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Can JPMorgan’s (JPM) Q3 Earnings Hide Trading Weakness?


The projected decline in JPMorgan Chase & Co.’s JPM trading revenue will likely deal a major blow to its third-quarter earnings given significant dependence of its top line on this source. But this might not lead the company to report dismal results on Oct 12. Benefits of higher rates, decent loan growth and relatively better performance of the other segments — particularly investment banking — may overshadow the trading gloom.

The stock, which recently showed strength on investors’ optimism over potential tax reforms as well as the Fed’s plans to unwind its giant balance sheet and keep increasing interest rates, may not take a hit due to the damage caused by the slump in trading revenue. This is because the bad news has already been factored out.

Moreover, though market volatility has not improved much since last quarter, the huge year-over-year decline in trading revenue — highest since 2011 — will primarily be attributable to comparison with a quarter, which had witnessed higher-than-usual volatility due to the Brexit aftermath and the impending U.S. presidential election.

While the momentum in investment banking business is likely to continue, growth in commercial and industrial loans as well as consumer lending should lend support to revenues.

However, we do not expect major support from lower expenses to the bottom line this time around, as JPMorgan doesn’t have enough scope to reduce expenses further. If fact, there were some legal expenses in the quarter.

While the Zacks Consensus Estimate for earnings has not been revised over the last seven days, the trend over the last 30 days depict pessimism. The Zacks Consensus Estimate for the to-be-reported quarter has been revised 1.2% downward over the last 30 days to $1.67, with four out of eight estimates moving lower and one moving higher. However, the Zacks Consensus Estimate reflects a year-over-year improvement of 5.6%.

Decreasing earnings estimates increase the chance of a beat. However, our quantitative model doesn’t point to an earnings beat this time. Here’s why:

JPMorgan doesn’t have the right combination of the two key ingredients — a positive Earnings ESP and a Zacks Rank #3 (Hold) or better — for increasing the odds of an earnings beat. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

Zacks ESP: The Earnings ESP for JPMorgan is -0.53%.

Zacks Rank: JPMorgan carries a Zacks Rank #3, but this alone isn’t enough to increase the chance of an earnings beat.

JPMorgan Chase & Co. Price and Consensus

Here is what should be at play:

Major slump in trading revenue: Third quarter appears to be more disappointing for JPMorgan in terms of trading business than the past several quarters, as indicated by CEO Jamie Dimon with his projection of about a 20% year-over-year decline in trading revenue. Similar to last quarter, a slump in fixed-income revenue is primarily responsible for this decline.

While this decline is primarily attributable to higher-than-usual volatility in the year-ago quarter, trading activities remained sluggish in the to-be-reported quarter in the absence of any tangible development on the reforms proposed by the Trump administration and lesser geopolitical tensions. Also, an unchanged monetary policy standpoint of the Fed did not contribute to volatility for the major part of the quarter.

Likely continuation of investment banking strength: The trend of pocketing solid advisory and underwriting fees might have continued in the to-be-reported quarter primarily on the back of higher debt origination. As the interest rate hike is expected to continue, many U.S. companies have been raising fresh debt capital over recent quarters to avoid higher interest rates later. As debt origination fees account for about half of total investment banking fees, this has been leading to strong gains for JPMorgan and the other largest U.S. investment banks.

On the other hand, with overall low volumes of M&A and equity issuance during the quarter, the related fees are expected to be lower for the largest U.S. investment banks. However, JPMorgan’s top ranking in this space is expected to be a saving grace.

Some improvement in mortgage banking: Expectations of a higher rate environment might have encouraged refinancing activities during the quarter. However, with the refinance boom nearing its end, no major help is expected from this segment.

Overall mortgage revenue might see some improvement, as fresh origination of loans was expected to increase during the quarter.

However, unlike Wells Fargo and U.S. Bancorp, JPMorgan hasn’t bulked up its mortgage banking businesses since the last recession. So, the contribution of mortgage revenue gains to total revenues will not be extraordinary.

Betterment in net interest income: In addition to higher interest rates, a moderate improvement in lending — particularly, in the areas of commercial and industrial as well as consumer — might perk up interest income.

Lesser scope of cost containment: As the majority of unnecessary expenses have already been cut by the bank, expense reduction may not be a major support. JPMorgan was supposed to pay $4.6 million to the United States Consumer Financial Protection Bureau’s (CFPB) civil penalty fund, as it failed to provide accurate screening reports. However, there were no major outflows related to legal settlements that might impact the firm’s earnings unusually in the to-be-reported quarter.

Stocks That Warrant a Look

Here are a few bank stocks that you may want to consider, as our model shows that these have the right combination of elements for an earnings beat this time around:

Comerica Incorporated CMA, scheduled to report results on Oct 17, has an Earnings ESP of +1.16% and a Zacks Rank of 3. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Bank of New York Mellon Corporation BK has an Earnings ESP of +0.32% and carries a Zacks Rank of 3. The company is scheduled to release results on Oct 19.

State Street Corporation STT has an Earnings ESP of +0.44% and carries a Zacks Rank #3. It is scheduled to report results on Oct 23.

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