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The Worst Stocks for 2010: Goldman Sachs

Morgan Housel
January 21, 2010

Oscar Wilde once said, "We are all in the gutter, but some of us are looking at the stars." I've always liked the quote because it reminds us that when things look darkest, the odds of improvement are brightest.

When it comes to Goldman Sachs (NYSE: GS  ) , I'd flip that quote around and say "When you're walking blindfolded on the edge of a roof, that gutter is just one step away."

Investing is a game of probabilities. You want to invest when the odds of winning outweigh the odds of losing. As Goldman sits on the very top pedestal of success, it's not hard to imagine that the odds of declining are being outweighed by the odds of uninterrupted euphoria. Here are two big reasons why.

1. Iceberg, dead ahead
I've belabored this point, but it's an important one: Goldman's success over the past year came from fixed-income trading. These profits aren't solely based on Goldman's talent, but on a yield curve sent from the banking gods above. Plenty of other banks, such as JPMorgan Chase (NYSE: JPM  ) , Citigroup (NYSE: C  ) , and Bank of America (NYSE: BAC  ) , have enjoyed similar success in this area, but few notice because credit card and real estate losses have overshadowed windfall fixed-income profits.  

Here's what's important: Short-term interest rates are as low as possible right now. They're at zero. They can only go up. When that happens, profit will start to get squeezed out of the fixed-income machine as short-term borrowing costs rise.

Some may counter that a rise in short-term rates will come only when the economy rebounds, and that rebound will be accompanied by gains in investment-banking revenue. This is true. I once believed that it was a bullish catalyst myself. But it's almost irrelevant when you consider that 48% of revenue last quarter came from the segment that houses fixed-income trading, versus just 7% from investment banking.

Bottom line: This is probably about as good as it gets for Goldman's main money machine. And just like with real estate in 2006, you should run for your life when it feels the best.

2. That faint scream you hear in the distance is Barney Frank getting angry
Consider this little nugget from the financial reform bill recently passed by the House of Representatives: "If the Board determines that propriety trading by a financial holding company subject to stricter standards poses an existing or foreseeable threat to the safety and soundness of such company or to the financial stability of the United States, the Board may prohibit such company from engaging in propriety trading."