If market swings tell us anything, it's that investors are rattled by economic uncertainty. The outlook remains cloudy with the possibility of recession on the horizon. Big bank earnings, coming Friday, could help clear some of that fog.
Wall Street will be looking for clues about what's to come as the Federal Reserve continues to aggressively hike interest rates and cool the economy.
What's happening: Four of the nation's largest banks — JPMorgan Chase, Wells Fargo, Citigroup and Morgan Stanley — report third-quarter earnings before the bell on Friday. Their CEOs will also answer questions from investors, analysts and reporters about their views on the wider economy.
Banks are able to charge more for customers to borrow when interest rates go up — so in theory, this should be a good environment for them. But a weakening economy also means demand for loans is beginning to dry up. Analysts surveyed by Refinitiv expect profits to fall from the year-earlier period at all four banks.
Beyond disappointing headline figures, Wall Street analysts are focusing on three important factors: loan growth, capital adequacy, and the economic outlook.
Loan growth: The rate at which businesses borrow money from big banks doesn't just tell us about the health of a financial institution itself. It also tells us a lot about whether businesses plan to expand over the next few months or if they're preparing for a slowdown.
Analysts expect that loan growth stayed strong during the third quarter. "Credit risk and loan loss exposure are beginning to creep into the picture, but will not be front and center for Q3 2022 results," wrote CFRA Research Director Kenneth Leon in a note.
But Wall Street estimates show that loan growth is expected to decelerate in Q4 and into next year.
Growth of Individual loans will likely decline, showing that Americans are beginning to feel the pinch of rising interest rates. Mortgage rates are now two times the level they were a year ago, and mortgage applications recently fell to a 25-year low.
Capital adequacy: Expect banks to take questions about how much money they have on hand. Recent upheaval in UK bond markets and negative headlines about Credit Suisse have caused concern about a "contagion" effect in the United States.
It's unlikely the turmoil will lead to another Lehman Brothers-esque financial crisis: The 2010 Dodd-Frank Act forced banks to double their capital ratios and quadruple their liquidity. Large banks also participate in annual stress tests performed by the Federal Reserve to measure their capital adequacy.
Still, investors are worried about direct exposure to European banks.
The other issue, wrote UBS analysts in a note, "is that while banks have sufficient capital and deposit flows to support loan growth, it is less robust than it has been in recent years, and we expect banks to be less well positioned to return capital to shareholders through buybacks." That will likely weigh on stock valuations.
Economic outlook: JPMorgan CEO Jamie Dimon has a knack for moving markets by predicting economic downturn. This week, stocks plummeted after he warned that the United States could enter recession within the next six months. Expect more commentary on the future outlook, and warnings from CEOs attempting to prepare investors for weaker days ahead.
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