Morgan Stanley

Expectations for tomorrow's J-Hole speech by the venerable Ben Bernanke vary from the mundane "things-we-can-still-do; monitoring-situation" to the exuberant "we'll-print-our-way-out-of-this-mess-no-matter-what-and-I've-got-your-back-for-anything-more-than-a-1%-drop-in-the-Russell". We suspect, like Morgan Stanley's Vince Reinhart that a lot of people are going to be grossly disappointed  as the FOMC (C for Committee) meeting is so close and the election being just around the corner means playing-down any miracle-making. Instead we suspect it will be more of the same - disappointment in economic performance, could do better, closely monitoring, Fed-has-tools; i.e. a replay of most of his recent speeches in tone. Reinhart does see some room for surprise though - especially on conditional policy rules (and the potential problems with over-reaching their mandate).

"Don't underestimate how close the Court verdict is" is the warning that Morgan Stanley's European Research group sends out in a note today. In their view, there is a non-negligible risk that the German Constitutional Court will voice concerns about the ESM and, potentially, also the fiscal compact on September 12. Given that the EFSF is still in operation, given that the Court views the scope of the German constitution as being exploited already, and given its record of voicing concerns about European integration, MS sees a 40% chance that the Court bans Germany from ratifying the ESM treaty (with major repercussions for financial markets), at least for now, and while their base case is for ratification of both treaties, they believe the market is not priced appropriately for the downside tail-risk of a possible 'no' verdict (and the asymmetric scenarios below).

Following the dismal failure of Draghi's OpEd this morning (which we assume was a reprint of his much-anticipated - and now cancelled - speech from J-Hole) to jawbone anything but a very brief pop in EURUSD, we thought it useful to aggregate all the great-and-good deeds the ECB elder is considering (and why). Europe remains in a long-term deleveraging phase (as much of the developed world finds itself). This lack-of-demand for credit has crushed the so-called 'money-multiplier in Europe, just as it did in the US (which we discussed in detail here as worse than the Depression); as banks have simply stockpiled the vast sums of LTRO/ECB-collateralized funds. This has left him feeling less than his normal omnipotent self and so he is forced to act even more extremely (or talk about acting that way). The following matrix from Morgan Stanley outlines his policy options under various scenarios as we note few (aside from a rate cut) are actionable in the short-term, and even fewer are likely to make any difference to this long-term deleveraging-cycle

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As the world anticipates Bernanke's speech on Friday - which most do not expect to explicitly say "NEW-QE-is-on-bitches" - we started thinking just what it is that he can suggest that would provide more jawboning potential. His speech is likely to lay out 'lessons learned' and outline the various conventional, unconventional, and unconventional unconventional policy options available (as we noted here). While open-ended QE, cutting the IOER, and 'credit-easing' are often discussed, none would be a surprise; this reminded us of an article from Morgan Stanley two years ago - after QE2 - that raised the possibility of Price-Level Targeting (PT), which is quite different from Inflation-Targeting. While its cumulative effect could be anti-debtflationary, it is however tough to communicate, reduces the Fed's inflation-credibility, and could be seen as inconsistent with the Fed's dual mandate. Our hope is that by understanding this possibility, the mistaken shock-and-awe is dampened.

The impact of unsustainable production in Chinese Steel-making plants, to avoid the inevitable employment consequences, has created a 'glut'. This excess inventory will need to be worked through before spot Iron Ore (and Coking Coal) prices can stabilize. Morgan Stanley believes the sharp raw material price declines since mid-July followed a collapse in Chinese steel prices and aggressive margin compression. This is in turn has resulted in aggressive thrifting of raw material purchases. More recently, the price declines have accelerated with Chinese re-bar and HRC prices reaching 33-month lows. In their view, prices of steel making raw materials can recover in 4Q 2012 and in 2013, but spot prices for both iron ore and coking coal first have to fall below the marginal cost of seaborne (not Chinese) production to  drive out the short-term supply overhang - Iron Ore prices could fall 17% further before this 'stabilization' and spot coking coal over 8% from current levels.

Under widespread NIRP, pensions, annuities, insurers, banks and ultimately all savers will suffer a slow but steady decline in real wealth over time. Just as ZIRP has stuck around since the early 2000’s, NIRP may be here to stay for many years to come. Looking back at how much widespread damage ZIRP has caused since its introduction back in 2002, it’s hard not to expect that negative interest rates will cause even more harm, and at a faster clip. In our view, NIRP represents the death knell for the financial system as we know it today. There are simply too many working parts of the financial industry that are directly impacted by negative rates, and as long as NIRP persists, they will be helplessly stuck suffering from its ill-effects.

Romney's selection of Paul Ryan as his veep clarifies the policy debate (forcing typically middle-of-the-road voters to become more polarized to the size of government) into the November election and materially changes the odds of the fiscal cliff's resolution. As Morgan Stanley's Vince Reinhart notes, "by tying one side to an explicit plan for fiscal consolidation, the Ryan selection makes it much more likely that the campaign will focus on the appropriate role of the government.  That is, the debate will be about the right level of federal expenditure relative to national income, the progressivity of the tax system, and the extent to which family incomes are protected on the downside by Washington, DC." Although theoretically the Ryan pick raises the chance of a benign, before-the-election resolution to the fiscal cliff 'issue', it also worsens the likely outcome if the legislative stand-off continues into 2013 - which the odds suggest is the case.

Walls-of-worry; Short-squeezes; money-on-the-sidelines; Everyone's Bearish, right? Well, instead of just listening to the drone of the mainstream media and talking heads, who appear once any rally appears in the hope of garnering some more AUM and taking commissions, we thought it worth a few minutes to look at actual data, positions, and sentiment across equity, debt, and FX asset classes. Sure enough - here are ten charts that show investors are anything but bearish and that the ammunition for the next leg from here can only come from central-banks (and we are concerned that disappointment is due).

There is plenty of talk about the looming Fiscal Cliff, but like so many other downside risks in this market, investors are not positioned for it as they appear convinced that it won't be allowed to happen or some compromise will occur. We remain on the side of the fence where nothing will occur; no compromise reached, until the governement is 'forced' by the market to take action - by some asset value plunge that scares then into scramble mode. Unfortunately, as these two simple charts from Morgan Stanley highlight, gridlock appears guaranteed (but then again, with a market economy at multi-year highs the incumbents remain dominant).

The retail sales figures from that perspective show a couple of very clear points: 1. Last year's Christmas season was not only weak and disappointing, it may have marked the inflection point in consumer spending (at least as far as retail sales measure); 2. The July "improvement" is far less impressive. June 2012 had an extra holiday shopping weekend, but registered only a 3.3% improvement over June 2011. Without an extra holiday weekend, July 2012 saw almost identical year-over-year growth; 3.4%. No matter what or how weekends were arranged within the calendar context, non-adjusted growth was not really all that inspiring in either month. If this inflection in consumption is indeed valid, it makes sense that the early part of 2012 would then experience economic “volatility” – revenue pressures at firms cause them to cut back on capex or re-investment in real projects, including a decrease in the pace of hiring new workers. Manufacturing falls off (seen in the ISM and regional Fed surveys) as reduced demand from businesses works its way back into this vicious cycle of employment malaise where job growth is consistently and vitally below population growth or labor force expansion. As government transfers drop off, the segment of the economy under the gun of stagnation rises in proportion and the bifurcated economy becomes more so – except that as the troubled half grows it inevitably pulls down the half doing relatively well. What looks like a muddle of weak growth is really the rot of monetary intrusions eating at what should be a free market-driven reset to the previous dislocation of failures from past monetary episodes. And it is all in the name of some ephemeral “wealth”.

Two weeks ago, PIMCO's Bill Gross stirred up a few ivory-tower academics, permabull sell-side commission-makers, and bloggers pressured by Series [X] investors to generate maximum page views when he called for the death of the cult of equities. His main point was the apparent paradox that the total return on equities can outpace GDP growth over long periods. While there has been much gnashing of teeth over this comment, Morgan Stanley has very succinctly clarified and confirmed that this is not so much a paradox as a Catch-22. The key point is that, in aggregate, investors do not typically reinvest their dividends (or coupons); and akin to Keynes' paradox of thrift, if investors actually tried this en masse then the historical returns reported in total return indices would be unachievable. So here’s the Catch-22: over the long run theoretical total returns can exceed GDP so long as investors don’t actually try to capture those returns. But if ever investors try to achieve such GDP-plus total returns, it will be impossible for returns to stay above GDP growth. Hence, equities for the short- and long-term, are essentially a Ponzi scheme - as long as everyone buys-and-holds - but if 'someone' decides (or is forced) to take-profits, equity ROE will rapidly game-theoretically collapse to GDP growth.

You heard our side of the story. It is only fair you hear the other side too.

How many muppets does it take to hold a half off Groupon sale on IPO stock??? Seriously!

Last Friday we presented the dismal performance (and major divergence with broad equity markets) of recent IPOs and reflected on what this meant for the millions of retail investors who were 'suckered' into these must-win dot-com-renaissance names. Again and again one name keeps coming up with regard to the worst-performing and most-1999-dot-com #fail-like names - Morgan Stanley. Since November of 2011, Morgan Stanley has 'successfully' brought three of the biggest disasters of Silicon Valley to market - GRPN, ZNGA, and of course, most recently, FB. What is stunning is that since the GRPN IPO on 11/3/11, investors in these three 'new' normal names have lost an incredible $58 billion in market cap with GRPN and ZNGA now down 70% from their IPO price and FB down 44%. Perhaps more intriguing is that IPOs keep coming as there appears to be a 'muppet' born every day.

While every investor you ask is vehemently concerned about any and every risk and sentiment surveys suggest there is a 'wall of worry' to climb, once again the truth is in the positioning. Based on DTCC data, via Morgan Stanley, investors' net bullish CDS positioning in European investment grade credit has never been higher - having surged recently. Critically, note that that investment grade credit index has a major exposure to European financials. Adding to the reality of positioning and self-deceiving biases of all those so afraid to miss the CB rally or look like fools in the face of momentum, bond markets are even more ebullient (as European bond spreads trade back under CDS spreads) and European credit implied volatility trades below realized vol - an even more unusual occurrence than in VIX currently. It seems the real pain trade is a risk flare in European financials once again - as opposed to all those who 'hear' everyone's bearish.