Morgan Stanley Leads Banks Lower After Downgrade

NEW YORK (TheStreet) -- Morgan Stanley (MS) led large-cap bank stocks lower on Thursday, with shares sliding 3% to close at $30.21.

The broad indices all ended lower following a huge upward revision of third-quarter U.S. gross domestic product growth by the Bureau of Economic Statistics to an annual rate of 3.6% from the previous estimate of 2.8%.  Economists polled by Thomson Reuters on average had expected the second GDP growth rate estimate to come in at 3.0%. 

The GDP growth rate increased from 2.5% in the second quarter, however, the news was not all positive, as "Real personal consumption expenditures increased 1.4 percent in the third quarter, compared with an increase of 1.8 percent in the second," according to the Bureau of Economic Statistics.

Also on Thursday, the Department of Labor said initial U.S. unemployment claims for the week ended Nov. 30 declined by 23,000 from the previous week to 298,000.  Economists on average had expected jobless claims to total 329,000.

The KBW Bank Index (I:BKX) was down 1% to 66.47, with all but two of the 24 index components ending with declines.  In addition to Morgan Stanley, large-cap banks seeing significant share-price declines included JPMorgan Chase (JPM), which was down 2.4% to $55.80, and Citigroup (C), which gave up 1.9% to close at $51.06.

In the midst of a two-year bull run for the U.S. stock market, investors are skittish over the prospect of a significant increase in long-term interest rates when the Federal Reserve begins to curtail its "QE3" purchases of long-term U.S. Treasury bonds and agency mortgage-backed securities.  The bond purchases have been running at a net pace of $85 billion a month since September 2012. 

Most economists were surprised when the Federal Open Market Committee cited conflicting economic data when it decided in September not to begin "tapering" the bond purchases.  Since then, the partial shutdown of the federal government du! ring the first half of October and an increase in the U.S. unemployment rate to 7.3% in October from 7.2% in September seemed to make near-term tapering unlikely.  But the steady flow of positive data this week could be raising investors' fears that the a decline in central bank bond purchases could be announced after the FOMC next meets on Dec. 17-18. 

But the FOMC is likely to continue to see conflicting economic data, according to Sterne Agee chief economist Lindsey Piegza, who wrote in a note to clients on Thursday that because third-quarter GDP growth mainly reflected an increase in inventories, while consumer spending growth slowed, "overzealous production last quarter is likely to severely contract from the current quarter's growth."

"Given the fragile consumer sector and tepid business investment end of the year growth is unlikely to push above 2%," she wrote.

The continued reduction in unemployment claims, together with the report fon Wednesday rom Automated Data Processing that private U.S. employers added 215,000 jobs during November, shed light on the Federal Reserve's main policy tool.  This is not QE3, but rather the short-term federal funds rate, which has been stuck in a historically low target range of zero to 0.25% since late 2008.

While many investors fear the disruption of a rise in long-term rates and falling bond prices that are likely to follow a tapering of the Fed's bond purchases, most bankers are licking their chops when considering the parallel increase in interest rates that will occur when the federal funds rate finally begins to rise.

The FOMC has said its "highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens."  The committee had previously said it could be appropriate to raise the federal funds target rate when the unemployment rate falls below 6.5%, but Federal Reserve Chairman Ben Bernanke has said the rate target could remain unchanged for some time, even after that milestone is achieved.

"[O]ur bias is that short-term rates won't rise as soon as some expect-possibly until following the 2016 US elections," Deutsche Bank analyst Matt O'Connor wrote in a note to clients on Wednesday.

Morgan Stanley

Morgan Stanley's shares have staged a mighty recovery, rising 59% this year, following a 28% return during 2012.  The shares trade for 1.1 times their reported Sept. 30 tangible book value of $26.96, and for 11.9 times the consensus 2014 earnings estimate of $2.53 a share.  The consensus 2015 EPS estimate is $2.97. 

Please see TheStreet's earnings coverage for Antoine Gara's detailed coverage of the boost to Morgan Stanley's bottom line brought about by the company's assumption of 100% ownership of its former retail brokerage joint venture with Citigroup.

As part of his advice to investors to cut risk in advance of the QE3 tapering, and in light of continued headline risk from regulatory actions such as the finalization of the Volcker Rule expected next week, O'Connor on Wednesday cut his rating on Morgan Stanley to "hold" from "buy," while lowering his price target for the shares to $30 from $31.

O'Connor also cut his rating for Citigroup to "hold" from "buy," while lowering his price target for citi's shares to $56 from $61.

The following chart shows the year-to-date stock performance for Morgan Stanley and Citigroup, as well as the KBW Bank Index and the S&P 500 :

data by YCharts

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-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email. Follow @PhilipvanDoorn

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.