3 Items Pointing To Stagnation On Wall Street

Includes: BAC, BBT, C, GS, MS, WFC
by: Bio Insights

In reaction to articles I've been reading and some data I've been noticing, I've developed a rather pessimistic outlook for the future of Wall Street and certain sections of the financial industry. Without major change in the political atmosphere or the situation with the European debt crisis, I think Wall Street stocks, especially the likes of Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS), are dead money.

There are simply too many hurdles for these firms to overcome, and as much as I like to be a contrarian, I might have to agree with the hordes of investors who are giving up their stakes in the financials. Here are my three biggest reasons.

1) Revenue figures are atrocious

The simplest way to see whether or not a bank or financial institution is growing or shrinking is by checking the periodic changes in its total revenue. Flat revenue is an obvious sign of a stagnant industry, and creates a ceiling on potential earnings - a very big red flag in my book.

Goldman's Q1 2012 earnings release provides plenty of dismal examples to pick at. Revenues from investment banking, client services (mostly for fixed income and equities), investment and lending, and investment management have all declined relative to Q1 2011. Companies often give specific explanations of one-time events for declines in revenue, but this quote from the release explaining the 9% drop in investment banking revenue says it all:

"Net revenues in equity underwriting were significantly lower than the first quarter of 2011, primarily reflecting a decline in industry-wide activity"

Goldman had no personal mistakes to account for the poor performance of its investment banking unit. This was an industry-wide contraction -and like gravity, it really cannot be stopped. The same comment was by Bank of America (NYSE:BAC) concerning its Global Banking unit in Q1 2012:

Revenue was $4.5 billion, down 5 percent from the year-ago quarter, primarily due to lower investment banking fees and accretion on certain acquired portfolios.

This problem isn't just limited to investment banking though. Let's consider Morgan Stanley's revenues from asset management. In Q1 2012, MS received $533 million. This is a 14.3% decline from Q1 2011, despite a ~10% increase in total assets under management in the same time period. The only feasible explanation is a huge decline in commissions.

As shown, it's virtually impossible for a firm to grow revenue in asset management these days, especially with declining commissions.

2) Wall Street is cutting jobs (rapidly)

Not every pink slip is issued for the same reason, although we can infer that the cause of these recent Wall Street layoffs has to do with the declining revenues. If a company is stagnant, and revenue is flat or declining, the next best thing to do is to boost earnings through cost-cutting. This is exactly what Goldman, Morgan Stanley, Citigroup (NYSE:C), and BAC have been doing.

Although it is particularly bad in New York, this seems to be an industry-wide phenomenon. In 2011, about 200,000 jobs in finance were shaved off. Judging by what we've seen so far in 2012, we're going to see another big contraction.

People are not as replaceable as offices or computers are. Even considering the cold and calculating nature of the financial jobs market, managers would not be making these moves if they didn't anticipate some major stress ahead for their respective companies. This alarming sign can be considered an early indicator of additional weakness in revenue for the financials in coming quarters.

3) The financial sector is oversized and superfluous

I wasn't quite sure how to describe this segment, but it is mostly based on an interpretation of the following chart:


The financial industry has become almost 1% of US GDP. Technological innovations (especially the introduction of the internet) has made it very easy for banks to process transactions and track information. In the last decade or so, we've seen very sophisticated software automate more and more tedious tasks in finance that used to be done by human hands.

As you may also know, people don't even trade the bulk of the volume on the stock market now. It's really amazing how easy and simple trades and loans can be made now.

With all this increase in efficiency, it's becoming increasingly hard to justify the existence of certain financial services, and of Wall Street in particular. Sure, you still need an investment bank to stage an IPO, but why pay a firm like Goldman an exorbitant amount in fees when you can hire boutique firms that do the same thing? Why pay an asset manager if he is just going to buy a basket of ETFs that you could find yourself?

Back to the basics

I say there is a much brighter future in consumer and mortgage banking, which is something Wells Fargo (NYSE:WFC) and BB&T (NYSE:BBT) seem to realize and take advantage of. We will hopefully see Bank of America follow suit as it fixes its balance sheet and downsizes Merrill Lynch. There are a large number of unmentioned regional banks that fit the bill.

More traditional banks are much less exciting to watch (on par with watching paint dry), but they are actually able to grow revenue and keep their employees. Boring is often a good investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.