Banks might lose steam in Q3, thanks to a slowdown in loan growth and a relatively quiet quarter for the trading division.

However, we shouldn’t forget that a higher interest rate environment works in favor of banks. On that note, let’s take a look at banks that are likely to make the most of the Q3 earnings season.

Bank Stocks Continue to Lag Broader Market

Big banks will be kicking off the earnings season this week, with JPMorgan (JPM – Free Report), Wells Fargo (WFC – Free Report) and Citigroup (C – Free Report) set to report on Oct 12. So far this year, banks have underperformed the broader S&P 500. Big banks have lost 8.1%, compared with the broader market’s gain of 4.6%. Big banks did manage to outperform the broader market at the start of this year, but the scene changed around mid-May.

 So, the obvious question is that why are banks underperforming? The answer can be found in the monthly fund manager survey by Bank of America Merrill Lynch. Banks have remained a popular trade in the last 10 years. We have often seen that popular trades underperform the broader market as investors have already taken a long position and there is little in the way of new funds that will push prices higher.

Some investors also think that banks have seen the top of the growth cycle, which might affect earnings. Loan growth remained subdued, as shown in Federal Reserve data. Non-banking players such as private-equity firms and insurers are giving banks tough competition at the loan segment. And net interest margins (NIM) were kept in check as LIBOR rates increased less than anticipated, while trading revenues slowed down. For the bank’s trading desk, summer has always been a tough time, as has been the case this year.

Do We Expect Lackluster Q3 Earnings for Banks?

Downward revisions to loan growth and NIM outlooks coupled with softer trading revenues don’t bode well for banks in Q3. However, a rising rate environment and growing economy offer some respite.