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I Wish Trading Profits Meant More Than They Do

By:

Chief Strategist at Interactive Brokers

Earnings season is now upon us, with financial stocks leading the way.  Yesterday we saw JP Morgan (JPM) rally in the morning before giving back many of its gains later in the session, and as of this morning we are seeing a similar pattern from Goldman Sachs (GS).  In both cases, the companies were able to beat market expectations thanks to strong performances by each of their trading divisions, and in both cases traders were able to profit by selling at or near the market opening and covering those sales a few hours later.  As someone who spent most of his career as a proprietary trader, I’ve learned that investors usually do not reward companies when trading profits bolster the bottom line.

There is a rationale for this, however.  Trading profits in one quarter can turn into losses in the next.  It is rare that skillful bank trading operations routinely post wildly divergent performances – their solid risk management and robust sales and trading franchises typically keep these divisions in the black – but they provide more variable revenue streams than most other parts of a multifaceted financial institutions.  Analysts like to see steady growth with little variability.  The nature of the trading business does not fit that model, making it less preferable to industry and portfolio analysts.

Money is money, and it is highly fungible by nature.  Yet investors care how it is earned, not just whether it is earned.  That is why the behavior that we saw this week from JPM and GS is relatively normal.  Those who react to the size of a major financial company’s earnings beat need to consider its source.  If the rationale for a solid earnings from a major bank stems from its basic business like commercial and mortgage lending, the stock’s performance on earnings day tends to be more lasting than if the trading desk made the money.

Yes, as a lifelong trader this dichotomy bothers me.  But as a trader I learned to identify and exploit patterns.  There is a pattern to markets undervaluing bank trading profits, and sometimes it presents opportunities for traders and investors alike.

JPM: 2 day chart, July 14-15

JPM: 2 day chart, July 14-15

Source: Interactive Brokers Trader Workstation

GS: Intraday chart, July 15

GS: Intraday chart, July 15

Source: Interactive Brokers Trader Workstation

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

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