Bank stocks are up +19.2% over the past year, outperforming the broader market’s +15.5% gains and the Finance sector’s +17.7% gain. But the industry has struggled lately, with stocks in the Zacks Major Banks industry down -8.6% since February 1st, underperforming the S&P 500 index’s -5.6% decline in that same period, as the chart below shows.

The biggest reason for this recent underperformance is the interest rate uncertainty, which has forced yields on the benchmark 10-year Treasury bond to generally move sideways and down over the last two months. This change in treasury yields represented a notable reversal of the uptrend that had been in place since September last year, during which the 10-year yield moved up more than 80 basis points and appeared poised to cross the 3% level.

Treasury yields have been hard to handicap over the last many years and the ongoing uncertainty on that front, a reflection of safe-haven trades resulting from trade-centric worries and the market’s evolving inflation/Fed outlook, reconfirm the difficulty of forecasting this key metric.

That said, the Fed remains on a steady tightening trajectory, with market uncertainty at present primarily related to whether the central bank will announce four rate hikes, as it has publicly stated, or more than that. But irrespective of whether we have four or more rate hikes this year, there is no question that we are heading towards the Fed Funds rate reaching a ‘normal’ or ‘neutral’ level before the middle of 2019. In other words, it may have been difficult to forecast yields over the last few years, but they should be going up in the months and quarters ahead.

The reason we are talking about treasury yields and interest rates in a discussion about bank earnings is that Interest rates act like oxygen for banks. The low interest rates of the last few years, resulting from a deliberate Fed policy, had put a lid on banks’ earnings power. Net interest margin, the difference between what banks pay their depositors and what they charge lenders, has been flat to down for the last few years. With revenue growth hard to come by as a result of this backdrop, banks were forced to maintain profitability by squeezing expenses out of their operations.

All of this has started changing, net interest margins have started expanding, at least on a year-over-year basis, offsetting some of the lingering weakness with loan portfolio growth.

What Are Banks Expected to Report in Q1?

The last earnings season was very messy because of huge one-time charges related to tax law changes, but we should start seeing ‘cleaner’ results from this earnings season onwards, with net interest margins potentially coming in better than many analysts have factored in their models.

The sharp uptick in market volatility is also helpful to the big banks’ capital markets businesses and we should see proof of that in trading results from JPMorgan (JPM Quick QuoteJPM - Free Report) and Citigroup (C Quick QuoteC - Free Report) as they report results on Friday, April 13th; Wells Fargo (WFC Quick QuoteWFC - Free Report) is reporting that day as well, but it is less of capital markets operator relative to its peers. PNC Financial (PNC Quick QuotePNC - Free Report) also reporting April 13th also isn’t a capital markets player.  

For the Finance sector as a whole, of which the Major Banks industry is the biggest earnings contributor, total Q1 earnings are expected to be up +19.1% from the same period last year on +4.5% higher revenues. This would follow +0.6% earnings growth in 2017 Q4 on +4% higher revenues.

The sector’s earnings growth pace is expected to materially accelerate in 2018 Q1 and the following quarters, as the chart below shows.

Please note that the sector’s strong growth in Q1 and beyond isn’t a function of easy comparisons, but actual growth. You can see this in the dollar value of total sector earnings in the chart below.

The table below shows the sector’s Q1 earnings growth expectations at the medium-industry level contrasted with estimates for the following four quarters and actual results for the preceding four periods.

Please note that the Major Banks industry, of which JPMorgan, Bank of America and others are part, accounts for roughly 45% of the sector’s total earnings (insurance is the second biggest earnings contributor, accounting for about 25% of the total).

Driving this improved earnings picture for the banks and other finance companies is the combination of lower taxes and higher interest rates.

Expectations for 2018 Q1 As a Whole

The strong momentum we saw in the preceding earnings season is expected to continue this reporting cycle as well, with total earnings for the S&P 500 index expected to be up +16% from the same period last year on +7.4% higher revenues. This would follow the +13.5% earnings growth on +8.6% revenue growth in the 2017 Q4 earnings season, the best quarterly performance in more than 6 years.

There were two aspects of the preceding earning season that really stood out and put that reporting cycle in a category of its own; we will be looking to what extent these two aspect s get repeated this earnings season. These two standout features of the 2017 Q4 earnings season were the very strong momentum on the revenue front and impressive turnaround on the estimate revisions front.

The revenue momentum likely reflected a combination of the synchronized global growth environment and a favorable foreign exchange backdrop. With both of those factors still very much in play in Q1 as well, we can reasonably expect to see the revenue momentum trend continue this earnings season as well.

The story about trends in 2018 Q1 estimate revisions is better told by the chart below.

What this chart shows is that earnings growth expectations for 2018 Q1 moved up significantly since mid-December 2017. This represented a major trend shift relative to what we have been seeing over the last many years when estimates would actually be moving in the opposite direction. To be fair, the revisions trend had stabilized in the preceding quarters as well, with estimates for 2017 Q4 essentially remaining unchanged in the three months ahead of the start of that reporting cycle.

A big driver of these positive revisions is obviously the direct impact of the tax cuts, but that isn’t the only reason, as you can see in the revisions trend for revenues in the chart below.

We will be keeping a close eye on how estimates for 2018 Q2 evolve as companies report Q1 results and share their outlook for Q2 and beyond. Estimates for Q2 went up as well, as they did for the following quarters, when the same was happening to 2018 Q1 estimates. As of today, total Q2 earnings for the S&P 500 index are expected to be up +17.9% from the same period the year before on +7.3% higher revenues.

The chart below shows 2018 Q1 earnings growth expectations contrasted with what is expected in the following three quarters and actual results in the preceding 5 quarters. As you can see in the chart below, the growth pace is expected to accelerate in Q2 and continue in the following quarters.

As you can imagine, expectations for full-year 2018 are for an impressive showing, with total earnings for the S&P 500 index expected to be +17.9% from the year-earlier level on +5.3% higher revenues. If achieved, this will be the highest annual growth pace for the index since 2010.

The table below shows the summary picture for 2018 Q1, contrasted with what was actually achieved in the preceding period.

Standout Sectors

As you can see, the Energy sector remains a big growth contributor in Q1, with total earnings for the sector expected to be up +60.3% from the year-earlier period on +15.6% higher revenues. But growth for the quarter would still be in double-digits even on an ex-Energy basis (last row in the table above).

What is driving the strong Q1 growth isn’t the Energy sector, but rather the breadth of growth across all sectors, with double-digit earnings growth for 11 out of the 16 Zacks sectors, including Technology and Finance.

For the Technology sector, total Q1 earnings are expected to be up +20.7% on +11.4% higher revenues, which would follow the sector’s impressive +24.2% earnings growth on +11.4% higher revenue growth.

The Finance sector, which sat out the preceding quarter with an essentially flat showing, total Q1 earnings are expected to be up +19.1% from the same period last year on +4.5% higher revenues.

Driving the Finance sector’s strong growth in Q1 and beyond is the combined effect of tax cuts, higher interest rates and an improved domestic growth environment. Finance sector’s earnings were only up +1.2% in full-year 2017 and in low single digits in the three years prior to that, but are on expected to be up an impressive +25.2% in full-year 2018.

The Technology sector, on the other hand, has already been on stronger ground, with full-year 2017 earnings for the sector up +15.8% and expected to be up +17.3% in 2018. The enterprise spending environment was expected to improve this year even before the tax cuts, with the tax windfall expected to give a much needed boost to those trends. On top of these we have the existing secular trends in cloud computing, artificial intelligence and big data that are expected to remain growth areas in the space.

Please note that Technology and Finance aren’t just any two sectors out of the 16 in the S&P 500 index; these two sectors combined are the twin pillars of index’s total profitability, bringing in more than 40% of the index’s total earnings this year. The Energy sector’s outlook has improved, but the sector simply lacks the heft of these two. The Energy sector is expected to bring in about 5% of the index’s total earnings this year.

Reporting Calendar

We have 7 S&P 500 members on deck to report Q1 results this week, including the aforementioned JPMorgan, Citigroup, Wells Fargo and PNC Financial on Friday, April 13th.

The chart below shows the weekly reporting calendar for the S&P 500 index. As you can see, the reporting schedule really gets going the following week, with more than 60 index members coming out with results.

Note: Sheraz Mian manages the Zacks equity research department. He is an acknowledged earnings expert whose commentaries and analyses appear on Zacks.com and in the print and electronic media. His weekly earnings related articles include Earnings Trends and Earnings Preview. He manages the Zacks Top 10 and Focus List portfolios and writes the Weekly Market Analysis article for Zacks Premium subscribers.

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Here is a list of the 20 companies including 7 S&P 500 and reporting this week.