Big Bank Season Rolls On As Morgan Stanley Easily Beats Expectations

The big banks are five for five after Morgan Stanley MS beat Wall Street’s expectations Wednesday. The Q1 reporting season is off to a strong start as stocks try to extend gains and continue the positive momentum generated earlier this week. Volatility continues to sag.

MS got the new day off with a bang, reporting record revenue and net income. Earnings of $1.45 a share beat analysts’ consensus expectations of $1.28, while revenue of $11.1 billion came in ahead of the consensus $10.4 billion. Overall, MS did very well. Their investment banking did well; their trading did well and so did their wealth management business.

Importantly, MS executives said they see one of the biggest risks going forward as geopolitical. That bodes well, because it means that the things that are more fundamentally important, like financial results going forward, aren’t necessarily an issue. Geopolitics are out of companies’ control, and always could be a factor no matter how the economy performs. 

Looking more closely at the numbers, MS benefitted from a sizable boost in fixed-income trading, which rose 9 percent. Currency and commodity trading also looked pretty strong, and so did equities trading. Shares rose more than 2 percent in pre-market trading and other major bank stocks also moved higher.

As the banks finished their reporting seasons, the stock market enters Wednesday with all three of the top indices up slightly for the year. The mood appears to be improving as the numbers so far indicate a positive start to earnings season. Arguably, investors needed to start hearing from companies and get some real numbers to trade on. The earnings data is something real and people understand that. Trading on rumor and innuendo is what helped provide so much negative energy before the reporting season began.

Don’t forget the positive effect of blockbuster results reported by Netflix, Inc. NFLX earlier this week. The NFLX earnings arguably are the first indicator of whether consumer demand picked up in Q1. If tech stocks keep rolling out results like that, it would likely signal positive consumer spirits and perhaps give the market more of a boost. 

Earnings season continues after the close today as American Express Company AXP reports.

A general sense of “risk-off” sentiment helped extend this week’s rally Tuesday as nearly every sector gained ground. Relief over a calming geopolitical picture and generally healthy earnings news combined to lift the major indices to their highest levels in about a month.

As stocks climbed the ladder, volatility took a nap. The VIX — the market’s most closely-watched volatility indicator — slipped below 15 intraday for the first time since mid-March after trading at well above 20 last week, perhaps a sign that some investors see less choppiness ahead. VIX was just over 15 early Wednesday, and we’ll see if it can fall for a seventh-straight session. At this point, earnings are front and center, so unless there’s a major geopolitical event, the focus could continue to be on company results and maybe not so much on the kind of headline news that recently buffeted Wall Street. Many long-term investors who feel tossed around by all the recent moves would probably welcome a smoother market, though nothing is guaranteed.

Tuesday saw shares of some companies lifted by strong results reported by others. For instance, shares of Walt Disney Co DIS rose nearly 2 percent, appearing to get a boost from the NFLX results. In fact, stocks across the media sector moved higher. When stocks move because of other stocks’ earnings, that’s often the signature of a healthy market.

Risk Off? Check Bond, Gold Markets

One odd thing, however, was the risk-off sentiment only showed up in the VIX and stocks. Other “defensive” areas didn’t seem affected. For instance, the 10-year Treasury yield actually pulled back a little to around 2.81 percent, and gold prices hardly fell. In a market that was bullish across the board, normally investors would be buying stocks and selling bonds and gold, but that wasn’t really happening Tuesday and it’s a puzzle. The so-called “three horsemen of risk” aren’t adding up when you look at VIX, bonds, and gold. 

This continues a stretch in which the stock market acts almost like a separate class from all the others, and that’s the only thing that might have some investors casting a “fish eye” at the current rally. Basically, the question seems to be whether bond traders know something that stock traders don’t, because if the economy is as healthy as stocks seem to indicate, it arguably could handle a 3 percent rate on the 10-year. 

Even though volatility eased Tuesday, it was the 52nd session so far this year with a triple-digit move in the Dow Jones Industrial Average ($DJI). In addition, the market’s rally came despite one key momentum sector — financials — not participating. In fact, financials came in dead last on the leaderboard Tuesday and actually lost a little ground while other sectors generally moved much higher. It was a broad-based rally that saw buying in both defensive areas like utilities and more aggressive sectors like tech and consumer discretionary.

Financials, Transports Lagging

That said, the best performers were mainly the sectors that investors tend to gravitate toward in a strong economy. The exception was financials, which fell slightly despite an earnings beat from Goldman Sachs (GS). On a day when the financials underperformed, the market’s overall rally looked even more impressive.

Transports didn’t really join in the market’s up-move, either, maybe reflecting some concern about climbing oil prices. This is arguably a good time to start listening to calls of some of the big railroad, airline, and trucking companies to see what executives have to say about energy expenses and when they think it’s time to start hedging crude oil. One idea is that $70 a barrel might be the level. Crude recently traded near recent three-year highs above $66. Remember, even long-term investors can benefit from knowing what company leaders have to say about the broader economy.

On the Earnings Beat

After the close yesterday, “Big Blue,” otherwise known as IBM IBM, reported earnings per share of $2.45, beating Wall Street analysts’ consensus estimate of $2.40. Revenue of $19.1 billion beat the third-party consensus view of $18.7 billion, marking the second-straight quarter of year-over-year revenue growth after a more than five-year-stretch of revenue losses. However, a decline in gross margin led some analysts to conclude IBM's shift from legacy hardware and software businesses to cloud computing and "big data" — higher-margin businesses — is not happening fast enough. IBM shares fell over 5 percent in aftermarket trading.

The IBM report is another reminder that expectations are high going into this earnings season. Anything less than a perfect release could spell trouble for a company's shares.  

Today’s earnings from Morgan Stanley (MS) round out the biggest banks. Looking ahead at the remainder of the week, General Electric Company GE and Procter & Gamble Co PG dominate the earnings picture as both report Friday morning. The Fed’s Beige Book later today is probably the biggest thing to watch from a data perspective, but also keep an eye on the weekly U.S. oil stockpiles report later today.

FIGURE 1: FINANCIALS MISSING THE PARTY? The financial sector (purple line) was the only down sector on Tuesday, and the sector has lagged the S&P 500 Index of late, despite solid earnings numbers from big banks.  Data source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Guidance Guide

Going into earnings season, one school of thought was that investors might be concerned more about companies’ forward guidance in some cases than in Q1 results. There was worry that perhaps the recent market turmoil and fears of a possible trade war could dampen some S&P 500 firms’ expectations for what the near future might bring. It’s less than a week since earnings began and guidance could still represent a speed bump in coming weeks, but so far it hasn’t been a problem. For instance, UnitedHealth Group Inc. UNH raised fiscal year guidance Tuesday, and Johnson & Johnson JNJ raised its revenue guidance. In other signs of general good cheer, Goldman Sachs Group Inc. GS raised its quarterly dividend, while Netflix (NFLX) reported big gains in subscriber growth. It’s still really early and things could change, but maybe some of those guidance fears could have been, shall we say, misguided? 

Caution - Curve

One reason some of the big bank stocks might be struggling despite strong earnings is the narrowing of the yield curve, now down to levels not seen in more than a decade. Why should people care? Sometimes a narrowing of the difference between two- and 10-year yields can point toward higher short-term borrowing costs that might slow down business and hit financial sector profits. The two-year yield recently stood at nearly 2.4 percent, rising Tuesday after San Francisco Fed President John Williams said he expects U.S. inflation to rise to the Fed’s 2 percent goal this year and stay at or above that goal for "another couple of years,” CNBC reported. Meanwhile, the 10-year yield traded near 2.81 percent, only 42 basis points above the two-year. That gap had been above 70 points not long ago. 

However, Fed Chair Jerome Powell said last month at a press conference, “I think it’s true that yield curves have tended to predict recessions if you look back over many cycles, but a lot of that was just situations in which inflation was allowed to get out of control and the Fed had to tighten and that put the economy into recession. That’s really not the situation we’re in now.” In other words, perhaps the yield curve isn’t as much of a recession predictor these days. That would be good news considering the path of yields recently.

Global, China Growth Signals

Two positive economic indicators came in slightly below the radar this week as many investors focused on the slew of fresh earnings reports on Wall Street. First, the International Monetary Fund (IMF) said it sees global growth at 3.9 percent this year and next, up from 3.8 percent in 2017. This is due in part to strong momentum, favorable market sentiment, accommodative monetary policy, U.S. tax reform, and a partial recovery in commodity prices, the IMF said. Additionally, China reported 6.8 percent economic growth in Q1, above the government’s expectations and reflective of robust consumer demand and export activity. Last year, a lot of Wall Street’s strength appeared to stem from “in-sync” economic growth in the U.S. and other major economies. After some shakiness earlier this year, the new numbers from China and the IMF might recharge ideas that some of the “sync” might not have faded, though some international and U.S. sentiment data haven’t been too inspiring lately.

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