Most investors would look at consumer staples stocks for protection against the whipsaws that the market can bring during cycles. While this theory tends to work over time and has worked over time, it is a widely accepted model. However, markets aren’t a simple model. They are dynamic, and each cycle is different, and today is no exception. This is why the financial sector might be a better place to be when trying to hedge away some of the cycle risk.
Banking stocks are in the spotlight this time. Investment banks like Goldman Sachs Group Inc. (NYSE: GS) are highly dependent on the business cycle and interest rates, which drive the volume of investment banking deals, sales, and trading volatility. That might be different from the place to be right now. On the other hand, other banks like Wells Fargo & Co. (NYSE: WFC) are more exposed to the commercial side of the industry, which is not as dependent on the business cycle.
Others stand in the middle of the spectrum, being exposed to investment banking and commercial banking activities to cushion the cycle. One such bank is Citigroup Inc. (NYSE: C), which will show investors this sort of diversification in its second quarter 2024 earnings results. Despite the stock trading lower by over 2% after the release, growing concerns will be cleared away by Wall Street expectations.
The Growth Engine Behind Citigroup Stock
Digging into the bank's quarterly earnings presentation, investors will notice a common trend: growth in every aspect of Citigroup stock's operations. Starting with the commercial side of the business, Citigroup saw a 6% revenue jump over the year.
Revenue increased due to higher net interest income (NII), a widely followed metric for banking earnings. The rising level of branded credit card usage is behind this profit metric, which is responsible for 8% of the revenue growth in that segment alone.
Most investors are aware of the rising trends in credit card usage now that most American consumers are feeling the choking effects of inflation. While that was the main driver on the commercial side, investors can take a look under the hood of the economy by dissecting Citigroup's investment banking side.
Investment banking revenues rose by 60% over the year, leading to higher bank profits. Now, investors need to understand that investment banking activities are highly dependent on the business cycle and interest rates. Low interest rates and flexible financing typically encourage more mergers and acquisitions (M&A) and other debt or equity issuance activity.
With the promise of interest rate cuts on the horizon, expected by September 2024, according to the CME's FedWatch tool, corporate activity may have been picking up, bringing Citigroup into the eye of the storm of potentially higher profits ahead.
This could be why Wall Street analysts felt comfortable with a forecast for up to 22% earnings per share (EPS) growth rate for the next 12 months. Of all these analysts, those at Oppenheimer are the positive outliers, as they slapped a valuation of $86 a share for Citigroup stock, daring it to rally by 33.5% from where it trades today.
More than that, rising profits across commercial and investment banking activities enabled Citigroup management to boost shareholder rewards. Dividend payouts are now up to $2.12 a share for shareholders, which at today's prices represent an annual dividend yield of 3.3%, which at least lets investors keep up with inflation rates.
What Citigroup Stock's Numbers Reveal About the Economy
Despite the growing revenue and profit numbers across the bank’s segments, there is one caveat. The Federal Reserve reports that current credit card delinquency rates are back to levels not seen since 2011, which is a huge warning sign.
This is a warning about the state of the U.S. consumer economy as consumers wait for a government bailout through interest rate cuts. In the meantime, banks like Citigroup are building up a war chest in case these rising credit card balances become delinquent.
Citigroup’s investor presentation shows that non-conforming loans rose to $2.3 billion this quarter, an annual jump of 59%. This means that loans at Citigroup that are considered delinquent jumped by 59% on the year, which says a lot about the consumer discretionary sector.
Investors can put a blaming finger on this statistic to understand why Nike Inc. (NYSE: NKE) and Starbucks Co. (NASDAQ: SBUX) took a dive recently to trade near their 52-week lows.
More than that, the allowance for further credit losses increased to $1.9 billion, showing worsening consumer expectations. While that may not affect Citigroup stock much, as investors know the bank can cushion the cycle, it is a robust data reference for making other investment decisions in different sectors.
