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Strong Q2 Results, Economic Activities Driving Financial Sector

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Sector fully recovered H1 2018 loss

After a dismal first-half performance, it seems that things are turning around for banking stocks. Since the start of July, the Financial Select Sector SPDR ETF (XLF), which has ~50% exposure to the banking industry, has gained ~5.2%. 

As a result, XLF has fully recovered the 4.7% value it lost in the first half of 2018. The surge in XLF’s price also outpaced the returns of the S&P 500 Index’s ~4.2% increase during this period.

The momentum in XLF’s prices was mainly driven by overwhelming second-quarter results reported by major US banks, which resulted in a sharp rise in their stock prices. 

J.P. Morgan’s (JPM) EPS of $2.29 beat Wall Street estimates of $2.22 and marked a YoY increase of ~34%. Citigroup’s (C) EPS grew 27.3% YoY to $1.63 and surpassed forecasts of $1.56. Bank of America (BAC) posted EPS of $0.64, which beat Wall Street’s expectation of $0.57 and increased 39.1% YoY. 

Goldman Sachs’ EPS of $5.98 beat analysts’ estimates of $4.66 and registered YoY growth of 51.3%. Morgan Stanley reported EPS of $1.25, beating the Wall Street estimate of $1.11 and marking a YoY improvement of 43.7%.

In mid-June, the Federal Reserve raised the federal funds rate for the second time this year by 25 basis points. 

Moreover, the central bank has hinted at four hikes this year instead of its earlier projection of three increases. Rising interest rates are expected to result in an increased spread, thereby enhancing the profitability of banks.

In late June, the Fed announced that majority of the 35 major US banks had passed the stress test, which checks their ability to endure a major economic crisis. On the basis of these test results, the Fed allows banks to increase their payouts to shareholders. 

Additionally, strong economic growth, an impressive job market, and tax cuts are other tailwinds that have created a friendly business environment for the banking sector. 

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What went wrong in H1 2018?

At the beginning of 2018, the financial sector was considered to be one of the favorites of investors. However, President Trump’s protectionist policies led to a trade war between the United States and China. This trade war spread to Mexico, Canada, and Europe. 

Although a trade war may not directly impact the banking sector, it may lead to a slowdown in business activities, resulting in reduced borrowing requirements. This trend made investors cautious about these banks’ growth prospects.

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