On July 15, Goldman Sachs (NYSE: GS) posted earnings that blew away expectations. Goldman stock charged up nearly $10 at the opening bell, but has cooled off some. About two hours into trading the stock is up just over 1%.
This is leaving investors wondering what Morgan Stanley (NYSE: MS) will do for an encore. The investment bank reports earnings on July 16. And with Goldman’s results already in, all eyes will be on the House of Morgan.
But as the pullback in Goldman stock is showing, I think investors are already realizing that the future of both stocks goes beyond this quarter’s earnings reports.
Why This Quarter Matters and Why it Doesn’t?
The answer to both is the same, the Federal Reserve. The Fed has been pumping trillions of dollars into the market. There is no shortage of liquidity and all that capital has to flow somewhere. In the case of Goldman at least, it’s paying off to be the middleman.
The firm’s equity business posted revenue of $2.94 billion, and its investment banking business posted $7.18 billion. Goldman generates approximately 40% of its business from sales and trading (as opposed to 33% for Morgan Stanley) and 17% from its asset and wealth management division (Morgan Stanley generates nearly 50% of its revenue from this division).
But it’s unrealistic to believe the Fed will continue to flood the market with liquidity. And no, I’m not saying that with my tongue in my cheek. There is evidence that the Fed has been slowing the amount of liquidity it is providing to the market.
And that means that you have to look at Goldman’s great results, and what analysts assume will be a solid report from Morgan Stanley tomorrow, as one-off events. These are results that are not likely to be repeated.
Plus trading revenue historically slows down in the back half of a year, and analysts are projecting the same is likely to be true this year.
One Size Does Not Fit All
Looking into a post-coronavirus world, we see the two banks are on different paths. Morgan Stanley is looking to get leaner, whereas Goldman Sachs is looking to get bigger. Let’s examine why that is.
In the case of Morgan Stanley, it comes down to real estate. The pandemic has forced the vast majority of their 16,000 financial advisers to work from home. This has been especially true in New York City where it is unlikely that employees will return to anything resembling “normal” capacity until 2021.
With that in mind, it has been encouraging that the financial advisers are not having trouble interacting with and servicing their clients remotely. But this is also adding fuel to a larger narrative. Morgan’s chief executive officer (CEO) has gone on the record to say that Morgan Stanley could operate with a smaller real estate footprint. And they are considering a plan to accomplish this.
What if each of the company’s 16,000 financial advisers independent contractors? This model, which is similar to that of Charles Schwab (NYSE: SCHW) is being actively considered and discussed among the bank’s veteran advisers, branch managers, and regional managers.
The plan does, however, raise questions about non-employees having access to proprietary research. In remarks to Fox Business, a Morgan Stanley spokeswoman said, “We have absolutely no plans to change the employment classification of our Financial Advisers.”
For its part, Goldman Sachs is rumored to be considering making a deal with a major commercial bank. Necessity is often said to be the mother of invention and that’s certainly the case here. The venerable firm that has always prided itself on being independent is having a hard time keeping up with the big banks.
This is becoming a larger reality with the coronavirus taking away the appetite and demand for big deals. However, even when companies were making deals, Goldman was having its struggles.
With a market value of just $59 billion, the company is less than a quarter of the size of a bank, such as J.P. Morgan Chase (NYSE: JPM). This size disparity continues to cost Goldman the ability to effectively compete on deals.
Regulations imposed in the aftermath of the financial crisis continue to squeeze profits in Goldman’s trading business. At the same time, the company is seeing a reduction in fees from its investment banking business.
And the Winner Is …?
As I noted above, I don’t expect either firm to continue posting great earnings reports for the rest of this year. But things can change. The Fed has made the decision that it is not going to allow the economy to fail. And, it can keep its printing presses on longer than investors can be stubborn.
That’s why to decide which bank is the better investment you have to look through a wider lens. Based simply on the business models that the companies are pursuing, I give the nod to Morgan Stanley. Over the long term, Morgan’s model fits where the industry is going. Goldman looks to be moving into an area where the industry has already been.
Plus from 2009-2019, Morgan Stanley stock has grown at 1.8x the rate of Goldman Sachs. It has also outperformed Goldman on both the top and bottom lines.
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