The way Bernstein analyst Chirantan Barua tells it, the only thing banks have to look forward to right now is the election – or near election, of Donald Trump in November. “Unless some kind of idiosyncratic volatility event happens banks aren’t going to make any money in 2016,” he says. “In the past six months, banks only made money on Brexit – without it, the first half would have been a disaster. Now, you need a big catalyst like the U.S. election to increase volatility again.”
He has a point. While foreign exchange traders are benefiting from sterling and yuan volatility, the VIX index, which measures expected volatility of U.S. equities, is at a two year low. “The S&P is expensive and unless you see a significant correction, it’s very hard for equity portfolio managers to churn their portfolios,” says Barua. “It’s just churning lower and lower.”
For the moment, therefore, equities trading is not a good place to be. Most banks’ equities sales and trading revenues plummeted in the second quarter. And if Barua is right, there is no respite on the way.
The problem isn’t just a lack of enthusiasm for secondary trading in over-priced markets, it’s also the cataclysmic decline in primary issuance. Initial public offerings (IPOs) are in a hole and it’s not clear what will pull them out. “Equity capital markets activity is down 48% this year,” says Barua,”That’s a big number.” Banks’ ECM revenues are down accordingly: at Goldman Sachs, J.P. Morgan, Citi and Bank of America the year-on-year second quarter declines ranged from 37% (J.P. Morgan) to 55% (Goldman Sachs).
“Primary market activity [in equities] tends to be subdued for 1.5 to two years,” says Barua, pointing to the chart below. “Right now, it’s been subdued for nine months, so we have a way to go.”
Based upon historic trends, the new IPO hole has yet to reach a bottom
Source: Bernstein Research
What about the 20 IPOs J.P. Morgan says it’s lined for September? Barua is skeptical: “You always have a strong pipeline of IPOs, the real question is whether you can bring them to market.”
Things will get much worse in equities, and then they will get much better
If equity capital markets bankers and equities sales and trading professionals can just hang on, though, Barua thinks they’ll be rewarded. Unfortunately, he also thinks things will get worse before they get better.
“My assumption is that you will get a market correction in the U.S. which will force investors to churn their portfolios,” he says. “The IPO market will also make a cyclical comeback and from the end of 2016 banks will benefit from better year-on-year comparisons [in their quarterly equities revenues].” The real improvements won’t happen soon, though: “This is not a 2016 or even a 2017 call,” says Barua, “It’s for 2018.”
Shown in the chart below, Barua’s forecasts for revenues at UBS’s equities sales and trading and ECM businesses illustrate the nastiness. This year, he expects UBS’s equities sales and trading revenues to decline by 20% and its ECM revenues to fall by 25% compared to 2015. Next year, he thinks there will be a slight comeback. But it’s only in 2018 and 2019 that things will really improve – and when that finally happens, equities sales and trading activity should drive revenues across the bank.
Barua’s prognosis suggests equities professionals just need to hang on in there – and not just at UBS. He says Goldman, Morgan Stanley and Barclays, should also benefit from the equities resurgence when it eventually comes.
For the moment, though, life in equities is hard. Faced with the need to cut high fixed costs, banks may feel the urge to trim equities in the fourth quarter of this year. There are signs that hiring which was supposed to happen has been put on hold. Goldman Sachs began upgrading its European equity research team in May, for example, and headhunters say further hires were expected. They haven’t been forthcoming: “Goldman hired three analysts and their head of research John Sawtell had indicated that it was supposed to be the start of a big build-up,” says one research headhunter in London. “Instead, there’s been nothing.” In the circumstances, maybe Goldman has decided just to wait and see?
Bernstein’s forecasts for UBS investment banking revenues, by product. Equities sales and trading professionals need to be patient