SAN FRANCISCO (MarketWatch) -- The credit market rally still has legs and that could support the big fixed-income businesses of Goldman Sachs and Morgan Stanley, Brad Hintz, an analyst at Bernstein Research, said Wednesday.
Goldman shares climbed 2.4% to $177.08, while Morgan Stanley gained 3.2% to $30.29 in afternoon trading Wednesday.
Goldman Sachs and Morgan Stanley are among the financial sector's top performers Wednesday on signs the fixed-income rally that's fueled big earnings in recent quarters still has legs. MarketWatch's Alistair Barr reports.
Junk bonds and other risky debt have surged in the past year as near-zero interest rates in the U.S. helped stabilize the economy and sent investors hunting for higher yields.
Read about the latest credit market mini-boom.
Goldman /quotes/comstock/13*!gs/quotes/nls/gs (
GS 177.56, +4.66, +2.70%) and Morgan Stanley /quotes/comstock/13*!ms/quotes/nls/ms (
MS 30.18, +0.82, +2.79%) have large fixed-income market-making businesses that benefit when investors trade a lot in these markets. Trading operations also benefit from very low short-term interest rates and higher long-term rates - known as a steep yield curve.
"For U.S. securities firms, we believe March data supports a case for the extension of the bond market rally, as further steepening of the Treasury yield curve provides an opportunity for traders to benefit from funding at 0% rates to earn positive net interest," Hintz wrote in a note to investors.
Merger and acquisition activity was still pretty weak during the first quarter and equity sales and trading was also relatively lackluster. That makes results from the Fixed Income, Currency and Commodities, or FICC, units of Goldman and Morgan Stanley even more important.
"As the first quarter of 2010 closed, evidence of cyclical headwinds on investment banking and equity sales & trading revenues in March tempered earnings expectations for these businesses and once again set the stage for a focus on FICC as the wild card for earnings growth in the quarter," Hintz wrote.
The recent fixed-income surge has sparked concern that credit markets may have rallied too much, especially as borrowing by the U.S. government picks up.
"The overhang of Treasury issuance has put upward pressure on long-term domestic bond yields," Hintz said. "Bears see this development as a harbinger of the end of the fixed income cycle. Based on their reasoning, interest rates will soon rise, yield curves will flatten and with this, FICC trading revenues will fall."
However, Hintz reckons rock-bottom short-term interest rates will still encourage investors to look for more yield in riskier and longer-term debt.
"In the long term, U.S. rates will drift higher with growing Treasury debt issuance, central banks will finally tighten rates and bond trading will become less attractive," the analyst wrote.
"But in the mean time, there remains a tremendous amount of liquidity looking for a home...With interest rates anchored at a zero, positioning new investment positions at the short end of a yield curve still represents a significant opportunity cost to fixed income portfolio managers."
There are also signs that the "second part" of the brokerage cycle -- mergers and acquisitions and equity underwriting -- may kick in soon, Hintz added.
Equity capital markets volumes and M&A mandates have climbed this year, versus 2009 and Bernstein expects announced M&A will climb 35% in 2010 and continue growing in 2011.
"These two high-margin businesses have powerful effects on performance beyond their direct revenues," the analyst wrote. "M&A transactions typically trigger underwritings, loan syndications and further corporate actions."
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