Morgan Stanley

Earlier today some blog pulled up some factual data that suggested that Morgan Stanley had $39 billion in total exposure against French banks at the end of 2010, up $30 billion from the year prior, and enough to wipe out its entire market cap and then some should French banks be pulled under. Sure enough, the stock tanked even though as CNBC pointed out "there was absolutely no news." Since then, first Credit Suisse defended Morgan Stanley for its "European exposure" (we wonder how long before Morgan Stanley returns the favor and has to defend Credit Suisse for its US exposure: judging by Credit Suisse's maximum outlier 3M USD Libor rate, not too long). And now it is bank #2's turn, in this case Alliance Bernstein, whose conclusion is that "we estimate that total risk to France and its banks is less than $2 billion net of collateral and hedges." Ah yes, collateral and hedges, which, lest we recall incorrectly, did miracles when Lehman blew up and the very fabric of net hedging offset was threatened when the viability of the initiator in the "gross" CDS chain was put into question (thank you AIG). Naturally, if and when the 3 Big French banks go down, everyone will be perfectly normal and have no problem netting of hedges. Naturally. As for the coup de grace in the AB report, it is this piece of rhetorical brilliance: "Over the last six months, there have been 5,600+ articles published by the press on the subject of "French Banks" and "Credit Risk". We believe Morgan Stanley's risk management staff and its trading units are fully aware of the highly publicized risks emanating from Europe and warnings about the firm's potential exposure to a European Sovereign crisis." And there you have it: just because everyone is aware the bank is doomed, means the bank is ok. See, this is nothing like the logic that comedy entertainment icons such as Cramer and Dick Bove used to endorse Bear and Lehman days before both imploded. Then again, the downside for AB to actually tell the truth is substantially higher (as in contagion which takes down the entire banking system, AB included), than the upside from, well, prevaricating. As for abovementioned blog, we are just waiting for the third bank to come to Morgan Stanley's defense to know it was 100% correct.

With French banks now a daily highlight in the market's search for the next source of contagion, and big, multi-syllable words such as conservatorship and nationalization being thrown about with increasingly reckless abandon, perhaps it is time to consider the downstream effects of a French bank blow up. And we are not talking French sovereign troubles, which are about to get far worse with the country's CDS once again at record highs means the country's AAA rating is as good as gone. No: banks, as in those entities that are completely locked out from the dollar funding market, and which will be toppled following a few major redemption requests in native USD currency. Which in turn brings us to...Morgan Stanley, the little bank that everyone continues to ignore for assumptions of a pristine balance sheet and no mortgage exposure. Well, hopefully we can debunk one of these assumptions by presenting the bank's Cross-Border Outstandings, which "include cash, receivables, securities purchased under agreements to resell, securities borrowed and cash trading instruments but exclude derivative instruments and commitments. Securities purchased under agreements to resell and Securities borrowed are presented based on the domicile of the counterparty, without reduction for related securities collateral held." We'll leave it up to readers to find the relevant number.

And so the Twist spin (pun and all that) begins after Morgan Stanley's Jim Caron tells clients that OpTwist will remove "more duration risk than expected." He says that the operation will remove more than $500 billion in 10 Year equivalents of duration risk from the market, which is far higher than the firm's expectations, and adds that he was "most aggressive on the street" saying the consensus was for $300 billion in 10 Yr equivalents, especially with QE2 removing $490 billion in 10 Yr equivalents. Well, Jim, the problem is that you are right about bonds - when it comes to Twist a lot of it was priced in, but judging by the 30 year reaction, not all. However, when it comes to stocks, the robots had been expecting not just Twist but a significant LSAP component, potentially up to $1 trillion. Which explains the unwind. And as for the opportunity cost of Twist, it is shown in the chart below. As SMRA just predicted, the average maturity on the Fed's balance sheet is about to soar by 33%, from 75 months to an all time record 100 months. This means the Fed goes all in on being able to control rates. Should the Fed have to print, and it will before long, at that time the Fed's interest rate risk will be unprecedented, and should it lose control, it will lose not only that, but all credibility it is capable of keeping something, anything, be it inflation, unemployment or price stability, under control. Then, it will be truly time to panic.

While Goldman continues to resolutely predict that the EURUSD will any minute now go back to 1.50 (and 1.55 in 12 months or so), Morgan Stanley has for once decided not to ape its far more capable and client "fornicating" competitor Goldman and has thrown up all over the EUR, slashing its EURUSD forecast "significantly lower"  to 1.30 by year-end and 1.25 in Q1 2012, before stabilizing in the second half of next year because the now second rate bank believes that "economic, political, constitutional and monetary policy developments in Europe have now become more challenging for the EUR, while international support is likely to decline." Its conclusion: "As a result, the EUR's attraction as an alternative reserve currency is likely to be reduced." So, let's do the math: EUR: not a reserve currency? Check.  CHF: not a reserve currency? Check (and pegged to the former). USD: about to be gang banged by the windowless corner office at the Marriner Eccles building housing America's central planners? Check. So.... what is left if one is looking for a reserve currency?

Morgan Stanley continues to demonstrate just how badly it lags Goldman. While the vampire squid is mostly known for sending its employees to run such places as the US Treasury, the New York Fed and the ECB (in 2 short months), Morgan Stanley has to be content with the inverse, i.e. hiring former Fed apparatchicks, in this case former long-time Fed advisor Vince Reinhart, who among other things is best known for collaborating with Ben Bernanke on discovering that Operation Twist does not work, and, of course, proposing the currently overt Treasury manipulation operation (for those times when QE is not sufficient) which involves selling puts on Treasury futures (link).

Everything you always wanted to know about the future of gold stocks and much more is now answered in this 79 page monster of a report just released by Morgan Stanley, which finally joins the crowd and goes megabullish on gold stocks, by estimating that "currently c.$1500/oz of value is accounted for in reserves in the ground – so, at a $1800-1900/oz gold price, this leaves $400-500/oz for stakeholders, of which shareholders come last (after debt servicing and tax/royalties). While this is a blunt tool, we do believe it provides a good illustration how the sector has historically discounted the spot gold price, but currently does not seem to believe that the current $1800/oz gold price will hold. Thus, we believe an opportunity exists to invest in reserves in the ground rather than bullion (ETF)." So for those who do not wish to chase bullion at record prices (although with currency collapse increasingly imminent, that is probably not a lot), here is MS' conclusion: "Broadly, on stock performance we would make the case for:  i) primarily, operating delivery; hence, which stocks look to offer value in their reserves through volume growth and cost reduction. ii) secondly, in the extremes of gold price movement, operating gearing can, but generally does not, supersede operating delivery; theoretically, higher operating gearing generally implies lower quality assets associated with difficult cost/volume control, hence our caution in looking at operating gearing in isolation from operating delivery and track record. iii) thirdly, valuation (but need to adjust for regional risk factors, by-product discount to rating, track-record and risk of delivery). Apparent valuation anomalies can rapidly be erased by big movements in the gold price or failure to deliver to operational expectations. Stocks screening favourably  on a balanced gold price outcome (and rated OW by Morgan Stanley analysts) include ABG, ABX, BVN, PMTL. While several of the growth stocks (RRS, KGC, GG) screen less well, delivery on the operating expectations would likely be positive stock drivers." Of course, as much as we like gold and its derivatives, Morgan Stanley's outright push is nothing short of an attempt to get investors to move away from physical into a stock certificate deliverable (and hence, "confiscatable") which is ultimately in the hands of the DTC: something, which, with the world on the edge of complete insolvency, we would hardly advocate.

Morgan Stanley is currently holding a call in which the firm's strategists, led by Adam Parker and Greg Peters, will be presenting their latest investment case for global equities. Sure enough, coming from Morgan Stanley the call will have a decidedly bullish tone to it, but maybe, just maybe, the firm will finally realize that as the 30 year "Great Moderation" winds down and reverts to its mean, there are other, less favorable outcomes on the horizon. Then again, this being Morgan Stanley, we doubt it. Regardless, the 52 page accompanying presentation is attached, and those who wish to dial in should just drop a line to their favorite Morgan Stanley snake oil salesman.

While we often pick on Morgan Stanley's Jim Caron (the same guy who year after year after year keeps predicting the yield on the 10 year will soar, and not just soar, but soar for all the wrong reasons, such as bull steepening and what not), has just diametrically changed his tune, by bringing us, drumroll please, Operation Torque. To wit: "Policy makers in both the US and Europe get back to work in September, and this month will be rife with deliberations on stimulus and market support policies. In our view, a duration extension to the Fed's SOMA portfolio is an optimal policy tool to engender easing. This can initially be done through extending the duration of reinvestments from MBS and agency holdings but may ultimately culminate in selling shorter-duration USTs in its SOMA portfolio in exchange for buying longer duration assets (‘Operation Torque’, as we at Morgan Stanley have dubbed it)." Why 2 Years? Because as per the August 9 FOMC statement, we know that there will no rate hike for the next 2 Years, and hence no duration risk. Which means that the Fed can sell an infinite amount of paper into a mid-2013 horizon without worrying about demand destruction. And by doing so it will, as we have been predicting since May, expand the duration of its portfolio, in the process pushing investors into risky assets for the third time in as many years. But there is a twist...

And so the last true blue, and much ridiculed economics team, that of Morgan Stanley's David Greenlaw's and his merry Buryini-ruler clad automatons, has waved the white flag. Specifically, in an email sent out yestrday by the firms' overabundant and soon redundant salespeople, both institutional and retail, we read: "WE HAVE BEEN ARGUING FOR A STRONGER 2H US ECONOMY..AND WE ARE CAPITULATING..." The all caps comes from them lest someone accuses us of being overly dramatic.

Over the weekend, we presented the suddenly very pessimistic outlook by Morgan Stanley's equity strategist team which stated in no uncertain terms that it "assigns a higher probability to our bear case than bull case, preventing us from becoming increasingly optimistic" adding that it "continues to assign a higher probability to the bear case than the bull case, and believe the recent price action increases the probability of the bear case." Yesterday, the firm's Credit Strategy team joined the call for a bearish outcome, when in a conference call it stated its case for why its "bearish strategic view is based on long-term structural and valuation issues." Two key metrics watched by MS: i) The unsustainable DM credit super-cycle may be approaching a difficult dénouement, and ii) based on long-term P/E valuation measures, US and UK equities are still expensive. MS warns that "a larger correction in risk assets is likely if a recession occurs, more so for equities" a topic discussed by the equity strategy team over the weekend which believes that the probability of a recession has surged (and continues to be confirmed by leading indicators such as yesterday's Empire State Fed survey). Morgan Stanley's concluding advice to clients: "look to reduce risk in Developed Markets  in Counter-Trend rallies." Luckily, any time volume trickles to a halt, the counter-trend rally should present itself providing ample opportunities for selling into it.

Listening to David Greenlaw and/or Jim Caron as they strike out again, and again, and again, with delusions of economic grandure over US GDP and some historic 2s10s bull steepener which is never, ever coming, one would be left with the impression that Morgan Stanley has inherited the title of most permabullish sell side advisory from Deutsche Bank's economics department. Nothing could be further from the truth. Like any other bank, MS has perfectly hedged its rosy outlook by spoonfeeding its retail clients with the rosy view, while whispering the apocalypse case to its institutional clients (judging by last week's pummeling in MS stock, there is not that many of them left). Below we present the view of MS' equity strategy team under Adam Parker, who gives not only a distribution range for his year end S&P target (1004-1425), but a matrix specifying the probability outcome of either case. Bottom line, "while there is 18% upside to the year-end bull case and 16% downside to the year-end bear case, we assign a higher probability to our bear case than bull case, preventing us from becoming increasingly optimistic." When even Morgan Stanley tells you (or rather the whale clients who are now more than happy to sell into every low volume, retail driven rally) there is little to smile about, it is high time to look for the exits.

Update: aaaaand it's up. DJIA must be down only 300 now...

Without looking at the ticker we will assume that market selling has accelerated since the BAC call ended and the DJIA is down 400... Were we right?

Update: it is now back online. Redemptions and liquidations shall proceed in an orderly, dignified manner please.

Some very interesting data points were disclosed in Morgan Stanley's just released 10Q. First, we learn that in the last quarter, the company which had "blow out" earnings, at least compared to expectations and Goldman, actually was not much to write home about by typical Wall Street standards, with a whopping 8 days of trading losses in Q2. Considering that most Wall Street firms had quarters in a row with no daily trading losses, this is, sadly, quite disappointing. Next, and more important, is that MS has disclosed it has a rather substantial $5 billion in gross exposure to the PIIGS, as well as another $3.5 billion in funding exposure to Europe. Considering that most European banks had already offloaded their PIIGS exposure, at least we now know who they were offloading risk to. Lastly, from the risk factors we read that a US downgrade will likley not be beneficial to Morgan Stanley or the stock market, to wit: "[a downgrade] could disrupt payment systems, money markets, long-term or short-term fixed income markets, foreign exchange markets, commodities markets and equity markets and adversely affect the cost and availability of funding and certain impacts, such as increased spreads in money market and other short term rates, have been experienced already as the market anticipated the downgrade. In addition, it could adversely affect our credit ratings, as well as those of our clients and/or counterparties and could require us to post additional collateral on loans collateralized by U.S. Treasury securities."

It was over two months ago that Zero Hedge first described why we though QE3 would ultimately appear in the form a reincarnation of Operation Twist first utilized by the Fed in the 1960s to prevent the gold exodus from the US into Europe (read more here and here), also known as Operation Twist 2. In essence what the Fed would do would be a curve patterning exercise in which the Fed would lower long-term rates by changing the average maturity of Fed holdings, in the process removing substantial duration from the markets, once again pushing investors into far more risky assets such as stocks (but certainly not gold: the CME will see to that). Today, Morgan Stanley's Jim Caron (who has yet to be right about one thing in his prior 3 year forecasts so take this with a grain of salt) explains why Morgan Stanley is a big supporter (read lobbying heavily on behalf of) of Operation Twist 2. Quote Caron: "As outlined in the recent congressional testimony, the Fed could consider several ways to ease financial conditions further. One of the options mentioned by Fed Chairman Bernanke was to provide explicit language to keep the fed funds rate and the Fed’s balance sheet unchanged for an extended period. Another approach would be to keep the balance sheet unchanged but increase the average maturity of its holdings. If this path is chosen, we believe that a significant amount of duration could be removed from the markets – to the effect of $90-150bn 10y equivalents which could lower 10y yields by 20-35bps. Let us explain." Explain away Jim.