U.S. financial companies, fueled by the fastest earnings growth in the Standard & Poor's 500 Index, are poised to reclaim their position as the market's biggest industry for the first time since the credit crisis.
Banks, brokers and insurance companies make up 16.8% of the S&P 500, almost double the level from 2009 and closing in on technology companies at 17.6%, according to data compiled by Bloomberg. Bank of America Corp. and Morgan Stanley are helping lead gains in the index this month after profits topped analyst estimates. Intel Corp. and Microsoft Corp. are among the worst after earnings trailed forecasts.
For bulls, the change signals banks will lead the economy even after the Federal Reserve begins to reduce stimulus. Bears say S&P 500 profits would be down this quarter if not for banks. They note that the last time financials were the biggest industry was in 2008 and the consequences were disastrous.
"The fact that we are seeing banks perform reasonably well provides a certain sense of confidence in the underlying economy," Kevin Caron, a Florham Park, New Jersey-based market strategist at Stifel Nicolaus & Co., which oversees about $130 billion, said in a July 25 phone interview. "Without the financials working, it would be hard to imagine that all the rest would be working at all."
Equities snapped a four-week rally as earnings from Netflix Inc. to Caterpillar Inc. trailed forecasts and Chinese manufacturing contracted more than estimated. The S&P 500 fell less than 0.1% to 1,691.65, after hitting a record 1,695.53 on July 22. The benchmark gauge for U.S. stocks is up 19% for the year, bringing the advance since the market bottomed in March 2009 to 150%.
The S&P 500 slipped 0.2% to 1,687.76 at 10:09 a.m. New York time today.
Earnings for companies in the S&P 500 are projected to climb 3.3%, led by a 27% increase in bank profits, based on more than 11,000 analyst projections compiled by Bloomberg. Without the financial industry, S&P 500 income would contract 1.2%.
Bank of America, Morgan Stanley and E*Trade Financial Corp. rose at least 13% and helped lead financial shares higher this month. Broadcom Corp., down 19% in July, and Microsoft, which has lost 8.5%, are dragging technology shares to the second-worst industry performance. Computer makers and software designers have reported earnings 0.4% below analysts' estimates on average, data compiled by Bloomberg show.
Banks were the largest U.S. industry during the bull market that began in 2002, when the S&P 500 more than doubled and the economy expanded as much as 3.5% annually, according to data compiled by Bloomberg. In the late 1990s, financial firms grew to 18.8% of the index, coinciding with the biggest stock rally in history and more than 4% average annual growth in gross domestic product.
While both JPMorgan Chase & Co. and Microsoft had about $21 billion in net income in 2012, earnings at the largest U.S. bank by assets were higher than the computer company last quarter as trading and investment banking picked up and demand for personal computers declined. JPMorgan boosted profits 31% to $6.5 billion and Microsoft, maker of the Windows operating system, reported a 12% decline to $5 billion during the previous quarter.
"We are coming back up with the healing in the banks," Jeff Saut, the chief investment strategist at Raymond James & Associates, who helps oversee $400 billion, said in a July 24 phone interview from St. Petersburg, Florida. "From an economic standpoint, it means that the banking system is getting healthier and eventually that flows into the economy in making it easier to get a loan."
The last time financial shares were the biggest group in the S&P 500 was May 2008, four months before Lehman Brothers Holdings Inc. filed the biggest bankruptcy in American history. The banking industry lost a record $14.65 a share during the fourth quarter of 2008 and took more than $2 trillion of credit- related losses and writedowns, after risky trading and home lending led to the credit crisis. About $11 trillion was erased from U.S. equity market value in the year and a half that followed, according to Bloomberg data.
Regulators are tightening rules to increase transparency and reduce risk in an effort to prevent another financial meltdown. They are requiring higher minimum capital requirements, a ban on proprietary trading and a mandate to push more swap trades through clearinghouses, which require upfront collateral.
JPMorgan, Goldman Sachs Group Inc., Bank of America, Citigroup Inc. and Morgan Stanley control 95% of cash and derivatives trading for U.S. bank holding companies as of Dec. 31, according to the Office of the Comptroller of the Currency.
"The regulators are going to look over the shoulders of the banks and make sure that they are not raising their risk profiles," Stanley Nabi, the vice chairman at Silvercrest Asset Management Group in New York, said by phone July 25. His firm oversees $13.5 billion.
While banks are surpassing analyst estimates by 8.9%, economists project slowing growth. GDP will increase 1.8% this year, down from 2.2% in 2012, according to data compiled by Bloomberg. For 2014, the projection dropped to 2.7% from 2.8% five months ago. Since 1990, the expansion averaged 2.4% annually, data compiled by Bloomberg show.
"You are seeing expectations where people are a little ahead of themselves," Matt McCormick, who helps oversee $9.1 billion as a money manager at Cincinnati-based Bahl & Gaynor Inc., said in a July 24 phone interview. "I would rather be betting on tech than banks this year."
Microsoft's profit missed analyst projections on July 18 as Windows sales suffered from shrinking demand for PCs. The stock has tumbled 11% since then, compared to a 0.1% gain in the S&P 500. Intel, the world's biggest chipmaker, is down 3.7% since it gave a disappointing forecast for third-quarter sales July 17, as the decline in the PC market may erode its largest business.
Google Inc., owner of the world's most popular Internet search engine, missed profit and sales estimates on July 18 as mobile advertising crimped average prices. The stock has lost 2.8% since then. Broadcom declined the most among technology stocks this month as the maker of chips that connect mobile devices to the Internet said revenue would fall short of analyst estimates amid slowing smartphone sales.
The six-biggest U.S. banks increased first-half revenue for the first time in four years, following about a half decade of cost cuts. JPMorgan shares are up 6.2% this month after the New York-based lender reported higher-than-estimated earnings.
"These banks will continue to tread higher," Dan Veru, the chief investment officer who helps oversee $4.5 billion at Palisade Capital Management LLC, said by phone July 25 from Fort Lee, New Jersey. "Investors are now starting to say that we need to put their money to work in this sector."
Goldman Sachs, the Wall Street bank that generates most of its revenue from trading, doubled earnings last quarter and exceeded the average analyst estimate, according to data compiled by Bloomberg. Record debt underwriting fees pushed first-half investment banking revenue to the most since 2007. The stock is up 30% in 2013.
"As the quarter progressed, solid economic data out of the U.S. began to moderate economic concerns," Harvey Schwartz, the chief financial officer at Goldman Sachs, said on a July 16 conference call with analysts. "Client activity, risk appetite, and asset prices improved as a result of the increased confidence."
Morgan Stanley's profit topped forecasts last quarter as stock-trading revenue jumped and wealth-management profit margins hit a record. Record brokerage revenue and investment banking pushed revenue up 26% to $8.33 billion. Shares of the New York-based lender have risen 45% in 2013, more than twice the S&P 500.
Net income at Bank of America, the second-biggest U.S. lender, climbed 63% to $4.01 billion last quarter. Profit from consumer and business banking rose 15% on lower bad credit expenses. Per-share earnings should more than double this year, according to the average of analysts' estimates compiled by Bloomberg.
"Financials were hit hardest in the crisis and they have been licking their wounds ever since," Todd Lowenstein, a Los Angeles-based fund manager at HighMark Capital Management Inc., which oversees $19 billion, said in a telephone interview. "We are still in the early innings of recovery."