East meets West: top banks say these are stocks to watch

Equities
Investments

Goldman Sachs and Morgan Stanley have produced fresh reports on stocks they think are about to do well.

Goldman’s focus is mainly on European stocks with an international reach. Morgan Stanley, on the other hand, has been appraising stocks that could highly benefit from stronger US-China ties.

Top banks’ stocks to watch

Goldman eyeballs these equities

CNBC reports Goldman has identified a number of stocks as poised to outperform their pre-pandemic earnings while Europe’s post-Covid reopening continues.

All of the large caps listed on Goldman’s Reopening Beneficiaries list have been rated as buys by the bank’s analysts with major potential upsides over their 12-month share targets.

Goldman has been tracking various sectors set to soar once economies are fully reopened, using Europe as a guinea pig with the bank pouring over hotel booking, flight, and restaurant booking data, as well as Covid-19 hospitalisation levels and vaccination uptake.

Starting with oil, three supermajors have been identified as buys, all with significant upsides. Currently, oil prices are soaring, with key benchmark contracts trading for levels not seen for at least two years. As such, the below stocks are at the top of Goldman’s buy list, beating their 12-month price targets:

  • BP – 45% estimated upside
  • ENI – 27% estimated upside
  • Total – 23% estimated upside

The aviation industry is clear for take-off too. Again, one major stock could be looking to fly high with a 45% topside. As we’ve touched on in the past, stocks related to international and domestic air travel may be big winners once the world opens up. That includes airlines themselves but also associated infrastructure like engine suppliers and airports.

Goldman Sachs identifies the following equities with high potential:

  • Rolls Royce – 45% estimated upside
  • Flughafen Zurich – 27% estimated upside
  • EasyJet – 18% estimated upside

Looking to retail, Goldman has several firms in different subsectors on its watchlist. According to the bank’s analysis, Swiss conglomerate Richemont, whose portfolio covers Cartier, Montblanc, and a host of jewellery and watchmakers, has high potential, but it may be outstripped by retail brands:

  • Swatch Group – 19% estimated upside
  • Adidas – 16% estimated upside
  • Richemont – 13% estimated upside

All of the above rests on the successful reopening of global and European economies, however. Vaccine rollout has been largely successful in key economies like the US, European Union and the UK. Covid variants, however, have led to some delays in the full lifting of restrictions. We’re not out of the woods yet, but the tree density is dropping off. Specks of light are seeping through the undergrowth.

Morgan Stanley looks eastward for stock picks

While Goldman has an internationally-facing European focus, Morgan Stanley heads to China to look at some equities that could be potential buys.

Morgan’s analysis, however, is all based on closer US-China relations. We all remember the trade wars of President Trump’s tenure. Morgan is betting on closer relations between Beijing and the Biden White House during the 46th US president’s tenure.

In one of the bank’s China-related portfolio, it has listed 30 Chinese firms that are dependent on the US market for solid chunks of their revenue.

Many have strong track records too, in terms of share performance. Morgan Stanley analysts reported earlier in June that the equities outperform the MSCI China index by an average of 206 points when things are good between the US and China.

It should be pointed out at this juncture that Joe Biden has maintained a tough stance on China. However, instead of pursuing sanctions, his administration is tacking a different tack by working more closely with US allies in the region, rather than instigating a tit-for-tat trade spat.

That said, if the frost relations thaw, then Morgan Stanley suggests the below could be poised to make big gains.

Universal Scientific International (USI)

USI is a subsidiary of US-listed, Taiwan-based ASE Technology. The firm manufactures electrical components used by other firms and recently inked a substantial deal with a European manufacturing giant in 2020.

Total profit grew to 351.5 million yuan ($54.9 million) in the first three months of this year, up 65% from 212.5 million yuan in the first quarter of 2020.

70% of USI’s revenue is sourced from the US market.

Futu

Futu is, along with Robinhood, part of the new breed of millennial-aimed investment apps. It is one of the two main apps young Chinese investors use to trade stocks listed overseas.

The company has ambitious growth plans, identifying Singapore and the US as its next target regions for userbase growth. Futu is also applying for licenses that would allow it to offer cryptocurrency trading in those two nations – something of big interest to the current crop of younger traders.

Morgan Stanley estimates 62% of Futu’s revenues comes from the US already, but it expects a large portion of 700,000 new customers to come from there too.

WuXi AppTec

WuXi’s business is the research, development and manufacturing of services for the pharmaceutical, biotech and medical device industries. It is currently focussing on beefing up its gene therapy and drug development industries.

55% of WuXi’s revenues, Morgan Stanley says, is generated by its business in the US.

All of the above stocks have been listed as overweight by Morgan Stanley, indicating they expect the stocks to perform better in the future. This does all depend on how US-China relations develop under Biden.

Of course, remember all investing and trading comes with the risk of capital loss. Do your due diligence and research before committing any money and only invest or trade if you are comfortable taking any potential losses.

Banks set to kick off US Q3 earnings season

Equities

The S&P 500 rose 8.5% to 3,363 over the third quarter, having hit an all-time of 3580 at the start of September, with an intraday peak at 3588. The market faced ongoing headwinds from the pandemic, but risk sentiment remained well supported through the quarter by fiscal and monetary policy.

A pullback in September erased the August rally but was largely seen as a necessary correction after an over-exuberant period of speculation and ‘hot’ money into a narrow range of stocks.

Q3 earnings come at important crossroads: Expectations for when any stimulus package will be agreed – and how big it should be – continue to drive a lot of the near-term price action, though the market has largely held its 3200-3400 range.

Elevated volatility is also expected around the Nov 3rd election. But next week we turn to earnings and the more mundane assessment of whether companies are actually making any money.

Banks kick off Q3 earnings season

Financials are in focus first: Citigroup and JPMorgan kick off the season formally on October 13th with Bank of America, Goldman Sachs and Wells Fargo on the 14th. Morgan Stanley reports on Oct 15th, In Q2, the big banks reported broadly similar trends with big increases in loan loss provisions offset by some stunning trading earnings.

Wall Street beasts – JPM, Goldman Sachs, Citi, Morgan Stanley and Bank of America – posted near-record trading revenues in the second quarter with revenues for the five combined topping $33bn, the best in a decade. At the time, we argued that investors need to ask whether the exceptional trading revenues are all that sustainable, and whether there needs to be a much larger increase for bad debt provisions.

Meanwhile, whilst the broad economic outlook has not deteriorated over the quarter, it has become clear that the recovery will be slower than it first appeared. Moreover, during Q3 the Fed announced a shift to average inflation targeting that implies interest rates will be on the floor for many years to come, so there is little prospect of any relief for compressed net interest margins.

Meanwhile there is growing evidence of a real problem in the commercial mortgage-backed securities (CMBS) market as new appraisals are seeing large swatches of real estate being marked down, particularly in the hotels and retail sectors.

At the same time, the energy sector has gone through a significant restructuring as we have seen North American oil and gas chapter 11 filings gathering pace through the summer as energy prices remained low. There is a tonne of debt maturing next year but how much will be repaid?

Key questions for the banks

  • Did the jump in trading revenues in Q2 carry through in Q3? Jamie Dimon thought it would halve.
  • On a related note, did the options frenzy in August help any bank more than others – Morgan Stanley?
  • Have provisions for bad loans increased materially over the quarter?
  • How bad are credit card, home and business loans?
  • And how bad is the commercial property sector, especially hotels and retail as evidence from the CMBS market starts to look very rocky?
  • How are bad debts in oil & gas looking?
  • How are job cuts helping Citigroup lower costs; how will its entry into China make a difference to the outlook?
  • How does Wells Fargo manage without an investment arm to lean on? So far it’s been a bit of a mess.
  • Was Warren Buffett right to cut his stake in Wells Fargo and some other US banks? Buffett pulled out airlines first then banks.
  • What do banks think of never-ending ZIRP and does the Fed’s shift affect forecasts at all?
  • How is Morgan Stanley’s wealth management division cushioning any drop in trading revenues?
  • What progress on Citigroup’s risk management system troubles?

Q2 earnings recap

JPMorgan beat on the top and bottom line. Revenues topped $33.8bn vs the $30.5bn expected, whilst earnings per share hit $1.38 vs $1.01 expected. The range of estimates was vast, so the consensus numbers were always going to be a little out.

The bank earned $4.7bn of net income in the second quarter despite building $8.9 billion of credit reserves thanks to its highest-ever quarterly revenue. Loan loss provisions were $10.5bn, which was more than expected and the quarter included almost $9bn in reserve builds largely due to Covid-19.

The consumer bank reported a net loss of $176 million, compared with net income of $4.2 billion in the prior year, predominantly driven by reserve builds. Net revenue was $12.2 billion, down 9%. Credit card sales were 23% lower, with average loans down 7%, while deposits rose 20% as consumers deleveraged.

The provision for credit losses in the consumer bank was $5.8 billion, up $4.7 billion from the prior year driven by reserve builds, chiefly in credit cards.

Trading revenues were phenomenal, rising 80% with fixed income revenues doubling. Return on equity (ROE) rose to 7% from 4% in Q1 but was still well down on the 16% a year before. ROTE rose to 9% from 5% in the prior quarter but was down from 20% a year before.

Citigroup EPS beat at $0.50 vs the $0.28 expected. Trading revenues in fixed income rose 68%, and made up the majority of the $6.9bn in Markets and Securities Services revenues, which rose 48%. Equity trading revenue dipped 3% to $770 million. Consumer banking revenues fell 10% to $7.34 billion, while net credit losses, jumped 12% year over year to $2.2 billion. Net income was down 73% year-on-year.

Since then the bank has offloaded its retail options market making business, leaving Morgan Stanley (reporting Oct 15th) as the major player left in this market. We await to see what kind of impact the explosion in options trading witnessed over the summer had on both. ROE stood at just 2.4% and ROTE at 2.9%.

Wells Fargo – which does not have the investment banking arm to lean on – increased credit loss provisions in the quarter to $9.5bn from $4bn in Q1, vs expectations of about $5bn. WFG reported a $2.4 billion loss for the quarter as revenues fell 17.6% year-on-year.

CEO Charlie Scharf was not mincing his words: “We are extremely disappointed in both our second quarter results and our intent to reduce our dividend. Our view of the length and severity of the economic downturn has deteriorated considerably from the assumptions used last quarter, which drove the $8.4 billion addition to our credit loss reserve in the second quarter.”

Bank of America reported earnings of $3.5 billion, with EPS of $0.37 ahead of the $0.27 expected on revenues of $22bn. Its bond trading revenue rose 50% to $3.2 billion, whilst equities trading revenue climbed 7% to $1.2 billion. But the bank increased reserves for credit losses by $4 billion and suffered an 11% decline in interest income.

Return on equity (ROE) fell to 5.44% from 5.91% in the prior quarter and was down significantly from last year’s Q2 11.62%. Return on tangible equity (ROTE) slipped to 7.63% from 8.32% in Q1 2020 and from 16.24% in Q2 2019.

Morgan Stanley was probably the winner from Q2 as it reported net revenues of $13.4 billion for the second quarter compared with $10.2 billion a year ago. Net income hit $3.2 billion, or $1.96 per diluted share, compared with net income of $2.2 billion, or $1.23, for the same period a year ago.

Wealth Management delivered a pre-tax income of $1.1 billion with a pre-tax margin of 24.4%. Investment banking rose 39%, with Sales and Trading revenues up 68%. MS managed to increase its ROE to 15.7%, and the ROTE to 17.8% from respectively 11.2% and 12.8% in Q2 2019.

Goldman Sachs reported net revenues of $13.30 billion and net earnings of $2.42 billion for the second quarter. EPS of $6.26 destroyed estimates for $3.78. Bond trading revenue rose by almost 150% to $4.24 billion, whilst equities trading revenue was up 46% to $2.94 billion. ROE came in at 11.1% and ROTE at 11.8%.

Expectations

(source: Markets.com)

Bank Forecast Revenues (no of estimates)

 

Forecast EPS (no of estimates)

 

BOA $20.8bn (8) $0.5 (23)
GS $9.1bn (15) $5 (21)
WFG $17.9bn (17) $0.4 (24)
JPM $28bn (19) $2.1 (23)
MS $10.4bn (15) $1.2 (20)
C $18.5bn (17) $2 (21)

 

Shares

None have really managed to match the recovery in the broad market but valuations are compelling.

Goldman trading either side of 200-day EMA

Wells Fargo can’t catch any bid

Bank of America bound by 50-day SMA

Citigroup still nursing losses after reversal in September

JPM breakouts consistently fail to hold above 200-day EMA

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