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Morgan Stanley Predicts Up To A 25% Collapse in Q3 FICC Revenue

With the third quarter earnings season on deck, in which S&P500 EPS are now expected to post a 5.1% decline (versus a forecast -1.0% decline as of three months ago), it is common knowledge that the biggest culprit will be Energy companies, currently expected to suffer a 65% Y/Y collapse in EPS.

What is less known is that the earnings weakness is far more widespread than just the Energy sector, touching on more than half of all sectors with Materials, Industrials, Staples, Utilities and even Info Tech all expected to see EPS declines: this despite what will likely be a record high in stock buyback activity.

 

However, of all sectors the one which may pose the biggest surprise to investors is financials: it is here that Q3 (and Q4) earnings estimates have hardly budged, and as of September 30 are expected to rise by 10% compared to Q3 2014.

This may prove to be a stretch according to Morgan Stanley whose Huw van Steenis is seeing nothing short of a bloodbath in banking revenues, with the traditionally strongest performer, Fixed Income, Currency and Commodity set for a tumble as much as 25%, to wit: "we think FICC may be down 10- 25% YoY (FX up, Rates sluggish, Credit soft), Equities marginally up but IBD also down 10-20%."

The reason for this: the double whammy of the ongoing commodity crunch as well as the collapse in fixed income trading, coupled with the lack of major moves across the FX space where the biggest beneficiary, now that bank manipulation cartels have been put out of business, are Virtu's algos.

To be sure, if Jefferies - which as we previously reported suffered one of its worst FICC quarters in history, and actually posted negative revenues after massive writedown on energy holdings in its prop book - is any indication, Morgan Stanley's Q3 forecast may be overly optimistic.

For the full 2015, the picture hardly gets any better: "In 2015, we see industry revenues going sideways - slowing after a strong Q1. Overall we see FICC down ~3% on 2014, Equities up ~8% and IBD down ~6%. Overall we expect top line revenues to be flattish in 2015. In constant currency, it would be a little better for Europeans. But below this, there is a huge competitive battle afoot as all firms vie for share to drive profits on the cost base."

 

At $20 bilion in FICC Q3 revenues, this is on pace to be the second worst quarter for banks in the past 2 years.

Looking at Dealogic data, MS notes that debt capital markets (DCM) revenues are down 15% y/y and 27% q/q with y/y weakness across the board except for BNP and BARC where DCM revenues rose 36% and 31% y/y respectively.

In equities, it's even worse: "ECM revenues are down across the industry in 3Q15 according to Dealogic with an average of -51% y/y and 55% q/q."

On a bank by bank basis, Morgan Stanely (which excludes itself from this exercise for obvious reasons), expected the biggest trading revenue declines at JPM at -17%, with other TBTF US banks, GS, BAC and Citi posting, -9%, -6% and -6% drops respectively:

We are forecasting a challenging Q3: with FICC down 10-25%; IBD down 10-25% and Equities up ~5% for many of the banks. See below.

The detailed breakdown:

Some more details from MS on the Q3 industry breakdown:

Our proxies suggest that Q3 FICC trading proxies remain weak q/q for rates, credit and FX. Y/Y looks more mixed with FX up and rates and credit mostly down. IBD revenues look weak y/y and q/q, based on Dealogic data.

 

Morgan Stanley's bottom line: consensus is far too bullish. "On EPS, we are 4% below consensus on average across our coverage in 2015e and 5% below in 2016e. The biggest delta is for BARC, BNP and GS in 2015e (all -15% vs. consensus), and Soc Gen, HSBC and BNP in 2016e (-33%, - 13% and -12% vs. consensus, respectively)."

Why is this important? Because as we noted before, "as a very "grim" earnings season unfolds, all eyes will be on this company" the company in question: Bank of America, whose earnings can mean the difference between the baseline EPS estimate, and one which is 1.4% lower.

On the other hand, with the dramatic central bank intervention in the only FX pair that matters, the USDJPY, which has sent the S&P soaring by some 100 points in less than a week as bad news is once again great news, and with the market already "pricing in" a very weak Q3 earnings season, perhaps a total collapse in EPS is precisely what the multiple expansion bots ordered. Because if bad economic news are great for stocks, that terrible news for stocks should be even greater... for stocks.