October 7, 2025

QuickTakes

Sweet Spot For Financials

Today, Oracle disclosed that its AI cloud business—particularly server rentals using Nvidia chips—is yielding very slim profit margins. That news weighed on the stock market, especially on technology stocks. Oracle's stock price fell 2.5%. The Magnificent-7 declined 1.1%. Financial stocks also dropped today. They tend to have more leverage and cyclical exposure, so when sentiment sours, they often fall harder than some defensive sectors.

We expect the Q3 earnings reporting season, which is set to begin next week with the major banks, to calm investors' nerves. Cloud companies are likely to report that their business is strong, thanks to the growing demand for AI-related services. The banks should also provide good news. The S&P 500 Diversified Banks stock price index is at a record high for several compelling reasons (chart). For starters, the industry's forward earnings is at a record high.

Most importantly, the growth rate in commercial bank loans and leases is picking up (chart). They were up 4.7% y/y through the September 24 week, twice as fast as at the beginning of this year. This confirms our view that the pace of economic activity isn't slowing. It may actually be accelerating.

Banks' net interest income should also be getting a boost from the steepening yield curve (chart).

The current period reminds us of previous sweet spots for banks, when easy monetary conditions, abundant liquidity, and rising stock prices stimulated more mergers and acquisitions (M&A) activity and the issuance of more corporate securities, which all generate fees for investment bankers (chart).

We've been surprised that the banks haven't lowered their relatively high loan-loss reserves (chart). Perhaps, they have been listening to pessimists like Jamie Dimon, who has warned since 2022 that bad times are ahead. If the banks gain confidence in the economy's resilience (which has been our base case since 2022), then they have ample room to boost their earnings by reducing their loan-loss reserves.

We are expecting a wave of bank mergers in response to the Trump administration's policies aimed at deregulating the financial sector. This should lift the prices of regional banks that might be acquired (chart). The wave may be starting: On October 6, 2025, Fifth Third Bancorp and Comerica, Inc. announced a definitive agreement under which Fifth Third will acquire Comerica in an all-stock transaction valued at $10.9 billion.

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