Weekly Buzz: What bank earnings reveal about the economy

Earnings season in the US has kicked off this week, and S&P 500 firms are on track to deliver earnings growth of about 23% for the latest quarter versus a year ago. If they manage it, it'll be the second quarter in a row above 20%, and the seventh straight quarter of double-digit growth. Analysts also expect the next two quarters to hold above that 20% mark, giving investors more reason to cheer.

What’s going on here?

The big banks are kicking things off. Goldman Sachs, Citigroup, JPMorgan, Wells Fargo, Bank of America, and Morgan Stanley all head into the season in good spirits. When stocks and bond markets get volatile – as they have been recently – banks can make, well, bank off increased client trades.

Investment banking activity has been picking up too, led by SpaceX's record-breaking listing in June, the largest IPO in history. Companies have also been rushing to borrow, with Nvidia raising $25 billion in its biggest-ever bond sale and Amazon following with another $25 billion to fund its AI buildout. More trading, more deals, and more fees all point to a strong quarter for the sector.

Keep in mind, the big banks are only the opening act. Other important earnings-growth stories this quarter sit in energy, where higher oil prices will likely have lifted profits sharply, and in tech, where AI spending has kept rolling.

What’s the takeaway?

Big banks have already had a strong year, so some of the good news is already priced in. Their results matter beyond their own share prices, though. Banks sit at the centre of the economy, which makes what they report an early read on everyone else. Loan demand signals whether businesses are investing, while credit quality signals whether households are coping with higher prices. That sets the tone for the rest of earnings season, and for the market underneath it.

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In Other News: Small caps are living large

After years of lagging behind, US small caps – companies worth roughly a few hundred million to a couple of billion dollars – have stepped into the spotlight. The Russell 2000, which tracks 2,000 of America's smaller listed companies, has gained around 22% so far this year, its best pace since 1991 and its widest lead over the S&P 500 since 2003.

A lot of this small-cap rally stems from one question: when does all that AI investment turn into profit? Rather than betting only on the tech giants doing the big spending, investors are looking beyond, to the equipment makers and niche suppliers powering the boom from behind the scenes. With the big-name hyperscalers expected to spend more than $700 billion on AI infrastructure this year alone, plenty of smaller players are benefiting from the knock-on demand.

There's a valuation factor at play, as well. Mega-cap tech stocks are looking increasingly pricey, but many profitable small caps still trade at relatively modest multiples, making them an attractive alternative for investors who want broader market exposure.

Analysts are expecting Russell 2000 profits to grow 38% this year, up from earlier predictions of about 23% back in January. Tax cuts and rebates have been supportive for consumers and smaller companies, which is helping the US  economy remain resilient even in the face of higher energy prices.

Keep in mind, there are risks. Smaller companies lean harder on floating-rate debt, which leaves them exposed to whatever the Fed decides next. Still, a rally that's spread beyond a handful of giants, down to the small caps, is a healthier one all round.

Past performance is not an indicator of future returns. These articles were written in collaboration with Finimize.