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Low Market Volatility Portend Future Risk?

The consideration of market volatility from a value-oriented perspective is quite different than traditional risk considerations. Rather, from a value slant, the current period of low volatility is raising additional risks, not opportunity. It is important that investors understand this and know what to expect from their investments during the next period of high market volatility.

Consider the simple premise:

  • Low Market Volatility precedes Market Turbulence
  • High Market Volatility precedes Market Opportunity

The period marking the biggest risk is in the low volatility period right before a shift in period (or regime) from low volatility to high volatility. The problem we as investors face is that the two periods are asymmetrical. Low volatility periods are marked by longer time frames and positive escalator-like returns. High volatility periods are punctuated and marked by negative elevator-like returns.

In my opinion, the shift from low volatility to high volatility is when valuation risk is realized. Why? Because low volatility periods generate a reinforcing feedback loop that drives greater participation in the market both in traditional long-only, buy-and-hold strategies and through the use of leverage. During this period, valuation plays second fiddle to market returns. The shift to a high volatility period clears the imbalances in the market whether it is in valuation, leverage, or resetting long-term growth trends.

Therefore, investors want exposure to the low volatility period and not the other. However, timing is difficult and investment strategies must be optimized between the two. Value investors sensitive to the price of the market are likely to reduce exposure through increased cash as the imbalances continue to build. Unfortunately, that will drive underperformance relative to a fully invested, buy-and-hold strategy during periods of low volatility — making it less appealing, when it is likely most appropriate.

Volatility Clusters

Volatility tends to be influenced by its most recent state. Back in 1963, Mandelbrot wrote “large changes tend to be followed by large changes, of either sign, and small changes tend to be followed by small changes.” This volatility clustering is what delineates periods of low and high market volatility. Figure 1 from James Montier at GMO suggests that volatility troughs are cautionary points before market downturns. In a research note I published last week, I discussed how those periods marked by red were also at times when Shiller’s 10-Yr Cyclically Adjusted Price-to-Earnings (CAPE) was at 24X or greater and the trailing 12-month earnings were significantly above the long-term average.

Figure 1: GMO’s Risk Does Not Equal Volatility Exhibit

(click to enlarge)

Source: GMO (I Want to Break Free 2010 White Paper)

Figure 2 details the last 10 years of the S&P 500 (SPY) combining the 50-day historical (realized) volatility and the actual return on an adjusted price basis (prices are adjusted for dividends received). The browned-out areas reflect the periods of high volatility based on the volatility reading relative to its long-term average. The last high volatility period was during the contentious 2011 US debt ceiling debate. Clearly, you can see the asymmetry between the low and high volatility regimes. The crossover of volatility above its long-term average is closely associated with (local) market tops.

The current low volatility regime has been in place since February 2012. Our current market return over this period has been ~29% or ~19.8% annualized. Despite my concerns last summer when volatility was approaching the long-term average — volatility briefly kissed the average before receding again.

Figure 2: S&P 500 SPDR Total Return & 50-Day Volatility (Annualized)

(click to enlarge)

Reinforcing the Low Volatility Period

There are several factors that can support a self-reinforcing feedback loop that stabilizes the low volatility period. In this current environment there are several:

  • The S&P 500 is at an all-time high. Any investment bought and held over the past 10 years will be positive. (The key is buy-and-hold, and not panic-and-sell).
  • Use of margin (borrowing to invest) in the equity market expands during low volatility periods. The contribution to any positive momentum (and trend) by its nature reduces volatility.
  • Regret versus the “Great Rotation” is driving new investors and fresh capital into the market.

Drawdowns Recovered

Consider that at any time over the past 10 years — an investment (buy-and-hold) in the S&P 500 (including dividends) would be positive today. Even the 50+% drawdown that began in October of 2007 was finally recovered last August on a total return basis. In other words, the S&P 500 is at all-time highs on a total return basis.

Instead of showing the market at an all-time high, consider previous declines experienced in a portfolio that held only the S&P 500. This is a risk measurement tool called maximum drawdown. Maximum drawdown calculates the peak-to-trough decline in an investment (in this case, the S&P 500). When it is at 0%, the investment is at an all-time high. The recovery in the decline in October of 2007 took almost 5 years (August 2012). Therefore, the memory of the 2007-2009 decline, while painful, will fade for those who maintained a strong discipline in a buy-and-hold strategy. Those investors with cash in 2009 have done very well.

Figure 3: SPY Maximum Drawdown

(click to enlarge)

Margin Debt

With the market at all-time highs and the memory of losses fading, leverage through the use of margin debt is increasing. While margin debt as an absolute number is influenced by the overall size of the (growing) market — clearly the generation of peaks indicate investors’ increased level of risk taking based on the low volatility environment and positive market momentum.

By definition, the existence of positive price momentum will lower the volatility of the market, which creates a powerful reinforcing factor. As shown in Figure 4, the recent spike in margin debt coincides rather tightly with current low volatility period.

Figure 4: NYSE Margin Debt

(click to enlarge)

Regret, not a “Great Rotation”

Is there really a “Great Rotation” from stocks to bonds, or is this really a matter of buy-and-hold gaining traction? We have already shown that given the market highs, a buy-and-hold strategy initiated over the past 10 years would be positive. Furthermore, a dollar cost average program such as in a 401(k) would have done even better.

Consider those investors who have been on the sidelines since the 2007-2009 market downturn or have allocated retirement contributions to a money market account? How long can an investor stand idle seeing the past 4 years of stock market gains pass them by when all they had to do was own the market. Pyramis Global Advisors recently put the issue in terms of investors balancing two types of regret: Active and Inactive.

  • Active: Active Regret reflects the regret of losses sustained in a market downturn. Active Regret fades over time along with the memory of the losses.
  • Inactive: Inactive Regret reflects non-participation in market upturns. As markets continue to rise, Inactive Regret builds.

Analysis of capital flows into equity mutual funds and ETFs helps put the Active/Inactive Regret theme in context. During the 2009-2012 time period — money flows into equities were essentially flat. This would suggest the dominance of the Active Regret, which remained strong given the recent memory of the 2007-2009 market downturn and distrust in the market. However, data from Pyramis shows that for the first 5 months of 2013, money flows into equities has been decidedly positive, which suggests that after 4 years, the Inactive Regret for many investors has become more influential (and intolerable) and investors have shifted capital back into the stock market (largely at the expense of money market funds).


  • The S&P 500 has been in a low volatility period for 17 months and shown solid gains.
  • Current volatility is ~13% versus long-term average of 17-18%. In March, volatility reached a low of ~9%.
  • Memory of losses has faded as any investment in the S&P 500 over the past 10 years would be positive today using a buy-and-hold strategy and retaining dividends.
  • Leverage based on NYSE margin debt has accelerated during the most recent low volatility period with a near-term peak currently in April.
  • Based on mutual fund and ETF flow data, cash is moving back into equities for the first 5 months of 2013 after being flat the previous 4 years.

Timing the Next Shift

Few long-term investors will get the timing correct on the next shift in the volatility period. Value investors in particular are notorious for being too early both in raising cash to early and buying too soon. While initial timing calls are proven incorrect and the low volatility period is sustained, the market continues to climb, confidence increases (and caution declines), valuations expand, and leverage is utilized.

While timing is a challenge, a caution flag is clearly warranted under the current market conditions. If Mr. Montier were to update the chart in Figure 1, a fifth red circle would likely be added to March of this year. Besides the low volatility conditions, the current period is similar to those four other market periods identified in red circles based on the S&P 500 10-yr CAPE of 24X or greater and trailing 12-month earnings significantly above the 10-year average.


Regardless of the style of investing from value-oriented, passive indexing, or tactical allocation strategies, know that all portfolio strategies and asset allocations will likely be stress tested at some point in the near future. As the low volatility period shifts to a high volatility period — valuation risk will likely take center stage again.

The conclusion is left to a sobering and important reminder from John Hussman, a portfolio manager known for his caution in discussing the current market climate:

There are actually numerous investment disciplines that I believe are effective over the long-term, including a buy-and-hold approach. The problem, in my view, is that investors constantly switch their discipline when it isn’t performing well at the time. Since 2000, a buy-and-hold approach would have required an investor to suffer through one 50% market loss and a second, distinct 55% market loss. Frankly, I think another one of a similar order will complete the present market cycle. Over the very long-term, buy-and-hold investors have done fine, particularly combined with good value-conscious stock selection. But the drawdowns can be intolerably deep from our perspective, and the full-cycle returns following points of rich valuation tend to be particularly disappointing compensation. I expect that this will be true over the coming decade as well.


By Matthew Crews

Financial Markets

With Fed Meeting on Tap, Investors Await Bumpy Ride By Matt Nesto

A month ago, the Fed’s revelation that the downside risks to the economy had diminished triggered an immediate four-day selloff following the June FOMC meeting. While that dive ultimately served as the set up for what would become a very powerful and positive July for the S&P 500, the seeds of worry that caused the last slump are still very much rooted in the minds of investors.

A barrage of clarifications by Ben Bernanke and several other Fed heads has seen rates pull back in, and in turn, allowed stocks to take off and set fresh new highs.

Related: Bernanke Is Too Transparent, Creating ‘Bizarre’ Market Volatility: Munson

“I think this next Fed meeting is going to be much ado about nothing,” says Paul Schatz, president ofHeritage Capital in the attached video. “I don’t think it is going to be anything different than what he said (in Boston) just two weeks ago.”

While Schatz acknowledges the effect “the Fed’s media parade” has had on markets, he feels that the recent rebound in treasuries, which saw the 10-year yield (^TNX) ease back down to 2.5% from 2.75%, is more the result of what’s happened in the equity markets than economic news.

However, given the outgoing Fed chief’s well-established commitment to communication, Schatz says there’s always the risk that the market could misinterpret something – even something that’s been said before.

Related: Yellen vs. Summers: Traders Placing Bets on Next Fed Chief

“The Bernanke Fed has tried to be very open and transparent, sometimes confusing people because they’re so open and transparent,” he says.

Ultimately, no matter how many times and ways it has been said before, the Fed will soon start reining in its “easy money” stance. As much as stock and bond investors everywhere already know this, it appears that they prefer not to be reminded of the inevitable, which is why Fed day, once again, will be fraught with risk.

GM profits beats on strong U.S. demand, smaller loss in Europe

GM profits on Thursday posted a higher-than-expected quarterly profit on strong demand in North America and cost-cutting in its struggling European business.

Europe, where industry sales hit a 20-year low in the first half, remains “very challenging,” GM Chief Financial Officer Dan Ammann told reporters. He added it was too soon to call any sort of improvement there.

GM’s net income in the second quarter fell to $1.2 billion million, or 75 cents a share, from $1.5 million, or 90 cents a share, a year earlier.

Excluding one-time items, mostly related to the acquisition of preferred shares in GM Korea, the automaker earned 84 cents a share, 9 cents above the average forecast of analysts polled by Thomson Reuters I/B/E/S. GM shares were up 2 percent in premarket trading.

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Revenue rose 4 percent to $39.1 billion, above the $38.37 billion analysts had expected.

In May GM reported a stronger-than-expected first-quarter profit as it kept a tight grip on costs in its North American and European businesses. That grip was still in place in the second quarter in Europe, where the company cut $400 million in costs compared with a year earlier. Ammann said GM continues to be aggressive in those efforts.

GM’s North American business had operating earnings of almost $2 billion in the latest quarter, easily topping the $1.75 billion that nine analysts polled by Reuters had expected. Ammann said the U.S. market remains robust, but GM declined to raise its full-year forecast for industry-wide U.S. sales.

GM Europe had an operating loss of $110 million in the second quarter, almost one-third smaller than Wall Street had expected. The company’s sales and market share in Europe fell in the quarter, however.

Ammann said GM remains focused on executing plans previously outlined in its alliance with PSA Peugeot Citroen (UG.PA) but has no plans to put more money into the French automaker.

GM’s international operations, which includes China, reported a disappointing profit of $228 million, down 64 percent. Ammann cited pricing pressure in Australia and Southeast Asia, as well as cost headwinds in India.

By Ben Klayman and Deepa Seetharaman

Translating Apple Inc.’s Guidance – by Paulo Santos

Apple (AAPL) apple earnings released its earnings for the June quarter. These were slightly higher than consensus estimates both for revenues and EPS. Revenues came in at $35.3 billion vs. $35.01 billion expected and EPS came in at $7.47 vs. $7.32 expected.

Apple also guided as follows for the September quarter:

• revenue between $34 billion and $37 billion

• gross margin between 36% and 37%

• operating expenses between $3.9 billion and $3.95 billion

• other income/(expense) of $200 million

• tax rate of 26.5%


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Revenue Guidance

A range of $34 to $37 billion has a midpoint of $35.5 billion. Market consensus was for $37.11 billion, so any of these levels represents a miss even at the high end of guidance. At $35.5 billion, revenues would be 4.3% below expectations — at the midpoint. At the high end of the range revenues would hardly miss the present expectation. This is better than last quarter in the sense that last quarter the midpoint guidance implied a 12.3% miss and the high end of guidance implied a 9.8% miss. While this guidance still implies a bit of downward revision, the market liked it during the after-hours session.

Year-ago revenues for the September quarter were $35.97 billion, so just meeting the midpoint of guidance would imply decreasing revenues. At the high end of guidance there would still be a bit of revenue growth.

Earnings Guidance

Taking into account the guidance items, this is what we can come up with for the top and bottom of the gross margin guidance at the three possible levels for revenues ($34 billion, $35.5 billion, and $37 billion):

As we can see, the guidance implies EPS between $6.77 and $7.93. Also relevant, during the March quarter Apple came in at $7.42, near the $7.46 top of the range I estimated. Thus we could conceivably expect that Apple is not going to come far from the top of the guidance this time either ($7.93).

These estimates compare to the existing consensus of $7.96, which saw a significant downward revision in this last week. If we were to just compare this range of estimates to the $7.96 consensus, the downside would be between 0.4% and 14.9%. Last quarter the downside was between 18% and 27%. But as I said, Apple came in at the top of the estimated range, and if it does it again, then there’s nearly no downside to the current earnings consensus. It is probably this that’s helping Apple shares in the after-hours session.

Finally, this estimate range implies a drop in earnings from 2012 of between 8.7% and 22.1%. Thus, while Apple is celebrating in the after-hours session, it probably won’t go too far.


Apple used to exceed its earnings guidance considerably. Now it seems to be targeting a realistic range, though as we’ve seen it still came in near the top end. I had called attention to this change in my previous article on Apple’s guidance, and it probably remains true for this quarter as well.


Apple’s guidance for the September quarter — while not fantastic — seemed to allay fears that it would again be disastrous. At the top of the estimate range the earnings guidance implies almost no downward revision to estimates, even if again, it also implies earnings which will trail 2012s.

At least this guidance once again puts the spotlight on the new products that are supposed to be announced at the end of September. With Apple’s low valuation and the prospect of new product launches coming up, this guidance is mildly positive.

Apple’s Next Big Leap Forward

Ignore Apple Earnings ?

Ignore Apple’s earnings announcement slated for July 23, after the close. Ignore the fear. Ignore the hysteria from the unspeakably ignorant pundits seeking free coffee in the waiting room at CNBC.

And ignore traders. Please, ignore traders. I am oh so tired of traders. If you are, life – your money management life – should be simple. Buy Apple. Sell some calls and, metaphorically speaking, go home. Do it every week or every month or every quarter. Use Apple as a basis for a 15% or more yield – from selling calls – and watch the stock appreciate, it will. I refuse to say it must despite the temptation.

Using the timeless and ultra sophisticated metrics of the long-term buy and hold investor – how much money does the company have and is it growing – and consider the following:

  • Apple sells at a 50% discount to the S&P 500. On the surface the stock sells a bit shy of 10 times next year’s earnings. Take out the cash on its balance sheet – more than $150 a share – and the stock sells for six times earnings, Seems immoral doesn’t it?
  • Apple has almost as much cash as S&P 499 – the rest of the S&P 500.
  • Apple sales are growing four to five times faster than the average S&P 500 company. It is not Microsoft redux – it faces growing markets with very innovative products, right now it is simply more expensive than many of their competitors, a voluntary choice to maintain margins triple that of many competitors.
  • Speaking of margins – Apple’s profit growth is four to five times faster than the average S&P 500 company.
  • Apple stock faces only upside catalysts – potential dividend increases, potential stock buy backs, potential market share gains, potential new product announcements.
  • That is the financial perspective. How about in the real world?
  • According to ChangeWave Research (part of the 451 Group), the iPhone is picking up considerable market share and this is in light of a potential iPhone upgrade – a major upgrade – later this year.
  • I am typing this on my new Mac Air. I am kind of cheap. My old laptop surrendered to age the ability to hold a charge. I looked at the alternatives and bought this Air. Took five minutes to buy, five seconds to register. An Apple experience. Customers agree and the iPhone, the iPad and the Mac product line are all at the very top of customer rankings in their respective markets.
  • Apple has purposely chosen to give up potential share to maintain margins. Other than memory costs Apple is looking at a favorable production cost curve and this means a lower cost set of products, and a lower price set of products, in the next 3-18 months. The first possibility is a deal with China Mobile, vendor to more than 625 million (million with an m, not thousands with a t) customers.

What to do? If you want to trade it, go watch some idiot on television screaming at you while he or she checks their BlackBerry – they may even recommend BlackBerry (BBRY) for comic relief. If you want to generate 15% or more a year in yield, buy the stock and sell calls. If you are the nervous type, wait until after the company announces earnings after the close on Tuesday July 23. If not, and you want in before earnings, the comapny should meet or beat expectations. And if you are still nervous, sell puts rather than buy the shares. The premiums are wonderful. Take a look in the $385-$400 range and if you have time, sell weeklies every week, not monthlies. If you don’t manage to get 15% a year or more doing this, you can borrow my cockapoo Sumo; he can do better when selling against Apple. (Apple AAPl Earnings )


By Michael Shulman

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Is Netflix A House Of Cards? We Will Find Out Monday After The Close By Michael Blair

Is Netflix (NFLX) a house of cards? The stock has certainly seen dramatic swings, dropping from the $300 range in 2011 all the way to $50 or so before bouncing back to over $250 recently.

(click to enlarge)

There is no doubt that this company has made headlines in the relatively short period since its initial public offering in 2002. In barely a decade, it went from unknown to household favorite with its movies-on-demand streaming subscription service propelled in part by the parallel success of the iPad and Android devices and its service has become standard fare for consumers and commuters needing some distraction without having to go out to the cinema.

With a market capitalization of some $15 billion, it had made founder Reed Hastings a lot of money not to mention those fortunate enough to be long or short at the right time in its short history. Speaking of “short history,” it has also been a favorite of short sellers with just over 7 million of its 56 million shares outstanding sold short. Options traders love the stock as well, particularly option sellers who can coin juicy premiums if they can time their sales to avoid some of the many adverse swings that have left more than one trader in tears.

The company’s fundamentals tell part of the story. Sporting a price to earnings multiple of over 600 times and living in the rarefied atmosphere of high tech darlings, it is a stock not for the faint of heart regardless of their bull or bear leaning.

No one should be surprised that Netflix does not pay a dividend. With earnings per share of $0.41 in the past 12 months and a stock price of $265 per share, a dividend would look like a rounding error. Book value of about $15 a share provides not much in the way of tangible asset value to support the share price and, surprisingly for a stock where the market has been willing to pay an enormous premium for shares (making the cost of equity capital pretty low), the company has $700 million long-term debt sitting on just over $800 million book value of equity.

Does anyone smell an issue here?

It is plain and obvious that Netflix bulls are betting big time that the company will grow sales and profits quite dramatically for an extended period of time to grow into its valuation. Insiders, reluctant to wait I guess, have been sellers.

Netflix might be worth $265 a share if it had a quasi-monopoly on streaming video entertainment, but of course there are other players in this game – Amazon (AMZN), YouTube, and Hulu to pick three – and over time we can expect Apple (AAPL) to continue to expand its iTunes service to an offering as broad and deep as that of Netflix. On the other hand, Netflix seems to have been successful in attracting former Pay TV subscribers who have shifted to Netflix and cut the cord on Pay TV. This together with innovative and exclusive content such as “House of Cards” and the company’s heady growth make up the bull case and the risks to short sellers.

In my view, all of this adds up to a pretty good short, not without risk, and possibly a crowded trade. A better way to get short is probably to buy in the money puts to keep the premiums as low as possible and maybe a put spread. The benefit of the puts is the limited losses if it turns out the bulls are right and the freedom from any short squeeze should the stock have a rapid rise.

I don’t have a position in NFLX, but by the end of Monday’s trade, I will be exposed on the short side one way or another. I think the earnings release due out after the close Monday will be a catalyst for a sizeable move on the stock and my bet is that it will be down. The market has not been kind to companies that miss expectations. Google and Microsoftboth missed expectations, and in each case, their stock dropped sharply after their recent quarterly releases.

At over 600 times earnings and trading at over 100 times trailing twelve months EBITDA, Netlflix is expensive by any traditional measure. Netflix’s price to earnings growth multiple of 5.25 is at a nosebleed level when compared to 2.01 for the market at large (Source: First Call). Multiples at these levels imply extraordinary earnings growth expectations which certainly applies to Netflix, with First Call consensus expectations for $0.40 per share net income for the quarter versus $0.11 last year, or a 263% increase, and full year earnings of $1.40 versus $0.29 last year.

Extraordinary is possible but unlikely in my view. I will be on the short side of the stock for a trade on the earnings report by buying puts if I can buy them at a premium I can stand.

Market Volatility

China tipped to surpass U.S. as top superpower

Will China supplant the United States as the world’s leading superpower and top player in the world economy?

A new Pew Research Center survey of 38,000 people in 39 countries found the widespread belief that China is well on its way.

Overall, a majority or plurality of respondents in only six of the countries surveyed believe the U.S. will remain on top.

“Publics around the world believe the global balance of power is shifting,” Pew wrote. “China’s economic power is on the rise, and many think it will eventually supplant the United States as the world’s dominant superpower.”

In both the United States and China, an increasing number of respondents agree with this thesis.

Two out of three Chinese now predict their country will overtake the U.S., an eight percentage point increase since 2008. The number of Americans who agree has jumped 11 percentage points to 47%.

When it comes to pure economics, the survey suggests that some people even think that China is already ahead of the U.S.

By almost any statistical measure, the U.S. economy is still top dog. But the perception that China has already built the world’s most powerful economy reflects the tremendous gains that have resulted from sustained 10% GDP growth over the past three decades.

Related story: China GDP growth slows to 7.5%

The survey also indicates that countries around the world have divergent views of the U.S. and China.

The U.S. retains a higher overall approval rating, with 63% of people around the world having a favorable view of America. China’s rating is marginally lower at 50%.

While the results differ from country to country, the report concludes that “China’s increasing power has not led to more positive ratings for the People’s Republic.”

Related: Economic slowdown tests China’s leaders

Pew isn’t the only group interested in the implications of China’s growing power. The Middle Kingdom’s increasing influence has also attracted plenty of predictions in Washington.

The U.S. National Intelligence Council released a report last year that offers a series of prognostications about how the world might change in coming decades.

One of its attention-grabbing assertions: China’s economy will surpass that of the U.S. by 2030.

“China alone will probably have the largest economy, surpassing that of the United States a few years before 2030,” the report said.

View this article on CNNMoney

Financial Markets

US homebuilder confidence, sales outlook soar

U.S. homebuilders are feeling more optimistic about their home sales prospects than they have in more than seven years, a trend that suggests home construction will accelerate in coming months.

The National Association of Home Builders/Wells Fargo builder sentiment index jumped to 57 this month from 51 in June.

A reading above 50 indicates more builders view sales conditions as good, rather than poor. The index hasn’t been that high since January 2006, well before the housing market crashed.

Measures of customer traffic, current sales conditions and builders’ outlook for single-family home sales over the next six months vaulted to their highest levels in at least seven years.

Steady job growth, low mortgage rates, rising home prices and tight supplies of homes for sale have supported a recovery in housing this year.


By Alex Veiga, AP Real Estate Writer

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J.P. Morgan, Wells Fargo earnings TODAY

NEW YORK (MarketWatch) — Two of the country’s biggest banks, J.P. Morgan Chase and Wells Fargo, are expected to report rising profits on Friday as they kick off earnings season for the financial sector.

Long considered the bellwether for its broad reach, J.P. Morgan’s (NYSE:JPM)   results will signal buoyant capital markets activity, and growing fees, for big banks, say analysts.

Wells Fargo (NYSE:WFC)  , the country’s biggest mortgage originator, will give a wider picture in terms of lending profits for the industry.

Getty ImagesEnlarge Image

J.P. Morgan Chase and Wells Fargo kick off earnings season in the financial sector

While analysts acknowledge that the environment remains challenging, expectations are that it will be a respectable quarter from the banks.

The financials sector is predicted to have the highest earnings growth rate, at 16.8%, of any sector for the second consecutive quarter in the S&P 500, according to analysts at FactSet.

“We expect the capital markets sensitive banks to fare a bit better than the regional players given some support from improved core trading and investment banking results,” said Moshe Orenbuch, analyst at Credit Suisse, in a research report.

Bank of the Ozarks is down after hours on its quarterly earnings report. New data out on European industrial production. J.P. Morgan and Wells Fargo will kick off bank earnings season before the bell. Victor Reklaitis has all you need to know about the next 24 hours in markets.

The market has already warmed to the two giants — shares for both stocks have seen major moves in the first half of 2013, up more than 24% year-to-date through Monday.

The J.P. Morgan gains in particular have come despite the firm being under intense shareholder and public scrutiny over the dual roles of Chief Executive and Chairman Jamie Dimon. Analysts want to know if second-quarter earnings growth can be sustained.

“What we’re watching for is the capital markets related revenues especially the trading side,” said Jeff Harte, analyst at Sandler O’Neill & Partners. “April and May were strong and then all of a sudden June looked like it was weak.”

Analysts expect the firm to report a profit of $5.6 billion or $1.44 per share for the second quarter, compared to $4.96 billion or $1.21 per share in the year-earlier period. The company is expected to report revenue of $24.96 billion, compared to $22.18 billion in the second quarter of 2012.


It’s been a good year for J.P. Morgan and Wells Fargo shares.

The recent market sell-off driven by an increase in rates in Treasury bonds could be positive for the firm’s fixed-income business, according to analysts.

The outlook by the firm for the mergers and acquisition and underwriting business will be key, given the sluggishness in the second quarter.

Lower credit losses and the release of credit reserves will be positive news.

“We expect mortgage credit to get better,” said Harte.

Bank of America Merrill Lynch analysts say the headwinds to watch out for the firm are a longer-than-expected low interest rate environment, a worsening of the European sovereign crisis, and further regulation and scrutiny of the financial industry.

Going into the next quarter, Bank of America analysts recommend bank stocks, including J.P. Morgan, with defensible revenue trends and the least likely to have earnings per share revised downwards.

J.P. Morgan’s price target remains at $57 a share for the analysts.

Wells Fargo is considered by many analysts as a super regional bank with its massive portfolio of loan originations, which are approximately a third of the total market share in the U.S.

“Wells Fargo’s quarterly earnings are not subject to swings in capital markets activities as some of the other bigger banks,” said David Hilder, analyst at Drexel Hamilton.

Up to 30% of Wells Fargo’s total non-interest income comes from mortgage banking revenue, but with higher interest rates in recent months, there are concerns that revenues will be down for the second quarter compared to the first quarter, from lower refinancing.

Another concern for analysts is the firm’s net interest margin, the difference between what the bank earns on loans and what it pays depositors.

The capital markets and investment banking arm, approximately 30% of the non-interest income for the bank, is expected to be strong by analysts, given the run-up in the stock market.

Wells Fargo is expected to report net income of $4.98 billion, compared with $4.4 billion the year before.

The firm is expected to report a profit of 92 cents per share, according to analysts surveyed by FactSet, compared to 82 cents for the same period the year before.

The country’s biggest mortgage lender is expect to report revenue of $21.17 billion for the first-quarter, compared with $21.28 billion the year earlier.

Market Volatility

Rates to stay low for long time ? Market Up

 The Federal Reserve will not be in a hurry to raise short-term interest rates, even after the unemployment rate comes down markedly, Chairman Ben Bernanke said Wednesday.

The Fed has set an unemployment rate threshold of 6.5% for the first rate hike from the current near-zero levels that have been in place since December 2008. The central bank has gone to great pains to stress that this tool is separate from the bond-buying program. The jobless rate was 7.6% in June.

Bernanke said the central bank will be in no rush to hike rates once the threshold is reached.

“There will not be an automatic increase in interest rate when unemployment hits 6.5%,” Bernanke said in the question-and-answer session of a speech to economists.

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Ben S. Bernanke, chairman of the U.S. Federal Reserve, in June

Given the weakness of the labor market, and low inflation “it may be well sometime after we hit 6.5% before rates reach any significant level,” Bernanke added.

U.S. stock futures rose on the comments, with the S&P 500 (GLC:SPU3)   contract tacking on about 0.7%.Read After Hours column for more markets coverage.

The Fed chairman drew a clear distinction between asset purchases and rate hikes.

The purpose of the asset purchases is to give the economy some forward momentum, Bernanke said.

Ian Shepherdson, chief U.S. economist at Pantheon Macroeconomics, said he was sticking with his forecast of a September tapering after Bernanke spoke.

Bernanke did make some fairly dovish comments.

He said that it is too early to tell if the economy had weathered the headwinds from fiscal policy and said the U.S. still faces “significant risks”

He also said that the unemployment rate probably understates the weak condition of the labor market.

And he stressed that the Fed was concerned about the current very low inflation rate.

If inflation does not move up closer to the central bank’s 2% target, “that would be a good reason to remain accommodative,” he said.

 Bernanke defended his decision to lay out a potential timetable for winding down asset purchases after the Fed’s last meeting.

The Fed chairman said the central bank could start winding down its $85 billion a month bond-buying program later this year and end it altogether by mid-2014.

“Notwithstanding some volatility that we’ve seen in the last six weeks, speaking now and explaining what we are doing might have avoided a much more difficult situation,” he said.

If financial conditions tighten too much to jeopardize the Fed’s goals, “we would have to push back,” he said.

At the moment, “with some luck,” positive factors will generate faster growth and labor market improvement through the rest of the year, he said.

Bernanke spoke after the central bank released the minutes of the Fed’s last policy-making meeting.

The minutes show a wide range of views among the central bankers on when to start to wind down the asset purchases.

But about half of the Fed’s top 19 officials said it would be appropriate to end the asset purchase plan late this year.