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Thursday, 16 April 2015 00:00

The Pop Media Is In Love With Goldman Again, Probably Because They Don't Read The Fine Print Featured

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If you do a Google search in Goldman's latest quarterly earnings, it looks something like this:

Goldman earnings google search Q1 2015 -1

Dudes!!! Don't you guys read the fine print?

There are two sides to investing, risk and reward. It seems all too often that everyone just wants to see the reward part - risk be damned! Yes, Goldman had a slam bang quarter in a raging equity market (low volatility) with lots of M&A activity. Yet, as volatility increases, Wall Street prop desks suffer. At first, its the risk metrics that crack, then often you see the nominal returns follow suit. Goldman is no different. It has been shown, historically and empirically, that prop desks choke in periods of high volatility.

Goldman Sachs Q3 Forensic Review Page 01

The volatlity in the tea leaves is.... significant. The ECB has gotten all Japo-Americana on us as they push QE and negative interest rates to the moon and back causing their banks' businesses to distort. Equities don't count as worldwide ZIRP and NIRP propel stock prices no matter what the hell the fundamentals are. This is NOT sustainable! I will explore this further in another article. Long story short, try to calculate DCF where the D is negative! Let's take a closer look at those portions where there was evident volaility. From the earnings page:

Net revenues in Fixed Income, Currency and Commodities Client Execution were $3.13 billion for the first quarter of 2015, 10% higher than the first quarter of 2014, due to significantly higher net revenues in currencies and interest rate products, partially offset by significantly lower net revenues in credit products, commodities and mortgagesDuring the quarter, Fixed Income, Currency and Commodities Client Execution operated in an environment generally characterized by higher volatility levels, which contributed to higher client activity levels, particularly in currencies and interest rate products, and improved market-making conditions compared with the fourth quarter of 2014.

Translation: We made 10% more in FICC (Fixed Income, Currency and Commodities) by taking advantage of clients who were getting muppeted by the spreads we charged (improved market-making conditions) when the Swiss did their thang (higher volatility levels)! We got caught holding significant inventory and exposure in oil as it plummeted, BTW (offset by significantly lower net revenues in credit products, commodities). I know that Reggie Middleton dude did explicitly warn us that oil was about to plummet on August 14th (or about 50% ago), but we don't listen those cutting edge FinTech dudes! And what the hell is Veritaseum, anyway? By the way, rumor has it that FX brokers who would have used it would have avoided that Forex negative equity thingy, and all solvency concerns related to it.

Delving a Little Deeper Into the Numbers... Since the Pop Business Media Won't Do It, I Will...

I have stated several times in the past that the much worshipped Goldman Sachs rarely earns its cost of capital. The many MBAs that bust their hump to get into the intern program there apparently haven't applied their financial analysis and valuation lectures to Goldman's operations. Let's delve into history (c. 2009):

GS return on equity has declined substantially due to deleverage and is only marginally higher than its current cost of capital. With ROE down to c12% from c20% during pre-crisis levels, there is no way a stock with high beta as GS could justify adequate returns to cover the inherent risk. For GS to trade back at 200 it has to increase its leverage back to pre-crisis levels to assume ROE of 20%. And for that GS has to either increase its leverage back to 25x. With curbs on banks leverage this seems highly unlikely. Without any increase in leverage and ROE, the stock would only marginally cover returns to shareholders given that ROE is c12% - on a fundamental, risk adjusted basis. Then again, who adjusts for risks, right??? Even based on consensus estimates the stock should trade at about where it is trading right now, leaving no upside potential unless we have material multiple expansion, and that should only happen on fundamental basis if risk is reduced. That is, of course, if investors still bother with fundamentals!

16112 a

Guess who just hit $200 this morning! I wonder - really wonder, how... Alas, apparently no one pays attention to this stuff but me. I need to get a life, no? Let's reminisce some more about Goldman's (Off) Balance Sheet. Contrary to popular belief, it does not appear that Goldman is a superior risk manager as compared to the rest of the Street.

15902 b

Of course that was then. How about now? Well, let's take a more forensic view of Goldman's most recent earnings as taken directly from the earnings page - Spoiler alert! I was as right 5 years ago as I am now - Goldman had to ratchet up risk in order to hit $200 per share again):

Goldman earnings google search Q1 2015

This is Goldman's stock since I wrote that from above. I see it as a chart of unbridled risk - and return...

goldman chart

Those who read the tea leaves the way we do, and who see additional volatility in the future may want to go against the crowd on this one - or with the risk adjusted return math. Over time, these numbers always return to mean...

 GS vs euro volatility chart

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