Bank on the Consumer this Earnings Season

Why stocks tied to consumer credit are poised to rise as the Fed pauses


My expectations for the bank reports this earnings season were fairly low. I was concerned about slowing growth and an interest rate environment that would make it hard for the banks to increase their net interest margin. I am still concerned about those issues, but along with many other analysts, I may have overestimated the problems banks would have at the net interest margin level based on the reports that have come out so far.

On April 12, the earnings season for the big banks was kicked off by reports from JPMorgan Chase & Co. (JPM), Wells Fargo & Co. (WFC), and PNC Financial Services Group Inc. (PNC). In all three cases, there was better than expected performance in consumer lending that contributed to surprising gains for JPM and PNC.

Net interest margin is essentially the difference between what capital costs the bank (or the bank’s borrowing costs) versus what they can charge customers. As the Fed raised the overnight rate, the banks were able to increase the amount they charge customers without suffering much of an increase on their borrowing costs. For example, JPM’s profits at its consumer bank was up 19% due to rapid growth in credit card debt and auto loans that was amplified by an improvement in their net interest margin.

This is a good sign that banks still have some growth potential and an incentive to continue lending. It also means, consumers are demanding credit for consumption. Those two factors are key components of economic growth. As you can see in the following chart, credit card debt has been rising rapidly since 2014 (red) while the interest rate charged on credit cards has jumped from 12% to more than 15%. Rising volume and higher consumer rates went a long way to boost profits for JPM and bodes well for the other bank reports due over the next two weeks.

Federal Reserve Bank of St. Louis

There were also some negatives in the data including flat overall margins when compared to the last quarter of 2018 and slowing investment banking and wealth management profits. However, I think the consumer financing news is positive enough to offset those negatives in the short-term. I also suggest that this data can help traders make estimates about housing and mortgages, and retail sales.


The average 30-year fixed mortgage rate in the U.S. has fallen to 4.12% since November 2018 when it was nearly 5%. There is a real potential that investors have underestimated how demand for mortgages and consumer real estate may spike over the next quarter because of the decline in rates for two reasons: 

  1. The increase in credit card debt and credit card interest rates could continue to stimulate demand for mortgage refinancing as credit card debt swells to all-time high levels for U.S. consumers. Shifting high-cost consumer debt into low-cost real estate debt by using the proceeds of a mortgage to pay off credit cards and auto-loans is a common pattern when rates fall.
  2. Consumers who are looking for a real estate purchase may use low rates and positive job growth to trigger their decision in the short term. One way can detect a shift in sentiment like this is by watching the National Association of Home Builder’s (NAHB) sentiment index.

The NAHB index will be reported on April 16, and I have found it to be a predictive indicator for housing stocks and lending. For example, prior to the collapse of the S&P 500 in early October 2018, housing stocks had already broken support. The NAHB had been signaling that there were problems in the market by declining steadily over the preceding 10 months.

As you can see in the following chart, the negative sentiment trend among homebuilders has bottomed out and is looking much more positive over the last 4 months. If the NAHB index surprises again on the 16th, the outlook for homebuilders and related stocks looks good. I recommend using similar indicators like the Existing Homes Sales report that will be released on April 22 by the National Association of Realtors, to confirm the positive signs from homebuilders.

I feel that the NAHB index is underappreciated by the financial press compared to other economic reports like housing starts and building permits because it lacks the same kind of quantitative data that those other reports include. However, what the NAHB report has that the others lack, is an adjustment for forward looking estimates by the survey respondents. Like the ISM’s Purchasing Managers Index (due to be released on May 1), I think forward estimates are a more accurate snapshot of present business activity than a look-back into historical data.

Retail Sales

As I mentioned previously, total credit card debt is at an all-time record high. When combined with auto-loans and student debt, consumers have taken on an unprecedented amount of “revolving” debt since 2008.

While all this debt creates profound negative risks in the future, in the short-term investors can use this information to evaluate the risks of investments in retail stocks as well as banking. What we learned from the JPM, WFC, and PNC reports was that demand for consumer credit has continued to be very robust despite rising consumer financing rates.

The growth in consumer financing has been supported by strong jobs numbers as well, that should postpone any serious negative consequences from the growth in debt until default rates start to rise again. Current delinquency rates on credit card debt are still near the long-term lows of 2-3%.

In my view, investors should interpret this data as positive for continued consumption spending. I have written previously about how retail stocks have seen their operating profit margins fall over the last year; however, as we learned from the banks, that risk is fading in the short-term as investors use lower interest rates to refinance short-term debt and access the equity in their homes to supplement rising wages.

Retail companies that provide their own financing could be especially interesting in the current market environment. For example, AutoZone Inc. (AZO), CarMax Inc. (KMX), and Rent-A-Center Inc. (RCII) are typical of the kind of stocks that should benefit from the combined demand for consumer financing and spending. Financing and credit providers like PayPal Holdings Inc. (PYPL), Berkshire Hathaway Inc. (BRK.A), and Discover Financial Services (DFS) will also add to their winning streak if the remaining bank and real estate reports continue as expected.

Bottom Line

I expect that earnings news from all sectors will dominate the press and determine the overall direction of the market for the rest of this month. However, what we have learned from some of the early reports indicates that consumer borrowing behavior will lead to outperformance among retail, housing, and financing stocks. The flow of capital into these sectors could easily make up for short-term slowing in industrial stocks and emerging markets. Investors with a view of the long-term will certainly want to be alert to any changes in delinquency rates, but, in the short-term, the profit opportunities appear very promising.

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