US bank earnings reports haven’t improved market sentiment. JP Morgan, Wells Fargo, and Goldman Sachs reported a total Q3 revenue of $83.6 billion. Despite this, US stock futures indicate a lower start, and the VIX index has gone up. Wells Fargo shares have risen in pre-market trading, Goldman Sachs is down 2%, while JP Morgan shares are stable. JP Morgan posted revenues of $47.1 billion and a net income of $14 billion but fell short of net interest income expectations. Analysts are worried about possible declines in net interest margins, as five rate cuts by the Fed are anticipated by 2027. JP Morgan set aside $3.4 billion for potential loan losses, slightly higher than expected, indicating that it can manage possible losses without threatening the financial system.

Confidence in Customer Credit Quality

The bank is confident in customer credit quality, even with some labor market weakness. It noted strong results in wealth management and other business areas. However, CEO Jamie Dimon warned about risks from private credit markets and possible stagflation. Wells Fargo aims for a 17-18% return on common equity, making it appealing due to its lower valuation compared to JP Morgan. On the other hand, Goldman Sachs faces market pressures, despite a 42% rise in investment banking fees and growth in trading and capital markets income. The market is signaling that we should focus less on the strong earnings from banks and more on the weak price movements. The rising VIX, now around 20, suggests traders are buying protection and expect larger price swings in the upcoming weeks. This implies that using options to hedge against volatility may be wiser than holding onto stocks directly.

Looking Ahead to Interest Rate Cuts

The market appears to be anticipating the five interest rate cuts projected by early 2027. These cuts will likely impact the net interest income that has bolstered recent profits. Data from the CME FedWatch tool indicates a greater than 70% chance of the first cut by March 2026, reinforcing this outlook. This makes purchasing longer-dated put options on a broad financial index like the XLF a smart hedge against future margin compression. A clear trading opportunity has emerged from this earnings season. It involves contrasting the strength of Wells Fargo with the weakness of Goldman Sachs. By going long on Wells Fargo and shorting Goldman Sachs, investors can capitalize on their differing valuations and operational results without being fully vulnerable to a broader market downturn. Jamie Dimon’s caution about stagflationary pressures should be taken seriously, especially in light of recent economic data. Last week’s preliminary Q3 GDP growth was a disappointing 0.8% annualized, and the latest CPI report revealed core inflation stubbornly holding at 3.5%. This context supports positioning for potential downside risks in the economy through puts on cyclical indices like the Russell 2000. This situation echoes what we saw in mid-2007, when strong bank earnings temporarily masked deeper risks before the market shifted. The fact that solid results from JP Morgan allowed investors to sell is a troubling sign. It suggests the market may be on a downward path, despite the seemingly strong fundamentals from its leading financial institutions. Create your live VT Markets account and start trading now.

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