Capital Markets

We posted this on Monday. With the SCOTUS ruling due out in minutes, here again is a preview of the various permutations that can come out today, and their impact on capital markets: "BofA outlines five possible scenarios and their potential impact across the healthcare sectors. They base the likelihood of their scenarios on a review of the March oral arguments, previous circuit court decisions, as well as surveys of legal experts and former Supreme Court clerks. Everything you need to know about the possible outcomes and actions to take."

What goes down, must shoot right back up. In this case we are talking about Spanish bond yields of course, which have yoyoed from a record 7.3% two weeks ago, back down to 6.3% last week, and right back up over 7% as of this morning. While the hope last week was that since the ECB is expanding its collateral it means an LTRO3 is on the way, the market promptly realized (even before LTRO3 was launched), that such a step means that Europe has run out of actual assets, and at this point is merely diluting the taxpayer collateral base. The result is that Spain is right back in purgatory where talk is cheap and unless Europe comes up with something concrete, purgatory will promptly be upgraded to the 8th circle of hell.

For the past six months we have extensively discussed the topics of asset depletion, aging and encumbrance in Europe - a theme that has become quite poignant in recent days, culminating with the ECB once again been "forced" to expand the universe of eligible collateral confirming that credible, money-good European assets have all but run out. We have also argued that a key culprit for this asset quality deterioration has been none other than central banks, whose ruinous ZIRP policies have forced companies to hoard cash, but not to reinvest in their businesses and renew their asset bases, in the form of CapEx spending, but merely to have dry powder to hand out as dividends in order to retain shareholders who now demand substantial dividend sweeteners in a time when stocks are the new "fixed income." Yet while historically we have focused on Europe whose plight is more than anything a result of dwindling cash inflows from declining assets even as cash outflow producing liabilities stay the same or increase, the "asset" problem is starting to shift to the US. And as everyone who has taken finance knows, when CapEx goes, revenues promptly follow. Needless to say, at a time when still near record corporate revenues and profit margins are all that is supporting the US stock market from joining its global brethren in tumbling, this will soon be a very popular point of discussion in the mainstream media... in about 3-6 months.

It takes a lot of talent to do so much with so little.

Just because ZIRP is so 2009 (and will be until the end of central planning as the Fed can not afford to hike rates ever again), the ECB is now contemplating something far more drastic: charging depositors for the privilege of holding money. Enter NIRP, aka Negative Interest Rate Policy.

Hours ago, in addition to making Cypriot sovereign bonds no longer eligible as collateral at the ECB, the European Central Bank also announced something that received less attention, namely that its balance sheet rose by €31 billion in the past week (due to an increase in the MRO) to a new all time record high of €3.058 trillion. In other words, even as the Fed's balance sheet continues to be flat, or is even modestly declining, the ECB continues to pick up the monetary slack with all new fiat ending up to benefit the US capital markets. Now as frequent readers know, this latest shift in the relative size of the two critical CB balance sheets also means something else: that the fair value of thje EURUSD implied purely on balance sheet correlation, a relationship that historically worked perfectly, yet in recent months has broken down due to the market's conviction that more QE is coming any minute now, is now just above 1.16, or just shy of 900 pips lower from here.

“Pessimism has become tiresome, so optimism is gaining a foothold”

If there is one bank report that Obama wishes is absolutely wrong it is the following note from Deutsche Bank's Jim Reid (definitely not part of the bank's laughable Trinity Of Perma Bull consisting of Bianco, Chadha and, of course, La Vorgna) who, looking at the timing of business cycles, makes the following ominous, for both the economy and Obama's reelection chances, prediction: "If this US cycle is of completely average length as seen using the last 158 years of history (33 cycles) then the next recession should start by the end of August." The only saving grace for the president: since the advent of centrally-planned markets, nothing is as it used to be, and the business cycle no longer exists ("JP Morgan Finds Obama, And US Central Planning, Has Broken The Economic "Virtuous Cycle""). Still, maybe, this is the one last trace of free capital markets that the Fed has (so far) been unable to totally destroy. We are confident it will get right on it.

GS just did what it does best: pulled the rug from under its most troubled peer: "We are downgrading MS to Neutral and removing shares from the America’s Conviction List. Since being added to the Americas Conviction List on January 29, 2012, MS shares are down 27% vs. flat for the S&P 500. Over the past 12 months, MS shares are down 39% vs. the S&P 500 up 4%. When we added shares to the Conviction List, we noted that MS had addressed a number of legacy issues including (1) the conversion of the MUFG preferred stock to common to bolster common equity capital ratios, (2) elimination of the CIC preferred dividend, (3) removal of the MBIA relationship//hedge overhang, (4) write-down of legacy real estate assets, (5) elimination of non-core asset management businesses, and (6) near-completion of the  integration of Smith Barney and Morgan Stanley Wealth Management. While that all still holds true today and should be beneficial towards long-term “normalized” returns, we believe several capital market overhangs will reduce out-year earnings visibility and cap near-term outperformance. While too soon to tell how counterparties will react to a new capital market ratings distribution post-Moody’s, this cycle has proven that banks with the largest increase in funding spreads have generally lost fixed income trading market share. In addition, with a number of global macro uncertainties likely to weigh on capital markets activity for the foreseeable future, MS has outsized exposure here as well....we are lowering our 12-month price target for MS to $16 (from $20) based on 0.6X TBV (from 0.7x) to reflect challenged near-term earnings power."

Capitalism at its best: kick 'em while they're down.

• On the continuing fraud that is Liebor: Libor Guardians Said to Resist Changes to Broken Rate (Bloomberg)
• Bank bailout to spark firesale of corporate Spain (Reuters) with Goldman and China just waiting
• EU Could Rewrite Eurozone Budgets (FT) but it won't because Germany will just say Nein again
• Congress Said to Delay Automatic Budget Cuts Until March (Bloomberg)
• China Says June Trade Improving in Sign Slowdown Stabilizing (Bloomberg)
• Biggest U.S. Banks Curb Loans as Regional Firms Fill Gap (Bloomberg)
• New York Fed Sells $4bn in Mortgage Debt (FT)
• Julian Assange’s fall from the heavens (Reuters)
• Wheeler to Lead N.Z. Central Bank as Kiwi Hits Exports: Economy (Bloomberg)
• Japan Lower House Passes Sales Tax Bill as Vote Divides DPJ (Bloomberg)

While everyone's attention was focused on details surrounding the household sector in the recently released Q1 Flow of Funds report (ours included), something much more important happened in the US economy from a flow perspective, something which, in fact, has not happened since December of 1995, when liabilities in the deposit-free US Shadow Banking system for the first time ever became larger than liabilities held by traditional financial institutions, or those whose funding comes primarily from deposits. As a reminder, Zero Hedge has been covering the topic of Shadow Banking for over two years, as it is our contention that this massive, and virtually undiscussed component of the US real economy (that which is never covered by hobby economists' three letter economic theories used to validate socialism, or even any version of (neo-)Keynesianism as shadow banking in its proper, virulent form did not exist until the late 1990s and yet is the same size as total US GDP!), is, on the margin, the most important one: in fact one that defines, or at least should, monetary policy more than most imagine, and also explains why despite trillions in new money having been created out of thin air, the flow through into the general economy has been negligible.

Last week, Europe was the source of transitory euphoria on some inexplicable assumption that just because the continent has run out of assets, and the ECB has no choice but to expand "eligible" collateral to include, well, everything, things are fixed and it is safe to buy. Today, it is the opposite. Go figure. Call it pre-eurosummit burnout, call it profit taking on hope and prayer, call it Brian Sack packing up his trading desk (just 5 more days to go), and handing over proper capital markets functioning to a B-grade economist, or best just call it deja vu all over again.

The Euro 2012 football competition has entered its elimination stages. According to Citi's Matt King - one of the few respectable strategists out there - the elimination round has also arrived for the other EURo. There is still hope, but it is rapidly fading, and every additional half-baked, semi-efficient "resolution" only confirms the skepticism of the ever-increasing crowd of naysayers: summits, summits, and more summits, all the while nothing changes, and the German population: the only source of any European stability, is becoming increasingly belligerent toward the entire European experiment. The other problem: we are now in the first session of extra time. So even as Germany inches ever closer to winning it all in the European football arena, will the tradeoff be a loss for everyone else who now relies exclusively on German benevolence? A few days ago, David Marsh, writing "Don’t count on Germany’s economic surrender" in the FT, made just this point. And he is right. Yet the capital markets, after nearly throwing in the towel on Spain last week, have rebounded strongly giving some hope that this time something may be different. It won't be. King explains.

Draw a Wall Street paycheck long enough and you will work with an amazing spectrum of personalities.  Today’s note from Nic Colas (of ConvergEx) is an homage to his past coworkers in the form of some offbeat comments that have stuck in his memory over the past 25 years on the Street (and will ring true to anyone who has spent more than a day on a trading floor).  On the psychology of money management: “Last year we made $360 million and lost $330 million."  On the importance of language in positioning an investment story: "The company’s revenues aren’t unpredictable; they are just chunky.”  And our favorite, from long ago: "Who cares if most money managers underperform.  They all seem to have big houses and pretty wives."  No, not all these quotes are exactly "Politically correct", but they all represent some useful truths about investing and capital markets.

Here we come:

• MOODY'S CUTS 4 FIRMS BY 1 NOTCH
• MOODY'S CUTS 10 FIRMS' RATINGS BY 2 NOTCHES
• MOODY'S CUTS 1 FIRM BY 3 NOTCHES
• MORGAN STANLEY L-T SR DEBT CUT TO Baa1 FROM A2 BY MOODY'S
• MOODY'S CUTS MORGAN STANLEY 2 LEVELS, HAD SEEN UP TO 3
• MORGAN STANLEY OUTLOOK NEGATIVE BY MOODY'S
• MORGAN STANLEY S-T RATING CUT TO P-2 FROM P-1 BY MOODY'S
• BANK OF AMERICA L-T SR DEBT CUT TO Baa2 BY MOODY'S;OUTLOOK NEG

So the reason for the delay were last minute negotiations, most certainly involving extensive monetary explanations, by Morgan Stanley's Gorman (potentially with Moody's investor Warren Buffett on the call) to get only a two notch downgrade. And Wall Street wins again.