Goldman's Golden Trading Goose Lays An Egg, Stock Looks Fairly-Valued At Best

Lloyd Blankfein's firm was no master of the universe this past quarter
Goldman Sachs is a leading global investment banking, securities and
investment management firm that provides a wide range of financial
services to a substantial and diversified client base that includes
corporations, financial institutions, governments and high-net-worth
individuals. It competes with Morgan Stanley, JPMorgan Chase, Credit
Suisse, and UBS.

We estimate that bonds, currencies & commodities trading constitute
around 37% of our $167 price estimate for Goldman's stock, with
equities trading accounting for around 17%. Our price estimate is
roughly inline with the current market price.

*Trading Under Pressure*
Of the financial bellwethers, the picture has been mixed so far as
JPMorgan reported strong earnings but Citigroup missed on account of
poor trading revenues. Citigroup blames tight credit spreads which is
due in part to a historically flat yield curve and loose monetary
policy which makes trading more difficult for many fixed income
traders. (See "Declining Fixed Income Revenues Could Spell Downside
for Citigroup Stock"). In addition to this, fixed income trading has
been down.

While Goldman is the gold standard in the trading business, with its
fixed income, currencies and commodities trading division one of the
most profitable in the industry, the macro environment has a been
difficult one for trading in the last half of the year.
Given Goldman's reliance on its trading and market making business,
many feel that Goldman will be one of the banks most impacted by the
Volcker rule.

The trading assets for bonds, currencies and commodities increased
from $220 billion in 2005 to $320 billion in 2007 but then fell to
$270 billion in 2009 due to the economic downturn. With the economic
recovery in swing, we expect it to gradually increase to around $300
billion by the end of our forecast period. However, the regulatory
issues and volatile trading environment may provide downside risk to
our estimates. If the trading assets for bonds, currencies and
commodities falls to around $240 billion by the end of our forecast
period, it would mean around 7% downside to our current price estimate
for Goldman's stock.

*Special Offer:* *Next Inning Technology's Paul McWilliams
recommended EZchip as his best pick for 2010 and it gained 122%.
What's on his buy list for 2011? Click here for the gory details on
more than six dozen tech stocks in _Next Inning Technology

*_Overhangs in the Open Now, Could Lead to Upside_*
However, the financial sector appears to be in much better shape
entering 2011 than 2010. Not only is the macro economic picture much
better but many of the regulatory unknowns that served as an overhang
are now at least out in the open. We expect that banks like Goldman
Sachs and Morgan Stanley, that depend more on trading and investment
banking for revenues will be forced to adjust their operations with
the rulings out there in the open.

As an example, both Morgan Stanley and Goldman Sachs are looking to
spin off units of their proprietary trading business, and Goldman is
changing its reporting structure to increase the transparency of its
proprietary trading business. These factors could add some visibility
to the stocks and help both the banks and their investors focus on
other issues than government regulations.

The yield on trading assets for bonds, currencies & commodities has
been following an increasing trend historically with the only
correction being in 2007 and 2008 due to the economic downturn. We
expect the yield on trading assets for bonds, currencies &
commodities, which was nearly 9% in 2009 to follow a decreasing trend
reaching 5% towards the end of the Trefis forecast period. If the
decrease is less than we expected 6% by the end of our forecast
period, it would mean around 7% upside to our current price estimate
for Goldman's stock.

* JP Morgan Downgrades Goldman Sachs on Volcker Rule [↩]