In what is shaping up to be a big week of bank earnings, Morgan Stanley (NYSE: MS) delivered its Q3 report on Oct. 14, comfortably beating analyst expectations on the headline numbers. However, as with Citigroup Inc. (NYSE: C) the day before, the market sold off the stock.
Morgan Stanley shares fell 2.7% in the Oct. 14 session, leaving them at around $180, where they had begun the year after a 20% slide from July’s high. For a headline beat, that is a chilly reception, and it points to a familiar tension in how the major banks are being judged this quarter. Like many of its peers in recent days, Morgan Stanley’s results looked strong on the surface, but the underlying fundamentals gave investors reason to pause.
So just how good was the quarter beneath the headline, and what do the results say about where the stock goes next?
The Wealth Engine Did Its Job
The best of the quarter came from the part of Morgan Stanley that is supposed to be boring, and that may be the most reassuring thing in the whole report. Its wealth management arm pulled in record revenue of roughly $9 billion while gathering more than $230 billion of net new client money, much of it the fee-based flows that keep paying year after year.
This is the heart of the bull case as we head into the final few months of the year. For a long time now, Morgan Stanley has been reshaping itself from being a cyclical trading house into a fee-driven wealth manager, and a quarter like this shows the strategy working. The more of its earnings that come from steady advisory and management fees, the less the wider business should be exposed to the market’s changing moods.
A Beat That Leaned on Trading
Look closer, though, and the quarter was less tidy than the headline, or solid wealth management results, suggested. A big slice of the strength came from equities trading, a notoriously fickle business that happened to boom last quarter, while fixed-income trading slipped and investment-banking fees barely grew. While it feels good when it lands like this, the snag is that a trading boom is the least reliable kind of beat there is, and can’t be trusted to repeat itself.
There were softer edges elsewhere, too. Profitability eased back from an unusually strong prior quarter, the firm tucked away more against potential loan losses, and a larger share of revenue went toward employee compensation. None of it was alarming, but together it made the beat look more cyclical, and less durable, than the top line implied.
That’s why a seemingly strong quarter still sent the shares lower. The market has no doubt that Morgan Stanley can beat when trading conditions are good; it just wants more proof that the wealth business can carry the load when trading inevitably cools.
How It Stacks Up Against the Pack
It will be some comfort, but perhaps not much, to investors that Morgan Stanley was far from alone in being sold after earnings. It’s been a consistent theme, with equities desks and dealmaking running hot, fixed income running cold, ordinary lending holding steady, and the reserves that banks keep against bad loans edging up. And shares are selling off regardless of how strongly results beat expectations.
For all the fuss, however, the longer-term case hasn’t changed, and may even have strengthened. A record wealth management quarter and a flood of new client assets are exactly the kind of results the long-term bulls will have wanted to see, and with the stock back to flat for the year, much of the summer’s froth has likely been shaken out.
The Upside Potential Is Still Strong
At the same time, the stock still holds a Moderate Buy consensus, and even the cautious voices see upside: TD Cowen reiterated a Hold last week with a $210 target, while UBS stuck with a Buy and a punchier $236.
Both targets sit comfortably above the $180 where Morgan Stanley shares traded after their post-earnings drop, and suggest the market may have been too quick to mark down a quarter that was, underneath it all, rather good.
The risk, as ever, is that the trading tailwind fades before the rest of the business can fully pick up the slack, and the stock isn’t yet priced as if that will happen. But for investors willing to look through near-term uncertainty, Morgan Stanley just reminded them why its long-term story is worth backing.