Morgan Stanley

Today's POMO has closed, with the Fed monetizing $3.609 billion in debt, far more than previously expected, and much more than last auction's $2.5 billion (is Liberty 33 sweating in its reliquification attempts courtesy of today's nightmarish economic date). The hit rate was also worse than the previous one, coming in at 16.5%, with 12.2% previously (another way of saying this is that the submitted/accepted ratio was 6.07). And yet again, Morgan Stanley was spotless, with its 9 bond predictions all eligible for purchases, and in fact seeing 6 of the 9 proposed issues purchased by the Fed. In a basket which had 27 eligible CUSIPs, this is quite an impressive result.

Attached is MS' most recent strategy slidepack covering European credit strategy, US rates (for those who just can't get enough of those 2s10s steepeners), credit strategy, and credit and equity derivatives. As the firm now has one the most bullish biases on Wall Street, the pack should at least provide those bearishly inclined with a sense of what not to do.

Update: and, lo and behold, the market was more than prepared to front-run the Fed: the issues prescribed by MS for prepurchasing (and then selling into the Fed's bid), account for 92% of the $2.551 billion in total Bids Accepted (out of a total $20.949 billion in Bid Submitted). The result: a stunningly low 12.2% hit ratio as everyone was more than happy to sell to the Fed. And guess where the cash the PDs just got from the Fed for selling into its bid is going...

This weekend we presented an analysis by Morgan Stanley which attempted to anticipate precisely which bonds will be bought, and which will be excluded (in How To Front Run The Fed With The Best Of 'Em) in today's FRBNY Open Market Operation. To Igor Cashin's credit, his projection was spot on: his suggested 10 issues expected to be monetized all made this list. And, more importantly, the six exclusions were all correct as well, yielding his prediction a 16 out of 16, or A++ score. The full list of securities to be purchased at 11am this morning is presented below. To those who bought in advance of this action as we recommended, congratulations. To those who missed, it, the schedule of upcoming CUSIPs most likely to be purchased in the next 4 auctions through September 1, is recreated below. Once the actual results of the auction with notional amounts is disclosed post auction, we will update this post. Regardless, the massive rip in Treasurys over the past week begs the question: was the action merely one massive frontrunning attempt, and is today's weakness in the Treasury complex just the unwind of that trade...And as for equities, now that POMO is back, it is worthwhile to remember that on POMO days, the market is up about 99.9999*% of the time.

One word how mortgage originators and funding desks feel right now (not to mention Morgan Stanley bull steepener clients): Panic. The 2s10s is now at the flattest it has been since May 2009 and going lower. All leading indicators (such as the Conference Board's, see the musing from the FRBSF yesterday on the topic) that use the flatness of the Treasury curve as an input variable are about to have a heart attack, further indicating the deflation is coming, in turn further pushing the yield lower. Ironically, those who followed Morgan Stanley's recent deflation hedge trade recommendations (1 Year dual digital out 100bp in one year if 2y CMS is below 0.8% and 30y CMS is below 3.3% at expiry for 16.5bp; and the 1y 1s5s conditional bull flattener, for zero cost, struck at 126bp. Currently, the spot 1s5s curve is at 130bp) are well in the money.

So much for trading perfection. After posting a flawless, and statistically impossible without cheating, trading record in Q1, Goldman followed in Bank of America's footsteps and posted 10 trading day losses in the quarter in which we saw the Dow plunge by 1,000 points intraday, and when the S&P ended broadly lower. The firm disclosed 3 trading days with losses of more than $100 million. But most notably, days with $100+ MM daily profitability dropped by more than half from 37 to 17. Of course, as usual, the statistical variance looks nothing like a standard Gaussian distribution. Elsewhere, Morgan Stanley reported 11 days of losses, but $100MM+ profitable trading days at 19, better than Goldman. Is the Morgan Stanley starting to outgun the biggest gun on Wall Street?

We previously presented a piece by SocGen's Albert Edwards that claimed that there is nothing now but to sit back, relax, and watch as the US becomes another Japan, as asset prices tumble, gripped by the vortex of relentless deflation. Sure enough, the one biggest bear on Treasuries for the past year, Morgan Stanley, is quick to come out with a piece titled: "Are We Turning Japanese, We Don't Think So." Of course, with the 10 Year trading at the tightest level in years, the 2 Year at record tights, and the firm's all out bet on curve steepening an outright disaster, the question of just how much credibility the firm has left with clients is debatable. Below is Jim Caron's brief overview of why Edwards and all those who see a deflationary tide sweeping the US are wrong. Yet, in what seems a first, Morgan Stanley presents two possible trades for those with access to the CMS and swaption market, in the very off case, that deflation does ultimately win.

The attached slide deck from Morgan Stanley provides a convenient 5 minute summary of the current state of the global financial and economic picture. Discussing everything from fund flows (nearly $300 billion in domestic equity outflows since the beginning of 2007: strong like bull), to equity hedge fund outflows in Q2 (and fixed income and macro fund inflows), proceeding to the US economy, where the dip in final domestic demand is expected to follow the GDP inflection point shortly (does anyone even remember the disappointing Q2 GDP number posted a long, long time ago last Friday?), a consumer spending number that based on the current saving rate is unsustainable, to the endless rally in corporate profit margins as firms fire any and all non-essential overhead, to China's PMI drop, to Morgan Stanley's reiteration of the bullish Chinese groupthink, to observations of the exquisite correlations between the US ISM, China's PMI, and the MSCI EM Total Perf, the unprecedented decline in US manufacturing as a share of total world manufacturing (charted below), to a hockeystick projection for Emerging Markets where decoupling this time is most certainly different, and other useful, if not particularly original, tidbits of data.

One of the odder stories of the day comes from Dow Jones, which reports that the Chinese Sovereign Wealth Fund (China Investment Corp, or CIC), has sold $138.5 million worth of Morgan Stanley shares in the past week, after dumping 4.53 million shares at $27.17 on Wednesday and 575,000 shares at $27.13 on Thursday. CIC began accumulating a massive Morgan Stanley stake in 2007, when it purchased its initial shares in the then troubled investment bank, and followed up with a June 2009 $1.2 billion investment, The reason for the sale, DJ speculates, is for the fund to avoid "additional disclosure requirements." Yet as a filing as recently as June 18 disclosed, the fund's Morgan Stanley stake was openly disclosed to be 11.64%. Surely the CIC administrator, the PM and everyone else in the front and back office were all too aware of this number. Which is odd since per both initial and follow up purchase agreements, CIC had stated it would not own more than 9.9% of MS' shares, and would remain a passive investor. That the firm would blatantly purchase 16% more than this threshold in the open market by mistake in the past year seems somewhat ludicrous. Worth recalling is that in June CIC disclosed a 10% MTM loss for the month of May, or roughly about the time it announced its above normal MS exposure. Are the two related? Has the CIC been covertly liquidating assets? It is unclear, as the one and only 13F for CIC is still the original one filed from February (covered here). One would imagine there would be at least some SEC requirement that a filer that has issued at least one 13F would be so kind to follow it up with at least a second one... eventually. In the meantime there is no official statement on the transaction: "A spokeswoman for CIC said she was unaware of the reason for the sales. A Beijing-based Morgan Stanley spokeswoman declined comment."

Morgan's Huw van Steenis shares his team's view on the "stress test" catalyst that is supposed to finally put ever-bullish MS in the money, and diffuse the pent up rage of its client base for losing it billions with all those short bond recommendations. The MS report has some quite objective observations: "Given the size of the fiscal and banking sector problems in Europe and elsewhere, a quick and easy solution is unlikely. However, we think a circuit breaker, such as a restructuring and recapitalisation of the banking system, is needed because unlimited liquidity provision by the ECB does not get to the root of the problem. In our view, for the recovery to get onto solid ground both financial and fiscal stability need to be restored equally. The sovereign debt crisis has shown how closely intertwined financial and fiscal stability are. In our view, Europe has been making good progress in mapping out how it intends to restore sustainable budget positions. But there are still concerns amongst investors about financial stability. In this context the stress test is key." Yet unfortunately, as expected, the conclusions are that all is well, despite the test obtaining largely different and far stronger conclusions than even MS' internal pre-testing setup. Nonetheless, a good one document summary of all the findings of the test together with some in depth commentary for those who just need that upside catalyst.

BN   7:52 *MORGAN STANLEY SMITH BARNEY HAD SET 15% MARGIN GOAL FOR 2010
BN   7:52 *MORGAN STANLEY'S PORAT SAYS `FLASH CRASH' SCARED AWAY INVESTORS
BN   7:52 *MORGAN STANLEY CFO PORAT SPEAKS IN INTERVIEW ON PROFIT GOALS
BN   7:52 *MORGAN STANLEY TO MISS BROKERAGE PROFIT-MARGIN GOAL, PORAT SAYS

Luckily the SEC is all over restoring investor confidence in the market... of hard core internet porn.

The2s10s has plumbed fresh new lows: - the most levered trade in the history of the world (the curve steepener for the uninitiated) is now the most abhorred. The amount of neg P&L incurred here over the past 2 months is just staggering. After hitting an all time of 290 in March, the 2s10s has collapsed by over 20% in the last three months. And as the leverage associated with this trade is second to none, the impact of this collapse is magnified hundreds of times, not to mention that the money banks charge for mortgages (if anyone wanted these to begin with) and credit cards is marginally so much lower that Q2 and certainly Q3 bank profitability will be very badly impaired. Which is why we were eagerly anticipating the one firm which has been the biggest defendant of the steepener trade to come out with its "double or nothing" all-in on the economic rebound which is critical for this bearish flattening to terminate. Today, we got our wish. As expected, Morgan Stanley's Jim Caron throws the kitchen sink into the bull case, and this time also pitches the "no fat tails" trade - the same trade that worked miracles for Boaz Weinstein and Merrill Lynch. Alas, with MS clients sick and tired of losing money, almost as much as Goldman's FX clients, this could be too little too late. Furthermore, with trite claims such as "no ‘double-dip’, We expect growth in China to slow but expect a soft landing, No deflation in 2H10, Policy rates to remain lower for longer, Europe to muddle along, and solvency risks in 2H10 overstated" it may be difficult for MS to find the last standing greatest fool out there. As for pitching the "Iron Butterfly" to said fool, good luck. But it sure sounds cool.

Morgan Stanley's Jim Caron in major damage control mode. Try keeping a straight face as you read this. "Why are UST 10s below 3%? Fear and greed, but mostly fear. Many in the market have surrendered themselves to the deflationistas. It seems to be all over the media these days. Concerns about a deflationary double-dip, rumors of the Fed re-opening QE and purchases of USTs as a liquid positive-carry hedge against risky assets are but only some of the culprits pushing UST 10y yields below 3.00%. We recognize and respect these forces and concede that UST10s can fall further in yield. We will not fight this current move. Instead, we will look for the opportunity to counter it."

Two days ago, we posted a story titled "Why VaR Is A Joke: Morgan Stanley Admits Losses in April And May Were "Much Higher" Than Anticipated" in which we extracted a segment from a report by Jim Caron to claim that VaR models are broken beyond fixing. Today, Morgan Stanley has asked us to provide a clarification on our post. We gladly comply.

Tyler,
The comments from Jim Caron that you reference in this article concern a model portfolio maintained by Morgan Stanley Research.  This fact isn't clearly reflected in the headline or in the article.  The headline in particular suggests that the Firm is disclosing losses.  This is not the case.  Again, Caron's comments concern a model portfolio within Morgan Stanley Research.  Please let me know if you can clarify this in an update, and let me know if you have any questions.

Thanks,
xxx
Morgan Stanley | Corporate Communications

We hope this clarifies everything.

Zero Hedge has long contended that risk models based on VaR "predictions" are flawed and only add to systemic instability due to the ever increasing correlations across all asset classes. We now read a first hand mea culpa from Morgan Stanley's Jim Caron, in which the head of the firm's rates strategy highlights precisely this problem: the complete collapse of predictive models when multiple sigma events like the May Flash Crash and the accelerating sovereign collapse of the past several months occurs: "April and May were difficult months for us and others, judging by fund data on market performance. We did not properly discount the risks associated with peripheral Europe. As a result, we had a larger risk exposure than we should have. We measure the return potential for our positions on a per-unit-of-risk basis, similar to a Sharpe Ratio. That unit of risk turned out to be much higher than we anticipated. This will force us, and many others, to right-size our risks." We wish we could agree with the last statement. Alas, each and every risk management group at comparable prop trading desks (to that of Morgan Stanley), will undoubtedly chalk off recent events to chance, and as these "will never recur", business we will promptly return back to normal, until we see another record crash in the Dow, only this time not 1,000 but multiples thereof.

There are some who will take up hundreds of pages to explain something as simple as the complete bankruptcy of the US entitlement program. Others, like Morgan Stanley in this case, present it succinctly- why write and write and write when a one page income (well, loss technically) statement will suffice? In a presentation, oddly focusing on Internet Trends, the MS team puts up an appendix page that probably should make the inbox of every politician in America. In a nutshell, when analyzing the math of entitlement spending, even as revenues flatline (at best), and decline (realistically), the expenses are quite literally growing geometrically. At this rate of deterioration, the Loss on the entitlement P&L will be at ($3 trillion) a year by 2013. For those who don't buy this estimate, here is a refresh: it was +$128 billion in 2001, (318) billion in 2005, and ($1,413) billion in 2009. Then there are some like former Western Asset Management personnel, who are so confused by numbers so massively negative, that they #Ref out their excel spreadsheets, and tend to ignore them altogether. Which brings us to the topic of the night - those who find the most efficient way to short Western Asset Management (and its retention policy of never hiring those proficient with positive and negative integers... forget about floating point) will win a free Zero Hedge hat.