Goldman a humbled money machine

The Treasury Secretary and chief economic advisor in the Trump White House are both former partners and senior executives of Goldman Sachs, the New York investment bank whose alumni were also luminaries of the Reagan, Bush (père et fils) and Clinton administrations. Yet the meteoric rise of Steve Mnuchin and Gary Cohn to the pinnacles of international politics has not been an argument to the shares of their alma mater Goldman Sachs once revered as the most profitable money machine ever seen on Wall Street. Goldman's first quarter 2017 earnings report was a huge disappointment. Goldman missed revenue forecasts of $8.45 billion by at least $400 million. Goldman earnings per share for Q1 was $5.15 a share, for below the sell side Street consensus at $5.31. The shares are now $30 below their post Trump win high of $225 as I write. It is obvious that one of swiftest, most spectacular rallies in global money centre banking ever witnessed on the NYSE has come to an end.

Goldman Sachs used to deliver returns on equity as high as 24-25 per cent in bull market cycles prior to 2008's global credit meltdown. That world is as dead and gone as Nineveh and Thebes. The Volcker Rule, restrictions over the counter derivatives and proprietary trading, a scaling back of balance sheet leverage, fines related to the Abacus scandal, higher compliance costs and lower fixed income, currency and commodities trading has had a huge impact on Goldman's bottom line. Goldman Sachs is now lucky if it can deliver even a 10 per cent return on equity, especially now that global cross-border mergers could well have peaked.

Goldman Sachs trades at a valuation premium to Citigroup or Bank of America even though it now trades at 1.25 times book value and 11 times forward earnings. It is entirely possible that the shares could fall below $200 a share this summer on global financial market angst about the successor to its legendary chairman and CEO Lloyd Blankfein, who has reigned for more than a decade as Capo di tutt'i capi at Death Star in lower Manhattan. David Solomon, Harvey Schwartz or Pablo Salame are on the short list to succeed Blankfein since Gary Cohn decamped to Washington. Of course, succession is not the only catalyst to goose Goldman Sachs this summer. The Federal Reserve will raise the overnight borrowing rate at the June FOMC. President Trump has promised to "do a number" on Dodd Frank and the Volcker Rule. Europe, Japan, China and the emerging markets are all in stealth bull market - and are all regions where Goldman Sachs has vast trading, sales, asset management and corporate finance franchises. I expect Goldman Sachs to trade in a 190-250 range in 2017.

Unlike Goldman, Morgan Stanley blew apart its first quarter 2017 revenue and earnings forecasts. Morgan Stanley exceeded its $9.27 billion forecast by an incredible $480 million and earned $1.01 a share in the first three months of 2017. Morgan Stanley has also boosted its return on equity to 10.7, the highest since 2014. Morgan Stanley's investment banking revenues rose 43 per cent, securities sales rose 30 per cent and asset management up 22 per cent, though equities posted a small loss. Morgan Stanley has raised its capital, derisked its balance sheet in fixed income trading and built the most formidable fee based global wealth management franchise since Charlie Merrill and his Thundering Herd rocked the pre-Stan O, pre-Abnass Wall Street. It is now rational for Jim Gorman's Morgan Stanley to trade at a higher valuation than its archrival "the vampire squid of humanity" at 12.4 times earnings and 1.3 times tangible book value. A credible trading range for Morgan Stanley could well be 40-48. As long as there is no recession or a steep stock market slump, Wall Street investment banking shares are perfect for range/option spread strategies.

While both Morgan Stanley and Goldman Sachs had spectacular 30-40 per cent rallies after Trump's elections, bank valuation have now lost their froth. As the IMF scales up global growth forecasts, as the Trump White House dream team (Gary, Steve, even Barron is ex-Goldman) implements his economic agenda, as the Fed nudges interest rates higher in its summer and autumn monetary conclaves, as deregulation and Laissez-faire replaces the legal Gestapo on Wall Street, money center banks are still in the embryonic stages of an epic valuation rerating. I recommend Citigroup in 2012 at $25. It is now 59 - but still trades at only 0.9 times tangible book value.