UNITED STATES banking is on a roll in pretty much every department, but it’s hard to look past stock trading for the kind of exuberance that should trouble almost anyone.
Given the amount of borrowed money that hedge funds and retail investors are using to bet on shares right now, there is good reason to worry about how unstable markets could become if, or when, a correction begins.
Each of the four big investment banks reporting earnings on Tuesday smashed revenue expectations on their equities desks.
For a sense of how surprising the numbers were, take the example of Goldman Sachs Group Inc.
The debate before the results was about whether it could produce more than US$5bil in stock trading revenue for a second time this year, after a record first quarter.
That was more than any US bank had ever made.
Well, the last three months’ revenue was US$7.4bil, up 72% from the same period last year.
This is mind-boggling and continues the sharp expansion of recent years. To add more context, its equities revenue this quarter was slightly more than its full-year result in that division in 2019, just seven years ago.
JPMorgan Chase & Co also smashed Goldman’s previous record, reporting a stunning US$6bil of revenue from share trading, up more than 85% versus its second quarter last year.
Bank of America Corp reported a 70% jump, while Citigroup Inc lagged with a 45% growth rate that would be remarkable any other time.
Morgan Stanley, the other equity-trading powerhouse, reports later.
There are a lot of factors behind this trading activity that are also helping the rest of the investment banking business lines.
The explosion of artificial intelligence investment is driving stock markets higher and being supported by billions in new and follow-on equity issuance.
The spending is boosting the wider economy and encouraging executives beyond the tech sector to pursue mergers and acquisitions, too.
Debt and equity issuance and deal advice all get fees flowing to investment banks, but also have a knock-on effect through more trading around the deals, funding for takeovers and hedging by companies, investors and others involved. All meat and drink for Wall Street.
The monster US$75bil initial public offering (IPO) of SpaceX in June delivered US$500mil in fees to a host of banks, but also engendered a wave of portfolio rebalancing before and after the deal, as investors made room for the rocket company’s shares or redeployed some early profits.
As exceptional as that IPO was, what makes my jaw drop is the scale of lending to hedge funds, which is helping to drive stocks ever higher.
Goldman is again the paradigm: Its second quarter revenue from financing equity trades, at US$3.3bil, has doubled in little more than a year.
The bank went big on expanding this prime brokerage business in Asia in the first quarter and is generally doing more with its biggest clients – the multi-strategy hedge funds – anywhere and everywhere they want to make bets.
Asia has also exemplified another startling phenomenon in big banks’ current money making: The structuring, financing and trading of leveraged exchange-traded funds (ETFs) for thrill-seeking retail investors.
Shares in chip companies including SK Hynix Inc have enjoyed wild rallies – and endured sudden drops – because of ETFs turbocharged with borrowed money.
JPMorgan chief financial officer (CFO) Jeremy Barnum said the second quarter was exceptional, particularly for equities.
“Is the current revenue run rate something we can count on?
“Obviously not,” he told reporters.
But that doesn’t mean everything is about to fall apart or that markets are necessarily unstable.
The absolute leverage in the stock market might be very high, but it’s not so unusual when you look at it in proportion to the value of all shares.
It would be naïve not to be worried, Barnum added, but while you’re busy fretting, the stock market can just keep on rising. Bankers have reason to be bullish, too.
Mergers and acquisition volumes are on track to make 2026 the biggest year for deals, Morgan Stanley analysts wrote recently.
And yet as a proportion of stock market valuation or gross domestic product – two common ways of judging activity – dealmaking is below 20-year averages.
The same is true for IPOs. And investors aren’t being overwhelmed with stock either. All equity issuance in the United States this year is expected to be counter-balanced with share buybacks by different companies.
The big banks themselves have repurchased more than US$100bil of stock between them already this year, according to data compiled by Bloomberg.
Despite all the deals already done, bankers said there was more to come.
“Our pipelines are still robust and growing,” Alastair Borthwick, CFO at Bank of America, told reporters.
His peers echoed that sentiment. For one thing, private equity buyout firms have still to rejoin the party in earnest – and several recent bids in the United States and the United Kingdom suggest they’re not far off.
Bankers, corporate executives and investors are riding a tide of confidence right now. Deals beget more deals as everyone chases scale or capital or new markets.
The thing to worry about, as always, is how much this is all being propped up with leverage: The more that borrowed money fuels these ambitions, the greater the chance that an eventual correction turns into a crash. — Bloomberg
Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance. The views expressed here are the writer’s own.
