Big banks will start releasing their quarterly numbers this week. Let’s delve into the earnings potential of the big six banking companies that could drive the performance of the sector ahead.

According to our methodology, a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold), when combined with a positive Earnings ESP, increases our chances of predicting an earnings beat, while companies with a Zacks Rank #4 or 5 (Sell rated) are best avoided. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

Inside Our Surprise Prediction

Among the big six, JPMorgan Chase & Co. (JPM Quick QuoteJPM - Free Report) , Wells Fargo & Company (WFC Quick QuoteWFC - Free Report) , Citigroup Inc. (C Quick QuoteC - Free Report) and are likely to report on Jul 12. The Goldman Sachs Group (GS Quick QuoteGS - Free Report) is expected to come up with earnings on Jul 15. Bank of America Corporation (BAC Quick QuoteBAC - Free Report) and Morgan Stanley (MS Quick QuoteMS - Free Report) are expected to report on Jul 16.

JPM has a Zacks Rank #3 and an Earnings ESP of +0.57%.

WFC has a Zacks Rank #3 and an Earnings ESP of +0.50%.

C has a Zacks Rank #3 and an Earnings ESP of -1.31%.

GS has a Zacks Rank #3 and an Earnings ESP of -1.35%.

BAC has a Zacks Rank #3 and an Earnings ESP of -0.46%.

MS has a Zacks Rank #3 and an Earnings ESP of -1.39%..

Are Negative ESPs a Threat to Financial ETFs?

As discussed above, chances of a broad-based earnings beat are low-to-moderate since most stocks currently have a negative ESP. Some of the largest US banks may report weaker profits for the second quarter as they earn less from interest payments and set aside more money to cover deteriorating loans to make up for the higher credit losses, per analysts, as quoted on Reuters.

Risks for higher commercial and industrial (C&I) loan losses may weigh on banks earnings results this time compared to the year-ago period. Under the Fed's stress-test scenario, C&I loss rates are projected to rise to 8.1%, from 6.7% in last year's screening.

Any Hope?

However, despite negative ESPs, we believe financial stocks and ETFs are up for a rally in the coming days on the likelihood of a steepening yield curve. The United States is currently undergoing a tight monetary policy era. However, there is a high chance that the Fed may enact at least one rate cut at the end of this year. This, in turn, may steepen the yield curve.

As banks seek to borrow money at short-term rates and lend at long-term rates, a steepening yield curve earns more on lending and pays less on deposits, thereby leading to a wider spread. This expands net margins and increases banks’ profits.

According to a banking analyst at Oppenheimer (as quoted on Reuters), net interest income will likely hit the bottom in the second or third quarters before starting to rise again as banks have started negotiating on new loans at relatively higher rates.

Moreover, dealmaking is a sweet point in the banks’ earnings picture. Merger and acquisition volumes hit $1.6 trillion globally in the first half of the year, up 20% from a year earlier, per Dealogic data, as quoted on Reuters. Equity capital market volumes jumped 10% during the same period.

Bottom Line

So, whatever the earnings surprise is, investors can play these financial ETFs on the basis of yield curve movement. Hence, investors pinning hopes on a bank rally must be keen on knowing how financial ETFs like iShares U.S. Financial Services ETF (IYG Quick QuoteIYG - Free Report) , iShares US Financials ETF (IYF Quick QuoteIYF - Free Report) , Invesco KBW Bank ETF (KBWB Quick QuoteKBWB - Free Report) , Financial Select Sector SPDR (XLF Quick QuoteXLF - Free Report) and Vanguard Financials ETF (VFH Quick QuoteVFH - Free Report) are placed before their earnings releases. These funds have considerable exposure to the aforementioned stocks.

Goldman has moderate exposure to the aforementioned ETFs. It is heavy on iShares U.S. Broker-Dealers & Securities Exchanges ETF (IAI Quick QuoteIAI - Free Report) .