Following a dismal 2011, the shares of Goldman Sachs (GS), Morgan Stanley (MS), Citigroup (C) and Bank of America (BAC) are off to a great start in 2012. While such shares lost between 44% and 58% of their value in 2011, they are currently up between 29% and 66% year-to-date as of 3/15/2012. Despite these hefty gains, at least two of these stocks, Goldman Sachs and Morgan Stanley, can potentially still move much higher by the end of 2012. Bank of America and Citigroup can also retain their current year-to-date gains and move higher, although some of the factors discussed herein can have a larger effect on Goldman Sachs and Morgan Stanley.
1. Long term market driven cyclical factors
During the past 10 years, since 2002, there has been three years only when the S&P500 did not appreciate by 3% or more: 2002 (-23.37%), 2008 (-38.49%) and 2011 (+0.02%). During such years, Goldman Sachs shares also suffered, recording substantial losses ranging between 26% and 60%.
Annual Stock Price Change 2002-2012
|S&P500 Index Annual Change||Goldman Sachs Stock Annual Change||Morgan Stanley Stock Annual Change||Citigroup Inc. Stock Annual Change||Bank of America Stock Annual Change|
However, on two such occasions where Goldman Sachs shares recorded an annual loss, such loss (on a percentage basis) was more than offset in the following year. In 2003, Goldman Sachs' stock gained 46.29% after having lost about 26% in 2002. In 2009, it gained 102.54% after having lost 60.42% in 2008. Meanwhile, in 2011, Goldman Sachs' stock lost 45.59%. So far, it is up 36.49% year-to-date, and as long as the market retains its current gains of 11.53% for the S&P500 index, and possibly adds to them, then there is a good possibility Goldman Sachs will appreciate substantially more.
Goldman Sachs Stock Price Chart 1999-2012
Source: Yahoo Finance.
As for Morgan Stanley, although its has not performed as well for such cyclical observation, it is still the case that whenever Morgan Stanley shares have dropped in excess of 20% in a given year, if the following year had resulted in gains in excess of 3% for the broader market, then Morgan Stanley shares also appreciate substantially, as in 2003 (+48%) and 2009 (+88%). Meanwhile, the S&P500 index is currently up 11.53%, year-to-date while Morgan Stanley stock had lost 43.9% in 2011, while it is up over 29% year-to-date. Once again, if the S&P500 index retains its current gains and possibly adds to such gains, then there is a good possibility Morgan Stanley stock can move substantially higher.
Morgan Stanley Stock Price Chart 1999-2012
Source: Yahoo Finance
Naturally, past performance is no indication of future performance, however a strength in the overall broad indices is also an indication of a strengthening economy, which can typically lead to increased revenues for Wall Street firms, as illustrated in the following two factors.
2. Higher Trading Commissions
Typically, when market indices move higher, it would be expected that trading commissions would increase for two reasons: a) due to an increase in the volume of shares traded, and b) due to an increase in portfolio and share values (whereby if commissions are a percentage of the value of a transaction, then higher value transactions due to higher share prices can result in higher commissions).
However, although such relationship does not necessarily always hold true on a year by year basis due to certain nuances, it does hold true when examined over a certain number of years. For example, when markets exhibit substantial drops, volumes would increase due to a deluge of selling. In the following months and possibly during the following year, volumes may drop as the selling subsides, and buyers may become wary of the market. Below is a table for the total annual number of shares traded on the NASDAQ.
NASDAQ annual change in index value and volume of shares traded
|Year||Annual Change in NASDAQ Index||Total Annual Number of Shares Traded||Annual Change in Number of Shares Traded|
In years other than those following the year where a major decline in the NASDAQ had occurred, whenever there is an increase in the NASDAQ index in excess of 7%, annual change in volume of shares traded showed an increase in excess of 7%, with the exception of 2010.
So far, the NASDAQ index is up in excess of 17% year-to-date as of 3/15/2012. As the NASDAQ index drop in 2011 was minimal and the change in volume of shares traded in 2010 was also minimal (despite an increase in the index of 16.91%), we expect a substantial increase in the volume of shares traded in 2012, as long as the indices maintain their current gains (and possibly add to such gains).
3. Higher trading profits and advisory fees
Due to the exit of several Wall Street firms such as Bear Stearns, Shearson Lehman and others, Wall Street competition has decreased substantially. One can possibly argue that Goldman Sachs and Morgan Stanley are possibly the only two major Wall Street firms left out there which do not hold major commercial banking operations. Other institutions such as Citigroup, Bank of America and J.P. Morgan Chase (JPM) certainly offer Wall Street services, but their core business is commercial banking (although they also stand to benefit).
With the markets currently up substantially year-to-date, we would expect Goldman Sachs and Morgan Stanley to benefit substantially due to a drop in competition and a possible increase in trading profits (as long as they do not find themselves holding substantial positions in fixed income assets in a rising interest rate environment). At the same time, it is currently estimated by Bloomberg that corporate cash levels stand at a record $1.24 trillion, driven by Apple Inc.'s (AAPL) cash holdings in excess of $97 billion. This could lead mergers and acquisitions activity to exceed expectations, adding to Goldman Sachs' and Morgan Stanley's advisory fees.
Goldman Sachs is expected to earn $11.28/share this fiscal year, and $13.23/share for next fiscal year. With a closing price 123.06 as of 3/15/2012, such earnings would provide a forward PE ratio of 10.9 and 9.3 respectively. Meanwhile, Morgan Stanley is expected to earn $1.89/share and $2.36/share respectively, providing forward PE ratios of 10.3 and 8.3 using a closing price of $19.51 as of 3/15/2012. Such PE ratios could prove to be quite attractive, especially if the previously listed factors lead to actual earnings exceeding estimates.
5. Macro factors
During the past few years, two major macro factors have weighed on financial shares: a) the U.S. subprime mortgage collapse, and b) European sovereign debt issues. However, both factors seem to have subsided (especially following the recent restructuring of Greek debt), although there could be additional tremors related to the European sovereign debt.
On the positive side, central banks have shown resolve to address such problems by pumping substantial liquidity into the system. The lifting of such two massive clouds would lead to a substantial improvement in sentiment. Although the jury is still out, it does seem currently that such clouds are starting to dissipate.
Financial shares have proven to be quite volatile lately. Whenever they have missed earning estimates, they have missed such estimates substantially. Meanwhile, whenever they have exceeded estimates, they have also exceeded such estimates substantially. In their latest earnings release, Goldman Sachs exceeded earnings expectations by 48% while Morgan Stanley exceeded expectations by 75%. Given the previously discussed factors, and subject to no severely adverse conditions from a market wide collapse, another financial debacle or substantially higher interest rates and inflation, shares of Goldman Sachs and Morgan Stanley can possibly move substantially higher.