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The big money center banks will report their Q1 earnings this coming week. They are included in the S&P 500 Financials sector, which has been the worst-performing one in the S&P 500 this year to date, down 7.3% through April 10, compared with a broadly flat market over this period (chart). One of the major culprits is the gathering storm in private credit. It has rattled investor confidence in the sector, dragging everything from asset managers to consumer lenders along.
Nevertheless, the stock market is not pricing a systemic financial problem into stock prices. Regional Banks are up 2.6% ytd while Consumer Finance is down 17.2%, a significant spread within a single sector (chart). Diversified banks are off just 2.6%.
The sector has participated in the stock market rally that started on March 31 and remains on a solid upward trend (chart).
Furthermore, while there are cracks in the "shadow" banking system, commercial banks are actually increasing their lending (chart). There’s no sign of a credit crunch in the Fed’s weekly bank loan data.
Of course, investors have other concerns about the banks, including the cap on credit card rates Washington has proposed; the increase in consumer delinquencies, worsened by higher energy prices; and the possibility that the Fed might have to raise interest rates if inflation proves persistent rather than transitory (again). Nevertheless, the Fed’s weekly data on banks’ allowances for loan losses remain relatively low (chart).
Forward earnings, calculated from the weekly consensus estimates of analysts who cover the sector, has continued to rise to record highs, led higher by S&P 500 Diversified Banks (chart).
The S&P 500 Financials sector has a forward profit margin of 21.5%, the second highest in the S&P 500. The S&P 500 Diversified Banks forward profit margin is currently 26.9.
If the economy continues to grow, as we expect, the forward P/E of the S&P 500 Financials, currently 14.6, is a relatively attractive valuation multiple (chart). The consensus is that the sector’s earnings rose 17.8% y/y in Q1, the second-highest among the 11 S&P 500 sectors, behind only Information Technology. With the sector trading at a 27% discount to the broader market, the bar for an upside re-rating is not high. To us, it’s a constructive setup.
The private credit stress is real and localized, concentrated in direct-lending vehicles with genuine structural issues, including liquidity mismatches and mark-to-model valuations. But the reflexive de-rating of the entire Financials sector isn’t warranted; it unduly conflates the problem in the shadow banking system to a problem for the health of regulated banks, insurers, and diversified lenders—none of which are seriously exposed to the private credit stress.
