“History doesn’t repeat itself, but it often rhymes.” – Mark Twain
(August 12, 2019) – On July 7, 2019, German banking giant Deutsche Bank announced that it would fire 18,000 employees—roughly 20% of its global workforce—and shut down its entire equity trading division. Days later the S&P 500 closed at an all-time high of 3,013.
Let’s turn back the clock.
On April 11, 2007, Citigroup announced it was eliminating 17,000 jobs. The S&P 500 closed that day at 1,438 and months later would trade as high as 1,565. Over the ensuing two years tens of thousands of Wall Street jobs would be eliminated and the S&P 500 would trade as low as 666.
To paraphrase another great American philosopher, baseball icon Yogi Berra, is the present correlation between financial industry consolidation and record stock market levels a case of “déjà vu all over again?” Subsequent to the moves initiated by Deutsche Bank, Citigroup dismissed dozens across its trading division, including cash equities and derivatives traders, and HSBC Holdings, in response to a worsening outlook for the global economy, ousted their CEO and announced plans to lay off 2% of its workforce. The buyside community has been affected as well, primarily due to the shift from active to passive investment. Legg Mason recently announced plans to cut 120 positions, or 12% of its staff. In January, BlackRock said it would cut 500 jobs, and State Street said it plans to dismiss 1,500 workers.
This paper compares the industry structure and economic fundamentals of the two time periods and examines the role consolidation within the financial services industry can play when it comes to forecasting future market behavior. That being said, never forget the quote made famous by legendary fund manager Sir John Templeton–“The four most dangerous words in investing are: ‘this time it’s different.’”
Industry Structure: 2007 vs. 2019
The power of financial services has risen over the last forty years as an evolutionary by-product of the growing demand for investment services, technological changes, deregulation and globalization. At the turn of the 21st century, investment banks were at the heart of a shadow banking system, inventing many of the products used by it and often disguising its operation to its customers. These factors loomed on the horizon in 2007, and arguably precipitated crises in the nation’s housing, credit and financial markets.
As such, much of Wall Street was in turmoil, especially those firms that invested heavily in the burgeoning mortgage-backed securities (MBS) markets. Moreover, banks around the world leveraged their balance sheets to maximize profits and growth. When these bets began to sour, pain was felt at all levels. In addition to the Citigroup job cuts, by November 2007 the following banks had also announced layoffs:
- Bear Stearns: 650
- Bank of America: 3,000
- Credit Suisse: 150
- Capital One: 3,900
- Countrywide Financial: 12,000
- JP Morgan Chase: 100
- Lehman Brothers: 850
- Morgan Stanley: 300
- Wachovia: 2,000
In contrast, Deutsche Banks’s downfall in 2019 was the culmination of a years-long descent into unprofitability and scandal based on a failed strategy of expanding beyond its core competency of conservative, Eurocentric, middle-market commercial lending and pursue through acquisitions (Morgan Grenfell in 1989, Bankers Trust in 1999) the glamourous niche of high-risk, high-rewards realm of stocks, bonds and derivatives trading. To make a long, ugly story short, the sleepy German bank waded into the deep end of the shark-infested investment banking pool inhabited by the likes of Morgan Stanley and Goldman Sachs and very nearly drowned.
Meanwhile, the pincer movement of sluggish trading volumes and functional automation throughout the first half of 2019 have negatively impacted Wall Street payrolls. Goldman Sachs reported a 24% year-over-year decline in equity trading revenues in the first quarter, and a 13% year-over-year decline in fixed income trading in the second quarter, and to date the company has laid off 260 employees. In March, after a review of staffing levels, J.P. Morgan fired hundreds of workers in its asset and wealth-management division. Société Générale announced 1,600 job cuts in April following several quarters of performance at is investment bank. HSBC, in response to pressure on revenues and a deteriorating economic outlook, will start in June to cut hundreds of jobs at its investment bank.
Economic Fundamentals: 2007 vs. 2019
The U.S. financial crisis, which erupted in August 2007, quickly spread throughout the overall U.S. economy and around the globe. The depth and the scope of the crisis came into focus in September 2008 when it entered a tumultuous new phase, badly shaking confidence in global financial institutions and sending financial markets reeling. This triggered a cascading series of bankruptcies, forced mergers, and radical government interventions — such as the U.S. government’s unprecedented $700 billion financial rescue plan to purchase or insure “troubled” assets (TARP) — to stem the fallout. In a single calendar quarter, America’s largest savings and loan, its largest insurance company, its two largest mortgage providers, its largest brokerage firm, and a leading commercial bank were the subject of a takeover, bailout or failure. By May 2009, financial institutions had taken more than $1.37 trillion in worldwide write-downs and losses, a figure representing the gross national product of the 12th largest economy in the world (between Canada and India).
The passage of time will determine whether the chorus of universal economic challenges confronted in 2019 are mere speedbumps to global growth or hazardous roadblocks that could disrupt financial markets around the world. First and foremost are the trade wars that began erupting in 2018, none more significant than that between the U.S. and China, the world’s two largest economies. Depending on the presidential tweet of day, this is an issue in which both sides are “nearing an agreement” and declare a ceasefire, or hardening their positions and thus retreat to their respective corners. President Donald Trump recently claimed his tariff battle with China is working after official data from Beijing showed growth dropping to its slowest pace since 1992. However, it should be noted that the rate of GDP growth in China has been declining since 2007.
A potential black hole growing at the heart of the world’s financial markets is negative-yielding debt—bonds worth less, not more, if held to maturity. Negative-yielding debt topped $13 trillion in June 2019, having doubled since December, and now makes up 25% of global debt. The U.S. is one of the few outliers, with none of its $16 trillion debt pile yielding less than zero, but bond strategists are warning that the problem will most likely get worse before it gets better.
Worries about a global economic slowdown and the daily news cycle associated with trade wars have also impacted physical energy prices. Oil has seen prices fall by 20% since their peak in April 2019, and prices of thermal coal and liquefied natural gas have hit multi-year lows.
Last but not least is the uncertainty related to Brexit, the United Kingdom’s planned succession from the European Union. Originally scheduled to take place in March, the move has been delayed to October 31.
The Rise of Financial Services and its Ability to Forecast
The rise of financial services has been driven principally by two factors. The first has to do with the rising demand for investment services driven by the growth of pension funds. Investment firms used this rising mountain of funds to sell fund management and advisory services, but more importantly funded pensions generated demand for new securities. The major investment banks responded to this demand by creating a supply of products whose potential side-effects weren’t fully analyzed. When these products fail to deliver adequate returns, those in charge with distributing them are usually relieved of their duties.
The second factor involves the introduction of technology and formal mathematical investment theories. Given the value of information in the securities markets, the industry has always been a savvy user of technology, and its application has had transformative effects on both capital raising and labor. As the power of computing increased, so did mathematical and algorithmic financial models, increasing the responsiveness and speed to changes in market dynamics. This led to a change in the behavior of financial professionals, from those skilled at building relationships to more entry-level and generic skills, fueling demand for graduates in computer science, engineering and mathematics. These people are cheaper to hire than traditional investment bankers, and the nature of their jobs leads to further automation and consolidation.
If we judge an industry by its effect on an economy, financial services are a good candidate for the most successful industry of the last forty years. There are two fundamental concerns, however. First, the shift in focus from relationship building and trust to financial engineering and trading suggests a shift to shorter-term objectives and incentives. The second problem is the extent to which boom in the industry has been driven by its political and ideological power. This is why consolidation within the industry can be a portent of future market behavior.
For sure, significant structural changes have evolved throughout the financial services industry since 2007, and those that exist in 2019 could soften the blow of a major market downturn. Firms now employ less financial leverage (borrowed money) to boost earnings, reducing profitability as well as risk. Moreover, storied investment banks Goldman Sachs and Morgan Stanley became bank-holding companies in order to lower their risk profiles.
Lastly, in June the Morgan Stanley Business Conditions Index, a survey of how their equity analysts feel about their companies, fell by 32 points, to a level of 13 from a level of 45 in May, the largest one-month decline on record. Every sub-index fell in June, except for the credit condition category. “The decline shows a sharp deterioration in sentiments this month that was broad-based across sectors,” said Morgan Stanley economist Ellen Zentner. In response to this data, Morgan Stanley downgraded its forecast for global stocks, suggesting over the next twelve months, there is now just 1% average upside to their price targets for the S&P500, MSCI Europe, MSCI EM and Topix Japan. “The time has come to put our money where our mouth is,” said Chief cross-asset strategist Andrews Sheets. “The positives of easier policy will be offset by the negatives of weaker growth.”
 “Asset Managers With $74 Trillion on Brink of Historic Shakeout,” Bloomberg, August 7, 2019
 “Wall Street Bloodbath: Layoffs Keep Growing,” CNBC, November 2007
 “Wall Street Banks Have Cut Hundreds of Securities Jobs,” efinancialcareers.com, April 25, 2019
 “Goldman 2019 Layoffs Hit 260 As Cuts Continue,” citywireamericas.com, June 26, 2019.
 “JPMorgan to Cut Hundreds of Jobs After Staffing Review, Bloomberg, March 27, 2019.
 “Société Générale Chairman Admits It Was Too Slow to Fire Traders,” Financial Times, July 2, 2019
 “HSBC To Cut Hundreds of Investment Banking Jobs,” Financial Times, May 30, 2019.
 “Turmoil on Wall Street: The Impact of the Financial Sector Meltdown,” State of New York, June 2009.
 “Historical GDP of China,” Wikipedia.
 “The Black Hole Engulfing the World’s Bond Markets,” Bloomberg, July 12, 2019.
 “U.S. Crude Oil Enters Bear Market Due to Global-Growth Fears,” Wall Street Journal, June 5, 2019.
 “Financial Jobs and Power in the Securities Industry,” Dariusz Wojcik, SSRN, July 2011.
 “A Morgan Stanley Economic Indicator Just Suffered a Record Collapse,” CNBC, June 13, 2019.
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