Drilling Under Common Sense

 | Aug 27, 2012 | 1:00 PM EDT  | Comments
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When something in the stock market seems like common sense to me, it makes me worry. I will tend to think: "Wow, this outcome is too easy to call. Why haven't others sniffed this surefire way to make money out, too?" After researching companies, industries, and the markets, I have learned this much: Should anything look to be a cakewalk, that's reason enough to head back to the drawing board.

However, I will say that the outlook for retail brokerages, such as Schwab (SCHW) and E-Trade (ETFC), are not that enticing. Common sense that is hitting me in the face includes:

  • Trading volumes have not been this low since September 2007. Nobody at home is acting after watching that ridiculous Charles Schwab commercial. This means those companies are not earning the measly fees that they have come to expect in a land of machines.
  • Trading volumes are about 30% lower in August compared with the five-year average. Hmm, it sounds as if portfolio managers are being cautious with client money while they are on vacation.

There is basic common sense. Still, one could challenge it with the fact that Schwab has garnered a strong amount of new total client assets in July -- 11% year over year, to be exact, and up 1% from the prior month. That will have positioned the company well if stocks climb into the end of the year, as volume will rise with more people want to catch rising stock prices.

At E-Trade, meanwhile, has flashed a sign of hope: The average revenue trade metric is on the mend amid a July month-on-month increase that surpassed rivals and improved relative to prior months.

I will break with rule of thumb and take the side of common sense on calling this sector. In addition to the risk to future earnings from a move lower in stock prices to close the year, which would likely leave many retail investors on the sidelines, this could also damage the advisory portions of these businesses that are essential to padding profit margins. Look at it from the perspective that declining stock prices leave corporations unwilling to utilize cash to buy out targets, as stock prices would be seen as not bottoming. That, in turn, reduces a need for advisory services.

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