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It’s earnings season and while this looks to be the first earnings quarter in which S&P 500 has contracted (no growth) since 2009, there are sectors that we need to pay especially close interest to that can drive market activity. This is bank week as the many of the big name banks report. The banking sector needs special attention, because it may influence perception of how the Fed will handle interest rates.

Bank Week

One sector has a special relationship with the Federal Reserve, it is the banking sector. They are directly involved as they are members of the Fed, borrow from the Fed, post reserves with the Fed, transact with the Fed. The Fed is an integral part of our banking sector. The regional Federal Reserve Presidents, which are selected by the board of governors of the Fed, are selected from CEO’s of member banks.

Banks fall into basically two categories, regional banks and the big banks (Too Big To Fail). The regional banks principal revenue is generated through loans, while the big banks are involved in a variety of financial businesses (brokerage, mergers, consulting, investing, etc.). Because these banks operate at two different levels and rely on two different primary sources of revenue, we can’t cluster them together during earnings season.

Regional Banks

The data has shown that while small commercial lending continues to be weak, the regional banks are still seeing growth on savings and loans. However, the problem remains the suffocation of a mountain of regulations from the Dodd/Frank act, which has raised the costs of operations considerably. One issue that was articulated by a regional bank executive earlier this year on forward guidance was that Dodd/Frank was meant to deal with the big banks involved in an array of financial services, but the regional banks not in those services still have to comply with the same regulations.

Courtesy of wikipedia

The other problem with regional banks is that small commercial loan business. The growth is stagnant, primarily because the fixed rates by the Fed make it more risky to lend to the small business community. With interest rates so low, the banks are not able to off-set risk in the higher risk lending arena of small business. Ironically rates are low, but those who need to borrow are unable to.

The combination of low rates and over-regulation for the regionals is creating headwinds for growth. Yet, it is not stopping a few of them and there are some regionals that have figured out how to run lean and generate profits. The rest are either failing or being gobbled up by the bigger regionals or even the big banks.

Big Banks

The big banks continue to remain “Too Big To Fail” and always will be. Obviously if the big banks are members of the Fed, the Fed selects their Presidents from the banks, the banks place there reserves with the Fed and the Fed is the loaner (discount window) to these banks – they will never fail and allowed to continue – if the Fed has any say. You could say, rightly so, there is a conflict of interest – when it comes to “Too Big To Fail”.

Courtesy of wikipedia

The Big Banks have had other revenue sources (capital markets) to fall on, if loans become weak they can fall back on brokerage, if brokerage is weak they can fall back on mergers, etc. Their balance sheets and revenue models have become so convoluted and complex it is hard to know if they are actually making or losing money. The capital market services has become such a major part of the big banks revenues, is the banks success or failure on any given quarter has become based on the strength of the capital markets. This last quarter the early data shows weakness in capital market businesses and that will not just weigh on earnings, but the banks in their earnings call will articulate how the results are indicative of the current economic outlook. This is important, because the Fed is listening – closely.

Transportation Bill

There is a Transportation Bill in Congress that would cut the dividend by the Federal Reserve to banks (paid for reserves) from 6% to 1.5%. The money is to be diverted to fund highway projects. That’s right, the money (YOUR MONEY) that you save and the banks pay you interest on, is to be CUT to pay for highways. (Additional money is to come from selling oil from the Strategic Petroleum Reserve, which seems odd to sell the bottom in oil, but that is government for you. Also from additional fees from the TSA and Customs, which is just another hidden tax). I thought we already paid taxes, I didn’t know my savings was going to be robbed to pay for highways? Also, what ever happened to the 100s of billions in surplus for those “shovel ready” programs?

Some analysts have gone as far as stating our banking system is quickly on the road to socialism. The justification from taking money that is paid in interest to savers is that the government offers FDIC insurance so they have the right to get some money back to pay for other services. The reality is that the banks (we) already pay for FDIC insurance. If the FDIC believes the premiums are too low, then let them raise the premiums, but don’t take owed interest and divert it to other government projects.

When, not if, this passes – expect less interest (which is already low) and also higher fees – as banks are continued to struggle under the weight of government.

Courtesy of FRED

New Markets

If you study economic history, every time a government intervenes, nationalizes, socializes, or tries to take control of a market, new alternative markets spring up as people seek better alternatives. As the banks have come under more government pressure of more fees, more regulations, more fines, and now government taking our interest on our savings – we have seen a blossom of new lending businesses. Crowd Funding (GoFundMe, Kickstarter, Indiegogo, etc.), Peer-to-Peer lending (Lendingclub and Prosper), and new Private Lending (Lendacy) and hosts of new lending services are springing up and growing. New business grows out of a need and when the government stifles and strangles a business sector a new one will rise up.

Earnings Week:

Tuesday: JP Morgan
Wednesday: Bank of America, Wells Fargo
Thursday: US Bancorp, Citi, BB&T, Goldman Sachs
Friday: SunTrust

More banks will be reporting, this is just to name some big ones we need to pay attention to. Do not pay too much attention to the bottom line or the earnings number. While that will certainly drive volatility into the banking sector and market, what we really need to focus on are; WHERE revenue is being generated, top line revenue growth or contraction, savings rates, default rates, and the forecast. Many are suspecting slightly weaker earnings for the banking sector as a whole, how much weaker or better time will tell.

If I had to put money into the banking sector it would be regional banks, like BB&T and I would avoid the big banks. They will never fail, if the incestual relationship with the Fed has anything to do with it, but they just might not perform. If you wanted to invest, look at the new boom in peer-to-peer, crowd funding, and private lending. That is where growth will be.

Support & Resistance

INDU 17,200
We have had a good bounce off the double bottom and looks like we are heading into the resistance area between 17,200 – 17,400. Expect some pressure as we move up to that area. Support now is in the 16,800 range.

NDX 4,400
This is the beginning of the resistance area and we can move up into that area, but expect some selling pressure until we get confirmation later in the month from the Fed.

SPX 2020
The S&P 500 can start seeing resistance in the 2020 range, but can climb up to 2040 and even jolt to 2060 before strong selling pressure comes to bear. Right now it needs to get above 2020. Again, a straddle strike in here with either a move lower or higher, until the Fed sets the tone with rates at their October meeting.

RUT 1180
All eyes are watching the Russell for general market order flow and if we are going to move out of the bear trend since July. If we can get up to 1180 and close above it on strength, we could be setting up for a strong rally. I don’t expect too much volatility higher or lower until after the FOMC meeting this October. I would look at 1140 and 1180 as the short-term range.

The bank earnings this week can jolt the market and also give us some perception to the Fed policy. If self-interest is any measure, the banking sector, mainly the big banks do NOT want rates to go up. Their growth is based on expanding margin/leverage on low rates. They are in the capital markets and one only has to look at the stock market since the beginning of the Fed monetary policy. Zero rates, bond buying, MBS buying, and increase in the money supply sends asset prices higher. So yeah, obviously, the big banks do NOT want a rate hike (regardless of what their analyst say, who are paraded out during Fed decision time).

Remember these banks are not only members of the Fed, their CEOs are selected to be the Fed regional Presidents. They are deeply related in an incestual way – so what they need and what they want are clearly heard at the Fed.

There are some that have argued, I think effectively, that there is an internal war at the Fed between the regional presidents and the newly President appointed governors. The Governors, appointed by the President of the United States are for the most part Academic Keynesians that support broader socialist policies (Doves). While the regional Fed Presidents have been more centrist and supporters of capitalism (Hawks). With the last two real Hawks, Plosser and Fisher gone, the Fed has moved far to the Dovish side with all governors now appointed by one President and new Fed Presidents more carefully selected with a similar like-minded philosophy.

One has to wonder if Yellen and the governors support ideas like the Highway Transportation Bill that diverts interest to social programs and out of savers pockets.

One Response to “BANK WEEK”

  1. Luana says:

    Here we go again, this time a tax on savings. It seems to me this puts a new twist on things: if the Fed (and regional banks) increase the interest on savings, and then takes away the increase to “pay for highways”, then the interest increase is only for the government’s programs that need funding. Right now the paltry .05% we get on savings (including CDs) is not going to buy many highway miles. I haven’t seen 6% for a very long time. The new move will make my savings not only shrink to minus earnings (compared to inflation), but minus-minus negative. Thanks Mike, As usual, an interesting overview.