Wall Street's biggest players have had a rough start to the year.
All of the biggest US banks saw profits take a hit in the first three months of 2022, ending a pandemic-era boom.
Citi, Goldman Sachs, Morgan Stanley and Wells Fargo all announced large year-over-year profit declines in their first-quarter earnings reports, joining JPMorgan Chase, which announced that its first-quarter profit fell 42%.
Citi saw a drop of 46%, Goldman Sachs fell 42%, Morgan Stanley dropped 11%, Wells Fargo fell 21% and Bank of America lost 12%.
In each report, the sprawling financial entities most certainly carry important insights not only into the health of the financial system, but the overall U.S. economy that is now potentially headed toward a recession in the near future.
With JPMorgan declaring "it's a fact" that "storm clouds" are on the horizon, there is good reason to parse each of the results and discern economic signals from individual firm execution.
Rollercoaster Results
The slew of important prints hitting the presses began on last Wednesday with JPMorgan's disappointing results, which signal dark clouds on the horizon.
In each case, headline figures came in below Wall Street expectations.
For JPMorgan, the issue was apparent in profitability, while Wells failed to reach previously expected revenue results. Much of the disappointment was blamed on Ukraine war, rising inflation, and preparation on the part of each bank to steel themselves ahead of expected market downturns.
"We've built $902 million in reserves, driven by increasing the probability of downside risks due to high inflation and the war in Ukraine, as well as builds for Russia-associated exposures, and [Corporate & Investment Banking] and [Asset & Wealth Management]," JPMorgan CFO Jeremy Barnum told analysts.
While loan growth and an increase in deposits were pointed to as bright spots, these were not enough to overcome significant declines in revenue from investment banking and equity underwriting.
The results for Wells Fargo were even more troubling, as the Main Street-focused bank took a big hit from expenses related to the bank's checkered past which exacerbated the impact of underwhelming net income figures. Further, much like JPMorgan before it, CEO Charlie Scharf warned about recession risks on the horizon.
"Our internal indicators continue to point towards the strength of our customers' financial position, but the Federal Reserve has made it clear that it will take actions necessary to reduce inflation and this will certainly reduce economic growth," Scharf said in a prepared statement. "In addition, the war in Ukraine adds additional risk."
As WFC shares fell in Thursday's session, the lackluster results are leaving investors less than pleased.
However, not all banks were so downbeat. In fact, Citi, Goldman Sachs, and Morgan Stanley quickly shrugged off this trend, far surpassing expectations and sending their shares skyward to start the shortened last week's final trading day.
While both Goldman and Citi noted the same significant impacts to Wall Street-focused divisions like investment banking as their underperforming contemporaries, CEOs across the board touted their resilience even amidst these headwinds. This resilience allowed each to top analyst estimates and shift pessimistic sentiment on the big banks to a notable degree.
"Despite the environment, our results in the quarter show we continued to effectively support our clients and I am encouraged that our more resilient and diversified franchise can generate solid returns in uncertain markets," Goldman Sachs CEO David Solomon told analysts.
Trading Tells the Tale
Solomon may be underselling the key aspect in earnings that bifurcated the trajectory of banking stocks, however. That aspect was clearly the trading divisions of each firm, with some more capable of capitalizing on volatility than others, overcoming consistent issues apparent across the industry.
"In Markets, our traders navigated the environment quite well, aided by our mix, with strong gains in FX and commodities," Citi CEO Jane Fraser said, speaking to this crucial cushion.
The firm reported a jump in fixed-income revenue from $2.43 billion in the fourth quarter of 2021 to $4.3 billion in the reported quarter. Meanwhile, equity trading income trended upward to over $1.5 billion from just over $900 million in the prior-year quarter. This was a crucial respite from concerns that have boiled over at Citi given its sprawling international interests, making it one of the hardest-hit U.S. banks from Russia's invasion of Ukraine.
Goldman's results reflected the same dynamic, with fixed-income trading clearing the bar set by analysts by $1.7 billion and equities trading eclipsing expectations by more than $500 million. In this case, the trading windfall far outpaced a fall in deal-flow as SPAC popularity rapidly subsided.
Finally, Morgan Stanley showed its prowess in trading and utilized these specific results to blow away top-line and bottom-line expectations. For the quarter, equity trading revenue reached $3.2 billion, $500 million above estimates, while fixed-income results soared about $700 million above analyst forecasts.
Additionally, wealth management, which now includes the ETrade platform was also cited as an area of strength by CEO James Gorman.
"Wealth Management's margin proved resilient and the business added $142 billion net new assets in the quarter, and Investment Management benefited from its diversification," he said in a statement. "The quarter's results affirm our sustainable business model is well-positioned to drive growth over the long term."
Recession Risks, Rising Rates
Yet, in the end, the bank earnings all appear to be showing investors the basic Federal Reserve-related dynamic that could define the trend for all banking stocks. That, of course, is still-increasing inflation and the ensuing Fed response.
At present, many of the banks benefiting from the current environment are not only succeeding in trading departments, but also eager to rise with the tide of interest rates. Historically, rising interest rates are a boon to big banks for a myriad of reasons.
Analysts on Wall Street are most certainly cognizant of this trend. In fact, just this week, Bank of America (BAC) analyst Keith Horowitz upgraded Wells Fargo to a "Buy" on the expectation that it could benefit greatly from a rising rate environment.
The question is about just how quickly the Fed will be forced to move. While banks are eager to increase margins with interest-rate hikes, a raise too steep can curtail any benefit by adversely impacting the economy overall.
JPMorgan CFO Jeremy Barnum was perhaps the most straightforward in outlining how persistently high inflation could soon trigger a full recession.
He explained that the bank is forecasting a heightened probability of a "Volcker-style, Fed-induced recession in response to the current inflationary environment...driven by commodity price increases, which are in part driven by the war in Ukraine."
As that war continues and sends gas prices skyward while COVID-19 lockdowns continue, supply-chain problems look as though they will persist for quite some time. With historic levels of inflation flowing through in CPI data in recent months, the Fed may well be encouraged to quicken their pace.
If this is the case, JPMorgan's "storm cloud" forecasts and preparation for such a rainy day may prove prescient. At the very least, investors in financials will need to remain vigilant as trading benefits from volatility might not shore up earnings results should such a scenario play out.
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