Making money in Wall Street bank shares
Last month was an excellent period to own financial shares. September US payroll data reinforced the odds of a Federal Reserve rate hike in December. The Deutsche Bank funding pressures did not escalate into a systemic banking crisis a la Lehman 2008. The Saudi-Russian deal to cut output led to sharp rally in Brent crude that will boost money center bank’s energy loan collateral. Institutional investors continued to accumulate bank, insurer and credit card issuer shares, particularly after blowout earnings or strategic repositioning. Let me recap my favourite financials.
Goldman Sachs beat earnings, thanks to its stellar fixed income, currencies and commodities (FICC) results. Even though the Abacus scandal, the Volcker Rule and Dodd Frank restrictions on warehousing derivatives had devastated returns on equity in FICC, once such a money gusher that Goldman was known as the world’s largest NYSE listed hedge fund. Goldman also generated $1.75 billion from its equity capital markets division. Goldman still trades at book value, a shadow of its pre 2008 incarnation. I still believe the shares can well rise to $200 in the next six months.
Morgan Stanley’s transformation into the world’s leading wealth manager (albeit not in Dubai since, alas, it closed its DIFC private wealth business) has accelerated under James Gorman. Wealth management earned $3.88 billion in revenues in the third quarter, boosted by banking business. No wonder net interest income surged 18 per cent. These results vindicate Gorman’s decision to buy the Smith Barney brokerage division from Citigroup in 2009 I had profiled Morgan Stanley ad infinitum in this column as one of Wall Street’s epic turnaround stories (after having made money and lost friends shorting the shares in the autumn of 2008), most recently at 25-26 earlier this summer. Thanks to its loans/ wealth businesses.
Morgan Stanley has a far less volatile revenue mix than its archrival Goldman Sachs. Note that Gorman slashed one out of four executive jobs in fixed income sales and trading. In Wall Street, a less volatile revenue mix can mean an easier Fed stress test, thus a juicier capital return. The bank can well generate 12–15 per cent EPS in the next two years. However, unlike Morgan Stanley, Goldman Sachs has increased its market share of global mergers and acquisition advisory deal making. In any case, I would aggressively buy Morgan Stanley on any sell off to 28-29 for a 36 target.
Wells Fargo’s CEO John Stumpf paid the price for the political/ regulatory outrage over its pressure cooker sales culture that saw the opening of two million unauthorised accounts and the sacking of 5300 employees over five years. Tim Sloan inherits a humbled institution, even though Wells Fargo is America’s third largest bank (by assets). Valuations have derated in 2016, even before the scandal broke in September.
Wells Fargo traded at 1.74 times book values and 13.4 times earnings three years ago. Now Wells Fargo trades at 10.9 times forward earnings and 1.29 times book value. Third quarter results still showed 1.27 trillion in customer deposits and Wells can well generate $20 billion in 2017. True, litigation risk and a regulatory backlash will prevent a short term valuation rerating. The Democratic landslide in the White House, Senate of House Representatives is a major political risk for Wells Fargo, as it is for US money centre bank. Yet Wells Fargo is now the Cinderella of US money center banking, though I doubt a fairy tale prince appears in the boardroom. The ugly stepsisters will go to the ball, not Cinderella.
American Express is one of the world’s iconic credit card issuer brands but the shares were a nightmare since 2014, when they peaked at 96 and then fell to 50 by February 2016 after Costco Wholesale switched to Citigroup as its exclusive credit card partner. Yet Amex was the hottest sock on the NYSE on Thursday after the shares skyrocketed nine per cent when the company blew apart the Street’s whisper number on both earnings and revenues. Obviously, CEO Ken Chenault’s new marketing blitz, cost controls and shift mix to premium cards (up 10 per cent in fees) was a winning strategy. It is hugely significant that management has raised guidance from $5.4-5.7 to $5.9-6.0 EPS in 2017. At $65, Amex would be a steal, with a dividend hike, a 150 million share purchase programme and its intact status as a financial jewel in Buffet/Berkshire Hathaway’s crown.