What happened
Second quarter earnings season begins this week, and analysts are forecasting that companies in the S and P 500 grew their profits by 23.6 percent compared with the same three months a year ago. If that number holds, it would be the second consecutive quarter of profit growth above 20 percent.
The heavy lifting starts on Tuesday, when JPMorgan Chase, Goldman Sachs, Citigroup, Wells Fargo and Bank of America all publish results on the same morning. BlackRock and Morgan Stanley follow on Wednesday. Between them these firms touch almost every corner of the financial system, from credit cards and mortgages to trading desks and asset management.
Earnings season is the six week stretch each quarter when listed companies open their books. It matters because share prices are, at bottom, a bet on future profits. When the bet and the reality diverge, prices move fast.
What makes this quarter unusual is where the market gains have come from. Almost all of the return in US shares over the past year is attributable to profits actually rising, rather than to investors simply agreeing to pay a higher price for each pound of earnings. That is a healthier foundation than the alternative.
Why it matters
Banks report first every quarter, and that is not an accident of the calendar. Banks sit at the centre of the economy, so their results are an early read on how everyone else is doing. Loan loss provisions tell you whether households and businesses are starting to miss payments. Net interest income tells you how banks are faring now that interest rates have stopped moving. Trading revenue tells you how nervous professional investors have been.
Because Wall Street is a bellwether, a weak set of bank numbers on Tuesday would cast a shadow over the technology, retail and industrial results that follow in the weeks after. A strong set does the opposite.
There is also a valuation question. US shares are not cheap by historical standards. When investors pay a premium price, they are implicitly demanding that companies deliver premium profits. A 23.6 percent growth forecast is a high bar, and high bars are easy to trip over.
For anyone outside the United States, this still matters. The S and P 500 is roughly two thirds of the value of all developed market shares, so if it stumbles, global funds stumble with it.
Explained simply
Think of earnings season as a school term where every pupil hands in their homework on the same few days. The banks are the swots who go first, and if their marks are bad, the whole class starts to worry.
A company share is a slice of ownership in a business. Owning it entitles you to a share of whatever that business earns. So the price people are willing to pay for the slice depends on how much they think the business will earn in future.
Nobody knows future earnings, so the market runs on forecasts. Professional analysts publish an estimate for each company, and those estimates get bundled together into an expectation for the whole index. That is where the 23.6 percent figure comes from.
Here is the crucial part, and it trips up almost everyone new to markets. Share prices do not move because profits are high or low. They move because profits are higher or lower than what was already expected. A company can announce record profits and see its shares fall, because the market had priced in even better records. The forecast is the exam pass mark, and beating the mark is what counts.
So when you read that a company beat expectations, that is what happened. The homework was better than the teacher predicted.
What it means for you
If you hold a workplace pension in the United Kingdom, you almost certainly own a slice of these banks without ever choosing to. Default pension funds typically hold 40 to 60 percent of their equity exposure in US shares, and the big American banks are among the largest holdings in almost every global tracker.
If you hold an S and P 500 tracker inside a Stocks and Shares ISA, the connection is even more direct. The financial sector is roughly 13 percent of that index. A bad week for banks pulls your fund down whether or not you have ever thought about JPMorgan.
The practical response for most long term savers is to do nothing. Earnings season is noisy, and reacting to a single quarter has historically been a reliable way to lose money. If you invest monthly through a regular savings plan, a dip simply means your next contribution buys more units.
What you can usefully do is check your exposure. If you are within a few years of drawing your pension and your fund is still heavily weighted to US equities, that is worth a conversation, regardless of what happens on Tuesday.
The bigger picture
Two straight quarters of profit growth above 20 percent would be remarkable in any decade. Historically, the long run average for S and P 500 earnings growth is closer to 8 percent a year. Growth at three times that pace is not something that can continue indefinitely.
The question hanging over this reporting season is therefore not whether profits grew, but whether the pace can be sustained into 2027 while borrowing costs remain high and consumer spending is slowing. Bank commentary on loan defaults will be the most revealing part of Tuesday, more so than the headline profit numbers.
Watch for what the bank chief executives say about credit quality. That is the sentence that moves markets.