Read It Here First: Half of Wall St. Profits Are Gone (So Far)

Last year, we looked at the issue of risk adjusted gains for the S&P500, and most especially for the Financial sector.

At the time, Financials were the largest sector in the S&P500, and had what were described as legitimate, sustainable, normalized risk-based earnings. Since then, we have learned that their earnings were anything but. And, they are no longer the largest S&P500 sector, having been supplanted Technology in Q2 2008.

Societe Generale’s Jame Montier notes that, even with the loss of leadership, financials remain an exceptionally large component of the market
itself. As the chart below shows, today’s 17% of market cap may be well
off the high of nearly 25% but remains a long way above the levels
before this bubble started:

US Financials as a Percentage of Market Cap


chart courtesy of Societe Generale, Investor Insight


Note the correction in Financials in 1987, 2000 and then again in 2007-08. The gains in these big run ups appear particularly vulnerable — much more so than the rest of the market. These are likely a function of the 35X leverage employed.

Note also that a good part of the rise over recent decades has been fueled on assumptions about risk that turned out to be incorrect. The NYT discusses this:

"Only a year ago, Wall Street reveled in an era of superlatives: record deals, record profit, record pay. But a mere 12 months later, nearly half of the profits that major banks reaped during that age of riches have vanished.

The numbers are staggering. Between early 2004 and mid-2007, a period of unprecedented wealth on Wall Street, seven of the nation’s largest financial companies earned a combined $254 billion in profits.

But since last July, those same banks — Bank of America, Citigroup, JPMorgan Chase, Lehman Brothers, Merrill Lynch, Goldman Sachs and Morgan Stanley — have written down the value of the assets they hold by $107.2 billion, gutting their earnings and share prices. Worldwide, the reckoning totals $380 billion, much of which reflects a plunge in the value of tricky mortgage investments."

The write-downs are ongoing, and if we are to believe what the Philly Banking Index — now making multi-year lows — is implying: We are not nearly through this.

That chart above also reflects the US moving from an industrial economy to
a services based one. The underlying question is how much mean
reversion will happen as deleveraging occurs and risk management returns to normalized levels.


graphic courtesy of NYT


S&P500 ex-Risk ? (November 2007)

Odd Data Point: Tech Passes Finance in SPX (May 2008)

Nearly Half of Wall St. Bank Profits Are Gone
NYT, June 16, 2008

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What's been said:

Discussions found on the web:
  1. Marcus Aurelius commented on Jun 17

    I’m glad that no one is depending on ROI on their stock holdings for retirement income.

    That would be terrible.

  2. Marcus Aurelius commented on Jun 17

    And an edit to the headline:

    Read It Here First: Half of Wall St. Profits Are Gone, so far.


    BR: Done!

  3. Jim Haygood commented on Jun 17

    “The gains in these big run ups appear particularly vulnerable — much more so than the rest of the market. These are likely a function of the 35X leverage employed.”

    Back when the U.S. was more of an industrial economy, cyclical stocks such as autos, mining and chemicals were notoriously tied to the economic cycle. They tended to receive a valuation haircut, comapred to steady growers such as consumer staples and tobacco, which were thought to be more recession-proof.

    With 35 times leverage, the financials are even worse than the old heavy cyclicals. One jolt in the credit cycle, and bang! — four years of earnings gone. Almost reminds you of the airlines, don’t it? Allegedly, they’ve never earned a cumulative profit since the Wright brothers flew.

  4. d commented on Jun 17

    BR, I’m not sure I understand the importance of the exhibit showing financial’s growing as a % of S&P market cap. I’m guessing the buggy whip industry’s % to market cap it at an all-time low. Does not the growth in financial’s as a % of corporate profit simply reflect the growth in services in today’s global economy?

  5. G commented on Jun 17

    I am in the bear camp- however, dont you see a similarity between CNBC, Bloomberg, Wall Street Journal, US Govt economic spokespersons and those working in the early 1930’s Ministry of Propaganda???

  6. Gary commented on Jun 17

    With the financials earnings wipe-out, it would be interesting to see if the asset/headcount ratio has adjusted, or is yet to adjust with a 3rd or 4th wave of layoffs.

  7. JP commented on Jun 17

    The first graph is interesting: What happened in 1970 to change the growth rate of financials?

  8. hans commented on Jun 17

    what happened in ’68-71??

  9. VennData commented on Jun 17

    Two steps forward, two steps back

  10. michael schumacher commented on Jun 17

    That LEH was able to get away with the outright lies it called an earnings report yesterday is criminal. Dick Fuld should be ashamed (as well as the rest of these pricks) for continually putting on the happy face in spite of reality.

    I guess no one else saw that PPI is up to levels of demand destruction as well…..but as long as Goldman can still get information fed to it all is well…

    I am surprised that we have not seen any chatter about “security issues” for these people since they are the root cause of many losing jobs and homes (may be not as many homes but certainly jobs)

    Goldman lays off how many and it’s already in it’s 10-Q but LEH issues 143m shares and it leaves that out of it’s “report”……

    Sad that most do not know that write-down’s are being done with the full intention of writing it right back up. Truth in accounting left the building long ago.

    Sad era we live in that it is allowed to continue all in the name of an election.


  11. Mark E Hoffer commented on Jun 17

    JP & hans are asking the Interesting Question..

    I find it compelling that that rise commenced after the Financial System succeeded in removing the, remaining, Silver from circulation. And, that timeframe coincided with the, arguable, Top in American Manufacturing dominance..

    Also, differently, these cats:
    admit to kicking in, in ’73.

    Along that line, anyone not reading:
    should cut out the middleman and buy a Cane..

  12. DownSouth commented on Jun 17

    There is something perverse with a society that values its productive sectors less than its financil sector. Isn’t there something in the Bible about money changers in the temple?

    Anyway, if we are going to get back to anything resembling a healthy, productive economy, technology and energy need to rise further and the financial sector still has a long, long way to fall.

  13. hans commented on Jun 17

    perhaps the end of bretton woods had something to do with it?

  14. dblwyo commented on Jun 17

    Bravo – I think we’re seeing the very earliest days of a major re-think of the Finance Industry’s Business Models – a multi-part, cumulative survive of which is stored in this archive:
    FinInd profits a % of total corporate profits showed a steady rise in the ’80s and an acceleration in the ’90s but didn’t jump to unprecedented heights until after the Tech Bust. Which suggests that if we return to safer levels of leverage that major changes at the deepest level are just beginning to be worked out. Bottom indeed.

  15. Mel commented on Jun 17

    Let’s see if I have this straight–bonuses are rewards for past earnings, earnings disappear, bonus are kept. Is there an incentive to play it straight?

  16. LLBatlanta commented on Jun 17


    You bring up an interesting observation (GS vs. LEH). I wonder if the terms of LEH’s offerings included full-ratchet provisions (hence, death spiral financing) and hence no mention in their ‘report’.


  17. Francois commented on Jun 17

    And a 2nd edit to the headline: (:-D )

    Read It Here First: Half of Wall St. Profits Are Gone, so far; 100% of losses socialized to the Fed.

  18. Larry commented on Jun 17

    how about putting up a same chart for energy and materials?

  19. v commented on Jun 17

    Blogosphere-wise your blog buddy YS over at Naked Capitalism posted about this yesterday. So, technically, read it there first.

    In any case, great minds think alike.

    And, what MS sed. Esp about PPI, I mean WTF, did anyone mainstream notice? Prolly not, lol.

  20. Ziggurat commented on Jun 17

    What about the old SIC classification FIRE — finance, insurance, and real estate?

    I would also not a couple of other things….first, about half the retail banking is now concentrated in the largest 10 names. There is some scale in ATM networks, etc. One of the things that we may be seeing is that banking was much less centralized and with consolidation is now part of the s&p 500. Hence, at least a few percent of the long term change is related to that.

    Secondly, the country is richer and private pensions have been replaced by 401k’s, etc. This would take a large chunk of assets and move them from industrial corporations to financial firms.

    Finally, investment banks are ground zero in this and it would be hard to argue that they are coming back. What does it look like if we just get rid of them.

    Having said all that, it looks like financials need to revert closer to their historical norms.

  21. Dave, Canada commented on Jun 17

    gee, will Stan O’Neal give back 154% of his 2004-2007 bonuses?

  22. William Yates commented on Jun 18

    Here’s what happened in ’72 — listed put options.Yeah, that’s right, listing put options had the effect of reducing market volatility, because speculators didn’t have to trade stock. That made the market more valuable, hence the rise in financials.

    The cure to all this is so simple, but yet remains beyond our reach. Let’s establish a date when all option transactions must be made thru a listed exchange. Trading derivatives on exchanges eliminates most, if not all, of the counterparty risk. Remember, it’s not the gun that kills, it’s the person wielding the gun.

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