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Banks’ record-breaking earnings streak has probably peaked

As banks close the books on another lucrative year, investors are looking for signs the era of record profits might have some more life.

Bank stocks are coming off their best year in more than two decades, outpacing the broader market with a 36% surge in 2019. And fourth-quarter profits at the six biggest U.S. lenders, set for release next week, will help them challenge the annual record of $120 billion set in 2018, according to analysts’ estimates. Strong consumer units and corporate tax cuts are fueling the gains.

But there are warning signs: Estimates for 2020 are for a combined profit drop of $10 billion as global interest rates remain stubbornly low and geopolitical tensions stay high. Chief executives reviewing their results will help clarify whether those kinds of risks are enough to end the good times.

Next week offers “the first look” at 2020 prospects, Jason Goldberg, an analyst at Barclays, said in an interview. “Anything that impacts economic growth tends to influence banks, so whether it’s at home or abroad, corporate and consumer confidence are important.”

Comments by bank chiefs in recent months have been mostly optimistic, but that was before a flare-up in tensions between Iran and the U.S.

Here’s what else to watch when JPMorgan Chase kicks off earnings season on Tuesday:

Capital markets

On the trading side, revenue will probably increase at least 20% from a year earlier, according to Susan Katzke, an analyst at Credit Suisse Group AG. Results will get a boost from comparisons to the last three months of 2018, when market turmoil took a toll on revenue, she said.

Some of the banks’ top executives said as much in December, with JPMorgan Chase Chief Financial Officer Jennifer Piepszak predicting trading revenue would be up “meaningfully,” especially in fixed income. Citigroup CFO Mark Mason said his bank’s trading revenue was set to rise by a percentage in the “high teens.”

Revenue from investment banking will benefit from a strong end to the fourth quarter, when deal announcements picked up and offered “a further affirmation of macro confidence,” according to Katzke. She expects investment-banking revenue to be “flattish on average.”

Piepszak said in December that she also expects fourth-quarter investment-banking revenue to be virtually unchanged from a year earlier, which was a more optimistic estimate than the decline JPMorgan predicted in October.

Interest rates

Interest rate whiplash characterized 2019. Banks expected to reap the benefits of higher rates when the year began, and then as the year progressed, the Federal Reserve embarked on a rate-cutting cycle, bringing net interest income — one of the banks’ main revenue sources — down as well. Net interest margin, the spread between lending rates and borrowing costs, is expected to have narrowed in the fourth quarter.

The biggest banks’ total net interest income fell in the third quarter for the first time since 2015, and is expected to have dropped again in the last three months of the year. But the decline was probably cushioned by loan growth, according to Gerard Cassidy, an analyst at RBC Capital Markets.

Consumer health

Cheap borrowing costs and low unemployment have been bolstering the U.S. consumer for years, to the benefit of banks that lend to them. Retail banking businesses have driven much of the record profits in recent quarters as capital-markets results came in mixed. Bank executives remained optimistic about this part of the economy as recently as last month.

“The consumer is incredibly strong,” JPMorgan’s Piepszak said last month at an industry conference, citing good credit, a strong job market and healthy consumer sentiment.

Expenses

Even after years of cost reductions and job cuts at banks, pressure on revenue means the efforts will continue this year. There’s room for technology spending to moderate, for example, and branch strategies are being tweaked for further savings, according to Richard Ramsden, an analyst at Goldman Sachs Group.

Investors are also watching headcount after global banks in 2019 announced the most job cuts in four years. Morgan Stanley planned to do away with 1,500 jobs, or 2% of its workforce, in a year-end efficiency push, people familiar with the matter have said. Last summer, Citigroup started eliminating 400 people from its trading division.

Wells Fargo

Charlie Scharf will directly address analysts and investors Tuesday for the first time since taking over as Wells Fargo's chief executive in October. Investors are keen to hear what updates he’ll provide on his ongoing review of the company. The firm has taken a beating in recent weeks, with a series of downgrades pushing analysts’ outlook on the bank to its bleakest since the financial crisis.

Bloomberg News