Wall Street banks are likely to post weak trading profits for the first quarter, after zigzagging markets caught traders by surprise and prompted many investors to remain on the sidelines.
Analysts are slashing their estimates for first-quarter bank earnings in part because of a rough trading environment.
Many traders were surprised by movements in multiple markets, including a surge in oil prices because of political unrest in the Middle East, and a jump in the yen after Japan's earthquake and tsunami.
"Who was hedged the wrong way on the yen when the tsunami hit? That's the question right now," said Steven Gerbel, founder of the $35 million hedge fund Chicago Capital Management.
Any decline would mark the third straight quarter of weak trading results for most of the biggest banks, and could potentially pressure bank stocks that have been falling since January. Some analysts believe the business could be under pressure for the rest of the year.
Bank executives have said that trading is still a strong business and profits there normally ebb and flow. But some investors wonder if regulatory changes may have a lasting impact on the profitability of trading.
Goldman Sachs shares have not recovered since its fourth-quarter report on Jan. 19 sent the stock 4.7 percent lower in a single day. The bank's shares have fallen 8 percent since the day before its fourth-quarter results.
Rapid moves in markets can increase trading volume and boost profitability for banks. But lately the lack of an obvious direction for many markets has spurred investors to wait for clarity instead of trading on volatility, a problem that has hurt banks for months.
Measuring this phenomenon is difficult, because many of the markets in question trade over-the-counter, and it is not always clear how trading volume in any one market will affect bank results. But composite U.S. stock market trading data shows that average daily volume has declined about 8 percent from the first quarter of 2010.
Canadian lenders like Toronto-Dominion Bank and Royal Bank of Canada ended their fiscal quarters in February, and both posted marginally lower trading revenue earlier this month.
Jefferies Group, a New York-based investment bank, also reported surprisingly strong trading results for its fiscal first quarter on Tuesday, but said profit was helped partly by taking market share from bigger rivals.
Jefferies Chief Executive Richard Handler told Reuters that March has been "a much choppier environment."
In recent days, analysts at Citigroup and Sandler O'Neill have cut their earnings forecasts for the biggest U.S. banks.
Citi's Keith Horowitz cut his first-quarter earnings per share estimate for Morgan Stanley by a dramatic 73 percent, to 20 cents, and for Goldman by 41 percent, to $3.50.
Sandler's Jeff Harte reduced his first-quarter earnings per share estimate for Morgan Stanley by 48 percent, to 50 cents per share, and for Goldman Sachs by 20 percent to $3.84.
Both estimates are well below consensus estimates for Morgan Stanley and Goldman of 62 cents and $4.07, respectively.
Given the risk to trading results, the best bet for investors worried about short-term stock dips might be JPMorgan Chase, which has skillfully navigated market trouble for the last few quarters, and is also among the least reliant on trading profits, analysts said.
Weakness in trading revenue could persist for several quarters, analysts said. Sandler's Harte reduced his earnings estimates for the biggest banks through 2012.
Oliver Pursche, president at money manager Gary Goldberg Financial Services, said that "market activity, in terms of trading volumes, has been subdued for quite some time."
"Whether it's Goldman or Morgan or JPMorgan or Citi, I would expect a difficult first quarter, but I would bet next quarter will be even more challenging, based on the underlying economic activity," Pursche added. His firm manages $500 million in client assets. "
Pursche has investments in Citigroup and Goldman Sachs. As a long-term investor, his bearish view for the near-term trading environment does not worry him enough to exit his positions.
Many executives in the banking industry see declines in trading volume as temporary. On a conference call in January, JPMorgan Chief Executive Jamie Dimon fielded a question from an analyst who noted that the bank had had several sluggish trading quarters, and who wondered if there were some structural change in the business that would result in lower volumes long-term.
"I don't think it is structural ... I think it is just the ebbs and flows of trading," Dimon said.
But with the coming implementation of the Volcker rule, a provision of last year's financial reform law that limits banks from trading with their own money, some investors wonder if trading profit could be permanently depressed for many banks.
Customer trading can be less profitable than so-called proprietary trading, but also is often less risky.
Analysts' average estimates for Wall Street firms account for some decline in trading profit in the first quarter.
Estimates for Goldman Sachs' first-quarter earnings are on average 27 percent below the year-ago quarter, which had atypically strong trading and advisory revenue. The estimate for Morgan Stanley is 34 percent lower than the year-ago period, according to Thomson Reuters I/B/E/S.
Analysts note it is exceedingly difficult to forecast trading revenue. With seven trading days left in the quarter, a lucky strike could turn things around for a firm that is struggling to meet profit expectations. But given that analyst estimate reductions often happen in waves — and the reductions so far have been quite dramatic — more forecasts could be lowered in coming days.
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