Banking sector trading update will show pick of the crop

WITH news that bankers at Goldman Sachs and Morgan Stanley are on track for bumper full-year bonuses, celebrated with the obligatory champagne and expensive dinners, you&rsquo;d be forgiven for thinking that the financial crisis had never happened. But while they might be in line for those bonuses, investors and traders will be scrutinising banks&rsquo; earnings reports more closely than they might have done two years ago. <br /><br />The second quarter earnings season for the banking sector is kicked off by Goldman Sachs on 14 July and after such a strong first quarter for many banks both on Wall Street and in the City, market expectations have been raised for their performance over the second quarter.<br /><br />Ahead of their first quarter results, banks&rsquo; chief executives were keen to tell the market just how profitable trading had been in January and February. <br /><br />This time they have remained stonily silent, even though the media and investors are desperate for some guidance.<br /><br />Joshua Raymond, market strategist at City Index, says: &ldquo;The problem now is that everyone in the market is hoping for some momentum. If they haven&rsquo;t managed that and haven&rsquo;t met those inflated expectations, then there may not be as a positive reaction this time round.&rdquo; <br /><br />But given that the first quarter results were boosted by volatile trading in the first two months of 2009 and banks&rsquo; balance sheets were bumped up by government bailouts, the second quarter &ndash; which has seen trading and activity at an absolute minimum, says Omer Bhatti, head sales trader at WorldSpreads. &ldquo;This means that the banks&rsquo; profits and revenues will be minimal as well and that might create a bit of a shake out,&rdquo; he adds.<br /><br />So which banks are expected to perform well in this quarter&rsquo;s earning season and what strategies should spread betters use to trade the banks effectively?<br /><br /><strong>RELATIVELY ACTIVE<br /></strong>In the United States, Goldman Sachs and JP Morgan have consistently shown themselves to be the best performers over recent months &ndash; both have started to repay Tarp funds back to the US government &ndash; and their second quarter results are also expected to be good. Much of Goldman&rsquo;s activity is in fixed income and commodities, which have remained relatively active&nbsp; in the second quarter. At the other end of the spectrum, both Citi and Bank of America-Merrill Lynch clearly need to show signs of strong recovery. <br /><br />On this side of the Atlantic, where banks report a week or two later than their American counterparts, HSBC seems to be the one that stands out. It hasn&rsquo;t had to draw on government money, has a strong presence in Asia, and was less exposed than its peers to toxic assets. <br /><br />While there are still concerns that further writedowns may follow for UK banks, the general consensus is that the large majority of writedowns that need to happen have already occurred. <br /><br />This is eminently not the case in mainland Europe where the European Central Bank (ECB) estimates that Eurozone banks may need to write down another $283bn on bad loans and securities over the next 18 months. <br /><br />So far the European banks have appeared much stronger than those in the UK and the US, but concerns about their exposure to Eastern Europe should be worrying spread betters. This is particularly the case for Austrian, German and Swedish banks, which have lent huge sums to Central and Eastern Europe (CEE).<br /><strong><br />SOLID BANK</strong><br /><br />If you believe UK banks will prove stronger than their European peers, then you could do a pairs trade by going long on a solid British bank such as HSBC and short a European bank that you think has particular downside risk. <br /><br />However, not all European banks have done badly and if you want a long option then BNP Paribas is Credit Suisse&rsquo;s pick of the French crop. <br />&ldquo;BNP Paribas has outperformed the sector by about 38 per cent year to date. Strong fixed income performance combined with poor reported performance by its peers, gives us cause to believe that BNP Paribas&rsquo;s shares could still have a long way to go,&rdquo; analyst Guillaume Tiberghien says.<br />The banks&rsquo; second quarter earnings season will prove crucial for the banks in demonstrating to investors and traders just how well &ndash; or badly &ndash; they have begun their painful recovery from the financial crisis. <br /><br />Volatility will undoubtedly provide opportunity for day traders, while more positional strategies could prove equally profitable for the slightly longer-term positional spread better.