US focus: Biden, banks and why rising yields matter

As we move closer to the end of the week two main events will be on investors’ minds. Firstly, key US bank earnings could set the tone for how stock markets perform at the end of this week as JP Morgan, Wells Fargo and Citigroup all report Q4 earnings on Friday. Secondly, market watchers will be waiting to see if President Elect, Joe Biden’s call for $1.9 trillion in Covid-relief spending will be enough to give US and global risk markets a lift at the end of the week. 

Can banks’ earnings justify their share price rally? 

Looking at banks first, Citigroup, Wells Fargo and JP Morgan will release earnings on Friday, with Goldman Sachs and Morgan Stanley following with their results next week. A theme of US stock markets in 2021 has been the “great recovery trade”, which has encompassed bank stocks, a sector largely ignored for most of 2020 until having a swift recovery rally in Q4 2020; JP Morgan is now past its pre-pandemic high. However, with value stocks back in fashion, banks were set to shine. Friday’s earnings data could go two ways, either it reinforces the demand for bank stocks, or weak earnings data gives investors time to re-focus and decide if bank stocks are worth a punt in 2021. Banking earnings could be messy for Q4 2020. Average analyst estimates suggest that earnings-per-share (EPS) could fall 8% in the final three months of 2020, and profits are also expected to fall relative to Q3, when some banks delivered better than expected results. 

Buy backs are back 

Investors and analysts will also be looking at debt write-downs in the final quarter of the year, and these are expected to rise relative to the third quarter, however they remain low compared with the levels of debt write offs after the 2009 financial crisis. If debt write-offs are not as bad as feared, then banks could see some temporary relief, with a lowering of loan-loss ratios that could refill some of the banks’ capital coffers. Of course, the spike in coronavirus cases at the start of this year could well see loan loss ratios revised higher at some point in the first quarter of this year, however, that may not be the focus for the Q4 report. Investors will also be watching whether banks will announce plans for share buy-backs, which could trigger decent rallies in banking shares at the end of this week, and the upside could last into next week as we wait for Goldman Sachs and Morgan Stanley to announce their earnings. Banks had been banned from share buy backs during the bulk of the pandemic, however, the Federal Reserve said in December that banks could restart them, albeit with limitations. If banks do pull the trigger on stock buy backs, they could be rewarded with a healthy rally in their share prices. 

Forward guidance is key 

Other aspects of the banks’ earnings reports to watch out for include earnings from mortgages, after mortgage originations reached record levels last year. While, stimulus cheques and loan deferrals have helped to ward off large scale unemployment the effect could be fading; initial jobless claims in the US rose by 1 million last week, which is the highest level of the pandemic so far, and also a sign that joblessness could rise further. Thus, it is worth listening to what Jamie Dimon has to say at JP Morgan, since it is the US’s biggest bank. If he sounds concerned about 1, the rising level of unemployment 2, the dangerous surge in coronavirus cases, especially as the vaccine rollout remains at an early stage, 3, long term low interest rates and 4, a decline in mortgage applications for this year then we could see a tapering of the market exuberance around share buy backs and banking stock gains could be limited over the coming days. 

Can the President-elect excite markets further? 

President Elect Joe Biden could be an important driver of US and global financial markets at the end of this week. He is expected to call for a $1.9 trillion stimulus package during a speech on Thursday night, which will lay out the priorities for the early days of his administration. He is also expected to call for $1400 per person direct payments to most households, to boost consumer spending and help those most at risk of the economic effects from the coronavirus. While some people will use this money to pay for essentials such as food and rent, many will use it to fund discretionary spending on consumer goods, holidays etc, which could boost the US economy down the line. Mr Biden is expected to urge Congress to act quickly, as the Covid death toll has recently topped 4,000 per day. He is also expected to re-introduce an increase in the minimum wage to $15 per hour, now that the Democrats have the deciding vote in the Senate. Infrastructure spending and more money to combat climate change is also expected to be part of Biden’s plan to create more jobs and make up for those lost to the pandemic. We believe that the stimulus cheques news is the most market friendly. Although not at the $2,000 level that was proposed by the current White House administration, it is still a decent chunk of change, and we expect US small caps to react well to this news. 

Is the dollar a coiled spring? 

Interestingly, the dollar index continues to fade, even though US yields are rising. In our view, something will have to give. If US yields continue to rise, and they may well do once the impact of Joe Biden’s spending plans on national debt are calculated, we believe that the dollar will be a beneficiary of a Biden Presidency.  However, breaching that 90.70 level in the dollar index, is proving to be a hard nut to crack, and it may take a couple of months before the dollar is reliably tracking higher.