Bank profits seem to be caught between two powerful currents sweeping in opposite directions. In the final quarter of 2011, retail sales strengthened and unemployment claims fell, providing some much-needed momentum for the U.S. economy. But the euro zone crisis boiled toward a crescendo, with the threat of worldwide repercussions that would be transmitted mainly through the global financial system.
Regardless of which trend prevails (the winner will be determined later this month as U.S. banks post their fourth-quarter results), analyst forecasts are poised to underestimate its severity, if recent history is a guide.
For much of the past four years, Wall Street's earnings projections for banks have been relatively poor predictors of actual results, according to Bloomberg data. In the top graph of the attached graphic at left, the blue line charts composite earnings per share for the trailing four quarters for companies in the KBW Bank Index. The line in red shows the average forecast made one year prior to the date shown. (The KBW Bank Index comprises 24 large banking companies, including entities like JPMorgan Chase and U.S. Bancorp at the upper end of the size spectrum, and institutions such as First Niagara Financial Group and Cullen/Frost Bankers at the lower end.)
Analysts had forecast gradually increasing earnings for the group in the year ahead through the late summer of 2007. (Composites for estimates made late in the summer of 2007 are shown a year later in the graph, or late in the summer of 2008, to synchronize them with actual results.) In fact, earnings per share began to tumble in early 2008.
Analysts failed to catch up with the violence of the crash through late 2009. Then they trailed the strength of the subsequent rebound.
To be sure, making accurate predictions during the financial crisis was an impossible task, and companies did not help by withdrawing guidance. (According to Bloomberg data, the vast majority of companies in the KBW Bank Index did not provide earnings forecasts before the recession, but most of the handful that did stopped doing so after 2007 or 2008, and have not resumed the practice.)
Moreover, while analyst projections have not grooved back into the tight correlation that prevailed for most of 2007 between actual results and forecasts made the year prior, the misses have become much smaller than during the earnings freefall of 2008 and 2009. Recent 12-month-forward estimates suggest that incremental improvement in earnings will fade late next year.
Projections also show gathering pessimism about the strength of the recovery in the medium term. The second chart shows composite forecasts for the current year, next year and 2013 as of the date that the estimates were made. In early 2011, analysts expected stronger improvements in 2012 and 2013 than they do now, with earnings per share estimates for those periods compressing sharply in late 2011.
A similar compression in medium-term forecasts unfolded as the year progressed in 2010. Now, analysts expect the smallest improvement in earnings over a two-year horizon for the members of the KBW Bank Index since at least early 2007.