————————————————————————————————

Monthly Discussion

Merrill Lynch

If there is one company that can be used as a proxy for the entire NYSE, it is perhaps Merrill Lynch. It is one of the world's leading financial management and advisory companies with offices in 43 countries and total client assets above $1 trillion, a record it broke in 1997.

I have chosen four different ways of looking at Merrill Lynch over the last ten years in order to anticipate its near future. I carefully avoided such things as revenues and profits, because these indicators are easy victims of “creative” accounting practices and would not justify the use of natural growth curves. I have also corrected all $ figures for inflation so as to look at real growth.

Exhibit 3 shows the evolution of the company’s total assets. Here the growth proceeded in two well-defined steps, which coincide with major acquisitions/mergers of Merrill Lynch such as Mercury Asset Management in 1997 and Herzog Heine Geduld, the third-largest NASDAQ market maker in 2000. A third growth step is altogether possible in the future, but otherwise there is no growth in sight.

Exhibit 3. The evolution of the company assets of Merrill Lynch in constant 2002 dollars. We distinguish two completed growth steps.

Exhibit 4 shows the growth of book value per share. The growth process here has followed a single S-curve over the last ten years and was 92% completed by 2002. Major events such as 911 and the two acquisitions mentioned earlier, interfered minimally with the natural growth pattern.

Exhibit 4. The evolution of book value per share for Merrill Lynch in constant 2002 dollars. The growth process over the last ten years is presently 92% completed.

Exhibit 5 shows total stockholder equity. This growth process has followed a pattern very similar to that in Exhibit 4 (perhaps not surprising). The natural-growth process was 94% completed by the end of 2002.

Exhibit 5. The evolution of stockholders’ equity at Merrill Lynch in constant 2002 dollars. The S-curve is presently 94% completed.

Finally Exhibit 6 shows total client assets, a variable that put the limelight on Merrill Lynch in 1997 when it broke the 1-trillion-dollar mark. Fitting an S-curve on these data revealed that the growth process has overshot its ceiling and subsequently declined. This is a pattern often encountered with non-cumulative indicators (remember the population of rabbits on a range, their number overshoots the range’s capacity before some rabbits begin to starve.) Total client assets should “naturally” grow back toward the equilibrium position of about $1.6 trillion, but no steady growth beyond that point.

Exhibit 6. The evolution of total client assets at Merrill Lynch in constant 2002 dollars. The natural-growth process (purple line) indicates the eventual equilibrium position.

There is a mental discontinuity in inferring that NYSE will follow the future of Merrill Lynch. There is another mental discontinuity in inferring that future growth of Merrill Lynch is bleak just because there is no remaining growth potential in the four variables analyzed above. S-curves are known to cascade, and new curves can be expected to take over from the old ones over the next ten years. Furthermore, there can be overshoots, as Exhibit 6 demonstrates. Yet, within all the uncertainties of these two mental steps, there is no evidence in my analysis at this point for imminent growth.

The one word of advice, therefore, in view of the market’s recent bullish trend is caution.