Job Growth and Bank Earnings: What Investors Need to Know

The June jobs report showed that our economy is creating far more jobs than expected, and this could make the Federal Reserve hesitant to cut interest rates. In this episode of Industry Focus: Financials, host Jason Moser and Fool.com contributor Matt Frankel, CFP, discuss the jobs report, the upcoming wave of bank earnings, and how these stories tie together. Plus, they address the downsides to the "War on Cash" and share what stocks they're watching now.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on July 8, 2019.

Jason Moser: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market each day. It's Monday, July 8th. I'm your host, Jason Moser. On today's Financials show, we're going to dig into the recent jobs report. Earnings season is getting ready to start, so we're going to talk about what that means for banks. We've also got another interesting listener question to deliberate this week. And as always, we've got ones to watch for you.

As mostly usual, I guess, we've had a little bit of a stretch here, Matt, where we've been missing each other. But joining me in the studio today is Certified Financial Planner Matt Frankel. Matt, how's everything going?

Matt Frankel: Pretty good. Yeah, I haven't talked to you in forever, I feel like.

Moser: It does feel like it's been a while.

Frankel: I had Dylan in the studio, then we had a week off, then you did one with Dan instead.

Moser: There's been this void in my life. I was wondering what it was. Now I'm feeling a little happier. Obviously, I was missing you, Matt.

Frankel: To be fair, Dan's probably as fun as me when it comes to hosting a podcast.

Moser: [laughs] Well, I think we've got a very good team. It's nice that there's no real single point of failure. That ultimately is the goal here. Okay, Matt, let's kick it because we've got a lot to talk about this week. Last week, we got the jobs report in. The headline there, I think, was ultimately a good one. Nonfarm payrolls rose 224,000 in the month of June, beating the market's expectations of 165,000. Now, we know that really, the story when it comes to the jobs report is all about the adjusted numbers. A few months from now, they'll look back, they'll make some adjustments, and that'll paint a little bit more of a picture of what really is going on. But generally speaking, it feels like it was a pretty good report there. What did you take away from this? Worth noting, too, that the unemployment rate actually ticked up slightly. That's just more of a math problem than anything else. But overall, what was your take on the report?

Frankel: Obviously, it was a big upside surprise. But the point is that there's so much talk of, "A recession's coming, a recession's coming, the economy is going to slow down, etc." But it hasn't really been reflected in the data. A lot of people were expecting it to be reflected in this June jobs number, and it just wasn't. The market's really expecting the Fed to start cutting rates and to start doing it soon, as in this month's meeting. In fact, there is a pretty decent chance of a double rate cut, according to the market. They're expecting either at 25- or 50-basis-point rate cut before this jobs report. With great jobs numbers, it's really tough to justify cutting rates.

It's really interesting to mention, however, that currently, there's a 0% percent chance that the Fed won't cut rates priced into the market. I wouldn't be as surprised if they didn't as the market seems they would be.

But the biggest change is that the expectation for a double rate cut, a 50-basis-point rate cut, has really gone down. It's gone down from 20% to a 7% chance based on the futures markets over the past week in a direct response to this jobs report. So expectations are definitely tapering as far as what the Fed's going to do. But I don't know if they've tapered enough, to be honest with you.

Moser: To your point about the recession, we sit there and we talk about it, it feels like we've been talking about this market that's been overvalued for the better part of...I don't know, seven years, maybe, now, it feels like we've been having that conversation? And we haven't seen any type of a material pullback. Certainly, that recession hasn't occurred yet. I have a feeling that we're going to keep on talking about it, and then one day, it's going to happen, and we're going to be like, "See! I told you so! We were just waiting for it!" I mean, a recession is a matter of when, not if. But it really does seem like, today, at least, the politicians in D.C. are trying to figure out a way to not ever have a recession at all.

I guess I get that, but by the same token, we know how the market's ebbs and flows work. It's a cycle. You do look at some of these companies out here today -- these companies are doing great things, but a lot of these valuations still don't make a lot of sense. They're really baking in a tremendous amount of success with businesses that haven't shown or proven any long-term sustained success. They just haven't been around that long. So, I'm feeling like, I really would love to see the Fed butt out of this for a minute and let things go, let the chips fall where they may. We're at a point where I don't know that unemployment can get much better, right? And even still in today's job market, you still have people who are feeling like they're being somewhat left behind when it comes to wages.

Frankel: Right. I can understand, like you said, why all the politicians in Washington don't seem to want a recession ever. No one gets reelected while a recession is going on.

Moser: No they do not.

Frankel: It's very tough to do. So, that's definitely easy to understand. I can get the case for a rate cut. The Fed's there to maximize employment and control inflation. We have no inflation. So, from that part of the dual mandate, it's really tough to make the case that a rate cut is not a good idea. The Fed wants 2% inflation. They're not getting that. So, a rate cut could theoretically help boost that a little bit.

But we are at pretty much full employment. Like you said, some stock valuations are just astronomical right now. There's some that I won't touch just on valuation alone. Not banks. Banks are actually pretty nicely valued right now.

But the other thing is, I'd love to see the Fed not cut rates, I'd like to see them save some ammunition for when there's actually a recession, like when we actually get some real negative data. Right now, they have, what, nine rate cuts they could possibly make to try to combat any slowing economy. I'd like them to save that for when the economy actually appears to be slowing down.

Moser: Well, right. To that point, assuming we hit a point where the you-know-what does hit the fan, if the Fed starts utilizing all of the tools that has in its toolbox today, what if they run out of ammo when they really need it? What are the options that are left there? I don't know that you have a whole heck of a lot left, other than you just start jumping back into that whole quantitative easing cycle, and it doesn't feel like we've fully gotten out of that to begin with.

Frankel: They've been winding down the balance sheet, they could potentially end that and cut rates at the same time, if they want to do a neutral-ish option. But yeah, there's always quantitative easing, but no one wants it to get to that point. That's essentially like lowering rates past zero. Nobody wants it to come to that. I personally would like them to keep a lot of ammunition. And, as a bank investor, keeping rates a little bit higher for longer would be a good catalyst for bank earnings, too. I'd like to see them hold steady. But it doesn't look like the market's expecting that at all. Right now, there's a 93% chance priced in of one cut, a 100% chance of at least one cut, in the July meeting. The market's not expecting them to hold steady.

Moser: Well, I guess we will find out soon enough. But let's jump over to earnings. You brought up bank earnings, and we've got Earningspalooza getting ready to start up again. This is always a fun time for stock nerds like us because it gives us something to do, something to read, something to talk about. It's always interesting to find out what's going on under the hood, so to speak. We look at some of the data that comes out. FactSet Data shows that third-quarter S&P 500 earnings are forecast to actually show a decline now versus a modest gain not all that long ago. We talk on this show a lot about the bank earnings and how banks had been working in somewhat of a challenging environment with these low interest rates. It just hasn't given them a lot of wiggle room in regard to profitability. It doesn't seem like that is going to be getting any easier anytime soon. What's your headline here as we go into earnings season, for the banks in particular?

Frankel: First of all, the banks are not going to be part of that earnings decline that you're talking about. Not the big banks anyway, for the most part. The point to remember with the banks is that they've been buying back stock hand over fist over the past year. If you buy back, say, 10% of your outstanding shares, and your earnings per share jumps up by 10% as a result, you didn't earn any more money. Buybacks are very distortive of bank earnings.

Moser: We call that putting lipstick on a pig, Matt. Is that too harsh?

Frankel: I've heard that expression. Citigroup is the first one to report on Monday. They're expected to report a nice earnings gain. I want to say that the consensus is for about 18% year over year. But the majority of that is going to be due just to buybacks. So, with the banks, the thing to keep in mind is, when it comes to the actual headline number and how it compares with the year before, take that with a big grain of salt.

The thing I would pay most attention to is how interest rate dynamics and any economic headwinds are affecting the bank's profitability. For example, as the Fed has been raising rates over the past couple years, we've seen interest margins expand for the most part at these big banks. That's a great side effect of rising rates. The Fed hasn't cut rates yet, but the market's expecting them to. So, we want to see if that's factoring into anything at all, if they say anything about it during their conference calls.

The other thing is any economic headwinds. Are loan volumes picking up or slowing down? Swelling loan volumes, especially when it comes to credit cards and things like that, can be a really good indicator that consumer confidence is starting to tick downward a little bit. It's always important to read between the lines when it comes to earnings, but with banks, because of the massive buybacks, it's really important this time to read between the lines and see how the major indicators are playing out.

Moser: Yeah. I think we're going to hear a lot of the rhetoric starting to pick up here as we inch closer to 2020. It is obviously a very big election season. It's going to be very, very interesting to see all of these forces at play here. It certainly seems like everybody's on a different page.

Frankel: Definitely. I would definitely keep an eye on what's going on in these banks all next week. We're lucky in the banking sector because we get to see the first glance of how everything's doing this quarter. You have Citigroup kicking things off on Monday. Tuesday, you've got JPMorgan, Wells Fargo, Goldman Sachs. Wednesday, Bank of America and U.S. Bank. Thursday, Morgan Stanley, Capital One, BB&T. Theirs will be interesting because of the merger coming up. And Friday, you have American Express and Regions, just to name the big ones. And that's all next week. We will be glued to our televisions and news feeds next week, I can tell you that much.

Moser: Oh, for sure. Yeah, we'll have a lot to talk about on this show for the coming month. Keep your Slack channel open, because I'm sure we'll be kicking around some ideas.

Okay, let's jump out of the banks here for a second. I want to talk about a listener question. I feel that recently at Fool Fest, we've talked about our big investor conference, I guess the best way to put it here, that we had recently. Fool Fest is a great event we have every year, and somewhere in the neighborhood of 1,000 members descended on our area here this year for us. One of those members, Bob Claude, he and I were speaking one day, talking about our show here. He had a lot of nice things to say about the show. One thing that he was asking us to consider discussing, we talk a lot about the war on cash and this move toward a cashless society, and all of the great things that come from it. Bob's question was, "Hey, you're not talking about the flip side of that necessarily as much as I'd like to hear." And I think there's some valid observations to take away from that. I agree with him. We want to talk a little bit about the drawbacks of going to a cashless society.

Matt, I'll go ahead and let you kick it off here. We do talk all the time about these investments in these companies that are helping spearhead this move toward a cashless society. But there are some side effects there from less cash. I wonder, what's the first thing that comes to your mind there, one of the problems or drawbacks of a cashless society?

Frankel: When I was kicking around this idea before we started recording, there's three big ones I can think of. The first one, from a consumer standpoint, is the vulnerability of your money. Obviously, cash can get stolen out of your wallet. But the flip side of that is all these data breaches, the hacking incidents, banks' electronic portals go down all the time. I had trouble getting into my bank this morning, actually. If that's your only money, if there's no cash and all of your money is electronic, it creates like a big risk, like having all your eggs in one basket. If your bank crashes one day, and all of your money has to do with electronic transactions, that's a problem. So, that's No. 1.

No. 2, also from the consumer perspective, a transition to cash -- we've talked about this on the show before -- disproportionately affects certain groups of the population, particularly lower-income individuals and older individuals who may be reluctant to switch to new technologies or not understand how they work. They call this the underbanked population. It could leave a lot of this group of the population behind and make day-to-day transactions a little more difficult for them.

Third, from a merchant's point of view, paying transaction fees. Right now, let's say you own a small business. Let's say Jason owns a restaurant. I'd go to Moser's Cafe.

Moser: Of course you would. I mean, there is Jason's Deli out there, but listen, that's not mine.

Frankel: It'd be cool if it was.

Moser: I'd probably have a sandwich on that menu named after you, Matt.

Frankel: That'd be awesome. But, let's say he owns Jason's Cafe, not to be confused with Jason's Deli. Let's say half of the customers pay with cards right now and half pay with cash. On average, he's paying about a 3% interchange fee for every card transaction. If 100% of those transactions were now in the form of cards, he's now paying a fee on 100% of his business. That doesn't sound like much, a 3% fee, but when it's replacing all of your cash business, which you're currently paying no fee on, from a merchant, that's a pretty big deal, especially in a low-profit-margin business like a restaurant or a convenience store or something like that. So, there are some downsides for everybody.

Moser: Yeah. To your point there, there are a lot of costs involved with this electronic money system that we're working with today. The thing is, you don't feel or see those costs, necessarily, from the consumer side all that often. But when you put the shoe on the other foot there, as the merchant, you're counting every penny, I would imagine. We've seen small businesses make that attempt to go to no cash accepted, it's cards and electronic payments only. To me, if I'm a small business owner, if I own my own business, I would open myself up to cash and cashless options. I want my customer base to be as big as it possibly can be. You do want to accept everyone. Just, you have to understand that managing a cash drawer, there are downsides that come with that, obviously. You're having to deal with running to the bank every so often, or deal with the threat of someone robbing your shop one day. So, I do see the benefits there of going cashless. But by the same token, it does seem like you're cutting out a valuable customer base.

One thing that Bob and I were talking about, and this comes from the parent's perspective, cash is a great educational tool for kids. I think back to when I was younger, and I think about the lessons that I learned in dealing with money, making money, spending money, managing money. It all centered around cash. I had my own little business where I mowed lawns in the neighborhood every summer. My dad made a deal with me one summer, where if I saved up enough money to pay for half of this new set of golf clubs that I wanted, then he would match the other half and help me get them. So, I went by, I was mowing yards. And listen, these people weren't paying me with Venmo, it was 1978 or 1982 or whatever. I was getting cash. I would take that cash home, and I would give it to my dad. And then when the time came, I had to actually hand him that cash in order to go get those golf clubs. So, there was the feeling of that exchange, there was that transaction. I was giving up something to get something in return. Today, you don't necessarily have that. Kids are clicking a button and getting something immediately. There's not that same sense of loss. That can have an impact, I think. You don't learn, perhaps, the value of a dollar, so to speak, quite as easily as maybe we did before.

As parents, I think piggy banks are wonderful educational tools there, and getting some cash involved with that kid's life so they can understand how money does work. I'm sure every parent out there has dealt with giving their kid five bucks and then finding that $5 sitting on their floor of their room, with all of their dirty clothes. And you're thinking, "Oh my god, does this kid not understand this is actual money here, and if you destroy it, then it's gone?" So, yeah, I think there's an educational purpose there that cash serves. I certainly try to incorporate that into our girls' lives still, but it's just not as easy.

Frankel: Definitely. My three-year-old daughter has a piggy bank in her room and I can't wait for the day in like 10 years when one of her friends comes over and doesn't know what's inside of it.

Moser: [laughs] "Is that candy?" "No, close." Hey, listen, for all of y'all out there, we love to talk about the merits of a cashless society, but I will stand firm, I do believe cash still serves a purpose. I am not rooting for cash to disappear. I just like the convenience and having the options. Good question. Thanks for the topic, Bob. I hope we gave you something to think about there.

Okay, Matt, let's wrap up this week here. We've got One to Watch time. What is your one to watch for this coming week?

Frankel: I'm looking at Deutsche Bank (DB 1.39%), ticker DB. They announced a giant restructuring plan. They're cutting 18,000 jobs over the next few years. If you're curious, that is a big number, but they have 92,000 right now, so they're not cutting 80% of their workforce. They're closing their global equities sales desk and their trading desk. They're creating a so-called bad bank, kind of like Citigroup did at the end of the financial crisis with Citi Holdings. The goal, obviously, is to improve profitability and stability. They say that this plan will cut costs by a quarter. Market's not thrilled with it, the stock was down by 6% this morning when I checked. I'm not saying it's a buy, but it's definitely one to keep an eye on as this progresses. If you are a long-term investor and want to take a risk and think that this is going to be a great institution 10 years from now, it could be worth a look.

Moser: Yeah. Anytime you see companies right-sizing their cost structure, there are lives are impacted by that, but from a business perspective, from the investor's perspective, it's usually a good thing. Always something to keep in mind there.

I'm going to go with Ameris Bancorp (ABCB 1.85%), a company that obviously we've talked about a lot before here. They just closed the Fidelity deal. We were talking about the big acquisition of Fidelity Bank in Atlanta. That's good. They finally got that knocked out. A bit of a surprise recently in CEO Dennis Zember -- you may remember that we interviewed Dennis back in February on this show -- Dennis Zember has stepped down according to the company base. There were some personal and some family issues, and he felt he needed to step away. It sounds like Palmer Proctor, who is with Fidelity, he served as the president of Fidelity, will be taking over as the CEO of the newly combined bank there, which will continue to be known as Ameris Bancorp. So, we'll have a new CEO to get to know. This wasn't quite a merger of equals, Ameris was the bigger of the two, but I do like the exposure. It gets to some very lucrative lending markets. Banks need to get bigger in order for investors to benefit from that, and it does seem like Ameris is doing the right stuff here to get bigger. Who knows? We'll reach out to Ameris and see if we can't maybe speak with Palmer Proctor one day. That'd be a nice interview to get on the show here. But again, I think it's good they've got that acquisition all wrapped up there, and now it's onward and upward, hopefully. We'll be keeping an eye on it.

Matt, thanks a lot for joining this week! It was good talking to you again.

Frankel: Always good to be here!

Moser: Okay. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Today's show was produced by Austin Morgan. For Matt Frankel, I'm Jason Moser, thanks for listening and we'll see you next week.