Bank stocks have experienced a fairly dramatic turnaround since the beginning of last month, with a number of major bank stocks trading at or near their highs for the year. The Zacks Major Banks industry, which includes all the money-center banks and big regionals like JPMorgan (JPM – Free Report) and PNC Financial (PNC – Free Report) that kick-off the Q2 earnings season for the industry on Friday July 14th, is now up +7%on the year, closing the gap with the S&P 500 index’s +7.8% year-to-date gain.

But as you can see in the chart below, the industry has handily outperformed the broader market since early June (blue line represents the banking industry).

Trends in treasury yields have an outsized bearing on bank stocks since they are a big driver of bank margins. You can see this correlation in the year-to-date stock performance of the industry relative to the 10-year treasury yield, with bank stocks moving in-sync with the treasury yield bounce since mid-June.

As important as yields are for banks, we should also be mindful of the group’s successful completion of the Fed’s ‘Stress Tests’ in late-June that allowed many of them to get the central bank’s nod to announce major share buyback and dividend hike programs. One can reasonably argue that with both of these positives now fully discounted, any further gains for bank stocks will follow quarterly results that start coming out on Friday.

My reading of the tea leaves suggests that banks’ Q2 results may turn out to be lot less impressive than what we saw from the group in the preceding reporting cycle. Trends in core profitability drivers weren’t as favorable in Q2 as they were in Q1. These include lower treasury yields (since partly reversed), continued deceleration in loan growth, and an overall trough backdrop for the capital market and advisory businesses.

Estimates for a number of these banks have come down in recent days and weeks to reflect these developments. But I suspect that they haven’t fallen enough to fully reflect the relatively softer ground realities.  

What Are Banks Expected to Report in Q2?

Estimates were going up at this stage in the last earnings season, but they have come down for all the major industry players, including JPMorgan (JPM – Free Report) ,Wells Fargo (WFC – Free Report) and Citigroup (C – Free Report) that will report results at the end of this week.

For the Finance sector as a whole, of which the Major Banks industry is the biggest earnings contributor, total Q2 earnings are expected to be up +5.8% from the same period last year on +2% higher revenues. This would follow +10.5% earnings growth in 2017 Q1 on +5.2% higher revenues.