benefit.

Retailer WH Smith could offer 25% upside above its current market price too, according to Goldman, while real estate firm British Land could offer investors 29%.

Moving to the continent, a mixture of stocks across a variety of sectors have been picked out by the investment bank as having high potential.

ACS, the Spanish infrastructure and construction group, is particularly strong. According to Goldman, ACS’ upsides could range as high as 41%. Property development stocks in general have the potential to be hot picks too. Take French shopping centre construction business Unibail-Rodamco-Westfield. They’ve been identified as offering a 35% upside in the current recovery climate.

European food services business also make the list. Those of note include France’s Elior Group and Italian firm Autogrill. The pair have been eyeballed as offering 34% and 23% potential upsides respectively.

Travel stocks on the list included Swiss airport Flughafen Zurich, with a potential 44% upside to Goldman’s 12-month price target, and Airbus, with 27% upside potential.

A separate list of international firms shows a mixture of businesses operating in sectors poised to benefit from a boom in travel. BP, for instance, could offer an upside of 71% against its 12-month price target on stronger oil prices.

Airline engine manufacturer Rolls-Royce could offer an upside of 59%. Low-cost airline easyJet’s potential upside has been forecast at 29%.

Summer heatwave for inflation

Morning Note

Inflation is getting hotter and hotter. UK inflation rose to 2.5% in June from 2.1% the previous month, smashing expectations and in the process likely to increase the pressure on the Bank of England to tighten monetary policy. It’s even hotter in the US, with headline CPI print hitting 5.4%, whilst the month-on-month registered its highest jump since June 2008. Core readings were particularly strong with the annual rate rising to 4.5% – a 30-year high – from 3.8% on a very aggressive month-on-month read. It’s becoming evident it may not be as transitory as the Fed thought it was going to be. It might not last forever but the Fed might just be minded to think that a taper announcement in Aug/Sep would be a prudent step.  You can explain some of it away from base effects from last year, but the core month-on-month number hit +0.9% and is accelerating. A large chunk of that was down to used cars and truck prices (+10.5% mom) and this shouldn’t continue for much longer, but it nevertheless underlines fears inflation is racing away faster than the Fed wants to run at. On used cars, the semi shortage could go on for longer so that needs to be considered – second-hand cars were singled by the ONS in the UK data, too. The Fed and Bank of England will hope that the hot readings are a summer heatwave driven by parts of the economy that were essentially shut down last year – travel, eating out, etc. Indeed US month-on-month food away from home rose 0.7% – the biggest jump in 40 years. Perhaps you can go out to dinner more than once a night, Jay. 

 

BofA’s July Global Fund Manager Survey pointed to the passing of peak growth, noting that investors are much less bullish on growth, profits and yield curve steepening, which has led them to unwind “junk>quality, small>large, value>growth trades back to Oct’20 levels”.  They note that the cyclical “boom” has peaked with July growth expectations 47%, down from 91% peak in Mar 2021, while global GDP & EPS readings indicate macro momentum is at its weakest since the third quarter of 2020. They also say that fiscal optimism is fading with survey expectation for US infrastructure stimulus down to $1.4tn, from $1.9tn in Apr 21. But on inflation fund managers are not so worried – percentage of investors predicting higher inflation at 22% from 93% in April. 

 

Anyway, enough buy-side ramblings, back to the market reaction. The CPI print sent the dollar up and stocks lower initially, but bond yields didn’t do much and both pared their respective gains/losses. Nasdaq futs dropped sharply but the composite was back at a fresh record high within an hour of the opening bell and the S&P 500 followed half an hour later. By the close however, the 10yr yield had jumped over 4 basis points to cross 1.4% and the major indices ended the day a little lower on the session. Market seems to be saying that higher inflation means earlier tapering/hiking chance of taper & hikes, but longer-run rates will be lower. This means a flatter curve and a riskier backdrop for the Fed to land this fighter jet on the aircraft carrier. European stock markets opened lower in early trade on Wednesday. 

 

Key question: are we still in the transitory phase? Interesting note from Citi about how the data will get more interesting from here on out. “June could be the last month where CPI is overwhelmingly driven by “transitory” factors, meaning the coming months of CPI data should again give us new information on the path and underlying trend of inflation.” San Francisco Fed president Mary Daly said she expected the pop in inflation, and they should be in a good position to start tapering by the end of the year. I think with this print it’s very clear we get the Aug/Sep taper announcement. In fact I think the way the inflation readings have been the last three prints, it’s a nailed-on certainty.  

 

Bank earnings were very good – Goldman Sachs delivered earnings of $15.02 per share vs. $10.24 expected, as revenues rose above $15bn. A surging IPO market sent investment banking revenues to $3.6bn – the second best ever after Q1 2021. JPMorgan posted EPS of $3.78, ahead of the $3.21 estimate, on revenues of $31.4bn. After setting aside vast sums for credit impairments, JPM recorded a net credit cost benefit of $2.3bn for the quarter as it was able to claw these back. CEO Jamie Dimon said: “In particular, net charge-offs, down 53%, were better than expected, reflecting the increasingly healthy condition of our customers and clients.” Trading revenues were down 30% but investment banking provided the offset.  

Cryptocurrency update: Bitcoin price drop prompts trading fall

The ongoing BTC lull and previous market crash may have caused a freefall in crypto trading volumes.

Cryptocurrency update

Crypto trading volumes fall as BTC price stalls

Trading volumes on major cryptocurrency exchanges dropped over 40% in June according to CryptoCompare data.

The market researcher found that trading activity had plummeted on the largest exchanges, including Binance, Coinbase, Kraken and Bitstamp.

Bitcoin’s current price is likely behind the drop. After peaking at record highs in April, the world’s most popular token has struggled to regain value after crashing to below $29,000 in June.

China’s move to crackdown on crypto mining operations and wrest control of decentralised finance markets into the hands of the government has led to Bitcoin’s struggles. Notably, with Bitcoin miners having to move out of China, the hash rate, or the rate at which new BTC tokens are minted, has fallen. Supply may be even tighter than usual.

Other criticisms around the Bitcoin from an environment, social and governance perspective has also put a dampener on BTC performance. In an increasingly environmentally conscious world, stories of BTC mining consuming as much power annually as Sweden may have put investors off.

The regulatory framework around crypto trading in general is still being hashed out on a global scale. When it comes to Bitcoin, however, intergovernmental bodies like the Financial Action Task Force, are keeping a close eye on its network. Money laundering and using BTC to fund illegal activities is something many watchdogs are keeping a close eye on.

Other financial and institutional bodies are stepping up their efforts to safeguard retail investors against the massive volatility and uncertainty crypto trading can bring too.

Then there are other concerns around the naivety of BTC investors and traders. Many are total newcomers to these two disciplines. They may not have the capital or the experience necessary to whether a Bitcoin bear market, as they only just got in when goings are good.

Even if trading volumes have slumped in June, they are still some of the highest volumes seen in crypto trading yet. But with half the market gone, and the BTC price in the midst of a lengthy correction, it may take something big to entice investors back.

Of course, many large scale buyers with the capital to match may be using this as a period of accumulation. We’ve seen Bitcoin whales snaff up tokens left right and centre during price lulls, and this may be what we’re seeing in the here and now.

El Salvador BTC plans may put a squeeze on the global network

El Salvador’s plan to introduce Bitcoin as legal tender continues to draw flack.

JPMorgan has warned that this would have negative ramifications for both the token and El Salvador should plans go through.

According to a report from the US megabank, such a scheme would put enormous strain on the Bitcoin blockchain network. It would severely limited Bitcoin as a method for exchange, the report said, with issues around illiquidity and the token’s trading nature causing big hurdles.

JPMorgan analysts said that Bitcoin is highly illiquid, noting that most Bitcoin trading volumes are internalized by major exchanges, with more than 90% of Bitcoin not changing hands in more than a year.

“Daily payment activity in El Salvador would represent 4% of recent on-chain transaction volume and more than 1% of the total value of tokens which have been transferred between wallets in the past year,” the report said.

JPMorgan also has worried about convertibility. A continuous imbalance of demand for conversions of Bitcoin and the United States dollar could “cannibalize onshore dollar liquidity” and eventually introduce fiscal and balance of payments risk, according to JPMorgan.

El Salvador’s government passed a bill in June that states Bitcoin would be accepted there as legal tender alongside the US dollar. Under the bill’s stipulations, merchants across El Salvador must accept BTC if offered as a method of payment.

The country also wants to be Central America’s mining hub, with an audacious plan to harness the power of volcanos to power its mining operations.

Coinbase a “tactical trade” says Goldman

Coinbase, the US’ largest crypto exchange, may be on course to beat Wall Street earnings.

The exchange’s Q2 2021 results are due soon as earnings season has begun on Wall Street. Goldman Sachs has identified the stock, which trades under the COIN ticker, as buy.

In an interesting bit of analysis, Goldman researchers say that the current parade of negative crypto headlines could actually be benefiting Coinbase. What Goldman calls “significantly higher elevated crypto asset volatility”, or the wild price action we’ve been seeing in recent months, may have led to increased pre-BTC collapse trading volumes. Coinbase can then capture this activity through its fees.

Even if BTC’s price stays low, Coinbase may be able to profit off uneasy traders looking to divest and others looking to buy in a market downturn.

Goldman acknowledged its analyst’s earnings per share estimate for Coinbase is “11% above consensus” for the year ahead – way ahead of the Wall Street consensus.

What do analysts say are the best investment bank stocks?

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Investments

Banks have enjoyed a rollicking recovery since the depths of the pandemic in March 2020. The XLF financials ETF has more than doubled since it struck a multi-year low over a year ago. A strong monetary and fiscal response from governments and central banks and a strong trading performance sparked the first phase of the recovery, whilst powerful economic growth and rising bond yields has helped the sector continue to gain.  

 

But among the major financial stocks, there are some top picks in the investment banking arena from JPMorgan that are worth a look. “The Investment Banking (IB) industry, in our view, is in a much better shape today compared to where it has ever been,” analysts from the bank said in a note. IBs operate a lower risk model as they become less capital-intensive,  revenue streams are more sustainable, barriers to entry remain high and they have an increasing share of so-called ‘captive’ wealth management. 

 

Here are JPM’s top investment bank picks and what other analysts say

 

In the global investment banking space, Goldman Sachs takes the top spot. “We see GS as a contender given its agile culture, which allows it to move as a Fintech, and its strong IT platform to retain its strong market share growth momentum from Tier II players,” the JPM team says.

Goldman also gets a buy rating on our Analyst Recommendations tool.

Goldman Sachs investment analysis rating.

In Europe, Barclays is the number one pick, with the analysts describing the UK-listed stock as “a relative winner with its transaction bank providing an advantage along with its diversified IB revenue mix”. UBS comes in second and Deutsche Bank also gets a nod. The German bank also received an upgrade from Kepler Capital.

Barclays investment analysis.

East meets West: top banks say these are stocks to watch

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Investments

Goldman Sachs and Morgan Stanley have produced fresh reports on stocks they think are about to do well.

Goldman’s focus is mainly on European stocks with an international reach. Morgan Stanley, on the other hand, has been appraising stocks that could highly benefit from stronger US-China ties.

Top banks’ stocks to watch

Goldman eyeballs these equities

CNBC reports Goldman has identified a number of stocks as poised to outperform their pre-pandemic earnings while Europe’s post-Covid reopening continues.

All of the large caps listed on Goldman’s Reopening Beneficiaries list have been rated as buys by the bank’s analysts with major potential upsides over their 12-month share targets.

Goldman has been tracking various sectors set to soar once economies are fully reopened, using Europe as a guinea pig with the bank pouring over hotel booking, flight, and restaurant booking data, as well as Covid-19 hospitalisation levels and vaccination uptake.

Starting with oil, three supermajors have been identified as buys, all with significant upsides. Currently, oil prices are soaring, with key benchmark contracts trading for levels not seen for at least two years. As such, the below stocks are at the top of Goldman’s buy list, beating their 12-month price targets:

  • BP – 45% estimated upside
  • ENI – 27% estimated upside
  • Total – 23% estimated upside

The aviation industry is clear for take-off too. Again, one major stock could be looking to fly high with a 45% topside. As we’ve touched on in the past, stocks related to international and domestic air travel may be big winners once the world opens up. That includes airlines themselves but also associated infrastructure like engine suppliers and airports.

Goldman Sachs identifies the following equities with high potential:

  • Rolls Royce – 45% estimated upside
  • Flughafen Zurich – 27% estimated upside
  • EasyJet – 18% estimated upside

Looking to retail, Goldman has several firms in different subsectors on its watchlist. According to the bank’s analysis, Swiss conglomerate Richemont, whose portfolio covers Cartier, Montblanc, and a host of jewellery and watchmakers, has high potential, but it may be outstripped by retail brands:

  • Swatch Group – 19% estimated upside
  • Adidas – 16% estimated upside
  • Richemont – 13% estimated upside

All of the above rests on the successful reopening of global and European economies, however. Vaccine rollout has been largely successful in key economies like the US, European Union and the UK. Covid variants, however, have led to some delays in the full lifting of restrictions. We’re not out of the woods yet, but the tree density is dropping off. Specks of light are seeping through the undergrowth.

Morgan Stanley looks eastward for stock picks

While Goldman has an internationally-facing European focus, Morgan Stanley heads to China to look at some equities that could be potential buys.

Morgan’s analysis, however, is all based on closer US-China relations. We all remember the trade wars of President Trump’s tenure. Morgan is betting on closer relations between Beijing and the Biden White House during the 46th US president’s tenure.

In one of the bank’s China-related portfolio, it has listed 30 Chinese firms that are dependent on the US market for solid chunks of their revenue.

Many have strong track records too, in terms of share performance. Morgan Stanley analysts reported earlier in June that the equities outperform the MSCI China index by an average of 206 points when things are good between the US and China.

It should be pointed out at this juncture that Joe Biden has maintained a tough stance on China. However, instead of pursuing sanctions, his administration is tacking a different tack by working more closely with US allies in the region, rather than instigating a tit-for-tat trade spat.

That said, if the frost relations thaw, then Morgan Stanley suggests the below could be poised to make big gains.

Universal Scientific International (USI)

USI is a subsidiary of US-listed, Taiwan-based ASE Technology. The firm manufactures electrical components used by other firms and recently inked a substantial deal with a European manufacturing giant in 2020.

Total profit grew to 351.5 million yuan ($54.9 million) in the first three months of this year, up 65% from 212.5 million yuan in the first quarter of 2020.

70% of USI’s revenue is sourced from the US market.

Futu

Futu is, along with Robinhood, part of the new breed of millennial-aimed investment apps. It is one of the two main apps young Chinese investors use to trade stocks listed overseas.

The company has ambitious growth plans, identifying Singapore and the US as its next target regions for userbase growth. Futu is also applying for licenses that would allow it to offer cryptocurrency trading in those two nations – something of big interest to the current crop of younger traders.

Morgan Stanley estimates 62% of Futu’s revenues comes from the US already, but it expects a large portion of 700,000 new customers to come from there too.

WuXi AppTec

WuXi’s business is the research, development and manufacturing of services for the pharmaceutical, biotech and medical device industries. It is currently focussing on beefing up its gene therapy and drug development industries.

55% of WuXi’s revenues, Morgan Stanley says, is generated by its business in the US.

All of the above stocks have been listed as overweight by Morgan Stanley, indicating they expect the stocks to perform better in the future. This does all depend on how US-China relations develop under Biden.

Of course, remember all investing and trading comes with the risk of capital loss. Do your due diligence and research before committing any money and only invest or trade if you are comfortable taking any potential losses.

Banks set to kick off US Q3 earnings season

Equities

The S&P 500 rose 8.5% to 3,363 over the third quarter, having hit an all-time of 3580 at the start of September, with an intraday peak at 3588. The market faced ongoing headwinds from the pandemic, but risk sentiment remained well supported through the quarter by fiscal and monetary policy.

A pullback in September erased the August rally but was largely seen as a necessary correction after an over-exuberant period of speculation and ‘hot’ money into a narrow range of stocks.

Q3 earnings come at important crossroads: Expectations for when any stimulus package will be agreed – and how big it should be – continue to drive a lot of the near-term price action, though the market has largely held its 3200-3400 range.

Elevated volatility is also expected around the Nov 3rd election. But next week we turn to earnings and the more mundane assessment of whether companies are actually making any money.

Banks kick off Q3 earnings season

Financials are in focus first: Citigroup and JPMorgan kick off the season formally on October 13th with Bank of America, Goldman Sachs and Wells Fargo on the 14th. Morgan Stanley reports on Oct 15th, In Q2, the big banks reported broadly similar trends with big increases in loan loss provisions offset by some stunning trading earnings.

Wall Street beasts – JPM, Goldman Sachs, Citi, Morgan Stanley and Bank of America – posted near-record trading revenues in the second quarter with revenues for the five combined topping $33bn, the best in a decade. At the time, we argued that investors need to ask whether the exceptional trading revenues are all that sustainable, and whether there needs to be a much larger increase for bad debt provisions.

Meanwhile, whilst the broad economic outlook has not deteriorated over the quarter, it has become clear that the recovery will be slower than it first appeared. Moreover, during Q3 the Fed announced a shift to average inflation targeting that implies interest rates will be on the floor for many years to come, so there is little prospect of any relief for compressed net interest margins.

Meanwhile there is growing evidence of a real problem in the commercial mortgage-backed securities (CMBS) market as new appraisals are seeing large swatches of real estate being marked down, particularly in the hotels and retail sectors.

At the same time, the energy sector has gone through a significant restructuring as we have seen North American oil and gas chapter 11 filings gathering pace through the summer as energy prices remained low. There is a tonne of debt maturing next year but how much will be repaid?

Key questions for the banks

  • Did the jump in trading revenues in Q2 carry through in Q3? Jamie Dimon thought it would halve.
  • On a related note, did the options frenzy in August help any bank more than others – Morgan Stanley?
  • Have provisions for bad loans increased materially over the quarter?
  • How bad are credit card, home and business loans?
  • And how bad is the commercial property sector, especially hotels and retail as evidence from the CMBS market starts to look very rocky?
  • How are bad debts in oil & gas looking?
  • How are job cuts helping Citigroup lower costs; how will its entry into China make a difference to the outlook?
  • How does Wells Fargo manage without an investment arm to lean on? So far it’s been a bit of a mess.
  • Was Warren Buffett right to cut his stake in Wells Fargo and some other US banks? Buffett pulled out airlines first then banks.
  • What do banks think of never-ending ZIRP and does the Fed’s shift affect forecasts at all?
  • How is Morgan Stanley’s wealth management division cushioning any drop in trading revenues?
  • What progress on Citigroup’s risk management system troubles?

Q2 earnings recap

JPMorgan beat on the top and bottom line. Revenues topped $33.8bn vs the $30.5bn expected, whilst earnings per share hit $1.38 vs $1.01 expected. The range of estimates was vast, so the consensus numbers were always going to be a little out.

The bank earned $4.7bn of net income in the second quarter despite building $8.9 billion of credit reserves thanks to its highest-ever quarterly revenue. Loan loss provisions were $10.5bn, which was more than expected and the quarter included almost $9bn in reserve builds largely due to Covid-19.

The consumer bank reported a net loss of $176 million, compared with net income of $4.2 billion in the prior year, predominantly driven by reserve builds. Net revenue was $12.2 billion, down 9%. Credit card sales were 23% lower, with average loans down 7%, while deposits rose 20% as consumers deleveraged.

The provision for credit losses in the consumer bank was $5.8 billion, up $4.7 billion from the prior year driven by reserve builds, chiefly in credit cards.

Trading revenues were phenomenal, rising 80% with fixed income revenues doubling. Return on equity (ROE) rose to 7% from 4% in Q1 but was still well down on the 16% a year before. ROTE rose to 9% from 5% in the prior quarter but was down from 20% a year before.

Citigroup EPS beat at $0.50 vs the $0.28 expected. Trading revenues in fixed income rose 68%, and made up the majority of the $6.9bn in Markets and Securities Services revenues, which rose 48%. Equity trading revenue dipped 3% to $770 million. Consumer banking revenues fell 10% to $7.34 billion, while net credit losses, jumped 12% year over year to $2.2 billion. Net income was down 73% year-on-year.

Since then the bank has offloaded its retail options market making business, leaving Morgan Stanley (reporting Oct 15th) as the major player left in this market. We await to see what kind of impact the explosion in options trading witnessed over the summer had on both. ROE stood at just 2.4% and ROTE at 2.9%.

Wells Fargo – which does not have the investment banking arm to lean on – increased credit loss provisions in the quarter to $9.5bn from $4bn in Q1, vs expectations of about $5bn. WFG reported a $2.4 billion loss for the quarter as revenues fell 17.6% year-on-year.

CEO Charlie Scharf was not mincing his words: “We are extremely disappointed in both our second quarter results and our intent to reduce our dividend. Our view of the length and severity of the economic downturn has deteriorated considerably from the assumptions used last quarter, which drove the $8.4 billion addition to our credit loss reserve in the second quarter.”

Bank of America reported earnings of $3.5 billion, with EPS of $0.37 ahead of the $0.27 expected on revenues of $22bn. Its bond trading revenue rose 50% to $3.2 billion, whilst equities trading revenue climbed 7% to $1.2 billion. But the bank increased reserves for credit losses by $4 billion and suffered an 11% decline in interest income.

Return on equity (ROE) fell to 5.44% from 5.91% in the prior quarter and was down significantly from last year’s Q2 11.62%. Return on tangible equity (ROTE) slipped to 7.63% from 8.32% in Q1 2020 and from 16.24% in Q2 2019.

Morgan Stanley was probably the winner from Q2 as it reported net revenues of $13.4 billion for the second quarter compared with $10.2 billion a year ago. Net income hit $3.2 billion, or $1.96 per diluted share, compared with net income of $2.2 billion, or $1.23, for the same period a year ago.

Wealth Management delivered a pre-tax income of $1.1 billion with a pre-tax margin of 24.4%. Investment banking rose 39%, with Sales and Trading revenues up 68%. MS managed to increase its ROE to 15.7%, and the ROTE to 17.8% from respectively 11.2% and 12.8% in Q2 2019.

Goldman Sachs reported net revenues of $13.30 billion and net earnings of $2.42 billion for the second quarter. EPS of $6.26 destroyed estimates for $3.78. Bond trading revenue rose by almost 150% to $4.24 billion, whilst equities trading revenue was up 46% to $2.94 billion. ROE came in at 11.1% and ROTE at 11.8%.

Expectations

(source: Markets.com)

Bank Forecast Revenues (no of estimates)

 

Forecast EPS (no of estimates)

 

BOA $20.8bn (8) $0.5 (23)
GS $9.1bn (15) $5 (21)
WFG $17.9bn (17) $0.4 (24)
JPM $28bn (19) $2.1 (23)
MS $10.4bn (15) $1.2 (20)
C $18.5bn (17) $2 (21)

 

Shares

None have really managed to match the recovery in the broad market but valuations are compelling.

Goldman trading either side of 200-day EMA

Wells Fargo can’t catch any bid

Bank of America bound by 50-day SMA

Citigroup still nursing losses after reversal in September

JPM breakouts consistently fail to hold above 200-day EMA

Warren Buffett slashes Goldman Sachs position

Equities

Warren Buffett dramatically cut his position in Goldman Sachs during the first quarter. Berkshire Hathaway’s latest regulatory filing revealed that the conglomerate sold 84% of its stake in GS, dropping the size of its position from 12 million shares to 1.9 million.

It’s another unsettling sign from the Oracle of Omaha, who famously rode to the rescue of market sentiment during the financial crisis, pumping a huge amount of money into companies to help shore up market confidence.

Goldman Sachs was one of these companies, with Berkshire making an investment of $5 billion through preferred stock. Buffett also invested $3 billion into General Electric, $5 billion into Bank of America, and bought Burlington Northern Santa Fe Railway for $26 billion.

Buffett sells Goldman Sachs, dumps airline stocks

The news that Buffett has dramatically cut his position in Goldman Sachs comes just after the company’s annual general meeting, in which he revealed that he closed his positions on the big four US airlines.

Berkshire had been among the three largest shareholders of American Airlines, United Airlines, Delta, and Southwest Airlines. Buffett stood behind the “four excellent CEOs” of the companies, but said that the outlook for air travel was a lot less clear thanks to the coronavirus pandemic.

Is Warren Buffett planning on sitting out this crisis?

Buffett’s response to the current market downturn couldn’t be more different to that of 2008-9. Berkshire Hathaway is sitting on a record cash pile of around $137 billion. Buffett bought very little in the first quarter and hasn’t found any interesting potential candidates for one of his famous multibillion-dollar acquisitions.

This has weighed on Berkshire Hathaway stock, which is down around 22% year-to-date, compared to a 9% decline for the S&P 500.

Is Goldman Sachs a sell?

Warren Buffett was not the only hedge fund manager selling Goldman Sachs during the first quarter. The Marketsx Hedge Fund Confidence tool shows that Ray Dalio of Bridgewater Associates closed his position. Greenlight Capital’s David Einhorn, however, opened a position worth $11 million.

Overall, hedge fund managers sold around 30 million shares in Goldman Sachs during Q1 (a third of which was Buffett), suggesting negative sentiment amongst the world’s leading money managers.

However, Wall Street analysts rate the stock a “Buy”, according to the Analyst Recommendations tool. The average price target at the time of writing represents an impressive 17% upside at $212.87. Nine analysts rate the stock a “Buy”, while seven rate it a “Hold”.

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