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Why Tomorrow Will Be a Day of Reckoning for the Stock Market

Tuesday was a generally upbeat day on Wall Street, although the Dow Jones Industrial Average (DJINDICES: ^DJI) failed to keep up with its broader index peers. The S&P 500 (SNPINDEX: ^GSPC) hit new all-time highs, while the Nasdaq Composite (NASDAQINDEX: ^IXIC) made more progress toward getting back to its high-water mark.

Index

Percentage Change

Point Change

Dow

(0.20%)

(68)

S&P 500

+0.33%

+14

Nasdaq Composite

+1.05%

+146

Data source: Yahoo! Finance.

The first few months of 2021 have been full of excitement about the potential for the U.S. economy to recover fully after a difficult 2020. Investors have waited to see confirmation of those gains in earnings, and on Wednesday, they'll get their first helping of first-quarter earnings releases from major banking institutions. With Goldman Sachs (NYSE: GS), JPMorgan Chase (NYSE: JPM), and Wells Fargo (NYSE: WFC) all set to give their latest read on the financial sector and the broader economy, bank earnings will either help support the market's bull move or disappoint bullish investors.

Image source: JPMorgan Chase.

What to watch for from top banks

Each of these three banks is different, with Wells Fargo having more of a consumer focus, Goldman Sachs leaning heavily toward institutional banking, and JPMorgan straddling the fence quite effectively to benefit from both businesses. Nevertheless, there are some common elements that investors will want to watch closely when banks give their latest results.

More than anything else, investors will want to see strong performance from financial stocks. That's likely to be relatively easy, because activity levels throughout the economy are ramping up compared to last year's first quarter, when the COVID-19 pandemic had just begun to have a major impact on earnings. Momentum from the last part of 2020 is likely to continue, although the pace of gains will probably slow as considerable reopening had already occurred by the fourth quarter of last year.

Longer term, bank investors will want to see what decisions banks make with their reserve levels. Higher loan loss reserves last year reflected considerable concern about how deep a recession might be. Already, banks have started to reverse those reserve decisions as things didn't turn out as badly as they could have. Stimulus measures played a vital role in keeping ordinary Americans afloat financially, and the most recent support should have a similar impact this quarter as well.

Business mix will be an interesting thing to watch as well. For instance, falling interest rates throughout the 2010s helped mortgage lenders by providing a constant stream of refinancing activity. However, recent rate increases could reverse that favorable trend. Some borrowers are rushing to lock in relatively low rates while they're still here, but a sustained uptick could take away what's been a vital source of recurring revenue for the banking industry.

The same is true for capital markets. The air pocket that high-growth stocks hit in February could weigh on bank trading operations, but also important has been the rise in the number of companies going public both through traditional initial public offerings and via special purpose acquisition company mergers. Earnings reports will give color on how well Goldman in particular has done capitalizing on opportunities.

Be ready for anything

With so much optimism, anything short of a glowing report could be enough to send the whole stock market lower. On the other hand, as the economy starts to heat up, banks should be in a position to take full advantage and give rosy outlooks for the remainder of the year and beyond.

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JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Wells Fargo is an advertising partner of The Ascent, a Motley Fool company. Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


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