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MASTERS OF THE UNIVERSE
Bank Earnings Results vs Expectations, Offside Capital
The AI boom allowed Goldman Sachs to beat earnings expectations by over 25% this quarter.
No other bank came even close to that jump, and there’s a reason for it…
Most companies joining the AI race have depended on available debt and equity raises to keep their projects afloat before reaching monetization.
Which means big fat fees for banks like Goldman who offer a mix of:
Underwriting the equity/debt issuance
Leading the IPOs, acquisitions, or mergers taking off in AI
Packaging loans and selling them to insurance companies or private credit
That last point is extremely important.
In 2008, Goldman was packaging bundles of subprime loans and immediately getting rid of them to private credit and insurance buyers.
Later it became obvious why they didn’t want to hold any of that risk in their balance sheet.
Today, the quarterly numbers show an eerily similar story when it comes to GPU-backed loan bundles.
That doesn’t mean it all collapses tomorrow though.
But,
J.P. Morgan Chase’s report on net interest income (NII) and their expectations for next year sure serve as a potential clock to follow.
That matters because we’re moving past the obvious question of:
“Were bank earnings good?”
And into a much deeper signal by asking:
“Who is left holding the AI credit risk that made banks earn so much money?”
We’ll also cover a very powerful price action gauge between two of these banks, and how their relative performance tends to predict the next few months of S&P 500 trends.
Let’s get into it,
Banking earnings: Goldman wants nothing to do with AI.
Blended Banking Results, Offside Capital
Let’s begin with the broader financials, specifically the NII and markets-related revenue segments.
I’ve highlighted Goldman Sachs because it is the extreme outlier in this peer set, especially if you compare the size of NII relative to markets revenue in all other banks.
Goldman is the only one with markets revenue larger than NII.
You can study the capital cycle in banks, and refer to CFA public studies to learn that:
Financial systems come into stress when banks earn more from segments not related to interest income (NII)
When revenue is specific to financial markets, it tends to mark a peak in speculative episodes
Edward Chancellor from Marathon Capital has done extensive work on this topic, so I will not go any further into cause and effect.
For now,
Know that equities trading jumped by 72% at Goldman while fixed income trading fell by 1% instead.
J.P. Morgan, on the other hand, saw its NII rise by 13% to drive most of the quarter’s revenue and signal a much healthier banking operation without speculative excess to report.
JPM 2027 NII Guidance, Offside Capital
Management at J.P. Morgan has guided for NII to increase by 10% or so in the next twelve months.
That matters because NII can only increase in two ways:
National interest rates go up
People deposit more at banks, allowing them to lend more
Such a combination would effectively lead to an economy that is cooling down, since deposits are negatively correlated with consumer spending.
In other words,
The bank is explicitly telling us that interest rates are going up, and that they expect people to spend less and keep more cash deposited in the bank.
Economic Take
Bank Deposits & Wealth Management Client Flows, Offside Capital
This is one of those “the poor get poorer and the rich get richer” sort of chart.
You can clearly see that deposits are on the rise right now and have been since the bottom of 2022 (which marked the last bear market and economic slowdown.)
Before that, deposits only spiked during COVID when people were forced to stay home and not spend that much money out of fear.
On the other hand,
Wealth management client flows at J.P. and Goldman Sachs all saw new business, and some of my prime brokerage sources tell me they are all looking to buy into this mania.
That tells you something very important…
The affluent households are the only ones carrying this economy in terms of consumer activity, and they are also heavily exposed to AI concentrated investments.
One downturn in this market, and we will truly see the effects throughout the economy.
Relationship Between Yields, NII, and Deposit Rates, Offside Capital
To finish the take on the economy,
You can see that people are also incentivized to keep money in the bank as yield spreads widen (10-year minus 3-months.)
And right now,
That spread is widening along with a stable NII/deposit balance, so I guess J.P. Morgan is right so far in expecting better interest income and deposits.
Sadly, that could also mark the end of a bull run in equities.
Peak Risk Cycle
IB Fees & Market Revenue Rates, Offside Capital
Now comes one of the most important lessons you can take from analyzing bank earnings.
The more investment banking (IB) fees grow at these banks, the lower future S&P 500 returns become.
As broader risk-taking ends up increasing the supply of equities and leverage, the results usually end with sharp market rotations and corrections to wash out the excess valuation and leverage in the system:
Through time, in the right chart, you can see how:
2016: Markets declined after the booming IB fees from the energy sector
2022: Markets declined from the SPAC and meme stock mania IB fees
Right now, we are back toward the peak of that cycle in the AI boom.
Judging by how much IB fees jumped in Goldman and J.P. Morgan, we are likely going to see a negative 10-15% return in the S&P over the next four quarters.
Markets know this…
JPM to GS Ratio, Offside Capital
I like to track the JPM to GS price ratio to get a feel for this peak cycle timing, since markets will trade this relative value according to their expectations.
As you saw from the financials, Goldman is more exposed to the excess in market and IB revenues, which boom along with bull markets like today’s.
On the other hand,
J.P. Morgan’s financials are more dependent - and defensive - on the state of the consumer, yields, and deposit rates.
Simply put,
Whenever the JPM/GS ratio goes up, it means breadth and defensive stocks outperform.
When the opposite is true, momentum and growth stocks take the lead.
Cyclical Correlations JPM/GS vs S&P, Offside Capital
As strong as this signal may be,
It doesn’t always apply.
We have to be in the right macro environment for that signal to hold, and right now it looks like we are.
Correlations to the S&P are negative, and so are their betas (roughly negative 0.28 now.)
This means for every 1% increase in the JPM/GS ratio, we can expect a ~0.28% decline in the S&P index as a result.
This is only one of several spreads you can track yourself as well.
When combining all of the commercial banks (driven mostly by NII) versus the investment banks (driven by IB and market fees), you can arrive at the following matrix:
Commercial vs Investment Banking Ratio Spreads, Offside Capital
The top spreads have a 1.0 beta or more to the unemployment rate and six-month forward S&P 500 returns.
Meaning,
When banks like Wells Fargo, Morgan Stanley, J.P. Morgan all outperform someone like Goldman Sachs…
The S&P 500 is down six months later while the unemployment rate is higher on average.
Load these onto TradingView, track them weekly.
You’ll thank me later.
AI Credit: A Banking Hot Potato
Banking Share of AI & GPU Financing Bundles, Offside Capital
As you can see from this distribution, the largest financiers of the AI boom have concentrated around NVIDIA and a handful of financial institutions like:
Goldman Sachs, Apollo, BlackRock, Blackstone, KKR, etc.
Most of these stocks are down in correction and bear market territory for a reason.
As I’ve explained before, the Anthropic financials and the Oracle data center delays are delivering a direct hit to these packaged loans.
In the sense that they will likely default or lose a lot of value.
That is one of the reasons why both NVIDIA and Goldman stock have managed to hold higher prices recently…
They have passed the hot potato for other entities to hold the risk instead.
Both the hardware and financial risk.
Here’s what that offloading looks like, and why it’s similar to the subprime mortgage offloading of 2008:
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