"Goldman, unlike the rest of the street and practically the rest of the I banking world, is ratcheting up off balance sheet risk!!! Is BoomBustBlog the only one inquiring as to WHY??? We have a few reasons in mind... And to think, many thought the Enronesque days of off balance sheet "hide the sausage" games have come to an end..." Go through your sell side analyst's quarterly update and if you don't find these tidbits of information thoroughly explained, but instead see a Goldman fan boy(girl) cheering section, come back and subscribe to BoomBustblog. At the very least, we tell it like it is!
My opinion and updated valuation for Goldman and its 3rd quarter performance is available for download to all paying subscribers: GS 3rd Quarter 2010 Update. While I can't spill the beans on the entire contents of the subscription document, there are a few issues (as usual) and observations that I would like to make public.
To begin with, I must commend Goldman's management. They do a helluva job massaging numbers and attempting to right their ship, particularly in relation to some other banks. Anecdotally, I'm aware of their losing some talent on the equities side but I am sure they have no problem replacing it. There is also the issue of their subprime servicing unit, Litton Loans, which I am sure will bring them nothing but heartache in the near to medium term, but at least that aspect of the business has been recognized by the sell side, if not under appreciated in terms of potential risk. Despite its small size in relation to Goldman's aggregate operations, it carries with it material reputation risk as well as the prospects for significant litigation and more.
Now, on to the aspects which the sell side decided not to cover - or somehow overlooked. Goldman was applauded for having strong accounting earnings. In Four Facts That BANG JP Morgan That You Just Won’t Hear From The Sell Side!!!, I warned of the danger at looking at accounting earnings as if they were actually a legitimate barometer of a companies actual economic value. If that were the case, wouldn't accountants be the best investors in the world? I will delve into the folly of relying strictly on accounting earnings later on this missive as well, particularly in regards to a company with management as crafty and capable as Goldman - but before I do let's realize that even those accounting earnings were down significantly from previous periods...
I have received a lot of feedback concerning my article posted yesterday, A Step by Step Guide to Exactly How Much Derivatives Risk Each of the 5 Big Banks Actually
Pick up your own "Fiery Swords of Truth" and aggressively seek out the facts. Don't be afraid to ask questions under the pretense you don't understand. Chances are, if it is so complex that you can't understand it, it is either wrong or many other people, including the creators and proponents, don't understand it either!!!
Have, and How It Could All Go Boom! (a must read precursor to this piece) in which I picked up the fiery sword of Truth and attacked all misinformation within reach. A decent amount of derivatives traders, salesman and financial engineers chimed in. Of course, being the simpleton that I am, I am at a loss how anybody can argue that the hedging and netting system actually works with the utter failure of the monolines, Lehman (wherein contracts were unwound and rewritten, but why would they have to be if everybody was netted???) and Bear Stearns (where the government had to step in to be the counterparty of last result), all of which allegedly netted out much of their risk - RIIGHHHT??? Nonetheless, I will go through some of the responses I received via email, all of which were cogent, intelligent and polite - but most of which took a swing at my thesis. Okay, I'm swinging back - and I'm swinging back with the "Fiery Sword of Truth" as well!
Here's the first one:
Hi reggie, love the independance of the blog. Couldnt help but wonder though, as to if the big 5 were really cross exposed to that degree. Surely hedge funds, private banks, real world commodity producers etc are other swap counter parties that you fail to include in your calculations. 1.7 trillion of unlevered hedge fund assets arent included anywhere for a start. How about other smaller banks too, that dont show up in the comparison, maybe there is more diversification than you think.
The latest on Apple's earnings that went so far in corroborating what I've been preaching for months to a bunch of crazed, excitable Apple fanatics who simply refused to see facts for what they were:
Apple surpassed quarterly earnings expectations again with the help of strong sales of its iPhone, but iPad sales and margins disappointed [strong demand, but the smart money is waiting to see what the Android tablets are capable of - I don't think they'll be disappointed], and its shares sank.
Weaker-than-projected gross margins [exactly as I anticipated - see How Google is Looking to Cut Apple’s Margin and How the Sell Side of Wall Street Will Enable This Without Sheeple Investor’s Having a Clue] and iPad shipments disappointed investors who had expected more from a company that had smashed Wall Street's targets in each of the past eight quarters. Apple shares dropped 7 percent in late trading after initially being halted. The stock finished the regular Nasdaq session [AAPL 318.00 3.26 (+1.04%) ] more than 1 percent higher. Sales of Apple's popular iPhone jumped 91 percent to 14.1 million units in the quarter. The company sold 3.89 million Macs, an increase of 27 percent. Apple sold 9.05 million iPods, marking a decline of 11 percent year over year. The company 4.19 million iPads in the quarter....
For those who are new to my writings and research (those who follow me should skip down to the next section), I have had relatively strong results in ferreting out weak companies which the sell side, the ratings agencies and the media consider "buys", "conviction buys", and AAA/AA credits - only to collapse, be acquired on the cheap or fall into bankruptcy less than a year later. Despite the painful rides necessary to ride out volatile markets that absolutely ignore fundamentals, in the end broke is broke and insolvent businesses tend not to last very long. The list of companies called out as insolvent against the rating agencies/sell side analysts/super smart billionaire investment crowd include:
- Bear Stearns: Is this the Breaking of the Bear? and Lehman Brothers (Is Lehman really a lemming in disguise)
- Washington Mutual and Countrywide
- Hovnanian: Credibility is the Key to Success for a CEO ï¿½ Hovnanian has Lost that Key: A letter to Mr. Hovnanian
- General Growth Properties: “GGP and the type of investigative analysis you will not get from your brokerage house“ (BoomBustBlog professional subscribers can download the entire GGP composite history in .pdf format)
- MBIA and Ambac: A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton
- among approximately 50 other similar calls..
These calls provided 5 quarters in a row of phenomenal returns (see performance) until the massive market melt-up of 2009 where we saw fundamentals get thrown down the sewer drain while math and common sense were turned on their respective heads. Well, guess what boys and girls... Methinks math is back and it may be here to stay for a while.
Yesterday, I sat through a conference sponsored by Andrew Schneider's Hedgeco.net on starting and marketing hedge funds. As I sat through the various presentations focusing on transparency, performance results, etc., I though to myself, " You know Reg, you probably rank in the top echelon of these guys in terms of absolute performance, and in terms of transparency you actually publish what you do on the web for all to see." Shortly thereafter I glimpsed at the latest issue of HedgeWeekly2010_No21 and decided to compare my blog results with that of the top funds.
As you can see, many funds were hurt in 2008, but there were some who did quite well, with the top of the pile pulling just over 72%. That's pretty damn good! Below is an excerpt from the BoomBustBlog post "Updated 2008 performance":
Below are the raw, absolute returns for my proprietary account. These returns are calculated by calculating the difference between my starting point and ending point, and is the number that I use for comparison (since it is the number that shows how much money I actually made).
||Reggie’s gross avg. return||S&P return|
|For all 2007 (6 months)
|For Q1 2008||50.03%||0.68%|
|For Q2 2008||53.46%||-8.66%|
|For Q3 2008||32.40%||-8.30%|
|For all 2008||196.11%||-8.69%|
|2008 absolute return||335.42%||
to S&P 500
The numbers below are average monthly numbers. They are posted for the sake of uniform comparison.
I have been bearish on European banks since the UK mortgage banks collapsed several years ago. To this day, despite mounds of fundamental and macro evidence pointing to very bad things happening, there are still cheerleaders stating that concerns are overblown. A good example can be found in the post "Greek Crisis Is Over, Region Safe”, Prodi Says – I say Liar, Liar, Pants on Fire!", on March 14th:
“The worst of Greece’s financial crisis is over and other European nations won’t follow in its path", said former European Commission President Romano Prodi. “For Greece, the problem is completely over,” said Prodi, who was also Italian prime minister, in an interview in Shanghai today. “I don’t see any other case now in Europe. I don’t think there is any reason to think the euro system will collapse or will suffer greatly because of Greece.””
Okay, I shouldn't have called him a liar, but a tad bit optimistic, maybe? I actually agree with the last part of his statement. The euro system will not suffer greatly because of Greece, it will suffer greatly because of individual member countries' problems collectively weighing on the union. As for Mr. Prodi's accuracy, let's take a look at the Greek CDS over the time period in question...
Yeah, that's right! Listening to the former EC President would have gotten you on the wrong side of the TRIPLING of CDS spreads. Not to fret though, the ECB allocated 1 trillion dollars to alleviate this problem, and now spreads have just more than doubled, but are still rising. And for those of you who believed me over Prodi (I apologize again for the "liar, liar pants on fire" bit, though)...
For those who have been following me in the Asset Securitization and Pan-European Sovereign Debt Crisis series this may be old news, but let's go through the exercise anyway. It looks as if we are back to those non-sense games being played by those that manipulate the market. Taking a look at Bloomberg.com's front page, you'll see "Stocks, U.S. Futures Rally on Economic Outlook; Yen Weakens, Bonds Decline" (hey, good times are here again) followed directly by "Banks Deposit Record $394 Billion With ECB, Avoiding Loans to One Another"(hey, isn't this the exact same environment wherein Bear Stearns, then Lehman Brothers collapsed leading the Treasury Secretary Hank Paulson to proclaim the end of the financial world was coming?). Then there's "Covered Bond Sales Surge; Transocean Tumbles: Credit Markets": Sales of covered bonds are accelerating as investors seek debt backed by collateral amid concern about the creditworthiness of governments and banks.
Okay, let's take this by the numbers....
In the news this morning:
- Stocks, U.S. Futures Tumble on China Growth Concern, BP Spill; Oil Plunges: We discussed the topic of China's unsustainable growth and the knock on effects its slowdown would have on other economies in detail just last week. How timely...
- The Narrowing Chinese Trade Surplus
- In Australia, Tax as a Contagion
- Australia: The Land Down Under(water in mortgage debt)
- BoomBustBlog China Focus: Inflation?
- BoomBustBlog China Focus: Interest Rates
- My China Ruminations Have Come to Pass As the Country Enters a Bear Market
- Chubble (The Unmistakeable, Yet Thoroughly Argued Chinese Bubble), Unemployed/Deleveraging Shopaholics Pushing Retail Stocks & Other News
- Euro Weakens Against Dollar on Speculation Crisis Hurting Region's Economy: Nothing new here. BoomBustBlog newcomers, see the Pan-European Debt Crisis here.
- BP Tumbles Most in 18 Years After Abandoning Attempt to Plug Leaking Well: The company's future doesn't look to bright!
- Paulson Drops 6.9% as Hedge Funds Post Biggest Monthly Losses Since Lehman (HNWs and institutional investors should take the time to read this article and my summaries): Many funds, including Paulson's, made hard bullish bets on the financial sector recovering, in direct contravention to my positions and research. Yes, the financial sector took off like a bat out of hell the last 3 quarters of 2009, but one shouldn't confuse sharp market price movements with fundamentals. Many, if not most are in bad shape, and it ain't lookin' much better in the near term either. See The Next Step in the Bank Implosion Cycle???. Most importantly, many (if not most) professional money managers and analysts totally underestimated the extent of the damage being done Europe. I have was weary of Europe since 2008, put short research and positions on in 2009 (with mixed results due to the bear market rally) and went full blown GRIZZLY BEAR in 2010 (reference the Pan-European Debt Crisis which publicly documents and details it all). Back to the news clip:
- (Bloomberg) -- John Paulson, Louis Bacon and Andreas Halvorsen navigated the global market turmoil of 2008 with little or no damage. They weren’t as successful last month as the Dow Jones Industrial average had its worst May since 1940. Hedge funds lost an average of 2.7 percent through May 27, according to the HFRX Global Hedge Fund Index, as the sovereign debt crisis in Europe triggered declines in stocks, the euro and commodities, and the gap in yields between U.S. short-term and long-term debt narrowed. It was the biggest decline since November 2008, when hedge funds lost 3 percent in the wake of Lehman Brothers Holdings Inc.’s bankruptcy two months earlier. Almost every strategy lost money in May, according to Hedge Fund Research Inc. in Chicago, as the Dow index of 30 big stocks sank 7.6 percent including dividends amid speculation that Greece’s debt problems would spread to nations such as Spain and Portugal. Some of the best-known funds saw their gains for this year erased. “Attempting to manage risk in an environment where everything that could go wrong does go wrong seems like a fruitless endeavor,” said Brad Balter, who runs Balter Capital Management LLC, a Boston firm that invests in hedge funds for clients. “The only defense that seems to work in months like these is being in cash.”
"SAC Capital Advisors LLC, the hedge-fund firm run by Steven Cohen in Stamford, Connecticut, with about $12 billion under management, lost 2.9 percent last month through May 21 with its SAC Capital International fund, trimming this year’s gain to about 4 percent, according to people familiar with the firm.
Citadel Investment Group LLC, the $12 billion hedge-fund firm run by Ken Griffin, lost about 2 percent with its biggest funds last month through May 21, said people familiar with the Chicago firm. The funds soared as much as 62 percent last year as markets rebounded after losing as much as 55 percent in 2008.
Brevan Howard Asset Management LLP in London, Europe’s largest hedge-fund firm, lost 0.1 percent for the month through May 21 with its Brevan Howard Fund Ltd., leaving it with a decline of 0.3 percent this year, according to an investor.
- I will gladly compare the performance of BoomBustBlog research to any bank, fund or asset manager that charges big commissions or 2 and 20! Reference Updated 2008 performance and the 2009 Year End Note to BoomBustBlog Readers and Subscribers for rough performance numbers covering 2007, 2008 and 2009.
- Analysts Boosting Forecasts See 25% Stock Gain Defying El-Erian New Normal: Yeah, but aren't analysts mostly wrong unless we're in a bull market? Stocks always go up, Right????!!!! Reference Blog vs Broker, Who Do You Trust?
- Cameron Bull Market in Gilts Beating Merkel Bonds as U.K. Keeps AAA Rating: For now, at least. Subscribers, see
UK Public Finances March 2010
In "With the Euro Disintegrating, You Can Calculate Your Haircuts Here", I explicitly illustrated the likely loss to principal of sovereign debt investors who would be forced to take haircuts "for the cause". While we fully stand behind the calculations and the logic, chances are several sovereigns may attempt to undergo sleight of hand in order to placate investors as best they can. We suspect we will soon be hearing of significant restructuring plans in the Eurozone, starting with Greece. The piece below expands on these thoughts and offers subscribers live spreadsheets that illustrate the potential repercussions. It is recommended that these scenarios be taken into consideration in light of the info offered in the post "Introducing The BoomBustBlog Sovereign Contagion Model: Thus far, it has been right on the money for 5 months straight!" and compared to the haircut analysis as well.
Greek Restructuring Scenarios
There are several precedents of sovereign debt restructuring through maturity extension without taking an explicit haircut on the principal amount, and many analysts are predicting something of a similar order for Greece. This form of restructuring is usually followed as a preemptive step in order to avoid a country from technically defaulting on its debt obligation due to lack of funds available from the market. It primarily aims to ease the liquidity pressures by deferring the immediate funding requirements to later periods and by spreading the debt obligations over a longer period of time. It also helps in moderating the increase in interest expenditure due to refinancing if the rates are expected to remain high in the near-to medium term but decline over the long term.
It has taken a while to get this out, but the core message hasn't changed...
1Q10 Results review
For 1Q10, MS reported significant increase in its net revenues to $9.1 billion from $6.3 billion in 4Q09 and $2.9 billion in 1Q09, primarily driven by trading and principal investments revenues which increased to $4.1 billion versus $1.3 billion and $205 million in 4Q09 and 1Q09, respectively. Trading and principal investment revenues in 1Q10 increased off improvement in debt-related credit spreads and better results in Fixed Income. Revenues from Investment banking and Asset management, distribution and admin fees increased 21.4% and 126.7% (y-on-y) to 1060 million and $1,963 million, respectively. However, both the categories reported a quarter-on-quarter decline in revenues of 36.6% and 0.6%, respectively. Commissions earned for the year increased 63.8% (y-o-y) and 1.1% (q-o-q) to $1.3 billion. Compensation expenses increased to $4.4 billion from $2.0 billion in1Q09 and $3.8 billion in 4Q09, while non-compensation expenses were up 38.4% (y-o-y) mainly off MSSB inclusion and higher business activity. Consequently, net income from continuing operations increased to $2.1 billion, which was further supported by a $382 million tax benefit associated with prior year’s undistributed earnings of certain non-U.S. subsidiaries.