JPMorgan (JPM  ) posted top and bottom-line results that topped analysts' expectations. Another constructive sign was that JPMorgan reduced loan loss reserves by $569 million which is an indication that defaults are less than expected. The stock initially gapped up but finished lower by about 1.5%.

Inside the Numbers

JPMorgan's earnings are considered to be a bellwether for the economy and banking sector. In the third quarter, JPMorgan posted a third-quarter profit of $9.44 billion which topped consensus views by about 30%. Revenue came in at $29.9 billion while analysts were looking for $28.4 billion.

Once again, the strongest segment was "sales & trading" as trading activity has been robust. Additionally, the strong stock market and abundant liquidity in financial markets have been a tailwind for the IPO markets, corporate credit, and M&A. Trading revenue was 20% higher compared to 2019's Q3. Fixed-income trading led the charge with a 30% increase, and investment banking revenue was 12% higher.

However, the rest of the bank's units showed improvement from the previous quarter which is another indication that the economy is more resilient than believed despite the failure to pass the second part of the CARES Act.

In the second quarter, JPMorgan set aside $10.5 billion in loan loss reserves, while it only set aside $611 million this quarter. In total, JPMorgan has set aside $34 billion in loan loss reserves, however, this figure is no longer growing which is a signal that the bank believes the worst is behind us. Of course, it has considerable insight given its daily monitoring of credit card spending, bank balances, mortgages, and loan payments.

It also upgraded its assessment of the economy in terms of better unemployment and a less-sharp contraction in GDP.

Stock Price Impact

Financial stocks have lagged the markets by a significant degree so far this year. They've been negatively affected by two factors - the coronavirus and economic weakness leading to a spike in default rates and the drop in interest rates.

Banks' core business is taking deposits and making loans. This is less profitable at current rates when short-term rates are near zero which makes people less likely to keep their money in a bank account, and long-term rates are so low. Thus, bank profitability is closely tied to the steepness of the yield curve.

However, the economy recovering better than expected would be a powerful catalyst for banks, as it would mean that fewer loans would go into default. And, it would start to put upwards pressure on long-term rates which would steepen the yield curve.

JPMorgan's stock is up about 35% above its March lows, while it remains about 30% below its pre-coronavirus levels. In contrast, the S&P 500 (SPY  ) is 57% above its March lows and 6% above its pre-coronavirus levels. The stock would likely begin to outperform if another stimulus package is approved, and the second wave of the virus is not as bad as expected.