Banking Shares Drag U.S. Stocks Lower as Earnings Reports Loom

  • Financial ETF sees longest outflows since bull market start
  • JPMorgan Chase, Citigroup, Wells Fargo report results Friday

Wells Fargo, Citigroup Beat 3Q Earnings Estimates

It’s going to take more than solid earnings growth to lure investors into financial shares.

Undeterred by forecasts that project lenders growing third-quarter profits the most among S&P 500 Index industries, retail investors extended withdrawals from an exchange-traded fund tracking the group to the longest stretch of the bull market, while options traders have pushed the cost of protecting against declines in the fund to the highest level since April 2014, according to data compiled by Bloomberg.

Investors have grown pessimistic on financial stocks a day before JPMorgan Chase & Co. and Citigroup Inc. deliver their latest earnings reports. While analysts surveyed by Bloomberg expect the group to boost profits by 4 percent in the third quarter, it’s an uphill battle to lure investors to a sector tainted by recent upheavals at Deutsche Bank AG and Wells Fargo & Co. At the same time, uncertainty abounds amid bets that interest rates will rise only gradually, capping profit growth amid sluggish economic expansion.

Financial shares slid as much as 2 percent Thursday before paring declines with the broader market as a rally in Treasuries sent bond yields lower after Chinese trade data rekindled angst over the strength of the global economy. Banks lost 1.1 percent at 4 p.m. in New York, leading the S&P 500 lower by 0.3 percent to 2,132.60. The gauge trimmed declines that reached 1.1 percent as utilities and airlines rallied, while consumer staples erased a drop.

“Maybe investors have finally caught on that analysts are too optimistic,” Brian Frank, portfolio manager at Key Biscayne, Florida-based Frank Capital Partners LLC, said by phone. “Another risk is a systemic-type risk -- the ouster of Wells Fargo’s CEO, Deutsche Bank today coming out with a hiring freeze. I don’t think it’s over for the too-big-to-fail banks, and that’s causing some hedging.”

Banks have been unloved for most of the year, with the S&P 500 financial index down 0.3 percent in 2016 compared with a 4.3 percent gain for the broader index. Deutsche Bank rattled the global sector last month after U.S. authorities sought a fine of up to $14 billion for crisis-era problems. Wells Fargo, which also reports results Friday, added to the mistrust when it was accused of creating fake accounts that led to Chief Executive Officer John Stumpf’s departure.

Investors have taken note, pulling $6 billion from banking ETFs so far this year, more than from any other industry. The SPDR Financial Select Sector ETF, or XLF, has seen three straight quarters of withdrawals, the longest stretch since the bull market began, data compiled by Bloomberg show.

Options protecting against a 10 percent drop in the XLF cost 9.5 points more than calls betting on a 10 percent rise on Sept. 30, according to six-month data compiled by Bloomberg. That marked the highest spread since April 2014. The spread was 6.8 points on Wednesday, still 11 percent above the measure’s two-year average.

Earnings season started with a thud this week, with the S&P 500 tumbling 1.2 percent Tuesday after Alcoa Inc. missed estimates and companies from Illumina Inc. to Seagate Technology Plc reported or warned of disappointing results. JPMorgan is one of the few big banks expected to report earnings growth in the July-to-September period. Citigroup and Wells Fargo will see profits fall by 12 percent and 4.2 percent, respectively, according to analyst estimates.

Banks were the focus in Thursday’s declines, while power companies, real estate and health-care share rose as investors sought out safety. The Dow Jones Industrial Average lost 42.76 points, or 0.2 percent, to 18,101.44, erasing most of a 184-point slide.

“China’s trade data below estimates is an overhang in the market, and from Europe, we’re hearing about a hard Brexit that’s making markets more jittery,” said Jeff Zipper, managing director of investments for The Private Client Reserve of U.S. Bank. “We also had yesterday’s Fed minutes showing a strong chance we move in December, and the market is concerned about earnings season as well. It’s all of these things hitting at once.”

Bets that the Fed will hike by December have increased, while the U.S. presidential campaign that’s entering its final weeks is also keeping investors on edge. Traders are pricing in a 65 percent chance the Fed will raise rates in December, though Fed officials remain steadfast in their intention to tighten policy only gradually.

A report today showed filings for unemployment benefits were at a four-decade low over the past two weeks. Upcoming economic data will give investors more indications about the potential rate path, including figures on retail sales, consumer sentiment and producer prices due on Friday.

“It’s going to take some pretty lousy data to persuade the Fed to not raise rates,” said Art Hogan, chief market strategist and director of research for Wunderlich Securities. “When you have the doves like Rosengren from Boston clearly turning hawkish, there’s been a pivot here. The Fed’s letting us know that December is something they have to be talked out of, not into.”

The CBOE Volatility Index climbed for a third day on Thursday, the longest streak in six weeks. The measure of market turbulence known as the VIX rose 4.2 percent to 16.58, poised for a one-month high, after posting its lowest quarterly average in two years.

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