Financials were a bright spot for the market after the FOMC announcement last week, rallying along with rates as investors rotated into the sector and out of many of the dividend-paying stocks.
This week, however, financials have hit a speed bump, retracing most of last week’s gains. Bank earnings kick off in less than 2 weeks. Given the focus on the banking sector, we anticipate more trading opportunities in the sector over the next month.
Along those lines, Morgan Stanley caught my eye this morning as I was going through earnings expectations for the global corporate and investment banks. Analysts have rapidly ratcheted down earnings expectations for the 1st quarter. All of the banks with large investment banking arms are expected to have flat to down earnings year-over-year, after a relatively weak trading quarter.
While analysts have modeled a flat quarter for MS in Q1, they are still modeling massive earnings outperformance vs. the sector for the balance of the year. However, when I look at the comparative fundamental situation of MS vs. its largest competitor, GS, the stock seems priced too rich here, especially if the industry backdrop remains weak.
Granted, I could be seen as biased since I still own GS stock as a former employee. But instead of opinion, let’s look at the actual financial figures and earnings expectations for MS and GS:
- MS has dramatically closed its valuation gap with GS since the stock started its massive run in July of 2012. Today, Price/Book in MS is 0.97, vs. 1.07 in GS, or only a 10% discount, the lowest gap of the past decade.
- MS trailing 12 month P/E is about 15 vs. about 10 for GS. A big reason is that analysts are modeling in much higher earnings growth for MS over the next couple years (20% vs. 5% for GS).
- The gap in analyst expectations is even wider for 2014, a year in which analysts have modeled in a -4% earnings contraction for GS, vs. +24% earnings growth for MS. That seems like a very high bar for MS vs. its closest competitor, particularly if the tepid trading environment from the first quarter continues later in 2014.
Technically, MS has failed to hold above the $32 level for the second time this year:
[caption id="attachment_38138" align="alignnone" width="600"]
MS daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg[/caption]
That level was resistance in late 2013, and broke to start 2014, but failed to hold after MS initially popped on better-than expected earnings. The stock is right at its 50 day ma (near $30.75), while larger support is in the $28.50-$29 area, where the stock bottomed in February, and coinciding with the rising 200 day ma.
Put it all together, and we like the odds of a pullback back to that support area in MS over the next 6 weeks:
TRADE: MS ($30.88) Buy May 30/28 Put Spread for $0.53
– Buy 1 May 30 Put for $0.84
– Sell 1 May 28 Put at $0.31
Break-evens on May expiration:
Profits: Between 29.47 and 28, make up to 1.47, max profit of 1.47 at 28 or below
Losses: Up to 0.53 between 29.47 and 30, max loss of 0.53 at 30 or above
Trade Rationale:
MS reports earnings in late April, so the May structure captures the earnings report. Moreover, we might even take the trade off before earnings if MS is weak into the event, which is possible if its peers report weak numbers in the week before MS reports. This put spread gives us enough time that it won’t decay much for the next few weeks.