Goldman Trades Where Morgan No Longer Treads With Gap Widening
Morgan Stanley executives have been trying to prove since the financial crisis that they run a different type of company than Goldman Sachs Group Inc. Investors may be finally starting to believe them.
The correlation between the two firms’ daily share-price movements, a measure of how closely securities move in tandem, is down 17 percent this year from the average over the last decade. The correlation in the third quarter so far dropped to the lowest for any quarter since 2003. Goldman Sachs is down 12 percent in 2010 and Morgan Stanley 15 percent, both trailing the Standard & Poor’s 500 Index, which is up 4.5 percent.
The change reflects how the two longest-surviving major investment banks have chosen different directions. Morgan Stanley Chief Executive Officer James Gorman, 52, has pushed his firm toward a lower-risk model, expanding into retail brokerage and leaving Goldman Sachs as the only firm among the 25 largest U.S. financial companies to get more than 60 percent of its revenue from investment banking and trading.
“There’s definitely been a divergence in the business emphasis of Morgan Stanley and Goldman Sachs as a result of the financial crisis,” said Jordan Posner, senior portfolio manager at New York-based Matrix Asset Advisors Inc., which manages more than $1 billion and owns Morgan Stanley shares. “While there are a number of industry variables that will be in common between Goldman Sachs and Morgan Stanley, as well as JPMorgan and other firms, there is now a choice in what kind of business model you want to invest in.”
After pursuing a strategy that emulated Goldman Sachs’s trading-centric model before confidence in financial institutions collapsed in 2008 -- prompting Morgan Stanley and Goldman Sachs to be approved by the Federal Reserve as deposit- taking institutions -- Morgan Stanley now has a revenue breakdown more closely resembling that of Merrill Lynch & Co., where Gorman worked from 1999 to 2005. Goldman Sachs has largely maintained the model that made it the most profitable U.S. securities firm in Wall Street history.
Morgan Stanley has cut the proportion of its revenue that comes from investment banking and trading to 54 percent over the 12 months ending June 30 from 65 percent in 2006. During that time, Goldman Sachs’s trading and investment-banking revenue has climbed to 80 percent of the firm’s total, from 75 percent. That compares with 27 percent at JPMorgan Chase & Co.
‘Mix of Business’
Morgan Stanley made its shift last year when it purchased a controlling stake in a joint venture with Citigroup Inc.’s Smith Barney brokerage. Gorman, who led the brokerage before taking over as CEO this year, said in a letter to shareholders in April that the unit “is going to play an increasingly important role in our growth and profitability.”
Goldman Sachs, led by former trading chief Lloyd C. Blankfein, 56, posted record profit in 2009, when 84 percent of its revenue came from trading and investment banking. The firm set a fixed-income-trading revenue record in the first quarter of 2010.
“Our mix of business is not necessarily driven by the management or the board sitting back and saying, ‘OK, we’d like to have x percent in this and y percent in this,’” Goldman Sachs Chief Financial Officer David Viniar said on a conference call in July. “A great portion of the way our mix of business unfolds is driven by what our clients want.”
Mark Lake, a spokesman for Morgan Stanley, declined to comment, as did Melissa Daly, a Goldman Sachs spokeswoman.
“Goldman has always traded at a premium,” said Peter Boockvar, an equity strategist at Miller Tabak & Co. in New York. “If Goldman continues to generate quarter to quarter of superior growth, they’ll get more of their premium back, and they can outperform.”
The correlation coefficient between the two firms’ daily share-price movements this year as of Sept. 24 was 0.66, down from 0.85 in 2009, according to data compiled by Bloomberg. That’s lower than Morgan Stanley’s correlation with New York- based JPMorgan and the same as Goldman Sachs’s with JPMorgan. The coefficient in the third quarter was 0.58.
The correlation coefficient is a ratio that measures the association between stock movements and can range from 1 to -1. Smaller values indicate less of a relationship, while negative values show an inverse relationship. Investors often use the correlation between securities to determine which stocks fit best in their portfolios and which firms are peers of others.
Among the 80 companies in the S&P 500 Financials Index, Morgan Stanley has had the highest correlation with Goldman Sachs every year since the end of 1999, the year Goldman Sachs went public. This year, Goldman Sachs is Morgan Stanley’s 17th- most correlated.
The correlation between the rolling monthly returns of the stocks over the last year is 0.88, according to data compiled by St. Louis-based Argent Capital Management LLC. That measure lessens the effect of a single day’s share-price movement.
While the daily movements are mirroring each other less, the two stocks have performed similarly for the year. Goldman Sachs is down 12 percent so far in 2010, closing at $147.28 on Sept. 24. Morgan Stanley has fallen 15 percent to $25.15.
“If you line up both of those businesses, you’re probably going to get 70 percent-plus overlap, so you should still have a relatively high correlation, but they are less similar than they were a couple years ago,” said James Ellman, a former Merrill Lynch bank-stock portfolio manager who is now president of San Francisco-based Seacliff Capital.
Some of the difference in share-price movement comes from a view that Goldman Sachs had greater legal and regulatory risk after the Securities and Exchange Commission accused the bank of fraud related to a collateralized debt obligation it sold in 2007, investors said. Goldman Sachs dropped 13 percent the day the SEC announced the suit, while Morgan Stanley fell 5.6 percent. Goldman Sachs rose 4.4 percent the day it paid $550 million to settle the case, while Morgan Stanley shares were up 0.2 percent.
“Goldman has been to some degree a victim of its own success,” Ellman said. “Morgan Stanley, while in the same boat as Goldman, is not seen as the same regulatory lightning rod as Goldman. That’s something that’s going to cause a different level of volatility.”
The daily correlation declined in the third quarter after Goldman Sachs’s second-quarter earnings missed analysts’ estimates for the first time in six quarters, while Morgan Stanley beat estimates for the third time in seven quarters.
The firms’ shares had a higher daily correlation in the first quarter, 0.82, as they both fell more than 8 percent over two days after President Barack Obama proposed the Volcker rule, which bars proprietary trading by banks and limits investments in private equity and hedge funds.
The decline in the correlation between the two firms’ shares comes even as the broader equity markets have traded largely in lockstep, reacting to economic data and questions about whether the U.S. recovery is sustainable. The median correlation between stocks in the S&P 500 and the index itself is 0.72 this year, the second-highest level this decade.
Gorman’s strategy differed from that implemented when John Mack took over as CEO in 2005. Mack, who is still chairman of the firm, bought stakes in hedge funds, started a private-equity business, expanded mortgage and real estate holdings and took on more risk in principal trading. That backfired when $9.4 billion of mortgage-holding writedowns led to Morgan Stanley’s first quarterly loss as a public company in 2007, and it reported $4.4 billion in real estate losses in 2008 and 2009.
“Morgan Stanley has deliberately rebalanced our institution away from our proprietary investing and proprietary trading,” Gorman said at a banking conference in Frankfurt this month. “We were doing this before the Volcker rule was put in place. We are doing it for good business. If you’re managing shareholder capital, third-party capital, investing on your own behalf is not what a large, public company should be doing.”
‘Poor Man’s XYZ’
A lower correlation over time may generate interest in Morgan Stanley from investors who previously chose just one investment-banking stock, said Kenneth Crawford, a senior portfolio manager at Argent. Goldman Sachs shares have outperformed Morgan Stanley’s every year this decade.
“If you think you’re buying a poor man’s XYZ stock, then you obviously have to be buying it at a discount,” said Crawford, whose firm manages about $900 million. “If that is no longer or just less of a discussion point for a company, then there are other things you’re looking at, and if you’re pressing the ‘B’ button, those different things must get you excited.”
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