The new trading rage for Morgan Stanley

Morgan Stanley under CEO James Gorman has done its best to reduce its dependence on high risk fixed income trading after its traumatic experience during the 2008 financial crisis, when a speculative run against its shares forced it to become a bank holding company.

However, Morgan Stanley has faced huge strategic, financial and cultural challenges in its quest to transform its franchise into a fee driven asset and wealth manager on a global scale. Morgan Stanley was, after all, the investment banking arm of the Morgan Guaranty Trust that was once Wall Street’s “white shoe” investment bank.

Morgan Stanley’s fourth quarter earnings were an impressive $1 billion or 47 cents a share. However, after adjusting for one time tax adjustments, earnings fell below the Street sell side analyst consensus at 48 cents a share.

Jamie Gorman has not been able to end Morgan Stanley’s vulnerability to volatile fixed income, foreign exchange and currency trading profits. FICC revenue was down a grim 74 per cent from the third quarter even though Gorman has scaled back the bank’s exposure to risky, capital intensive trading businesses such as mortgage backed securities or commodities.

Morgan Stanley’s oil trading business was hit hard by the crash in world oil prices since June 2014. Strangely enough, Goldman Sachs earned record trading profits in commodities, adding to Morgan Stanley’s distress.

Morgan Stanley’s total revenue was also a disappointment at $7.8 billion, below the $8.2 billion Street consensus. Morgan Stanley was a victim of the big chill in global financial markets in October and December.

The most significant strategic move Mr Gorman made to boost Morgan Stanley’s franchise as a global wealth management specialist was to purchase the retail brokerage arm of Smith Barney from Citigroup. However, wealth management revenue and asset growth was flat in fourth quarter 2014 and the number of private client brokers actually sank.

The reluctance of US regulators to approve share buybacks or dividend hikes means Morgan Stanley cannot hope to return to the pre-Lehman 25 per ent plus returns on equity and global wealth management revenue growth will suffer as European, Japanese and US debt yields sink. Global wealth management is, after all, 42 per cent of Morgan Stanley’s total revenues now.

It is probable that Morgan Stanley earns $3 a share in 2014. The bank is thus trading at 11 times earnings. This is somewhat expensive for a business that generated return on equity of only 10 per cent in 2014, a great year for global capital markets.

I believe Institutional Securities will remain the crown jewel of Morgan Stanley, with its world class franchises in investment banking, mergers/acquisitions and deal equity underwriting Regulatory risk, as always, will be Morgan Stanley’s Achilles heel, even though Jim Gorman has greatly derisked its balance sheet.

My ideal buy range for Morgan Stanley in 27 or nine times earnings. The shares could fall to 27 if there is a significant correction in global capital markets. The valuation metrics will not rerate until Gorman can hike dividends, boost share buybacks and raise ROE to at least 14 per cent. So my trading buy/sell range for Morgan Stanley is 27–36 in 2015.

The $1.6 trillion ECB quantitative easing programme should, hopefully, save Europe from deflation, revive exports as the euro crashes and boost the prices of debt, equity and property as interest rates crash. This means Europe’s banks can well expect a valuation rerating as consumer spending expands, bank balance sheet/credit quality improve in Italy, Spain, France and Germany. Germany is also Europe’s export colossus and benefits from the euro free fall. Spain’s BBVA at 12 times earnings or BNP Paribas at 10 times earnings will benefit.

Researched and compiled by Matein Khalid. Khalid is a global equities strategist and fund manager. He can be contacted at: matein@emirates.net.ae