Banks such as Morgan Stanley (MS) and Goldman Sachs (GS) reported their quarterly earnings Tuesday morning, with mixed results. Many on Wall Street often turn to banks as a sign of things to come for the year. What can investors learn from these reports?

Chris McGratty, KBW Head of U.S. Bank Research, joins Yahoo Finance to discuss the recent mixed earnings reports from banks and his outlook for the year.

When asked about pricing of bank stocks in current market, McGratty claims: "They're cheap. Banks are always cheap. In my 20-year career they've always been cheap because of the value aspect of the business, the regulation. What's interesting is the speed at which the market re-rated this group. We went from 8 to 9 times earnings to 11 to 12 pretty instantaneously, when the Fed [did] the pivot in December. What we think is fair value for the group right now is around 10, 11 times and there's work we've done with where level of interest rates are in the multiple. We had a big run into the year. It's not surprising we've seen the air come out of it."

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Editor's note: This article was written by Nicholas Jacobino

Video Transcript

- Bank earnings Goldman Sachs and Morgan Stanley out with earnings this morning, Goldman beating Wall Street expectations reporting a 51% profit. Different story though from Morgan Stanley. Fixed income and equities trading revenue fell short of forecasts, and the bank warned of lower margins in its wealth business to come. And that comes as the other big banks reported last week, projecting quite a mixed picture for the financial sector and an uncertain outlook for the regional banks.

So, to get some clarity here, we've got Chris Mcgratty, head of US Bank Research at KBW. And Chris, let's start right there. We've got this mixed picture so far from bank earnings. How should investors be digesting that picture?

CHRIS MCGRATTY: Sure. Thanks for having me back. What we've seen thus far in earnings and it's early is really-- we're going through a bottoming process for the traditional commercial banks. We're seeing net interest income or the top line revenue, that's in the process of bottoming. And that's a good thing because that destroyed about 25% of earnings last year.

The question that we're having is, how is the full effect of interest rates going to play through to credit quality, and that process is normalizing.

- And Chris, I'm interested, you know, obviously, for the banks we saw this late year rally there, they've moved-- some of those names have moved hard to the upside. How does valuation generally look to you for the sector, Chris, here?

CHRIS MCGRATTY: Yeah, they're cheap banks are always cheap in my 20-year career, they've always been cheap. And that's because of the value aspect of the business the regulation. What's interesting is the speed at which the market rerated this group. We went from eight to nine times earnings, to 11 to 12 pretty instantaneously when the Fed-- the pivot in December.

And so what we think is fair value for the group right now is around 10 or 11 times. And there's a lot of work we've done with where the level of interest rates are in the multiples. So we had a big run into the year, it's not surprising to us that we've seen some of the air come out of it.

- And I'm curious then when it comes to the right multiple on banks following their earnings. What is the single biggest catalyst for further growth that the market may not be pricing in fully right now?

CHRIS MCGRATTY: Right. I think the biggest uncertainty that we're looking at is how is the economy going to react on a lagged effect to higher interest rates, right. We saw 500 basis point increase in rates, that takes some time to go through the economy.

If the economy and the banks go through 2024 and asset quality turns to hold up and we think it will, that's the biggest rerating opportunity for the sector. Because I think a lot of conversations that we're still having is, how did this perform? How did this company? Or how did this industry perform during 2008?

And now, that's a tough comparison. Things are different, a lot of the risk has moved out of the banks. But banks need to be tested, the balance sheets need to be tested from a credit perspective.