Wall Street banks are AI stocks now

Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Good morning. A lively day in markets yesterday — including a 25 per cent haircut for IBM — was a welcome distraction from the war in the Middle East. But the conflict didn’t take the day off. The US and Iran are “striking selected sites that signal how each is willing to raise the stakes as they battle to control the strait [of Hormuz]”, the FT reported. Brent crude is parked above $80, and we’re starting to think $90 could be the next stop. Email us: [email protected].

Wall Street banks

Four of the five big Wall Street banks reported yesterday: JPMorgan Chase, Bank of America, Citigroup and Goldman Sachs (Morgan Stanley chimes in today). The numbers were outstanding, as one would expect in a quarter when markets whipped around and big deals were done. In aggregate, equity and debt trading revenue at the four hit $38bn, up more than a third from a year ago and 60 per cent higher than two years ago. Investment banking fees, at $10bn on the quarter, have grown almost as much.

The stocks have had a tremendous run. Goldman, Morgan Stanley and Citigroup have all more than doubled in the past 24 months. Goldman is more or less a market pure play; Morgan Stanley adds a sizeable wealth management business which is also levered to share prices. Citigroup is a slightly different story. Its healthy Wall Street operations are attached to a somewhat misshapen diversified bank that is in recovery mode.

Meanwhile, JPMorgan and BofA have large commercial and consumer banking operations in addition to their Wall Street operations. They have risen less dramatically — but still beat the S&P 500.

Our colleagues over at the Lex column have made exactly the right point about Wall Street’s bonanza: it is a side-effect of the AI boom. It is AI that has markets churning and drives capital-raising. The banks are another example of the false “broadening” of the stock market that has also driven up industrial and utility stocks in the past few years. All these sectors have lived, and could die, with AI.

Stock pickers with bubble worries may be tempted to take profits in the Wall Street pure plays, Goldman and Morgan Stanley, and shift towards the three more “universal” banks. Goldman and Morgan Stanley’s price/book valuations doubled, after all:

This attempt at diversification would be a wasted effort. A big reversal in the AI trade would not just take a hammer to investment banking and trading revenues. It would wreck credit quality in commercial banking and shrink client assets in wealth management units. Falling short-term rates, courtesy of the Federal Reserve’s efforts to stop the bleeding, would take a bite out of net interest margins. It’s not too much of a generalisation to say: the big banks are a straight AI play now.

Soft CPI

June’s cool CPI inflation report is good news for anyone hoping that the Federal Reserve won’t raise rates. But it probably isn’t as good as it looks. The sharp fall in CPI inflation is, as chair Kevin Warsh might put it, an echo of history. History in this case was that brief window in which we believed the Iran war was over and the Strait of Hormuz had reopened. It’s not clear that’s true today.

The headline annual rate came in at 3.5 per cent, down from 4.2 per cent in May, and the month-over-month rate went negative. The deceleration was driven by falling energy prices, especially petrol. But the falls in core goods and services categories were significant too. Core CPI fell month-over-month, bending the longer-term rolling averages downward:

Markets are still expecting almost two quarter-point rate increases by April of next year, and the conventional take is that yesterday’s data bought the Fed more time. Raising rates at the July meeting was always a long shot, but there’s clearly a hawkish pivot under way on the Federal Open Market Committee — and not only because of Warsh’s arrival. Governor Chris Waller on Monday drew his line in the sand at core PCE inflation persistently above 3 per cent; Goldman Sachs forecasts that yesterday’s print will bring core PCE down to 3.3 per cent. It will take more than one cool inflation report to take those rate increases out of the forecast for good.

One good read

Small caps!

FT Unhedged podcast

Can’t get enough of Unhedged? Listen to our new podcast, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.