Bank on wealth management for high margins

Serious Money: I've spent much of my career gently mocking the apocalyptic pessimism of Stephen S Roach, the chief economist of Morgan Stanley. As it happens, he is an extremely charming fellow and not prone, as far as I can tell, to a depressive personality. But for as long as I can remember, he has, with just one or two notable exceptions, been a prophet of doom, writes Chris Johns

Despite this, it has been possible to be a fan of Steve for one simple reason: he is almost unique amongst the dismal profession for the clarity of his opinions. We never find him saying "on the one hand. . .".

His literary style is as polemical as it is clear: combinations of market drivers are always "lethal", imbalances inevitably "unsustainable", speed of movement invariably "unprecedented", and future events are often likely to be "disconcerting".

He is the doyen of the bears: in the words of a recent - now ironic - article in the International Herald Tribune, he is the chief executive of the "perma-bears".

So, imagine my consternation, last week, when Steve changed his tune. The focus of his concerns - low US savings, massive balance of payments deficits - remain the same, but he is now optimistic about their resolution.

One of the peculiarities of the investment research game is that getting it wrong rarely seems to do much damage to career prospects. Perhaps that's because most of us do get it wrong and hope always springs eternal.

Or perhaps we remember failure more easily than success. Most analysts will claim that all they can ever do is get it right some of the time: if the hit ratio is higher than 50 per cent, then they are adding value, helping investors to make more money than they lose. Fortunately for those of us in the recommendation game, few audits are ever done, let alone published - although there are one or two signs that this is changing.

Hence, there is no publicly available assessment of Steve's track record. But his reputation for bearishness probably means that he has got it wrong quite often.

And it is reasonable to ask whether his recent adoption of a cheerful demeanour is, in fact, a classic contrary indicator. Stock market history is littered with analysts who capitulated just before their long-held views were finally vindicated. Has Steve thrown in the towel only now to see the world economy collapse, taking stock markets with it?

Personally, I doubt it. But that just makes me a biased optimist. As a matter of fact, I sense that many other commentators are moving in the opposite direction: it is quite fashionable right now to be pessimistic about stock market returns through the course of the rest of the year.

The more high-profile technical analysts in particular, the ones who rely on spotting patterns from price charts, are getting quite bearish. My own, admittedly jaundiced, view is that much of this stems from the view that markets have gone up for three years now, and a correction is therefore due. A sort of what goes up must come down view.

For those few of us who think that stock markets can continue to press ahead, an obvious question is "which sectors?" Will it simply be a momentum play, which will see those stocks that have done well already continue to rise? Or will leadership be taken up by a new bunch of names?

I think that the next few months will see a change. So far this year, in Europe at least, mining and engineering stocks top the performance league tables.

Mining shares - BHP, Xstrata - are probably the most vulnerable to a correction: notwithstanding the ongoing favourable supply/demand background for commodities, there is clearly more than a hint of speculative excess.

People are quite often surprised to learn that engineering companies - Alstom, Man AG, Atlas Copco, Sandvik - have done as well as mining this year. These latter shares have probably done their thing for now.

So which big sector could take up the running? My bet is on financials in general and banks in particular.

So far, the European banking sector has performed more or less in line with the overall market.

The main headwind for bank share prices has been the interest rate environment: rising bond yields are traditionally argued to be bad for banks.

Historically, this is true, up to a point at least. But I suspect that rising interest rates will not be as bad for bank profits as they have been in the past.

The more important thing is that the operating environment for banks is improving dramatically.

From the simple business of making loans to the neglected area of wealth management, we can see great strides being made.

Banks that make money looking after the interests of wealthy individuals should do particularly well as there is a secular growth story going on that the market is, in my view, missing.

The business of wealth management, unlike traditional asset management, is a high-margin business and is growing very rapidly.

There are lots of reasons for this, including the obvious one of more economic growth. But this is the first time in centuries that Europe has not managed to destroy most of its wealth in a war.

Today, assets are being passed on rather than being blown up, and banks that know how to help with this process are going to do very well indeed (some are a lot better than others).

Chris Johns is an investment strategist with Collins Stewart. All opinions are personal.