Expect Nasty Surprises From Banks Come Earnings Season

 | Mar 14, 2017 | 12:00 PM EDT
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Stock quotes in this article:

XLF

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KBE

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kre

Trading profits saved bank earnings in the fourth quarter of last year, but I am not so sure that will be the case for the current quarter. Banks are currently sitting on losses on their for-sale securities. A look at the weekly H.8 banking report put out by the Fed shows that profits on banks' securities positions tumbled into losses in January through now. It's been a big swing down, as you can see from the chart below.

Banks are now under water on their for-sale securities positions and, with the Fed about to raise interest rates, it looks like the situation could become worse. That's because they're probably holding bonds and stocks -- both likely to see more downside following a rate hike.

This news is bad enough. However, as I have been telling you, the growth in bank credit, i.e. loans and leases, has been collapsing. Take a look:

Credit is the major "product" of banks. That's where they make most of their money and, when credit demand is falling as it looks to be (and not just falling, but plummeting), then this a serious matter for the banks if they're not able to offset it in some other area of their business. Clearly, that area won't be in "trading" this quarter. Frankly, I don't see how this will not adversely affect their bottom lines.

Meanwhile, investors are buying up bank stocks. The S&P Financial Sector SPDR (XLF) is trading right near a two-year high and if it breaches that, it would be at a nine-year high. The SPDR KBW Bank ETF (KBE) is at a nine-year high and the KBR SPDR Regional Bank ETF (KRE) is at an all-time high. These are elevated price levels, given what appears to be the deterioration in underlying conditions.

A lot of the recent rally in bank stocks has been due to promises of financial deregulation by President Trump. Granted, he did roll back some Dodd-Frank-related regulations in February via executive order, but is that enough? You can't trade forever on hope while your actual business is deteriorating.

Ultimately, the banks' core businesses will need to improve. I mean, it's truly shocking how brutally the chart of loans and leases has collapsed. We're not talking about a slow, gradual decline but rather, something more like falling off a cliff.

On top of this we have the general macroeconomic environment, which looks increasingly weak. Last week we saw the worst trade deficit in five years and we also saw a decline in wholesale inventories. That means the one thing that contributed most to fourth-quarter GDP growth --inventory investment -- is now falling and the one thing that subtracted the most from fourth-quarter GDP-- Net Exports -- is getting worse.

Add it all up, and I don't see where the growth is coming from. With fiscal flows (federal spending) now only growing about 0.4% over last year, I'd say that would be a pretty good estimate of where first-quarter GDP will come in: 0.4%.

Looking forward, Trump's budget will be released this week and it's being reported that he will submit "historic" levels of spending cuts. While the budget has to be passed and there is much opposition to these cuts in non-military domestic spending, there is quite a bit of unanimity in Congress on the subject of debt and deficit reduction, as foolish as that is.

So, investors, I'd be careful about buying up these bank stocks, as loan growth plummets and bank trading positions remain underwater. I have a feeling there's going to be quite a surprise come earnings season, and it won't be pleasant.

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