What they reveal about stock market trends

Traders putting off potential interest rate cuts by the Federal Reserve (Fed) may be in for a tough time. According to the FedWatch tool on CME Group Inc., the Fed began the year by proposing cuts starting as early as March 2024; traders now see these cuts postponed until September 2024.

After reporting first quarter 2024 results, Citigroup Inc. NYSE:C kicked off earnings season for financial stocks on a better-than-expected note. That stock rose about two points in premarket hours Friday morning. Despite the contraction in financial data, the bank’s underlying trends suggest potentially better times ahead for the stock market.

At the corporate and consumer levels, retail investors can gain enough insights from Citi’s data to adjust their portfolios accordingly. Before the party begins, here’s an overview of what drove the stock market to its recent all-time highs and why these levels may not be as risky as some think.

Squeeze the last leg

How Citi earned during the quarter can give investors insight into what’s happening under the hood of the financial markets. Investment banking revenues were reported to rise 35% over the past 12 months.

As investment banking gets hotter, the SPDR fund for selected financial sectors NYSEARCA: XLF it tends to do well, which is why it has kept pace with the broader S&P 500 in hitting new all-time highs.

Mergers and acquisitions (M&A) typically command the most fees for investment banks, and these departments only become agitated when their clients can close deals. Low interest rates, or the expectation of lower rates, allow for cheaper financing for these operations.

Despite traders betting on the Fed postponing rate cuts, the pulse of Wall Street is still surprising this year. Citi’s net interest income has fallen 2% each quarter, signaling the start of a credit market adjustment to upcoming rate cuts this year.

In the banking segment, debt capital markets (DCM) fees increased by 62% during the year. In contrast, equity capital markets (ECM) fees increased by just 57%. As rates have remained elevated throughout 2023, it makes sense to see DCM banking activity this high; however, this may soon change.

Citi said in its investor presentation: “I see good momentum in announced mergers and acquisitions in the technology and healthcare sectors.” This is corporate jargon for “get ready,” as these two sectors are set to push markets higher in the coming months.

With the Selected healthcare SPDR fund NYSEARCA: XLV at all-time highs, it makes sense that M&A activity could begin in healthcare stocks. Lower interest rates will likely create jobs for the sector and spur consumer discretionary activity and corporate IT spending to help tech stocks.

Consumers need help

Despite high interest rates, consumer loans increased 1% quarter-on-quarter and 5% over the past year. The problem lies in the number of customers who now have to rely on credit cards to combat the persistently high inflation rates affecting the U.S. economy.

As a percentage of total FICO scores, those below 660 now make up 15% of total loans, up from 14% a year earlier. Those above 660 saw a similar 1% decline, meaning the credit profile of these credit cards is deteriorating.

Non-performing loans are also on the rise, characterized by a period of insolvency (missed payments) equal to or greater than 90 days. Valued at just $1 billion in the first quarter of 2023, they now stand at $1.8 billion and represent 4.5% of average loans, whereas a year ago they represented just 2.8%.

Citi may be taking a long-term view, knowing that US consumer sentiment is now at a 3-year high; the bank could bet on lower rates in the future by taking on some short-term risks in lower-profile consumer lending.

Stocks are still in fashion

Trading revenue helped Citi beat analysts’ expectations despite a low volatility index (VIX). The composition of earnings between stocks and fixed income securities (bonds) also has a lot to say about this trend.

Over the year, revenue from equity markets increased by 5%, while revenue from fixed income markets decreased by 10%. Retail investors may jump to conclusions, but one fundamental truth remains: Citi likes stocks over bonds, and so do its traders.

Citi has outperformed competitors such as Bank of America Inc. NYSE:BAC in the last six months; an 11% gap compared to the competitor can be a sign that the industry still has something to offer and an even better signal for the next stock market rally.

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