Finance

Michael P. Regan is a Bloomberg Gadfly columnist covering equities and financial services. He has covered stocks for Bloomberg News as a columnist and editor since 2007. He previously worked for the Associated Press.

Wells Fargo boss John Stumpf may want to play the lottery tonight. 

In a move that could only be attributed to a stroke of luck, the bank picked a good day to unload some bad news. Banks were helping to lead a stock market rally when Wells Fargo reduced its 2016 target for return on equity to a range of 11 percent to 14 percent from a previous estimate of 12 percent to 15 percent. Its target for return on assets was cut to a range of 1.1 percent to 1.4 percent from 1.3 percent to 1.6 percent. 

The cuts weren't huge and the disclosures from the bank's investors' day may not be too big of a surprise, as analysts pointed out, because profit estimates have been coming down pretty aggressively at Wells Fargo and its peers.  

Sinking Feeling
Like most banks, earnings estimates have been declining for Wells Fargo
Source: Bloomberg
Note: Average of analysts' estimates for adjusted full-year earnings per share.

Still, on any other day when traders weren't engaged in a two-fisted binge on every financial stock they could find, cuts like these could have had an ugly effect on Wells Fargo's share price, which is down 9 percent for the year, or really the stock of any bank. Wells Fargo's outlook for energy credit certainly wouldn't have helped either. The bank said it expects continued stress in the oil patch: "More credit losses will be realized and there is the potential for additional reserve builds."

Waiting for a Boost
Shares of Wells Fargo are down 9 percent this year
Source: Bloomberg

What especially makes Wells Fargo's outlook worth watching is that the company stands out for its relative strength in an otherwise uninspiring environment for banks. Even with that cut in its ROE target, the bank is still likely to be among the top three or four of the 24 companies in the KBW Bank Index when it comes to that profit metric. It's trading at a valuation to match -- about 1.5 times book value, compared with 1.05 times at JPMorgan Chase and 0.6 times at Citigroup and Bank of America. 

In the face of the bad news announced on Tuesday, Wells Fargo's shares are up about 1 percent, the weakest gain in a KBW Bank Index that is up almost 2 percent.

What this highlights is how confident the market has become in another Federal Reserve interest-rate increase and the faith investors have that it will provide a much needed boost to the profit margin for lending at banks. The KBW Bank Index is up more than 5 percent over the past five days as traders aggressively re-examined expectations for interest rates: 

Rate Speculation
In the course of just a week, traders have priced in much higher odds of at least one Federal Reserve interest-rate increase this year
Source: Bloomberg data
Note: Implied probabilities based on Fed funds futures

But the road to higher profits may be a little more rocky than simply betting on the Fed to pave the way. For one thing, a disappointing economic data point or two between now and June could cause the bars in the chart above to shift once again. And there are a lot of variables worth considering should the Fed follow through on its hints of possibly higher rates this summer. Will the dollar continue strengthening, and what will that do to the price of oil and, ergo, energy company debt? Could that same strengthening dollar cause China to continue weakening its currency and spook the markets as it did in August and January? Was the surge in new home sales reported on Tuesday a sign of economic strength that could bolster the Fed's confidence in raising rates or just a sign of buyers being "nudged off the fence" by prospects of those same higher rates? And what happens to credit quality as rates increase? 

None of this is to argue that Wells Fargo and all the other big banks aren't worth taking a look at -- only that there's a lot more in the mix than simply the Fed's next move, and news like what Wells Fargo reported Tuesday shouldn't be ignored. If you hitch your wagon to a horse as mercurial as the outlook for interest rates, don't expect a smooth ride.  

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Michael P. Regan in New York at mregan12@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net