Inflation, Banking, and Financials
Financials have kicked off second quarter earnings with several big names like BlackRock Inc. (BLK) and JPMorgan Chase & Co. (JPM) disappointing and prompting the U.S. stock markets to continue falling.
Financial Select Sector (SPDR ETF) YTD Performance
While some investors and analysts anticipated a decline in banking and financials’ revenues from Q1 2021 and that the short-term pain caused by spiking inflation would be overshadowed by long-term benefits attributed to income on loans, the fear of defaults is rising.
Not only did the latest CPI indicate a rise in inflation to 9.1%, but PPI also surged 11.3% year-over-year, making it a seventh consecutive month of double-digit increases. And while JPMorgan believes they will do “quite well” even in a recession, the current analyst revisions indicate otherwise.
Inflation is rising, and many financial institutions have slowed or halted share buybacks due to declining capital. It’s also unclear how many banks and financial institutions are feeling the wrath of the bond market. And the amount of increased lending over the last year and consumers borrowing on credit are now exposed to higher rate increases. Consumers’ probability of default and delinquencies is higher and can strain financials’ balance sheets, which is why I believe many financial institutions and banks are seeing a slide in earnings.
Investing in the Financial Sector
Banking and financial stocks typically possess advantages that include long-term performance, some of which have benefited from rising rate environments, offering dividend income. For investors interested in identifying financial stocks with strong buy recommendations, here’s a list of Top Financial Stocks. In rising rate environments like we’re seeing, banks and financials can typically charge higher rates, as we see with mortgages and other loans. However, as the fear of recession and economic slowdown rears its head, many banks are looking to stash cash to cover potential defaults. Whether recovering, slowing down, or experiencing a recession, these financial stock picks possess uncertain outlooks, with BlackRock and JPMorgan Chase falling after very disappointing Q2 earnings.
JPM vs. BLK vs. S&P 500 1yr Price Performance
2 Big Financial Stocks Miss Earnings: Canadian Banks Hike Rates
Market volatility continues, and JPMorgan’s warning didn’t help the cause. JPMorgan CEO Jamie Dimon stated that the economic climate and business spending remain healthy. However,
“Geopolitical tension, high inflation, waning consumer confidence, the uncertainty about how high rates have to go and the never-before-seen quantitative tightening and their effects on global liquidity… are very likely to have negative consequences on the global economy sometime down the road.” –Dimon
Despite being some of the world’s biggest names and well diversified, thus less susceptible to the downside, a number of the giant financial companies missed estimate expectations this week and gearing up for loan defaults, a decrease in spending, and possible recession.
1. BlackRock, Inc. (BLK)
Market Capitalization: $89.18B
Quant Rating: Sell
Quant Sector Ranking (as of 7/15): 569out of 684
Quant Industry Ranking (as of 7/15): 68 out of 89
Dividend Yield (FWD): 3.32%
A publicly owned and traded asset management company, BlackRock Inc. focuses on an array of investment products, funds, and services globally. A high-quality business with a solid reputation, this stock has not fared well in the current environment, posing a 30% fall in Q2 profits.
After $10B in investor outflows from actively managed funds, rising interest rates, and inflation, BlackRock is far from in the black, prompting a revised consensus and 12 downward estimate revisions.
BLK Growth and Profitability
Following the “worst start to the year for both stocks and bonds in half a century,” said BlackRock Chairman and CEO Larry Fink, BLK’s Q2 operating income of $1.7B dropped 14% year-over-year. As businesses brace for recession, firms like Blackrock feel the heat and bracing for a potential recession, especially as investment managers and bankers bring in significantly less revenue.
Asset managers feel the effect of investor outflows and investors wanting to go to cash amid stock declines. In addition to a decline in AUM from $957T in March of 2022 to $8.49T, EPS of $7.36 also missed by $0.66.
“Despite double-digit declines in equity and fixed income indexes year-over-year, second quarter base fee and securities lending revenue of $3.7 billion was down just 2% year-over-year… While we can’t control near-term market volatility, we are always prepared for it… We have navigated these choppy waters before and are well prepared for what may lie ahead. As always, we remain committed to optimizing organic growth in the most efficient way possible.” -Gary Shedlin, BLK CFO.
As a result of declines, BLK’s performance fees have dropped 69%, one of the largest declines from a single-strategy hedge fund. As BlackRock’s outlook appears an uphill battle in an era riddled with fear and volatility, its valuation and momentum continue to paint a picture that this stock is overpriced and on a downtrend.
BLK Stock Valuation and Momentum
As indicated by the D- overall valuation grade and forward P/E ratio of 17.03x, BLK is highly overvalued, more than 76% above its sector. In addition, its forward Price/Book of 2.32x is a 117% difference to the sector.
When reviewing BlackRock’s price performance over the last year, the stock is down 31% and has been on a bearish trend, as evidenced by the below YTD performance, -34%. Quarterly, BLK’s momentum has been on a gradual decline, outperformed by its sector peers by two and three times over the nine- and 12-month periods.
Despite all of the negative characteristics that have reared their head for this stock over the last year, BlackRock still maintains a stellar dividend scorecard with an attractive 3.32% dividend yield, A+ dividend safety, and 18 years of consistently paying a dividend. The company has repurchased nearly $1B in shares and plans to take advantage of any relative undervaluation opportunity in its stock. However, BLK’s overall quantitative metrics indicate that BlackRock has characteristics historically associated with poor future stock performance. As such, this stock has a Sell rating. With declining revenues, poor growth, and momentum metrics, let’s look at the following stock, which also experienced dismal Q2 earnings.
2. JPMorgan Chase & Co. (JPM)
Market Capitalization: $328.69B
Quant Rating: Hold
Quant Sector Ranking (as of 7/15): 208 out of 684
Quant Industry Ranking (as of 7/15): 16 out of 56
Dividend Yield (FWD): 3.70%
One of the biggest and most well-known names in banking, JPMorgan Chase offers diversified banking products and services, including asset and wealth management, retail banking, loan origination, and investing and lending products. JPM kicked off Q2 earnings on Thursday with a 28% fall in quarterly profit, resulting in a suspension of buybacks and a discussion about the firm needing to build capital reserves.
Rapidly-rising interest rates have slowed loan demand, impacting revenue generation, lower fees, and a decline in debt and equity issuances have hurt JPM’s investment banking business. JPM recorded $1.1B in credit losses, with revenue from business declining 61% to $1.4B. The announcement led to a near 5% decline in JPM’s stock price. As we look at JPM’s growth and profitability, this large bank is likely to prove resilient regardless of a recession, which is why we believe this stock is a Hold.
JPM Growth and Profitability
JPM’s F growth grade is highly unattractive and reflects the company’s write-downs on bridge loans, declining revenue growth, and top-and bottom-line misses. EPS of $276 missed by $0.15 and revenue of $30.72B missed by $1.10B, resulting in 10 downward analyst revisions.
Although high interest rates typically benefit banks, JP has been capitalizing on trading revenue from its wealth and asset management departments, helping offset the weaker capital markets and divisions. In addition to some of the previous optimism reflected by Dimon during the Q2 Earnings Call, JPMorgan has a long-standing track record of managing business cycles. The CEO has indicated that the company is prepared for a recession.
“Our credit card portfolio is prime. I mean, it’s exceptional. But again, we’re adults in that. We know that if you have a recession, losses will go up. We prepare for all that, and we’re prepared to take it because we grow the business over time,” said Dimon.
Despite its poor Q2 showing, JPM is a high-quality company with a solid dividend and reputation, trading at a relative discount.
JPM Stock Valuation and Momentum
JPM trades at a relative discount, with a forward P/E ratio of 9.6x, a slight difference to its sector, but its trailing PEG of 1.14x is substantially higher than its peers.
With bearish momentum and a D overall momentum grade, this stock’s quarterly price performance has been on a steady downtrend, indicating that some prudence is required if considering this stock. Based on its overall performance, I maintain that this stock is a hold based upon the quant ratings.
Not only have the earnings results for some of the biggest U.S. banks, lenders, and financial institutions surprised investors, recession fears and uncertainty led to the Bank of Canada issuing a shock 100-basis point rate hike. Some of the largest Canadian banks increased targets overnight, with TD and RY among the names.
3. Toronto-Dominion Bank (TD) and Royal Bank of Canada (RY)
In a surprising turn of events, as recession fears plague the globe, Canada’s big banks raised prime rates by 100 basis points this week, exceeding economist expectations, making it the most significant hike since 1998. To try and tame inflation, more than 30 central banks have hiked rates by 1%. Although Toronto-Dominion Bank (TD) and Royal Bank of Canada (RY) have solid profitability metrics and have annually increased shareholders’ equity by 5.5% and 6.7%, respectively, Canadian banks are in substantial debt to GDP.
Attributed to bank lending practices, which include five-year fixed-rate mortgages requiring individuals to refinance at the latest – and higher – interest rates, this is likely to serve as a devastating blow to households; Canadian households are already in tremendous debt, which continues to grow.
Whereas the U.S. made strides in 2009 to reduce debt, as interest rates in Canada continue to rise, the nation’s largest banks face substantial risks. Fellow Seeking Alpha contributor Jordan Sauer recently wrote, TD And Royal Bank: Canada’s About to Implode. “Canadian banks are like ships sailing on a sea of debt. Everything looks fine right now, but even the Titanic can sink.”
The economic outlook of Canada’s big banks is skating on thin ice with consumer debts mounting. In a statement from the Bank of Canada, “A greater number of Canadian households are carrying high levels of mortgage debt… these households are more vulnerable to declines in income and rising interest rates.” As a result, we may see defaults and bankruptcies leading to government bailouts. Bailouts could lead to higher inflation like we experienced post-pandemic in the U.S., but only time will tell.
TD Stock vs RY Stock Factor Grades
When we look at TD stock and RY stock’s factor grades, although they maintain an A+ profitability rating, they’re relatively overvalued, with collective metrics that position both stocks as a Hold, while still susceptible to an economic outlook and debt that could be bad for the companies as a whole.
Although equities generally perform poorly in rising rate environments, financials tend to generate greater revenue from varying revenue streams. The combination of rising rates, fear, and inflation has resulted in banking and financial stocks with poor quarterly performance. BLK and JPM dominate the market share, yet one is rated Sell, and the other Hold, given the latest quant ratings and earnings results. Investors that typically sought increased exposure to the financial sector as a potential inflation hedge are shying away from these companies, resulting in some of the biggest outflows.
The stock picks discussed today have bearish momentum, slow growth, and are relatively overvalued. Check out the Grades on your stocks or consider defensive sectors like Top Consumer Staples or Top Utility Stocks to help hedge against inflation. Our investment research tools help to ensure you are furnished with the best resources to make informed investment decisions.