The financial sector, which accounts for 19.8% of the S&P 500 index, saw a superb 2013 thanks to a reviving banking sector in the U.S. In fact, financial stocks drove the recent rally in the equity market. Sound balance sheets, an improved asset market and lower loss provisions were the major contributors to this advancement.
 
Q4 Earnings So Far
   
The sector seems to have benefited a great deal from easy comparisons to Q4. As per Zacks Earnings trends for this season, the financial sector is expected to expand 20.1% on the bottom line, but suffer 5.1% on the top line. Total earnings for the finance sector are expected to be up 20.1%, notably the highest contribution to the S&P 500 index.
 
Insurance activity is on the rise thanks to the rising rate environment and is likely to have given a big-time boost to the overall finance sector in the fourth quarter.
  
The mixed bag response to the sector can so far be validated by some latest earnings reports from sector bellwethers including Goldman, Wells Fargo, Morgan Stanley, JP Morgan Chase & Co., Bank of America Corp. and Citigroup.

Apart from Goldman, Wells Fargo, and Morgan Stanley, no other banking large cap stands out on both earnings and revenues. While JP Morgan and BofA beat the Zacks Consensus Estimate on earnings, the duo fell shy of the top line estimate. Performance by Citigroup was discouraging as it lagged on both lines (read: Can Bank ETFs Bounce Back After Recent Downgrade?).

However, Morgan Stanley’s performance was a bit surprising. While its earnings from continuing operations were a downer (fell 79% year over year) hammered by $1.2 billion of legal expenses, its adjusted earnings beat the Zacks Consensus Estimate by a nice margin and as did net revenues (excluding DVA adjustments).

Results in Detail

Goldman earned $4.60 per share in 4Q, down from the year-ago earnings of $5.60, but ahead of the Zacks Consensus Estimate of $4.14. Net revenue declined 5% year over year to $8.8 billion, but outpaced the Zacks Consensus Estimate of $7.8 billion.

However, investors might have demanded more from this banking giant as shares were in the red in immediate trading after the earnings release.
 
Wells Fargo earned $1.00 in 4Q13, achieving the sixteenth consecutive quarter of earnings per share growth. Results improved from $0.91/share earned in the year-ago quarter. The reported figure bettered the Zacks Consensus Estimate by $0.02.
 
The quarter’s total revenue came in at $20.7 billion, outpacing the Zacks Consensus Estimate of $20.6 billion. However, revenues were down 5.5% year over year.
 
Morgan Stanley continued its positive surprise streak, delivering another beat in this past quarter and posting $0.50 per share of adjusted earnings. Net revenue (excluding DVA adjustments) went up 9% to $8.2 billion that outpaced the Zacks Consensus Estimate of $8.0 billion.

Big Bank Earnings
 
Meanwhile, BofA delivered a positive earnings surprise of about 7.4%. Quarterly earnings were also 3 cents higher than the year-ago period. Though fully taxable-equivalent adjusted revenues were up 14% year over year, it was marginally lower than the Zacks Consensus Estimate.

On the other hand, after running into some trouble in the third quarter, JP Morgan booked a solid earnings result in the fourth quarter. Its earnings of $1.30 per share came ahead of the estimate by $0.05 per share.
 
Kudos mainly go to JP Morgan’s inflated legal reserves. However, earnings were lower by $0.09 per share from the year-ago period. Net revenue of $24.1 billion in the quarter was down 1% from the year-ago quarter and was also lower than consensus estimate of $25 billion (see all the financial ETFs here).
 
Like Q3, Citigroup restrained itself from posting dismal results in this quarter as well.  Its earnings of $0.82 per share were up 19% year over year but lagged the Zacks Consensus Estimate.
 
Revenues dropped 2% and fell short of the Zacks Estimate. Issues in its mortgage pipeline and fixed income trading business hurt its operations.

Market Impact

All the aforementioned companies have considerable exposure in funds like iShares U.S. Financial Services ETF (IYG), PowerShares KBW Bank (KBWB), Market Vectors Bank and Brokerage ETF (RKH), Financial Select Sector SPDR (XLF), U.S. Broker-Dealers Index Fund (IAI) and Vanguard Financials ETF (VFH) (read: Top Ranked Financial ETF in Focus: KBWB).

Among these ETFs, only IAI (0.44%) and RKH (0.64%) gained in the last 5 days thanks mainly to Goldman’s and Well Fargo’s relatively better results among the banking set, respectively. In fact, the magnitude of gain was higher in these names than the S&P 500 index (0.42%). Conversely, the other four slipped in the range of 0.02% to 0.66%.

What’s in Store Ahead?

The stupendous rally in finance stocks in 2013 might stumble in the upcoming quarter as the current Zacks earnings trend calls for a year-over-year slowdown in each of first three quarters of 2014 mainly due to lower revenue expansion.

However, the scenario will become brighter again starting in the third quarter of 2014. Long-term projections are also favorable with, respectively, 10.6% and 10.3% growth projected for 2014 and 2015 (see all the top Ranked ETFs here).

Investors should note that while everything seems to be in place for the U.S. financial sector, some near-term glitches arising out of stringent banking rules might loom large in the coming days. Among a variety of rules, the Dodd-Frank regulations which came into being in 2010 take the top spot.

Recently, a lot has been said about one major clause of the Dodd-Frank regulations – the so-called ‘Volcker Rule’. This specific rule had been kept on hold for long, and lately the variety of financial regulators have agreed on a way to move forward with this rule, giving banks until July 2015 to meet the terms of the provision (read: 3 Financial ETFs to Watch on Volcker Rule Implementation).

If this was not enough, the credit-rating organization Moody’s (MCO) downgraded the long-term senior unsecured debt of four top-tier U.S. banks including Goldman and J.P. Morgan last December, to add to the woes.

Bottom Line

Having said all this, financial institutions which are more into the broker-dealer/capital markets segment might get their share of aid next year thanks to the Fed’s potential phased tapering. Also, the companies which are more domestic-centric can win the show this year as these will capture the growth stories in the U.S. and potentially profit again in 2014 (read: Financial ETFs Tumble on Citigroup Warning).

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BANK OF AMER CP (BAC): Free Stock Analysis Report
 
ISHARS-US BR-D (IAI): ETF Research Reports
 
ISHARS-US FN SV (IYG): ETF Research Reports
 
JPMORGAN CHASE (JPM): Free Stock Analysis Report
 
PWRSH-KBW BP (KBWB): ETF Research Reports
 
MKT VEC-BANK&BR (RKH): ETF Research Reports
 
VIPERS-FINANCL (VFH): ETF Research Reports
 
SPDR-FINL SELS (XLF): ETF Research Reports
 
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