Goldman Sachs (GS) reported an extremely disappointing earnings results at a really bad time. The company saw revenue rise 26.7% to $8.03 billion, but that was half a billion short of expectations. EPS was also 2 cents shy of expectations at $5.15. While that means GS’s P/E still remains very low (about half of the S&P 500’s average P/E), it’s not enough to bolster shares. GS fell 4.7% in after-hours trading.
The results weren’t that big of a shock, with disappointments being little more than rounding errors, so why the big drop? The real story here is timing.
Remember the big bump in financial stocks at the end of 2016? The idea was quite simple, and it’s gotten a tad old: President Trump will deregulate banks, encourage more infrastructure spending, lower tax rates for corporations, and drive inflation higher. These things have failed to materialize, so pricing in these dynamics has become riskier and riskier. Now more people are fretting that these promises will never be fulfilled—meaning the big run up in companies like GS was premature and is doomed to correct.
What investment banks needed to do to soothe these fears was show a strong earnings release for the first quarter. And some things in GS’s release were good. Book value per share rose 1.4% in the quarter, and the company’s equity tier 1 ratio (14.2% on standardized measurement, 12.9% on Basel III) is extremely strong. The company maintains significant liquid assets to secure it from another 2008-2009 kind of event.
Then there’s the actual returns. ROE on shareholders’ equity was 11.4%—very impressive in a world where U.S. Treasuries pay less than 2.5% annually over a decade. The firm’s net margin was 28%, again impressive.
This is all good news, but the worst news came from trading.
“The operating environment was mixed, with client activity challenged in certain market-making businesses and a more attractive backdrop for underwriting in our investment banking franchise,” said CEO Lloyd Blankfein in a statement.
“Client activity challenged in certain market-making businesses.” What exactly does that mean?
He’s talking about trading. Specifically, he’s talking about providing banking services for institutional investors who trade in stocks and bonds. Looking deeper into the firm’s results, institutional client services fell 2% on a year-over-year basis. That was all due to lower stock trading. Equities trading fell 6%, bringing net revenues from that business to $1.67 billion. That’s 20% of the bank’s revenues, so it’s not an insignificant issue.
While a fall in equity trading is often offset by higher fixed income revenues, we’re not seeing that at GS right now. FICC trading was flat at $1.69 billion. So a full 40% of the bank’s operations are either flat or falling. And this is happening in a time of market strength and higher expectations that we’re moving away from a Fed driven bull market towards a more complex and volatile market where institutional investors will have more work to do. That hasn’t materialized yet.
And that’s a real concern for an investor in GS. If you’re not seeing a market change where investment banking services, especially the most lucrative trading business, is rising, the value of the bank is not rising either. And hence the sudden and steep fall despite the relatively meager disappointment.