Making Sense of 2Q Earnings

So far, markets have been cheering the news coming from US financial firms – sparked by news that Goldman Sachs handily beat analysts’ profit estimates. And the party continued as JP Morgan, Bank of America, Citigroup and other institutions posted similarly upbeat reports.

But, wait a minute!

Aren’t these the same firms that were receiving billions and billions of tax-payers money just to stay afloat a couple of months ago?

Sure, Goldman has already repaid the $10bn it borrowed directly from Uncle Sam. That’s probably so just so it can hand out huge bonuses again this year.

Investors don’t really seem to care about such trivialities. They’re just cheering the news and move the stocks higher.

Here are the financial earnings hoopla – that the profits are largely based on government handouts used for big trading profits during self-inflicted volatility. Consider the fact that CIT – a major small business lender – just barely cleared a deal to keep itself out of bankruptcy. Not all financial institutions are smelling like roses.

Of course, profits came from the trading units, but not all units are winners. Goldman is still wrestling with a losing commercial real estate loan portfolio and slow investment banking operations. Meanwhile, JP Morgan, BAC and Citigroup are seeing deteriorating conditions in their consumer loan portfolios.

And with new legislation on the horizon – including the credit card reforms, possible caps on executive compensation and other major initiatives – it is hard to picture how these institutions will have a smooth sailing from here on out.

Consumers are changing their behaviour. Credit is unavailable and companies that produce frivolities are going to suffer the consequences. Consumer retrenchment is happening here. It is going to dictate how quickly or slowly the economy turns around and it has major implications for all stocks in your portfolio.