More Dow Pain: Will Financials Bring on the Next Correction?

By Markets Fool.com


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The stock market continued its run of dramatic moves Wednesday morning, sending the Dow Jones Industrials on another roller coaster ride as traders dealt with new challenges on the earnings front from the financial sector. As of noon EST, the Dow was down 245 points for the day, having lost more than 500 points in just over 24 hours between this morning and the market's major reversal Tuesday. Nearly all of the Dow's 30 component stocks were down on the session, with only pharma companies Pfizer and Merck holding out for modest gains.

One of the biggest movers today was Dow component JPMorgan Chase , which plunged 4.5% after releasing its fourth-quarter earnings report this morning. With the venerable Wall Street institution leading off earnings season for the banking sector, investors are increasingly concerned that financials might be just as vulnerable to changing macroeconomic conditions as the energy sector has been. Could trouble in financial stocks be the catalyst of the next Dow correction? Let's take a closer look at what JPMorgan's results showed.

Fear on Wall Street
JPMorgan disappointed shareholders with its fourth-quarter results, which reflected declines in both revenue and net income compared to the year-ago quarter. Revenue of $23.6 billion was roughly what investors had expected, but the $1.19 per share in earnings was almost 10% lower than analysts had estimated JPMorgan would make. Returns on tangible common equity, which reflect the bank's ability to maximize profits from its business operations, plunged a full 3 percentage points to 11%.

Yet when you look at JPMorgan's business performance, it's clear that the bank continues to fire on all cylinders. On the retail banking side, deposits were up 8%, and credit card volumes rose 10%. Business loan originations climbed an even more impressive 18%. On the commercial banking side, real-estate loan growth led to another quarter of strong performance, and JPMorgan's investment-banking and asset-management divisions maintained their solid reputations as leaders in the industry and build up greater assets under management for the company.

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Indeed, JPMorgan's big downfall for the quarter was a legal expense of almost $1 billion after tax. Although investors have gotten used to big Wall Street institutions paying costly settlements and related expenses on a regular basis, the amount of the provision was more than double what some analysts had projected. With ongoing investigations from the Justice Department and other regulatory bodies for various events, JPMorgan probably won't be able to put its legal troubles behind it anytime soon.

Still, there are some clouds on the horizon beyond the legal front. JPMorgan's provision for credit losses has ballooned over the past year, suggesting decreasing confidence in the quality of some of the bank's assets. At the same time, revenue from trading operations fell, with the fixed-income market in particular suffering a steep 23% decline that was only partly offset by better performance in stock market trading revenue.

What financials mean for the markets
Banks have faced unexpected problems over the past year, as the Fed's gradual exit from its quantitative easing program in 2014 didn't result in higher long-term rates. That in turn has squeezed net interest margins, which potentially makes lending less profitable. If that trend continues, then profits throughout the banking sector could fall, creating a vicious circle in which stock market volatility sends nervous investors into the bond market, sending rates even lower and exacerbating problems for big banks.

Yet investors should take heart from the fact that rival Wells Fargo , which also released its earnings results this morning, painted a slightly rosier view of the sector. With income growth of 2% year over year, reduced loan-loss reserves, and reduced charge-off activity, Wells Fargo's picture of the economy gives hope to bank investors that they aren't doomed to poor results for the quarter.

JPMorgan's report is troubling, and if other banks follow suit, the fallout could be large enough to spur a correction in the Dow Jones Industrials. For now, though, that prognosis is premature, and investors should look closely at the wave of bank results coming over the next week to make a better assessment of the health of the financial sector broadly.

The article More Dow Pain: Will Financials Bring on the Next Correction? originally appeared on Fool.com.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of JPMorgan Chase and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.