Morgan Stanley's E*TRADE Deal Could Signal Long-Term Top

Morgan Stanley (MS) will buy E*TRADE Financial Corporation (ETFC) for around $13 billion in stock, adding over 5.2 million accounts to the company's customer base of 3 million. The firm will now handle assets of over $3 trillion while gaining exposure to a less affluent retail demographic. Morgan Stanley CEO James Gorman crowed about the deal, telling CNBC it was "ridiculous" that E*TRADE stock was trading under book value during the summer of 2019.

Despite his enthusiasm, the news has unnerved shareholders, who have watched Morgan Stanley underperform Wall Street rivals since the 2008 economic collapse. Many sold the news aggressively on Thursday, dropping the stock nearly 5%. It is trading even lower in Friday's pre-market, testing the 50-day exponential moving average (EMA) for the first time in a month. More ominously, the decline has unfolded at a 20-year old trendline of lower highs, raising the odds that the stock has topped out for this economic cycle.

Two headwinds may be contributing to post-news selling pressure. First, the all-stock transaction will dilute current shares, forcing the company to find economies of scale to offset the lower value of each share. Second and more importantly, E*TRADE stock plummeted with other discount brokers in October 2019, forced to match The Charles Schwab Corporation's (SCHW) zero commission initiative. Many analysts believe that discount brokers will have a tough time booking profits going forward.

The timing of the acquisition also poses risks because financial transactions tend to rise in bull markets and sink in bear markets. The current economic expansion has now entered its tenth year, well beyond a typical four- or five-year cycle. Morgan Stanley hopes to capitalize on online banking as well as brokerage transactions in the coming years, but as shareholders discovered in 2002 and 2008, this sector is highly vulnerable to an economic downturn.

MS Long-Term Chart (1994 – 2020) (Log Scale)

Chart showing the share price performance of Morgan Stanley (MS)

The stock entered a powerful uptrend after breaking out above resistance near $10 in 1995, lifting to an all-time high at $91.31 in the fourth quarter of 2000. Committed bears then took control of the ticker tape, generating a steep and persistent downtrend that found support in the mid-$20s in October 2002. The subsequent bounce posted healthy gains during the mid-decade bull market, reversing at the .786 Fibonacci sell-off retracement level in the mid-$70s in 2007.

A garden-variety correction accelerated into a near-death spiral in the second half of 2008, breaking 2002 support before ending just 17 cents above the 1994 low. The recovery unfolded in three broad waves, reversing within three points of the .786 retracement of the 2008 to 2009 bear market decline in March 2018. A sell-off through mid-year found support in the upper $30s, yielding a recovery wave that has now reversed within two points of the 2018 peak.

Hidden Trendline

This logarithmic-scale chart reveals a declining highs trendline going all the way back to the 2000 high, with rallies into 2007 and 2018 reversing right at this formidable barrier. The bounce into 2020 has now added a fourth point to this dangerous line, warning investors that the stock may have topped out for this economic cycle. Given the pattern's enormous size, it makes sense for sidelined investors to avoid this stock like the plague until there's a breakout into the mid-$60s.

The monthly stochastic oscillator is also flashing a warning sign, lifting into the most extreme overbought reading in three years and crossing into a downturn that will set off a major sell signal when the blue line drops through the 80% level. However, this indicator isn't useful for short-term timing, so current shareholders may wish to maintain positions as long as price action holds above the rising highs trendline in place since 2008.  

The Bottom Line

Morgan Stanley's E*TRADE acquisition could signal a long-term top for shares of the old-school financial institution.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.

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