| | | | | Saturday, October 24, 2015 | |
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Eric Fry, worried about Goldman Sachs, reports...
The chart below presents one more reason why precious metals may be heading higher.
Revenues and earnings at America's big investment banks have been going nowhere for several years.
Despite the fact that the U.S. government moved heaven and earth in 2008 and 2009 to rescue these banks - and has been coddling them ever since - revenues and earnings at the big banks refuse to get off the mark. This persistently mediocre profitability at the heart of America Inc. suggests the U.S. economy may not be as vigorous as advertised.
If that's the case, the Federal Reserve may refrain from raising interest rates for a very long time. And even if the U.S. economy is faring reasonably well, Janet Yellen might refrain from raising interest rates anyway, simply because her friends on Wall Street aren't faring very well.
Think about it... If you had committed seven years and several trillion dollars to the project of rescuing and nurturing America's "essential" banks, would you put that pet project at risk by raising rates "too early?"
Bottom line: Janet Yellen is likely to suppress interest rates well into 2016, if not beyond. The longer she plays that hand, the greater the likelihood that she invites a new inflationary trend that undermines the U.S. dollar and ignites a powerful bull market in precious metals.
We'll be watching...
Pity Goldman Sachs
You know things are bad when even the big investment banks can't make money. And that's in markets that have been rigged for their benefit for many years. Third quarter earnings announcements by big U.S. investment banks show that they are struggling.
Goldman Sachs (NYSE: GS)... Morgan Stanley (NYSE: MS)... JPMorgan Chase (NYSE: JPM)... Bank of America (NYSE: BAC)... Citigroup (NYSE: C). It's a roll call of the crème de la crème of the U.S. investment banking industry. Their tentacles spread into every nook and cranny of the global financial markets, feeling out the best profit opportunities on offer.
So you'd be forgiven for thinking that life would be pretty good for these leviathans of loot (or should that be looting?). But a raft of weak earnings figures shows the mammoth money movers continue to languish in the realms of low profitability.
All of them have reported third quarter results in the past week or so. One thing has been clear right across the board: Revenues have been weak. This is despite ongoing largesse from the world's biggest central banks, those dispensers of "welfare for the wealthy." In particular, all the banks' fixed income businesses have taken big hits and are bringing in a lot less money than last year.
Like so many terms in finance, "Fixed Income" is actually a misnomer. It refers to the fixed coupon interest payments on a standard government or corporate bond (a bond being nothing more than an easily tradeable loan).
But fixed-income departments at the big banks do not simply buy bonds and "clip coupons." Instead, the fixed-income departments are a mishmash of many different businesses and "product factories," as bankers like to call them.
So fixed-income departments trade standard bonds, but also variable rate debts, complex derivatives like swaps and options (of many kinds), world currencies, commodities... the list goes on. They also do straight lending to big corporations.
Because fixed-income departments are so wide-ranging in their disparate activities, they tend to be the largest part of investment banks, or the investment bank divisions of commercial banks.
(The other main areas are "Equities" - share trading and derivatives thereof - and "Investment Banking" or "Corporate Finance" - mergers and acquisitions, debt and equity capital raising.)
Given their size, the fortunes of fixed-income businesses will pretty much determine the profits of the investment bank as a whole. They also use up most of the investment banks' capital due to ever-tighter regulations.
So if an investment bank can't make money in fixed income, then it will be sure to make a terrible return on its capital. A low share price is sure to follow.
Let's see how the big banks are doing relative to last year, going from least bad to worst. Bank of America and JPMorgan both saw fixed-income revenues fall 11% year over year in the third quarter. Citigroup was down 16%. Goldman Sachs collapsed 33%. But Morgan Stanley takes the crown, down 41% over the same quarter in 2014.
Those are huge falls by any yardstick, especially because these businesses have massive "operating leverage." Costs are partially fixed, so when revenues rise or fall, profits move up or down faster. In a typical investment bank in a normal year, revenues could fall 20% and profits would be down 40%, or thereabouts, and vice versa.
So investment banks have massive operating leverage. When times are good, they are very, very good. But when they are bad, they are horrid.
All these banks are already struggling with extremely tight new capital regulations brought in since the global financial crisis. Put simply, this means they can't be as leveraged as before. That makes them less risky - and less likely to need a government bailout in the future. But it also means that profitability is harder to come by.
For example, the return on equity at Goldman Sachs was about 7% in the third quarter, on an annualized basis. Return on equity is an essential measure of profitability in a capital-intensive business like banking. It's the profit divided by the shareholders' equity (also known as net assets or book value).
That's a pretty pathetic return. I can remember the days when Goldman was consistently making returns on equity of 30% or more. This is important.
Like any business, a bank's profits can be used for two things. They can be invested into growing the business or they can be paid out to shareholders in the form of dividends or stock buybacks. So a low return on equity means either low future growth - and hence low capital gains - or low payouts to shareholders... or both.
All these banks have price-to-book ratios around or below 1-to-1, which is to say they are trading around or below liquidation value. Often that marks out an investment bargain.
But in the case of the investment banks, this seemingly low valuation is well deserved. Sometimes things are "cheap" for a reason. Investment bank shares fall squarely into that category.
The bigger point is this: Central banks still have interest rates pinned to the floor and are propping up asset markets. Some are still printing money in the form of quantitative easing...
You know things are bad if the big investment banks are still struggling to make decent revenue in this environment.
"Patience" remains our watchword.
Good investing,
Marco Polo
For The Non-Dollar Report
P.S. If you enjoyed today's issue, please check out OfWealth to find similar insights from Marco Polo.
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