Morgan Stanley

From JPM: "We downgrade GS from OW to N today. Our downgrade is driven by considering it has reached our Target Price of $175, offering the lowest upside within our Global IB universe. Even the theme of capital re-leveraging is discounted now in our view with the share price upside potential limited at a re-leveraged PE of 9.0x assuming $15.2bn buyback (17% of market cap) in 2012E, as discussed in Table 7 below. The Basel 3 Tier I ratio would be reduced to 9.9% from 12.1% in 2012; in-line with our JPM required capital methodology."

Morgan Stanley's real estate division hits yet another home run in (in fees) as investment clients get (literally) taken to the bank.

After Morgan Stanley's call for the 10 Year hitting 4.5% in 2010 ended up being one of the worst calls of the year (together with each FX call by the Goldman team), the firm's head rates strategist Jim Caron is back on the scene with his latest set of Top Trades for 2011, as well as some views on where the fixed income market is headed next year. In summary: just fast forward the firm's bearish 2009 view on yields one year forward. After all if the firm was so wrong one year, it can't possibly be wrong two years in a row...

Morgan Stanley's Arnaud Mares, who a few months ago made the jarring claim that a European default is all but inevitable (and the only question is what shape it will take), has followed up with the next piece in his Sovereign Subjects series, in which he attempts to quantify the practical inputs that would lead to sovereign default, and, more importantly, to government overthrow. Obviously the two are linked, and as Mares notes "out of 19 cases surveyed, on 18 occasions default was followed by the incumbent government losing elections." Which means that Europe is certainly interested in resolving its unresolvable issues in a way that affords fiscal adjustment in a way that does not almost inevitably lead to some form of government overhaul. The problem is that as the following chart demonstrates, the "fiscal adjustment" option which is the only one that at least gives the possibility of preserving incumbency, and unfortunately, this option is that one that not only impairs only taxpayers and not creditors, but is also prolonged over time and not instantaneous. This is also the option that guarantees a build up of resentment not only toward the ruling politicians, but toward the banking oligarchy, has the potential to result in a far greater, and more violent outburst of "social discontent", and just happens to be the state in which America will be trapped for a long time. Yet back to the core topic at hand: in looking at the only feasible way in which a "fiscal adjustment" could work, Mares approaches the issue from a game theory angle, and finds that only a "Deux Ex Machina" can prevent a systemic collapse. While he refers to the IMF, we believe the Federal Reserve, and its various systemic backup facilities (such as the FX swap line), are a much more appropriate subject to fill these shoes. We believe that since to every quid there is a quo, the Fed will not give Europe an infinite handout for free: the leverage the Fed will use, will be to force the ECB to keep the Euro artificially high, threatening with pulling all support if Europe defects in a world in which its consistency is predicated upon the Fed's ongoing generosity. Which is why in the race to the bottom, an eventual EURUSD parity thesis may have to be revised.

By now everyone is aware that M&T bank acquired Wilmington Trust in today's version of Merger Monday... however this time with a twist. The company was acquired at a 40%... discount. That's right, as shareholders were happy with their WL positions at close yesterday, it appears the financial firm, and its acquirer were all too aware that the sellside pump syndicate was woefully wrong on the name, and 11 analysts had an average target on the stock of $10.31. The question then becomes if Wall Street is so very wrong in evaluating one of its own to the tune of a 40% plunge to closing price, and 60% to the target consensus, just how overvalued are all other financial firms, all of which continue to trade based on circle jerk rating boosts by one another, even as those behind the Chinese Wall (such as M&T management and WL executives) know all too well the fair value of assets is way below where the gullible public is buying the stock. Which is why we present some of the most egregious examples of sellside hubris and pumpatude disclosed by this price discovery event: below are the hall of shame analysts who missed this take under by about a mile.

Paulson and David "Balls to the Wall" Tepper just can't catch a break these days...

A few months ago, before it became a staple MSM topic, we speculated that the dereliction of capital markets by both equity and credit traders would mean a complete collapse in Wall Street sales and trading (aka hedge fund proxy) revenues, now that investment banks rarely if ever perform traditional IB activities like advisory and underwriting work. As the latest battery of Q3 bank earnings has confirmed, we were correct, however nowhere more so than as pertain to Morgan Stanley: the bank's Q3 revenues were an abysmal disaster, with total sales and trading revenue collapsing from $3.7 billion in Q2 (and $4.1 billion in Q1, $3.2 billion in Q3 2009) to just $1.8 billion. The drop was especially pronounced in Fixed Income S&T, which plunged from $2.3 billion to $846 million. Yet what is scary is that this plunge did not occur in an environment of moderating risk management: oh no. In fact, the firm's aggregate average trading and non-trading VaR in Q3 2010 was the highest on record, coming at $189 million! Meaning the bank had to stretch and put massive amount of risk on the books to eek out even these pathetic numbers. It also means that one day, as MS and others once again start raising their VaR in pursuit of that elusive last HFT dollar, another market crash will result in billions in trading desk losses in a span of minutes.

From Morgan Stanley's Peter Richardson, who has just become one of the bigger gold/silver/platinum/palladium/platinum/rhodium bulls: "We have raised our 2011 gold price forecast in our base case by 14.3%, to an average US$1,315/oz, and in our bull case, which anticipates a more aggressive level of dollar weakness and a protracted period of negative real interest rates, we have raised our price forecast to US$1,512/oz from US$1,380/oz."

Jim Caron has some truly brilliant comments this morning which should be read by all who think they have any handle on the market: "The fixation on QE comes at a price. It is that interest rate volatility will rise due to the uncertainties surrounding QE. And since the performance of interest rates is closely tied to the performance of risky assets, including gold and the USD, then it follows that volatility in those assets may rise as well. Investment decisions across many asset classes today are tantamount to an educated guess on what the Fed decides to do regarding QE. In the near-term this trumps fundamentals, valuations and almost everything else. Thus the risk in the market is man-made, not freely determined by the market. In general, this is not a good thing because it may invite greater risks in the future...If the Fed does not follow through with QE as the market expects, then risky assets may suffer." To put it mildly...

There is no debating that the FOMC announcements and liquidity injections are if not the key factor that drives stocks then certainly one of the main ones. Yet for those who wish to frontrun the Fed without participating in the stock market, which these days would be pretty much everyone, as the risk of a market crash increases exponentially with every single day that equities ramp ever higher not on fundamentals but merely liquidity, Morgan Stanley has found another cheap FOMC-coincident trade that at least on the surface allows for a quick and painless pick up in a few bps, and can be conducted without touching stocks at all.

And so Wall Street continues to not grasp that as long as the vast majority of people realize just how manipulated and broken the market is, they will simply stay out of it. Today, Gasparino breaks the news that Morgan Stanley has instituted a hiring freeze and that if the current volume drought which will certainly wreck EPS for Q3, persists in Q4, the firm will follow up with "fairly significant cuts." Since we don't anticipate the corrupt regulators to do anything that will return confidence to capital markets (and no, Brian Sack, closing the market by one penny in the green will not help), and since the 2s10s will continue to flatten, the pain for banks will only get worse and worse. Add on top of that the likelihood that very soon the FASB may require banks to report the actual MTM value of their hundreds of billions in underwater loans, and it becomes increasingly obvious why financials will soon be the industry that drags the entire market much lower.

Today's peculiar stock trading action was exclusively due to Morgan Stanley's previously highlighted expectation that the Fed would announce QE 2 in one week (and had nothing to do with Hatzius' announcement that there may or may not be a November event: Hatzius has been claiming this for two exactly months running now, for all those to whom this may be news). Which is why David Greenlaw's just released announcement which essentially eliminates MS' expectation of a hike may wreak some havoc on stock prices tomorrow (and potentially gold, although now that it has passed a new psychological level, we think the odds of that happening are modest). Quote David Greenlaw: "we now believe the likelihood of additional easing being announced at the Sept FOMC meeting is quite low (perhaps 10% to 20%)." Sorry, no QE2 for at least two months, and most likely not until January, but which point it will be too late to do any actual good to the economy (but not to surging gold prices).

Exactly a week from today, the FOMC will meet on September 21, to decide whether or not to go from QE Lite to a full-blown QE 2 regime. And while most pundits had previously lost hope that the Fed will go full retard in its dollar destruction ways as early as next week, instead opting for the November 2 meeting if not wait for 2011 entirely, Morgan Stanley (specifically Jim Caron) came along: "We see considerable risk that the Fed may open the door to QE2 at this September 21 meeting despite the stronger-than-expected August payroll results and even if upcoming economic data stabilize. We believe that QE2 may come in the form of a vague outline for a plan to buy assets, expand its balance sheet and keep interest rates low conditioned upon economic data." Why the sudden change in opinion?  "We believe that the Fed may be reluctant to act aggressively after September 21 so as not to influence the election outcome. However, if deterioration in economic conditions warranted it, then the Fed may uncharacteristically act close to the election date. Acting sooner rather than later would be consistent with Bernanke’s plan to stave off deflation risks before they arise." Right or wrong about the Fed's choice (and with Caron's recent track record, one may be tempted to choose the latter), Morgan Stanley does correctly observe that volatility will likely jump in the weeks and months ahead, even as its has been moving progressively higher lately: "Interest rates have been subject to big daily swings." Curiously, as a hedge to surging rates vol, Morgan Stanley proposes the opposite Variance Swap trade that caused a massive loss for Goldman in Q2, and was Goldman's Top trade of 2010. Let's see who blows up first: Goldman, which still expects a decline in vol, or Morgan Stanley who is on the other side. Perhaps the two firms can just trade with each other (that wouldn't be that much of a change from the current regime).

Somebody better remind Morgan Stanley's Jim Caron that he is now pitching 10s30s flatteners, cause he sure seems giddy over the 25 bps move in the 10 Year (coupled with an even bigger, i.e. steeper, move in the 30 Year), which of course means his advice continues to lose his clients money. Of course, this being the most optimistic bank on Wall Street, Caron immediately equates rising rates with surging stocks: "The last time UST 10y was around 3.00%, S&P's were around 1127. If the high level of correlation between bond yields and stocks hold, then the breach in the bull UST 10y trend may signal better performance of risky assets." And that, ladies and gentlemen, is how you cherry pick data. Because taking Caron's chart a little further back, shows that the last time the 10 Year was here, as Rosenberg reminded us three weeks ago, the S&P was at 805. So... 1,127 or 805? The upside/downside after today's 1,110 close sure looks very attractive to the upside. Just like Caron, we will leave it with the  rhetorical "Just an observation to think about before you head home for the weekend", and we'll add - "pick your kool aid."

The firm that was long the biggest bull on Wall Street, Morgan Stanley, with its initial 5.5% target on 10 Years by the end of 2010, has finally folded: "We are downgrading our outlook for second-half growth to 2-2.5% from 3-3.5% previously. This downgrade from above-trend to below-trend growth has  important implications for forecasts of the unemployment rate, inflation and monetary policy." Ostensibly it also has implications on rates, with the firm now actively calling for a flattener, just in time for the 10s30s to start creeping out again. Of course, this being Morgan Stanley, nothing is ever easy, and the firm obstinately refuses to see the plunge in H2 GDP as anything more than just a temporary blip: "we don’t think this slowdown will last beyond H2, much less morph into a downturn. In his Jackson Hole speech, Chairman Bernanke seemed to agree that the current economic weakness does not augur a weaker outlook for 2011. We agree. Among the reasons: Downside risks probably will prompt policy actions, balance sheet repair will be more advanced, and we expect net exports to improve in the second half of 2010 and into 2011. In fact, we see no reason to downgrade 2011 and possible reasons to upgrade, especially if policy turns more stimulative." Ok, Richard Berner, your colleague Jim Caron's rates call already lost a ton of people even more money : we will be sure to remind you of the bolded statement on January 1, 2011.