Morgan Stanley

From Morgan Stanley: "In our mind, many of the approaches to algorithmic execution were developed in an environment that is substantially, structurally different from today’s environment. In particular, the early part of the last decade saw households as significant natural liquidity providers as they sold their single stock positions over time to exchange them for institutionally managed products... While the time horizon over which liquidity is provided can range from microseconds to months, it is particularly shorter-term liquidity provisioning that has become more common." Translation: as retail investors retrench more and more, which they will due to previously discussed secular themes as well as demographics, and HFT becomes and ever more dominant force, which it has no choice but to, liquidity and investment horizons will get ever shorter and shorter and shorter, until eventually by simple limit expansion, they hit zero, or some investing singularity, for those who are thought experiment inclined. That is when the currently unsustainable course of market de-evolution will, to use a symbolic 100 year anniversary allegory, finally hit the iceberg head one one final time.

Whether its rating downgrades (which are much more critical than one would imagine given haircuts and collateral shortages), anxiety-inducing elections that could bring tensions in the 'party' that is Europe's political union, or referenda, the next few months have more than their fair share of event risk to navigate. Starting with Italian (and then Spanish banks) next week, it seems the market is starting to sense the squeeze that events could cause.

The latest consumer-credit data showed a slowing in the growth of the borrow-to-spend trend that had re-appeared through the holiday shopping period. This deceleration signals the deleveraging of the consumer is back and as the following charts from Morgan Stanley shows once people start saving historically, they have tended to remain saving; and that in the kind of low-/no-growth environment (or more specifically a balance sheet recession) we see a lack of credit demand even as credit availability is high. The momentum of saving and the correct focus on debt minimization as opposed to profit- (or living-standard) maximization will eventually outweigh the ever-increasing need for dollar-debasement money-printing flow to maintain the social market status quo. Add to this deleveraging concern the fact that Europe is seeing bank lending contract absolutely (notably weaker than in the US for now) amid tighter lending conditions and this is just another example of the cloggage in the Fed/ECB's transmission channels in this environment.

We have been pointing to the 'changes' that are evident in the high yield credit market (bonds, credit derivatives, and ETFs) for a few weeks now. The fall in the high-yield bond advance-decline line (and up-in-quality rotation); the decompression of HY credit spreads; and the lack of share creation, discount to NAV, and underperformance of JNK/HYG; but these canaries-in-the-coalmine pale in comparison to the massively over-crowded nature of the high-yield credit protection bullish positioning among arguably levered market participants. As Morgan Stanley notes: "US High Yield Investors Are 'Full Overweight'". Remember large crowds and small doors are no fun.

While equity trading last March trading was affected by the excess volatility arising from the Fukushima explosions a year earlier, and the Japan earthquake induced volatility in general, today's monthly volume update by the NYSE shows that no matter what the reason for the volume collapse, toplines for banks and traders will suffer, on both a Y/Y as well as sequential basis. Per the NYSE: "European and U.S. Cash ADV Down 13% and 24% Year-over-Year.... NYSE Euronext European cash products ADV of 1.6 million transactions in March 2012 decreased 12.7% compared to March 2011, but increased 0.5% compared to February 2012. NYSE Euronext U.S. cash products handled ADV in March 2012 decreased 23.6% to 1.8 billion shares compared to March 2011 and decreased 0.6% from February 2012." An even bigger year-over-year collapse took place in the one product which everyone thinks is taking the place of individual stock trading: the synthetic CDOs known as ETFs: "NYSE Euronext U.S. matched exchange-traded funds ADV (included in volumes for Tape B and Tape C) of 222 million shares in March 2012 decreased 29.3% compared to March 2011, but increased 4.1% compared to February 2012. In the first quarter of 2012, NYSE Euronext U.S. matched exchange-traded funds ADV of 221 million shares was 21.8% below prior year levels." The YoY collapse in trading volumes for derivatives was less compared to cash, but the sequential drop from February 2012 was even more pronounced: "NYSE Euronext global derivatives ADV in March 2012 of 8.1 million contracts decreased 11.5% compared to March 2011 and decreased 15.4% from February 2012 levels." We can only hope that banks have found some innovative ways of compensating for this collapse in overall market participation, such as traditional revenue pathways like underwriting and advisory fees, as well as lending and arbing the carry trade. Alas, as the following Bloomberg piece points out, this will hardly be the case, as Zero Hedge has warned previously.

• With a 2 Year delay, both FT and WSJ start covering the shadow banking system. For our ongoing coverage for the past 2.5 years see here.
• Trouble in shipping turns ocean into scrapheap (Telegraph)
• First-Quarter Home Prices Down 20.7% in Capital (China Daily)
• Bernanke Says Banks Need Bigger Capital Buffer (Reuters)
• Monti’s Overhaul Can’t Stop Pain From Spain: Euro Credit (Bloomberg)
• Spain Confronts Crisis Threat as Rajoy Seeks Deficit Cuts (Bloomberg)
• Japan’s Noda Announces Anti-Deflation Talks as BOJ Sets Policy (Bloomberg)
• White House makes case for Buffett Rule (CNN)
• Cameron to Make Historic Myanmar Trip (FT)
• 'Time for Closer Ties' With India (China Daily)

At the end of January we first discussed the rolling over of corporate margins and sure enough the consensus for 2012 margin compression has turned our way with only 42% of the S&P 1500 now expected to increase net margins YoY. What is simply 'incredible', in the words of Morgan Stanley, is the jump from 2012 to 2013 expectations of net margins as this chart so well indicates. In 2013, 89% of firms are expected to miraculously rediscover their pricing power and increase net margins. Our word for this is 'magic'.

A lot.

This is easily the meatiest, most offensive, most controversial and probably the most hardhitting post of the year. Here's proof that Goldman STUFFED ITS MUPPET clients!!! 20 pgs of research warning non-muppet clients to back off, proof of the Muppet biz model...

The only sector of the S&P 500 that was not red today (and for that matter the week) is Tech as AAPL managed another wonderful 1.45% rally today (up 5.6% on the week - it's best performance in 3 weeks and notably AAPL hasn't had a down week since 1/13 -0.6%). As SNL might say, "we need more parabola". Volume was average (for equities and futures) today but bigger blocks came through to sell into the close ahead of the long weekend and tomorrow's early excitement. Financials once again struggled and along with Energy are the worst of the week but it is the majors (in particular Morgan Stanley) that has been hammered this week as MS is -8.2% from Europe's close on Monday with the rest of the TBTFs down around 6% - finally catching up to credit's weakness. Equities closed down marginally but sold off in futures after the close - back below VWAP - having dropped all the way to reconnect with IG and HY credit's less ebullient perspective this week (before credit extended its losses to its widest in three months!). Treasuries managed to entirely recover their post-FOMC spike closing near the low yields of the day/week with the 7Y belly outperforming on the week down around 5bps (with 30Y -1bps on the week). Commodities halted their descent (much to the chagrin of media commentators it seems) as Oil outperformed on the day (and into the green for the week) over $103. Gold and Silver are still underperforming the USD's gains on the week (up 1.4%) led by EUR and CHF weakness. FX chatter was dominated by the spike-save in EURCHF (taking out Goldman's stops) and the mirror CAD strength JPY weakness relative to the USD. It seems EURUSD has become relevant again as it heads back towards 1.30 the figure (3 months lows). VIX went briefly red around the European close and broke 17% before closing marginally higher on the day as the term structure steepened a little more once again.

A major potential negative catalyst for financials globally is rapidly approaching as 114 banks are on review-for-downgrade by Moody's across 16 countries. Why do we care so much about ratings given their historical credibility? Ask James 'Jimmy-boy' Gorman of Morgan Stanley who is currently begging cap-in-hand to Moodys not to downgrade his empire bank, since he knows (and so it seems does the CDS market) that, as the FT notes, a downgrade could also force the bank to provide additional collateral to back its vast derivatives business - where it acts as one of the largest counterparties. In Europe, the fun heats up in the next few weeks as first Italian banks (4/16), then Spanish banks (4/23) and then Austrian (4/30) face from 1 to 4 notch downgrades and the potential to lose their short-term (funding-/CP-related) Prime-1 top rating, implicitly raising funding costs (and liquidity concerns) even further.

If you spend your day listening to mainstream financial media you could be forgiven for believing that things have never been better for corporate balance sheets - exceptionally high levels of cash and fortress-like conservatism for example. However, in the trenches of reality, from a high-yield and investment grade credit market perspective (and perhaps this is why credit markets are expressing considerably more concern than equities still) there are three trends that point to deterioration and far-from-Nirvana cash-flow protection that should be paid close attention to.

Last week Mario Monti, like a good (ex) Goldmanite, did his best to buy what Goldman is selling, namely telling anyone gullible enough to believe that the "European crisis is almost over." Funny then that we learn that just as this was happening, Ben Bernanke held a secret meeting with the entire banker caretel, in which discussed was not American jobs (seasonally adjusted or otherwise), nor $5 gas, but... helping European with its debt crisis. But, but... Mario said. In the meantime, European spreads are back to late 2011 levels.

The Fed moved to defense. A tactical disavantage.

• Low cost era over for China's workshops to the world (Reuters)
• The HFT scourge never ends: SEC Probes Ties to High-Speed Traders (WSJ)
• Rehn says Portugal may need "bridge" (Reuters)
• China's GDP likely to have slowed in the first quarter (China Daily)
• Chinese Premier Blasts Banks (WSJ)