APRIL ACTIVITY MONITOR
• FIXED INCOME TRADING – VOLUMES SLOWED IN APRIL: In fixed income trading, slowing volatility led to lower trading volumes in both cash and derivatives products. Specifically, cash fixed income volumes decreased 21% sequentially (but were up 15% from April 2007). Similarly, in rates, volumes fell 22% vs. March, but were up 20% YOY. FX and commodities trends remain robust (although also modestly down vs. March). Looking to the May 2Q08, sequential fixed income activity is mixed, with cash volumes tracking up 4%, FX volatility up 33% and derivative volumes off 6% (although all volumes are tracking up solidly on a YOY basis). Of course, solid trading volumes are expected to be mostly offset by a challenging environment in March and hedging losses in April. (Exhibits 44-65)
• EQUITIES TRADING – SLOWING VOLATILITY DRIVES LOWER TRADING VOLUMES: April saw overall cash and derivatives volumes decrease from March levels (but remain solidly up on a YOY basis) as slowing market volatility led to lower trading volumes. Specifically, cash volumes were down 18% in April from March, while derivatives volumes decreased 10%. However, for the May 2Q08, derivatives volumes rose 2% from 1Q08 (25% YOY) and cash volumes are tracking down 2% from a very strong 1Q08 (but, up 33% YOY). In terms of proprietary trading, given the uncertain environment at the beginning of 2Q, we don’t believe the brokers were willing to put capital to use to take advantage of the more positive trending markets since mid March – potentially limiting proprietary trading gains. (Exhibits 11-43)
• GLOBAL INVESTMENT BANKING – UNDERWRITING VOLUMES IMPROVE MEANINGFULLY: Equity underwriting volumes rose 25% in April from March (and doubled from February), while fixed income activity increased 64% (to a 10-month high). In M&A, although announced M&A increased 46% from March, completed volumes were down 39%. Looking to 2Q, with May MTD volumes trending similar to (or even better than) April, we expect total investment banking activity to show sequential improvement during 2Q (although YOY volumes remain decidedly weaker). (Exhibits 88-110)
• CAPITAL MARKETS CONTINUE TO SHOW SIGNS OF IMPROVEMENT IN MAY, BUT 2Q08 REMAINS CHALLENGING FOR BROKERS: While the improving capital markets environment in April has continued into May (credit spreads down 8% from the end of April, US equity markets up 2% MTD), the brokers with November FY still face some stiff challenges, with 2Q08 EPS estimates clearly at risk. For one, March was a very difficult month given the panic around BSC’s demise and the negative impact on credit and equity markets (and thus trading results). Secondly, we have seen derivatives dramatically outperform the cash markets, and the brokers could see material hedging related losses since they tend to use the derivatives markets for hedging balance sheet exposures (i.e. the CMBX, ABX, etc.). Thirdly, as noted above, less risk taking could impact proprietary trading. Thus, we are likely to see further 2Q EPS cuts as we get closer to the end of the quarter (5/31), which could keep a lid on the stocks in the short-term.
• CONTINUE TO FAVOR BROKERS OVER BANKS: Looking beyond F2Q08, while the broker stocks could be held in check over the next few weeks as investors absorb 2Q08 EPS cuts, we are getting increasingly upbeat on the stocks’ prospects for 2H08 as the capital markets continue to show improvement. Overall, we continue to favor the brokers over the banks given attractive valuations (at 1.4x 2008E book value, stocks are near trough levels), much higher exposures to non-US revenues (and materially less US consumer lending exposure), an ability to move past the mortgage woes more quickly than the banks given the mark-to-market nature of their balance sheets (with the markets a much quicker discounting mechanism than bank loan portfolios), and overall greater leverage to a credit markets recovery. Our favorite names within our universe are MS and LEH (although we would note that LEH is likely to have the weakest 2Q results given greater use of hedging). Among the banks, we prefer JPM and BK. (Exhibits 2–9)