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Why Morgan Stanley Thinks The S&P Is About To Crash

Why Morgan Stanley Thinks The S&P Is About To Crash

Echoing Guggenheim’s fears that US equities are in for a dramatic collapse, Morgan Stanley’s Mike Wilson warns that “…if equity markets fail one more time at our key resistance point, we believe the reversal is likely to be sharper and deeper than one might expect, even if the earnings recession is more benign than we expect.

Via Morgan Stanley,

Breaking out is hard to do. 

The S&P 500 remains the pied piper for global risk markets yet it continues to struggle with current levels for the third time in the past 18 months. While our 2400–3000 call from 18 months ago may look vulnerable, we think this latest surge will fail again, as we don’t expect a Fed cut to rekindle growth the way market participants may be hoping,and now pricing.

Market internals remain weak…

While the S&P 500 has made new highs, leadership remains decidedly defensive, with bond proxies and high-quality stocks disproportionately contributing to performance.

Underperformance of broader indices like the Russell 2000, Wilshire 5000,and equal-weighted S&P 500 suggest poor breadth, which is not a healthy development.

… Because fundamentals remain weak. 

We have been consistent in our view that growth would disappoint this year on both the earnings and economic fronts. Earnings forecasts have fallen significantly since the beginning of the year and economic surprises have skewed to the downside.

We have been consistent in our view that growth would disappoint this year on both the earnings and economic fronts. Earnings forecasts have fallen significantly since the beginning of the year and economic surprises have skewed to the downside.

 …click on the above link to read the rest of the article…

Big disappointments in capital spending and business surveys suggest growth could slow further in 2H. Our economists are forecasting a material deceleration in 2H US GDP vs 1H.

 …click on the above link to read the rest of the article…

The Fed, China, And The Markets

Amid market volatility and continued downside surprises in global growth, investors are focusing on the Fed and China. Regarding the Fed, the issue is whether and when it could signal potential changes in balance sheet normalisation (as it has on the policy rate path). On China, the question is when growth could stabilise. We think policy-makers will take the actions necessary to manage their countries’ respective growth trajectories. We believe that China’s growth will bottom in 1Q19, while the Fed has begun to signal some flexibility on its balance sheet policy, if there is a material deterioration in the growth outlook.

The Fed has altered its policy trajectory on rates, but not yet on the balance sheet. Despite robust trailing consumption growth and strong labour market dynamics, the US economy is unlikely to remain immune to slowing global growth. In addition, the recent tightening in financial conditions has affected capex intentions, and we expect the impact of fiscal stimulus on growth to fade in 2019. Recognising this slower growth environment, the Fed has signalled its flexibility on the policy rate path. However, the Fed has not yet given a clear signal on when the balance sheet reduction would end.

The normalisation process has not been as smooth as assumed. The Fed had anticipated that once it announced the path of balance sheet normalisation, markets would discount that “passive and predictable” pathway and that the process would be akin to “watching paint dry”.

However, we see the challenge as follows:

(1) Even though the Fed communicated the pace of the unwind well ahead of its start, uncertainty remains as regards the final, optimal size of the Fed’s balance sheet. Moreover, we believe investors are concerned that the Fed has remained on a set course, even though the US and global growth outlook has weakened.

…click on the above link to read the rest of the article…

“Jarring” FedEx Outlook Cut Suggests “Severe Global Recession”

FedEx shares tumbled 7% after what Morgan Stanley called a “jarring” cut to its annual forecasts, suggesting global growth is slowing far more than most expect, and prompting expectations of an “uber-dovish hike” by the Fed.

The global logistics bellwether slashed its outlook just three months after raising the view, reflecting an unexpected and abrupt change in the company’s view of the global economy amid rising trade tensions between the U.S. and China. Not only were the cuts were deeper than the Street expected according to Morgan Stanley analyst Ravi Shanker, but everyone is pointing to the following comment from the press release: “Global trade has slowed in recent months and leading indicators point to ongoing deceleration in global trade near-term.”

Needless to say, with little in terms of warning, Morgan Stanley was shocked by the magnitude and severity of the cut, and suggested that this implies a “severe global recession” is unfolding:

“We recognize that global growth has slowed but we are very surprised by the magnitude of the headwind, which is what might be seen in a severe recession,” Shanker wrote. “We believe global growth concerns are also likely to get worse before they get better next year, which could mean more of a drag on FY20 EPS.”

Quoted by Bloomberg, Shankar also said that the Express unit is also likely to remain an overhang, Shanker said, as FedEx management didn’t provide an outlook for fiscal 2020 or its timeline for improving the cargo airline, which has been hit by worsening economic conditions in Europe.

FedEx shares tumbled 7% on Wednesday morning, the lowest intraday price in about two years and the 10th decline for FedEx in 11 days.

…click on the above link to read the rest of the article…

To One Bank, This Is The Flashing Red Warning That A Crash Is Dead Ahead

For much of 2018, the prevailing market theme was the one Morgan Stanley dubbed “rolling bear markets” when any time a given asset was hit, whether emerging markets, Italian bonds, or tech stocks, money would simply rotate from one place to another. However, at the end of September, when rates spiked amid concerns the Fed was prepared to push rates beyond neutral, things changed overnight.

Fast forward to now when what appeared to be somewhat orderly sequential blow ups have mutated into wholesale market panics in which everything starts to go wrong at once, or as Bloomberg describes it “everywhere you look, something’s blowing up.”

In commodities, it’s the record plunge in oil. In equities, it’s six weeks of turbulence in the S&P 500. Debt markets have been rattled by the turmoil engulfing General Electric and PG&E. Bitcoin just plunged 13 percent. And Goldman Sachs, the storied investment bank, is having the worst week since 2016.

As Bloomberg correctly notes, by themselves these sudden asset air pockets would be enough to incite panic, “but have them erupt all around and even the most grizzled Wall Street types can start to sound paranoid. Does GE have something to do with Goldman? How does Bitcoin sway the stock market? Wildfires have nothing to do with crude’s convulsions, but both are bad news for banks.”

“The risk of contagion is understood. What’s not understood is where and how connected things are,” Stewart Capital Advisors’ Malcolm Polley said by phone. “Just about anything can create panic, create contagion, and it doesn’t have to be something that makes sense.”

That bad things should congregate isn’t surprising to Donald Selkin, chief market strategist at Newbridge Securities, who sees it as a consequence of having it so good for so long. He’s waking up every night to check the futures.

…click on the above link to read the rest of the article…

Morgan Stanley: “We Have Hit The Tipping Point”

Having been one of the most bearish voices on Wall Street for a good part of 2018, with downgrades of small caps and tech stocks earlier this summer and one month ago going so far as to call the peak of both Treasurys (in September) and Stocks (this December)…

… in his latest Sunday Start note, Morgan Stanley’s chief US equity strategist Michael Wilson, takes what may end up being yet another premature victory lap following the latest equity selloff inspired initially by surging rates and the continued chaos over the Italian budget process and – overnight – the Chinese market crash, and writes that “the break higher in interest rates last week appears to be the tipping point, enabling the rolling bear market to complete its unfinished business in these last bastions of safety.”

Wilson also reminds us that based on the bank’s Equity Risk Premium framework, the S&P 500, as a whole, had become overvalued for the first time since January, and that “this overvaluation was apparent as yields on the 10-year broke through the 3% barrier. Small caps had already been underperforming for several months, but as rates moved above 3%, their  underperformance accelerated. With last week’s surge toward 3.20%, weakness finally came to the high-flying growth stocks where valuation is the most stretched.”

In short: for Wilson, it’s all downhill from here, even though the stock peak appears to have come some 2 months earlier than he had predicted earlier.

We present his full note is below:

The Tipping Point

September bucked the normal seasonal pattern, proving to be a fairly calm month for financial markets. Global equities even started to broaden out a bit with international stocks doing better, led by Japan. Credit markets also displayed resilience with one of their better months this year, despite the fact that the rates market was suffering one of its worst.

…click on the above link to read the rest of the article…

The Yield Curve Is The Economy’s Canary In A Coal Mine

The Yield Curve Is The Economy’s Canary In A Coal Mine

The economy has hit a wall and is now sliding down it. I don’t care what bullish propaganda may or may not be bubbling up in the headlines from the financial media and Wall Street, the hard numbers I look at everyday show accelerating economic weakness. The fact that my view is contrary to mainstream consensus and political propaganda reinforces my conviction that my view about the economy is correct.

As an example of the ongoing underlying systemic decay and collapse conveyed by this week’s title, it was announced that General Electric would be removed from the Dow Jones Industrial Average index and replaced by Walgreen’s. GE was an original member of the index starting in 1896 and was a continuous member since  1907.

GE is an original equipment manufacturer and industrial product innovator. It’s products are used in broad array of applications at all levels of the economy globally.  It is considered a “GDP company.” GE was iconic of American innovation and economic dominance. Walgreen’s is a consumer products reseller that sells pharmaceuticals and junk. Emblematic of the entire system, GE has suffocated itself with poor management which guided the company into a cess-pool of financial leverage and hidden derivatives.

As expressed in past issues (the Short Seller’s Journal), I don’t put a lot of stock in the regional Fed economic surveys, which are heavily shaded by “hope” and “expectation” metrics that are used to inflate the overall index level. These are so-called “soft” data reports. But now even the “outlook” and “expectations” measurements are falling quickly (see last week’s Philly Fed report). The Trump “hope premium” that inflated the stock market starting in November 2016 has left the building.

…click on the above link to read the rest of the article…

Morgan Stanley: The Tech Bubble “Can Burst At Any Moment, Without Warning”

Earlier this week, Goldman Sachs, whose market-timing calls leave much to be desired, declared that tech stocks are “not a bubble”, and went so far as to predict that the secular increase in tech names could continue for decades, spawning vivid memories of Goldman’s May 2008 prediction of $200 oil just months before the start of the second great depression, and before oil crashed more than $100/barrel, wiping out a generation of muppets.

However, it is now safe to say that with the exception of some truly naive individuals, virtually nobody believes Goldman any more, and thus Goldman’s “all clear” may be just the top-tick so many had been waiting for.

One skeptic is Bank of America’s Michael Hartnett who back in March, just as the tech sector suffered its first big rout of 2018, had the gall to tell the truth and observe that the “e-Commerce” sector, which consists of AMZN, NFLX, GOOG, TWTR, EBAY, FB, was now up 617% since the financial crisis, making it the 3rd largest bubble of the past 40 years, and at this rate – assuming no major drop in the 6 constituent stocks – was set to become the largest bubble of all time over the next few months.

Hartnett followed up this this week by noting that while so far Tech stocks have seen record inflows as they have emerged as the “defensive growth” sector of the late market cycle…

… the “big risk” is “as in 1998, that credit tremors spread and investors forced to deleverage from risk assets, raise cash”, while the “biggest risk” is a “quick, deep tech selloff.  Or, as Bloomberg’s Andrew Cinko put it on Friday it, “if the times get tough and investors must delever they will sell “what they own,” and that “those who are rotating to financials and banks this week and away from tech may simply be trading the frying pan for the fire.”

…click on the above link to read the rest of the article…

Italian Bonds Tumble, Triggering Goldman “Contagion” Level As Political Crisis Erupts In Spain

When it comes to the latest rout in Italian bonds, which has continued this morning sending the 10Y BTP yield beyond 2.40%, a level above which Morgan Stanley had predicted fresh BTP selling would emerge as a break would leave many bondholders, including domestic lenders with non-carry-adjusted losses…

… there has been just one question: when does the Italian turmoil spread to the rest of Europe?

One answer was presented yesterday by Goldman Sachs which explicitly defined the “worst-case” contagion threshold level, and said to keep a close eye on the BTP-Bund spread and specifically whether it moves beyond 200 bps.

Should spreads convincingly move above 200bp, systemic spill-overs into EMU assets and beyond would likely increase. Italian sovereign risk has stayed for the most part local so far. Indeed, the 10-year German Bund has failed to break below 50bp, and Spanish bonds have increased a meager 10bp from their lows. This is consistent with our long-standing expectation that Italy would not become a systemic event. That said, should BTP 10-year spreads head above 200bp, the spill-over effects onto other EMU sovereigns would likely intensify.

Well, as of this morning, the 200bps Bund-BTP level has been officially breached. So, if Goldman is right, it may be time to start panicking.

Ironically, almost as if on cue, just as the Italy-Germany spread was blowing out, a flashing red Bloomberg headline hit, confirming the market’s worst fears:

  • SPANISH SOCIALISTS REGISTER NO-CONFIDENCE MOTION AGAINST RAJOY.

This confirmed reports overnight that Spain’s biggest opposition party, the PSOE or Socialist Party, was pushing for a no-confidence motion again Spain’s unpopular prime minister. The no-confidence call follows the National Court ruling on Thursday that former Popular Party officials had operated an illegal slush fund, as a result of which nearly 30 people were sentenced to a total of 351 years in prison.

…click on the above link to read the rest of the article…

“Worst Case Scenario” Emerging: Morgan Stanley Warns “Selling Has Shifted”

Confirming JPMorgan’s “worst case scenario” that forced de-levering in vol-based strategies would lead to retail ETF outflows and create a vicious cycle downwards, Morgan Stanley’s Christopher Metli warns that today’s moves lower are likely not being driven by systematic supply – this appears to be more discretionary selling.

Risk-Parity funds are seeing some of the biggest losses in history…

But, as we previously detailedJPMorgan offered hope that this vicious circle of de-leveraging could be stalled – and had been in the past – by dip-buyers from greater-fool retail inflows.

In the past, just as we have seen this year, these risk-parity-correlation tantrums have been cushioned by equity market inflows, and we note that, in particular, YTD equity ETF flows have surpassed the $100bn mark, a record high pace.

If these equity ETF flows, which JPMorgan believes are largely driven by retail investors, start reversing, not only would the equity market retrench, but the resultant rise in bond-equity correlation would likely induce de-risking by risk parity funds and balanced mutual funds, magnifying the eventual equity market sell-off.

Which could be a problem…

As ETF outflows are surging…

And as Morgan Stanley’s Christopher Metli – who previously explained what happens when VIX goes bananas – notes, today’s moves lower are likely not being driven by systematic supply – this appears to be more discretionary selling. 

Systematic supply from vol target strategies is largely out of the way now, while consensus trades are getting hit:  NDX is underperforming SPX, momentum is down 1%, and the Passive Factor is up, indicating actively held names are underperforming names better held by passive funds.

So why now, even though the systematic supply is largely out of the way?

…click on the above link to read the rest of the article…

Liquidity Provider Signals Collapse In Global ETF Trading 

Liquidity Provider Signals Collapse In Global ETF Trading 

Trading in low cost, passive investment products might be more vulnerable than some thought. Global ETF trading collapsed by 14% in Q3 2017 versus Q2 2017 – and was described as “unusually slow”. Global ETF trading in September 2017 was 24% lower than the same month a year ago.

For those unfamiliar, Flow Traders NV is a global electronic liquidity provider specializing in exchange-traded products (ETPs). The Company continuously quotes bid and ask prices for ETPs listed across the globe, both on and off exchange, in all asset classes. Flow Traders is a proprietary trading firm with offices in the Netherlands, Singapore, the USA, and Romania.

Today’s results from specialized ETF trader, Flow Traders NV (Euronext: FLOW), fell well short of consensus, with trading volume both for the company and the ETF market significantly lower in Q3 2017 versus the previous quarter. The share price rose 1.98%. This from Bloomberg:

[24 October 2017 at 13:54:31 UTC+1] Zero Hedge: Flow Traders Misses on Weak Volumes, Margins]

Flow Traders 3Q Ebitda was 14% below consensus and driven by weaker volumes and margins in Europe, says Morgan Stanley (equal weight).

  • Net was 2% below consensus due to one-off tax rebates
  • U.S. revenue was down 53% Y/y, hurt by weaker volumes and low market volatility
  • 3Q net trading income EU31.7 million
  • Flow Traders expects “declining trend in cost growth to continue in 4Q17 towards the lower end of the guided 15-20% cost growth target range for full year 2017”
  • Flow Traders intends to increase the pay-out ratio to at least 75% of its net earnings over 2017

The results summary below taken from Flow Traders’ quarterly earnings release shows a quarter-on-quarter decline in the company’s ETP trading (Exchange Traded Products – basically ETFs) of 14% and 9% in Europe and the Americas, respectively. More significantly, the bottom three lines show that the total value of ETF trading fell by 14% and 15% in the Europe and Americas, respectively, and by 14% on a global basis.

…click on the above link to read the rest of the article…

Major Problems Announced At One Of The Largest Too Big To Fail Banks In The United States

Major Problems Announced At One Of The Largest Too Big To Fail Banks In The United States

Wells FargoDo you remember when our politicians promised to do something about the “too big to fail” banks?  Well, they didn’t, and now the chickens are coming home to roost.  On Thursday, it was announced that one of those “too big to fail” banks, Wells Fargo, has been slapped with 185 million dollars in penalties.  It turns out that for years their employees had been opening millions of bank and credit card accounts for customers without even telling them.  The goal was to meet sales goals, and customers were hit by surprise fees that they never intended to pay.  Some employees actually created false email addresses and false PIN numbers to sign customers up for accounts.  It was fraud on a scale that is hard to imagine, and now Wells Fargo finds itself embroiled in a major crisis.

There are six banks in America that basically dwarf all of the other banks – JPMorgan Chase, Citibank, Bank of America, Wells Fargo, Morgan Stanley and Goldman Sachs.  If a single one of those banks were to fail, it would be a catastrophe of unprecedented proportions for our financial system.  So we need these banks to be healthy and running well.  That is why what we just learned about Wells Fargois so concerning…

Employees of Wells Fargo (WFC) boosted sales figures by covertly opening the accounts and funding them by transferring money from customers’ authorized accounts without permission, the Consumer Financial Protection Bureau, Office of the Comptroller of the Currency and Los Angeles city officials said.

An analysis by the San Francisco-headquartered bank found that its employees opened more than two million deposit and credit card accounts that may not have been authorized by consumers, the officials said. Many of the transfers ran up fees or other charges for the customers, even as they helped employees make incentive goals.

…click on the above link to read the rest of the article…

Major Problems Announced At One Of The Largest Too Big To Fail Banks In The United States

Major Problems Announced At One Of The Largest Too Big To Fail Banks In The United States

Wells FargoDo you remember when our politicians promised to do something about the “too big to fail” banks?  Well, they didn’t, and now the chickens are coming home to roost.  On Thursday, it was announced that one of those “too big to fail” banks, Wells Fargo, has been slapped with 185 million dollars in penalties.  It turns out that for years their employees had been opening millions of bank and credit card accounts for customers without even telling them.  The goal was to meet sales goals, and customers were hit by surprise fees that they never intended to pay.  Some employees actually created false email addresses and false PIN numbers to sign customers up for accounts.  It was fraud on a scale that is hard to imagine, and now Wells Fargo finds itself embroiled in a major crisis.

There are six banks in America that basically dwarf all of the other banks – JPMorgan Chase, Citibank, Bank of America, Wells Fargo, Morgan Stanley and Goldman Sachs.  If a single one of those banks were to fail, it would be a catastrophe of unprecedented proportions for our financial system.  So we need these banks to be healthy and running well.  That is why what we just learned about Wells Fargois so concerning…

Employees of Wells Fargo (WFC) boosted sales figures by covertly opening the accounts and funding them by transferring money from customers’ authorized accounts without permission, the Consumer Financial Protection Bureau, Office of the Comptroller of the Currency and Los Angeles city officials said.

An analysis by the San Francisco-headquartered bank found that its employees opened more than two million deposit and credit card accounts that may not have been authorized by consumers, the officials said. Many of the transfers ran up fees or other charges for the customers, even as they helped employees make incentive goals.

…click on the above link to read the rest of the article…

Federal Regulators Accuse Banks Of Not Having Credible Crisis Plans, Would Need Another Bailout

Federal Regulators Accuse Banks Of Not Having Credible Crisis Plans, Would Need Another Bailout

Perhaps the biggest farce to result from the Dodd-Frank legislation designed to “rein in” banks was the ridiculous notion of “living wills” –  a concept that makes zero sense in an environment where the failure of even one bank assures a systemic crisis and could – as the Lehman financial crisis showed – lead to the collapse of all other interlinked financial institutions.

Which is why we were not surprised to read this morning that federal regulators announced that five out of eight of the biggest U.S. banks do not have credible plans for winding down operations during a crisis without the help of public money.

Which is precisely the point: now that the precedent has been set and banks know they can rely on the generosity of taxpayers (with the blessing of legislators) why should they even bother planning; they know very well that if just one bank fails, all would face collapse, and the only recourse would be trillions more in taxpayer aid.

As Reuters writes, the “living wills” that the Federal Reserve and Federal Deposit Insurance Corporation jointly agreed were not credible came from Bank of America, Bank of New York Mellon, J.P. Morgan Chase, State Street, Wells Fargo. What is more impressive is that the Fed and FDIC found any living will to be credible.

Also amusing: it was only the FDIC which alone determined that the plan submitted by Goldman Sachs was not credible while the Goldman-dominated Fed gave its blessing; alternatively, the Federal Reserve Board on its own found that the plan of Morgan Stanley – Goldman’s arch rival in investment banking – not credible. Citigroup’s living will did pass, but the regulators noted it had “shortcomings.”

…click on the above link to read the rest of the article…

The Oil Short Squeeze Explained: Why Banks Are Aggressively Propping Up Energy Stocks

The Oil Short Squeeze Explained: Why Banks Are Aggressively Propping Up Energy Stocks

Last week, during the peak of the commodity short squeeze, we pointed out how this default cycle is shaping up to be vastly different from previous one: recovery rates for both secured and unsecured debts are at record low levels. More importantly, we noted how this notable variance is impacting lender behavior, explaining that banks – aware that the next leg lower in commodities is imminent – are not only forcing the squeeze in the most trashed stocks (by pulling borrow) but are doing everything in their power to “assist” energy companies to sell equity, and use the proceeds to take out as much of the banks’ balance sheet exposure as possible, so that when the default tsunami finally arrives, banks will be as far away as possible from the carnage. All of this was predicated on prior lender conversations with the Dallas Fed and the OCC, discussions which the Dallas Fed vocally deniedaccusing us of lying, yet which the WSJ confirmed, confirming the Dallas Fed was openly lying.

This was the punchline:

[Record low] recovery rate explain what we discussed earliernamely the desire of banks to force an equity short squeeze in energy stocks, so these distressed names are able to issue equity with which to repay secured loans to banks who are scrambling to get out of the capital structure of distressed E&P names. Or as MatlinPatterson’s Michael Lipsky put it: “we always assume that secured lenders would roll into the bankruptcy become the DIP lenders, emerge from bankruptcy as the new secured debt of the company. But they don’t want to be there, so you are buying the debt behind them and you could find yourself in a situation where you could lose 100% of your money.

…click on the above link to read the rest of the article…

Kuroda’s NIRP Backlash – Japanese Interbank Lending Crashes

Kuroda’s NIRP Backlash – Japanese Interbank Lending Crashes

Not only has the Yen strengthened and stocks collapsed since BoJ’s Kuroda descended into NIRP lunacy but, in a dramatic shift that threatens the entire transmission mechanism of negative-rate stimulus, Japanese banks (whether fearing counterparty risk or already over-burdened) have almost entirely stopped lending to one another. Confusion reigns everywhere in Japanese markets with short-term interest-rate swap spreads surging and bond market volatility spiking to 3 year highs (dragging gold with it).

As Bloomberg reports,

The outstanding balance of the interbank activity plunged 79 percent to a record low of 4.51 trillion yen ($40 billion) on Feb. 25 since Bank of Japan Governor Haruhiko Kuroda on Jan. 29 announced plans to charge interest on some lenders’ reserves at the monetary authority.

While Kuroda wants to lower the starting point of the yield curve to reduce borrowing costs and spur shift of funds into riskier assets, the interbank rate has fallen only about as far as minus 0.01 percent, above the minus 0.1 percent charged on some BOJ reserves. The swings on bond yields will make it harder for financial institutions to determine how much business risks they can take, weighing on lending in a weak economy even as they are penalized for keeping some of their money at the central bank.

It will take at least another month until the market finds a level where many dealings are settled, as financial institutions face uncertainty over how the new policy affects monthly fund flows, said Izuru Kato, the president of Totan Research Co. in Tokyo.

“Since past patterns don’t apply under the entirely new structure, financial institutions will take a conservative approach until the financing picture is nailed down,” Kato said. “If the funding estimate proves wrong, banks might lose by prematurely lending in negative rates. People are cautious and staying on the sidelines.”

…click on the above link to read the rest of the article…

 

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Olduvai II: Exodus
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