NEW YORK (BLOOMBERG) - Options traders are showing caution ahead of earnings for the biggest US banks - trepidation that holds ominous signs for the broader market.
JPMorgan Chase & Co. kicks off a string of results from the biggest banks this week, with economists forecasting that profits for the group will contract 5.4 per cent in the third quarter. Financial firms wield the second-most earnings influence out of 10 major groups in the Standard & Poor's 500 Index, and a poor showing may challenge US stocks' rebound from their biggest selloff in four years.
Investors are bracing for bad news, with the ratio of puts to calls on the SPDR Financial Select Sector ETF at its highest level since March. Short interest on the exchange-traded fund is almost double its one-year average, according to data compiled by Bloomberg and Markit Ltd.
Financial companies make up just 16 per cent of the S&P 500 on a market capitalization-weighted basis, a distant second to technology among the 10 industries. Yet they account for 21 per cent of earnings in the benchmark gauge, trailing slightly behind the tech group.
US stocks are entering earnings season just as the S&P 500 is climbing back from a 10-month low. The benchmark index has rebounded 8 per cent since Aug 25, including its biggest five-day gain of the year last week. Financial companies have jumped 4.8 per cent from their August lows, though they are still down 9 per cent from a seven-year high reached in July.
Earnings for all S&P 500 companies are expected to decline 7.2 per cent for the quarter. Financial-services firms in the index are forecast to see profit fall by 5.4 per cent, with diversified financial companies estimated to deliver a 6.6 per cent decline.
The biggest banks by market weighting - including Goldman Sachs, Morgan Stanley, JPMorgan and Bank of America - are particularly vulnerable due to their heightened exposure to capital markets in a volatile trading environment, Keith Horowitz, a bank analyst at Citigroup, wrote in a client note on Monday. Trading profits will decline 5 to 6 per cent on a year-over-year basis, the report said.
Once financial earnings are reported, the sector will continue to face hurdles in sustaining its recent stock rally, according to strategists at Cantor Fitzgerald. Of particular interest for investors will be the Federal Reserve's timetable for raising interest rates. Higher rates would mean more interest income for large lenders, though bond traders have pushed the odds that the central bank will act by January to below 50 per cent.
"We'd be looking to aggressively hedge out bank exposures," Peter Cecchini, chief strategist and global head of macro equity derivatives at Cantor Fitzgerald, wrote in an Oct 8 note to clients. "Global regulation, the opacity of balance sheets, a flatter yield curve and lower economic activity will weigh heavily on multinational and money center banks."