Now, JPMorgan Chase & Co.  (NYSE: JPM) has issued a report suggesting that investment-banking returns on capital will be sharply down over the next few years. Perhaps this will be only a moderate downturn.

However, there’s also a good chance that labor-cost pressures – combined with tightening margins – will take the likes of JPMorgan and Goldman Sachs Group Inc. (NYSE: GS) down a path similar to that of General Motors Corp. (NYSE: GRM) and Chrysler Group LLP, both of which earlier this year declared bankruptcy.

Challenging Headwinds

JPMorgan anticipates that the regulatory changes that are likely to take place over the next year or so will reduce investment banks’ return on equity (ROE) to around 11% – down from its previous forecast of 15%.

More capital will be needed for trading activity, which naturally reduces the return on capital from that activity. However, there will also be effects from new transparency requirements on derivatives. (Most – if not all – derivatives will have to be traded and cleared across central exchanges.) And tighter limits on commodities positions will prevent firms from cornering less-active markets.

This effect will be concentrated on investment banks themselves – firms such as Goldman Sachs and Morgan Stanley (NYSE: MS) – as well as on the investment banking activities of such firms as Credit Suisse Group AG (NYSE: CS), Deutsche Bank AG (NYSE: DB), Citigroup Inc. (NYSE: C), and JPMorgan Chase.

Old-fashioned commercial banking, on the other hand, will likely become somewhat more profitable. That’s because the sharp reduction in securitization activity has reduced the excessive competition for much of the lending business. It’s also improved the lending business profitability.

Investment banks will have to reduce their headcount by another 3% from present levels and cut their overall cost per employee by another 15%, to around $543,000 in 2011, according to the JPMorgan study.

What agony! (Actually, that joke is not quite fair – the cost per employee includes the building, the equipment and all the fancy information services, so the take-home is much less. Even so, these guys – at least those who keep their jobs – won’t starve.)

The New Reality

We are so used to investment banking growing and becoming increasingly more profitable – on virtually an uninterrupted basis – that we have never even considered what might happen if that trend were to reverse.

Even after last year’s crash, Goldman Sachs reported record second quarter profits in 2009. Spreads in all kinds of trading widened dramatically and Goldman found its market share dramatically increased after the demise of Lehman Brothers Holdings Inc. (OTC: LEHMQ).

But here’s the thing: The trillions of dollars poured into the markets by the U.S. Treasury Department and the U.S. Federal Reserve were the driving force behind those profits. Investment banks like Goldman weren’t just given a level playing field – they were given one that was essentially (and artificially) cleared of obstacles. Even the few “competitors” that remained were hobbled by their past mismanagement.

Investment banking is not particularly difficult or intellectually challenging. And the proliferation of new and complex products that turbocharged the profit growth of investment banks during the past few decades won’t continue. Any new financial product will be forced to run a gauntlet of regulatory bureaucrats before being allowed to emerge.

Had the credit-default swap (CDS) been invented today, can anyone doubt that it would have been fenced in by restrictions so onerous that the damaging derivative would have never made it to market? The painful memories of last year’s near-unraveling of the global financial markets are still fresh. So it’s unlikely that investment banks would be able to get the regulatory nod for a big-risk strategy that is likely to result in a taxpayer bailout.

The bottom line is clear: The reduction in U.S. investment banking profitability is likely to be permanent, with various rent-seeking scams blocked. In this post-crisis era, investment pools from China, the Middle East and other parts of Asia – backed by increasingly sophisticated financial players in those markets – will acquire the necessary capabilities to enter the market and further reduce the returns of domestic investment banks.

We have seen this before: An industry, previously very profitable, finds itself hemmed in by government restrictions and its most-profitable products get regulated out of existence. Foreign competition enters the market and grinds away at the domestic market share.

The natural reduction of competitors doesn’t happen, as one or more are bailed out by taxpayers and survive to continue competing for the business.  Legacy costs of remuneration promises made when things were better place an ever-increasing burden on the industry’s returns. Reducing the work force pay becomes very difficult, as the workers have great power over production and resist the necessary downsizing of their excessive pay.

Sound familiar? Last time, it was the U.S. auto industry, and the eventual result was the bankruptcy of GM and Chrysler. Reducing pay to a work force when market conditions become harsh is extremely difficult, if now downright impossible.

Of course, investment bankers have no United Automobile Workers (UAW) representing them. But shareholders will know from past experience that the investment-banking work force’s ability to suck up available profits is huge, whereas losses suddenly devolve back on shareholders.

Don’t forget, militant autoworkers could only beat up “scabs” when their livelihood was threatened. Militant traders could re-jig the computer systems so that the trading algorithms worked backwards, producing losses instead of profits. In an era of credit default swaps and millisecond trading, this could wipe out shareholders in half an hour of frantic activity before anyone realized what had gone wrong in an era of credit default swaps and millisecond trading.

It may take a couple of decades for the investment banking business to decline, as it did for the much larger U.S. auto industry. But by 2030, collapse could loom.

The comparison isn’t a stretch. In fact, it wasn’t just a ticker-symbol letter – “G” – that  the two companies shared: GS for Goldman Sachs, and GM when General Motors was still a public company. It turns out that their underlying business models also shared similar strategic flaws. And those flaws put the two on a similar path to ruin at the hands of forces that grew out of the crises in their particular industries – crises that they each helped create.

Source: Could Goldman Sachs Share GM’s Fate?

The stock is still a far cry from its record-high level of $83.56, but is only 0% below its 52-week high of $53.46.  Much has changed since then, as the U.S. auto industry is no longer producing the 16 million cars it produced in 2007, nor the 13 million it managed to sell last year.  This year we are looking at some 10 million units sold, according to J.D. Power and Associates, the leading forecaster in the industry.

But there is encouraging news:  The very quick restructuring of both General Motors Corp. (NYSE: GRM) and Chrysler Group LLC, the U.S. Federal Reserve’s efforts to stabilize the financial markets, and the U.S. government’s fiscal stimulus plans have helped keep the economy from falling into a depression.  The Fed’s support for the auto industry included buying auto receivables under the Term Asset-Backed Securities Loan Facility (TALF) program, in order to restart this type of securitization.

Therefore, the paralysis of sales that we saw late last year, when the financial system froze and there was no financing available, has subsided and sales are increasing.  In fact, J.D. Power expects U.S. vehicle sales to increase to 11.5 million units next year, a full 15% pickup from projected 2009 levels.

In fact, we are already seeing an increase in auto sales already, thanks in no small part to the government’s Car Allowance Rebate System (CARS), popularly known as “Cash for Clunkers.” So far, CARS has spent some $1.29 billion and Congress has expanded the original $1 billion authorization by another $2 billion.

Total light vehicle sales for July were just shy of 1 million units, a milestone the industry hasn’t topped since August 2008, mostly due to the program’s success.

This shot in the arm on the back of the general cost restructuring that Ford Motor Co. (NYSE: F) is carrying out under Allan Mulally has already prompted Ford to increase production of its Focus model.

Similarly, Chrysler has reported that it is running two plants in overtime and a third shift at another plant just to keep up with demand.  And GM, which is seeing a huge rebound in sales, will add to this by increasing advertising spending and selling new cars on eBay Inc.’s (Nasdaq: EBAY) popular online auction Web site. Most of Wall Street is in “wait-and-see” mode, which gives us more of an incentive to jump in.  But the steel story is not just about cars.

Nucor will not only profit from the remaining $1.75 billion to be deployed through the government’s cash for clunkers program and the general improvement in market conditions, but on the pick-up in government construction in the United States that will result from U.S. President Barack Obama’s massive fiscal stimulus.

Additionally, the company will benefit from the already massive stimuli being deployed in China, Brazil, India and Russia.  And let us not forget Europe, where the European Central Bank will soon consider raising its benchmark lending rate to 1.25% from its current record low of 1% in order to prevent inflationary expectations from building up.

China will achieve more than 8% growth this year, driven by public spending, especially in construction and a strong pickup in auto sales  (up 63.6% in July from a year earlier) and domestic appliances.  All of these have a very high content of steel.

Similarly, India’s gross domestic product (GDP) will grow by more than 6%, barely down from last year’s 6.7% expansion. Auto sales in India jumped 18% last month.  Remember that India’s Tata Motors Ltd. (NYSE ADR: TTM) launched the cheapest car in the world last January and this is likely to work wonders in today’s budget-conscious market.

So what about Nucor itself?

The company reported a second quarter loss of $133 million, which improved over the first quarter’s $189 million loss.  But the key is that volumes are already turning around.

Volumes increased 11% in the second quarter, which allowed the company to increase its capacity utilization from 45% to a still very low 46%.

And this is where the upside lies.

In capital-intensive industries like steel, the very high fixed costs induce very large swings in profits, depending on volumes.  And not only did Nucor see its volumes pick up in the second quarter, the trend should continue accelerating in the third quarter and beyond, thanks to the recent burst in car sales and increased government infrastructure spending.

In addition, prior to the cash for clunkers program, Nucor announced it already expected to see an improvement in its third-quarter results. The company said that many of its customers had run their inventories too low and would need to replenish them just to meet demand.

So, at reporting time, investors could be very positively surprised by Nucor and many other companies in the sector, which will provoke many analysts to increase their stock targets.

And to make the whole story even better, we are counting on increasing inflationary expectations and a weaker dollar, which will continue to drive portfolio managers to hedge this risk in commodity stocks.

That means Nucor, which has been bumping into strong resistance levels since the beginning of January, but making higher lows in every subsequent correction, is likely to break out of its current range with an explosive rally before it even reports third-quarter earnings.

Nucor stock closed down 92 cents, or 1.93%, Friday at $46.79 a share.

Source: Nucor Corporation Will Get Is Due for a Boost from Government Spending

“These are not ordinary circumstances, in the midst of a financial crisis and a recession allowing the U.S. auto industry to collapse is not a responsible action,” said President Bush, who made the final decision to move ahead with the bailout after Senate Republicans last week balked at passing a House-approved rescue of the auto companies.

“Chapter 11 is unlikely to work for the American automakers at this time,” he added.

The $13.4 billion will be taken from the Troubled Asset Relief Program (TARP). GM and Chrysler will then get an additional $4 billion in February.

However, both companies are being forced to accept a number of conditions that include limiting executive pay, reducing debt obligations, and striking new agreements with the United Auto Workers union that bring employee wages and benefits down to levels that are more competitive with those of foreign-based automakers working in the United States.

The companies will also provide the government with warrants for non-voting stock, and federal officials will examine all of the companies’ financial statements. The government has the authority to block any transaction of $100 million or more.

The government’s debt will have priority over all other debts, and if the two automakers fail to demonstrate financial viability by March 31, the loans will be called and the money returned. That’s a tall order for GM and Chrysler, which are faced with plummeting sales and a harsh economic environment.

GM, the nation’s largest automaker, has suffered roughly $73 billion in losses since 2004, and its U.S. sales are down 22% this year, Bloomberg News reported. The company said earlier this month that light vehicle sales plunged 41% in November, dropping to 153,404 vehicles from 261,273 during the same month a year ago.

Chrysler sales were off 47% last month and down 28% through the first 11 months of the year. The company yesterday (Thursday) announced that it would close all 30 of its North American manufacturing plants for four weeks. GM followed suit temporarily closing 20 factories.

“I’ve been in this business since the time of Lee Iacocca and all the bad times we went through in the 1980s were nothing compared to this,” Tim Finegan, owner of a Chysler dealership told The Associated Press. “But for now, our lights are still on and our bills are paid, so you just show up every morning and say maybe today will be a little better.”

Source: White House Approves $13.4 Billion in Loans for GM and Chrysler