December 13, 2011
This story was updated at 12:20 p.m. EST on Tuesday, December 13.
Investment banks and other financial industry participants involved in stock trading and market making just can't seem to catch a break.
Firms like Goldman Sachs (GS), Morgan Stanley (MS) and the beleaguered Jefferies Group (JEF) have already reported dismal results for the third quarter. Now comes news from the New York Stock Exchange that all of its member firms – those broker-dealers that make up the exchange – appeared to share the pain.
Only 96 of the 175 NYSE member firms reporting results indicated any kind of profit for the third quarter of this year; the number of unprofitable firms soared. Collectively, those member firms that do business with the public lost a stunning $1.92 billion in the third quarter, compared to profits of $2.1 billion in the second quarter and $4.7 billion in the third quarter of 2010.
Without question, the period was the worst three months on record for the industry since the height of the financial crisis three years ago, as investors avoided trading in volatile markets and companies were forced to postpone or even shelve plans to issue stocks or bonds whenever possible.
The outlook for the current quarter and the new year don’t appear much rosier. Jamie Dimon, CEO of JP Morgan Chase (JPM), warned attendees at Goldman Sachs conference last week that he expects investment banking revenues will stay flat and that the bank’s private equity division may report a loss. Analysts promptly trimmed their forecasts for the company's earnings, with Richard Bove of Rochdale Securities slashing his estimate by 13 percent to 88 cents a share. That's below the consensus – analysts expect the bank to earn 96 cents a share in the fourth quarter and $1.15 in the first quarter of 2012.
But can those estimates be trusted?
Not really, suggests new research from ThomsonReuters, which last week reported that its StarMine SmartEstimate models – which put greater emphasis on the most recent reports by the analysts with the best track records – appear to signal that the consensus is excessively bullish at this point. The StarMine models indicate that there is a high probability that between now and the time that firms like Goldman, Piper Jaffray (PJC) and Jefferies report their earnings for the fourth quarter early in the new year, investors will see more cuts in earnings estimates.
The pink slips have already been flying on Wall Street for most of the year, with even the reasonably healthy firms slashing away at overhead in a bid to stay that way. Scarcely a bank hasn't cut back, with HSBC (HBC) and Bank of America Merrill Lynch (BAC) leading the way – both firms announced in late summer that they plan to cut 30,000 jobs worldwide over the next two years. MF Global's collapse cost about 1,000 employees their jobs, and Jefferies has also been thinning its ranks.
Nor is the atmosphere of fear and unease being alleviated by higher bonus checks for the lucky survivors: Compensation advisory firm Johnson Associates noted recently that investment bankers can expect a 10 percent to 20 percent cut in bonus payments, with the slump in liquidity and the resulting difficult market environment for fixed income traders and bankers leading to a 35 percent to 45 percent decline in bonus payouts.
Some factors contributing to this bleak environment may change with time – for instance, the European sovereign debt crisis isn't likely to be as much of a factor in each of the next five years as it has been in 2011 – but the disappearance of exotic, high-margin products, regulatory requirements that force banks to rely less on proprietary trading and other systemic changes are likely to make investment banking and trading far less lucrative for their practitioners for a long time to come.
The best that Wall Street CEOs like Dimon can do at this point is to try to draw their shareholders' attention to what they say are the bullish long-term prospects for the industry, rather than extrapolating the current bearish environment. The problem, alas, is that investors may not want to stick around that long.