Kass: The Broken Brokers
By Doug Kass 07/09/12 - 12:00 PM EDT
TheStreet Premium Services
A complimentary preview
of Real Money
This column originally appeared on Real Money Pro at 8:46 a.m. EDT on July 9.
NEW YORK (Real Money) -- Key takeaways:
- The brokerage industry's business model is broken and has been disrupted.
- Cyclical industry conditions are weak.
- The group's adverse secular changes will translate into considerably lower industry returns on invested capital and profits.
- Trade the sector, but don't invest in the sector.
With all the seedy bank behavior that has been exposed since the financial crisis, it's stunning that there's still dirty laundry left to be aired. We've had predatory subprime lending, fraudulent ratings, excessive risk-taking and even clients being taken advantage of in order to unload toxic mortgages. Yet even with these precedents, the Libor scandal still manages to shock. -- Joe Nocera, "Libor's Dirty Laundry," The New York TimesJoe Nocera's op-ed column in Saturday's New York Times brought me back to thinking about the intermediate- to long-term outlook for the brokerage sector. (My observations have some applicability to the outlook for bank stocks and profits as well.) There is little doubt that there will be many trading opportunities in brokerage stocks over time, but a combination of current cyclical and future secular factors will likely weigh on the stocks and inhibit a return to anything like their former glory -- whether measured in share price, P/E multiples or, most importantly, returns on capital. This is a big and topical subject -- it has been since the bank and brokerage industries exported financial weapons of mass destruction and nearly bankrupted the world's financial system in 2008. After several high-profile bankruptcies, the crippled financial sector became a political piņata. The Dodd-Frank Wall Street Reform and Consumer Protection Act was introduced (and the Volcker rule was reintroduced) to not only avoid the mistakes of the past but to prevent a repeat of 2007-2008. Recently, the JPMorgan Chase (JPM) trading gaffe and Barclays' (BCS) involvement in Libor fixing have led to some high-profile bank resignations, which are obvious signals that little has been learned from past abuses and that the clarion call of separating propriety trading from traditional customer activity will ring louder in the months ahead.
"We shape our buildings; thereafter they shape us." -- Winston ChurchillToday's opening missive covers a polarizing and emotional subject to many who are in the investment business. Some of the points I bring up will not be greeted well by bankers and brokers, but frankly, considering the magnitude of the abuses (particularly in the last economic upturn), it is hard to be sympathetic: Three to four years later the global economies still feel the weight of the abuses of the 2000-2005 period, as reflected in subpar economic growth.