Banks and Chips

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Early Birds, Worms or Warnings?

This week’s column is going to cover two topics that are completely unrelated, except for the fact that both have made headlines this week and are worth watching for investors. We couldn’t choose a favorite so we’re doing both.

First up: bank earnings. Third quarter earnings season kicked off with a handful of big banks, as it usually does. Banks are always watched closely early in earnings season to set the tone for economic sentiment, and provide a read on consumer borrowing and spending activity, along with capital markets activity across the Financial Services sector.

This quarter’s results were quite strong across the board.

We look to banks for clues about the health of the American consumer, and for any early warning signs of increases in delinquency rates. Although there has been an uptick in delinquency rates this year, the levels are not alarming as of now, and banks have set aside increasing amounts of loan loss reserves to protect against any possible increases in delinquencies in the future. 

This conservative approach, along with positive results across financials so far, are promising for the current state of the economy.

Another positive sign is the relationship between banks and utilities, which we track as an indicator of cyclicality. When banks are performing better than utilities (i.e., the line below is rising) it indicates optimism around economic activity and strength in the cyclical trade, compared to when the opposite is happening, which can be an indication of defensiveness in markets. 

Thus far, it has been a good start to earnings season.

Recent Crumble in Chips

In contrast, some earnings news in the semiconductor industry sent a different message this week. Semiconductor manufacturing company ASML posted a big miss on net bookings for the third quarter – less than half what analysts were expecting. Demand for ASML’s products comes mainly from other semiconductor companies such as Taiwan Semi – which is a major supplier for companies such as Apple and Nvidia – making these disappointing results an eyebrow raiser for demand in the space overall.

This is just one company and certainly not a conclusive signal at this point, but is something to keep an eye on. Semiconductor stocks were down in sympathy on the news, which pressured another market relationship we track – semiconductors vs. software, shown below. Also shown below is the cyclical relationship between copper and gold, which has been falling this week.

This chart contrasts with the banks vs. utilities chart above and is sending a mixed signal on cyclicality. Generally speaking, in optimistic and strong cyclical trading environments, we’d see semiconductors outperforming software, and copper outperforming gold. The opposite is happening above, albeit over a very short timeframe. 

Zooming out, the semiconductor industry still brings with it strong expectations for growth over coming quarters, with earnings growth expectations hovering in the 30-40% range.

Bottom line, the ASML news is notable and worth keeping on our radar, but not a major bruise on the entire industry as of now. Earnings results for other big tech companies will roll in over coming weeks and we’ll have a more comprehensive view of the third quarter.

Earnings season is off to the races, and despite some mixed signals, appears to be in good shape. We’re in the early innings though, and coming up on the final days before the election and the next Fed meeting. Never a dull moment.

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