A new earnings season is beginning to kick off, bringing on periods of increased volatility and opportunity to investors as long as they position themselves within the favored industries and names in the economy. As a nation's profit center, banks are considered one of the most important names to report during the season, as their underlying capital flows and profitability can aid asset managers and even the FED in understanding where we are in the business cycle.
The financial sector has delivered a flattish performance over the past twelve months, as measured by the Financial Select Sector SPDR Fund (NYSEARCA: XLF). This instrument has underperformed the broader markets by 8.7% during the period.
One of the largest asset managers in the world, BlackRock (NYSE: BLK), is seen trading higher in the pre-market hours of Friday morning. The 1.1% pre-market advance is due to the financial giant reporting its second-quarter 2023 earnings results, which will likely be scrutinized for detail, especially now that the economy is going through a significant turning point, creating the need for markets to find a clear direction.
After giving up formidable gains seen during the 2020 to 2021 period, the stock is now hovering at a critical technical level, one that may be left behind after today's catalyst found in earnings.
BlackRock management's press release leads with one of the critical features traders look for, especially within this niche, to find a clear direction. The asset management giant boasts a net $80 billion of quarterly total inflows, an attribute that raised the total level of AUM (Assets Under Management).
This figure ends up being the primary driver of future profit-making activity within the business. Total AUM for the quarter rose to $9.4 trillion, mainly driven by fixed-income inflows and other firm-sponsored ETFs (Exchange Traded Funds). However, one key trend may act as a warning sign for equity investors.
Net equity product flows reflected a net $4.3 billion decrease, which is alarming considering that analysts expected a net inflow of $21 billion. This is extremely important for investors, even if they are not BlackRock investors. This simple metric reliably gauges what broader markets like and dislike.
By pouring more capital into fixed-income and diversified ETFs while decreasing exposure to individual risk-concentrated equity products, markets are clearly indicating the future outlook. In a nutshell, bonds and diversified products are the preference today, rather than individual stocks and other equity instruments; perhaps the outlook for earnings and valuations is beginning to sour.
However dire these capital flows may seem initially, the fact is that BlackRock insiders themselves (a.k.a. management) believe that the near-term outlook for the business is still steadily positive.
Management repurchased up to $375 million of the common stock off the open market, a subtle hint letting public markets know that, as measured by the willingness to reinvest in the business at these valuations, BlackRock's business may be staring down at a cyclical recovery.
BlackRock analyst ratings may point to the conservative scenarios currently perceived by markets today, considering that the consensus price target leads to only a 4.6% upside potential from today's prices.
Implications of Buybacks and margin expansion
By repurchasing as many shares as they did and achieving higher-than-expected non-operating income, BlackRock delivered earnings per share growth of 28.3%. This increase should have led to a similar rise in the stock price.
However, BlackRock stock has been trading at a tight channel for the past twelve months, hovering between the $600 to $750 per share range. This range would place BlackRock into the Wall Street definition of a 'Bear Market,' otherwise known as a 20% retracement from all-time or recent high prices.
The answer to this discrepancy is found in the firm's operating margins.
Within management's earnings presentation, investors can find a declining chart portraying the asset manager's operating margins. Margins declined from 46.6% in the fourth quarter of 2021 to a low of 40.4% recently during the first quarter of 2023, which may have been enough of a fear factor to keep the stock from finding direction; despite the rise in EPS.
Today, however, BlackRock is returning to normality, as operating margins rose to 42.5% to regain profitability not seen since the second quarter of 2022. Perhaps the catalyst markets are looking for is a continuation of margin expansion, which could be the final push this stock needs to break out of this channel.