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Alex Cho

Expectations for Big Banks a Little Too Low?

It almost sounds like the base case scenario is looking to be the worst case scenario for banks these days. Needless to say, here’s a brief snapshot from Deutsche Bank on the topic of investment banking, forex/fixed income/commodities trading, and equity trading.

Source: Deutsche Bank

The worst performers in investment banking is expected to be JPMorgan Chase and Goldman Sachs. However, expectations on FICC is most subdued for Morgan Stanley. Whereas JPM and BAC are expected to perform the worst out of the group in terms of equity trading. Now, personally I think these estimates are going to be pretty hard to model out, and expectations are set extremely low for both JPMorgan Chase and Morgan Stanley. I believe these companies have a low wall of worry to overcome if the expectation is that JPMorgan’s IB/trading business will perform this badly.

From what I’ve seen, JPMorgan tends to pull a lot of surprises in its trading business. One year they lose billions of dollars through mismanagement of a trader, and the next year they’re back to earnings billions of dollars. It’s really hard to predict, furthermore investment banking activity will likely pick up for the entire group as tech IPOs have been more subdued over the course of 2015. This implies that deal activity for IPOs should pick up if the equity market recovers by the latter half of 2016.

In other words, if expectations are this low for the group. You’ve got to wonder what the EPS beats will be in the next couple quarters assuming S&P 500 reaches 2,200 to 2,300 by the end of the year. I think macro concerns are way overblown and fears of economic contagion from the energy sector has been pumped to extraordinary heights by media pundits. Even if energy is in secular decline the reduction in energy cost is a favorable cost driver for transports, which are cyclically sensitive to energy prices and the macro environment. Cheaper airfares and lower gas prices translates into more discretionary spending, so lower energy prices isn’t always bad for the economy. The GDP figures proved to be okay, but could have been better this year. Maintaining 2% GDP growth will be hard in this environment, but I believe we’ll stay above 1% GDP growth and rotation from emerging markets will propel stocks this year despite weakening macro indicators.

With the dollar expected to outperform in a negative interest rate policy environment, international managers are dumping foreign stocks to hedge against dollar risk. In other words, the flight to safety will become a catalyst for U.S. based investors, and assuming banks are heavily leaning on the long side (which they are) you’ve got to wonder how much money they’re going to make once asset managers rotate from emerging market to developed markets.

I view the concerns on macro way overblown, and the cost of energy defaults can be contained with modest increases to loss reserves for non-investment grade energy exposure. In other words, buy the banks on the cheap, but if there are two companies positioned to blow past expectations I would pin it on JPMorgan and Morgan Stanley. The environment is improving, and with expectations set so low, it will look like a bungee jump over analyst consensus by 2H’16.

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