Monday, March 24, 2008

Recent Investment Bank Performance

Last Tuesday, Goldman Sachs (GS) and Lehman Brothers (LEH) announced better than expected earnings that helped to bolster confidence in the investment banking sector. Later that same day, the Fed cut the target Fed funds rate to 2.25% and opened up a Primary Dealer Credit Facility to provide additional liquidity for investment banks. With these moves, the odds have increased that the recent risk to the financial system has already peaked – though it will undoubted take a considerable period before this is fully reflected in improved balance sheets and investor confidence.

The charts below show the performance of the stocks of four of the severely beleaguered investment banks (MER, LEH, MS, UBS) during the past 195 days from the June 2007 highs, as well as during the most recent 36 days, when the pressure on these institutions was greatest. One inescapable conclusion is that UBS has been the least resilient among the group so far – a development that bears watching going forward.


4 comments:

Henry Bee said...

Hi Bill,

You used to post your VWSI indicator every Monday and have recently stopped. I miss it! I'm wondering if you plan on resuming it in the near future. Thanks a bunch.

Henry

Bill Luby said...

Hi Henry,

Thanks for asking about the VWSI. I will be glad to resume posting about it each weekend.

For those who are interested, the VWSI was -1 following the close on 3/7 and -4 following the close on 3/14 (the strongest signal so far in 2008.)

As an added bonus, the VWSI moved back to +1 today. This is an almost neutral reading (surprising, given the recent rally) and suggests to me that while other indicators my be pointing to a short-term overbought condition, the recent move up may have more staying power than some think.

Cheers,

-Bill

Felix said...

Last week, I posted a comment to the effect that I really didn't understand Mr. Market's grossly negative reaction on the Monday after JPM's Sunday night $2 bid for BSC.

My take on the situation was all that was positive news. The Fed, by its actions in facilitating the deal and allowing primary brokers to borrow directly from it, had drawn a line in the sand and was basically saying it wasn't going to let the entire financial system go down without a fight. BSC, in a real sense, was a 'sacrificial bear' that the Fed was willing to give up to protect the system as a whole.

So I was surprised by Mr. Market's negative reaction on Monday: the SPX made its intra-day low for the year, and the VIX nearly made a 5-YEAR closing high (though it didn't make its intraday high for the year, set back in January).

I thought I was going crazy... or the market was.

The one positive I saw Monday was the afternoon rally off the lows, resulting in a 'hammer' candlestick, which suggests a possible reversal... and sure enough, we caught a big rally on Tuesday.

Because of this, I've been doing a lot of thinking and reading about the BSC meltdown and its effect on Mr. Market, and have come to some observations:

- The initial, highly emotional & fearful reaction to news of the $2 deal largely discounted what the Fed was doing. After the dust settled (and people started to think), articles started coming out about the Fed's bold moves and why they were positive overall. But I think the Monday a.m. reaction was simply fear... not just the usual fear of losing money, but of losing one's job (at an investment bank or hedge fund), fear that the financial system might be broken, etc.

- The financial reporting, which I think is pretty awful in general, reached new lows... a lot of mis-information about the deal and the Fed's role, combined with too much hyperbole, served only to stoke people's fears. It took reporters and editors a few days to calm down and/or catch up to events, imho.

- The more I think about it, JPM's revised bid for BSC is a good thing, marketwise. A lowball bid might work when the market is panicked (like the Fri and Mon around the $2 deal), but a more reasonable valuation should prevail when the market is more rational (now). The higher $10 bid is even a good thing for JPM... it would've been difficult for them to close the original deal once the fear of bankruptcy passed, and by buying 39% of BSC on Apr 8th with their own stock, they pretty much guarantee they'll get shareholder approval. And the stock they use to buy the 39% stake doesn't cost JPM in the end... they get it back if/when the merger is consummated. Pretty slick.

- The amended guaranty agreement is a piece of work -- the original one had a serious flaw, which some say was the leverage BSC had to get a better price. Rather than go thru the legalese, you can check out the key terms here. It's important because it's JPM's big stick in the deal. The problem for BSC was that counterparties wouldn't trade with it, because in effect they lost confidence that BSC would make good on its trades... that crisis of faith would shut down BSC's trading desk. JPM's guaranty solved that, but it is contingent on the merger going thru... and any competing bidder would have to extend a similar guaranty. Not many firms in a position to do that right now!

- Since the Fed will be buying effectively 'buying' $30B of the 'most toxic' mortgage-based paper on BSC's books, much of the financial risk to JPM is off the table. The real difficulties for JPM and Jamie Dimon are going to be key employee retention and keeping large clients from defecting to GS and other investment banks. I've been thru many mergers myself (on both sides), and it's no joke to say that the employees are a major asset in such cases. I understand that the first meeting with BSC employees did not go well; it remains to be seen whether the revised bid (and healthy retention bonuses) will allow JPM to acquire more than just the shattered shell of BSC.


But going forward, my contrarian nature betrays(?) me. Despite the market rally since 'Bear Stearns Monday,' I am not entirely sanguine about the financial industry or the overall market... yet:

- There are way too many reporters asking pundits if BSC' fall marks a market bottom.... and too many opinions that it is or might be.

- Key BSC employees are apparently being heavily recruited by the other investment banks. That suggests to me that the fear Wall St. had last week (about the market, and for their own jobs) has largely disappeared. That loss of fear could indicate a bull market is coming, but it feels like they got over it too quickly. After all, the VIX didn't even make a intra-day high for the year... a VIX of over 40 wouldn't be out of the question for a capitulation bottom.

- JPM is the big winner, yet they have a huge challenge ahead of them to ensure the 'win' Jamie Dimon has a lot of experience and talent in this kind of activity, but it will take much of JPM's energy and mindshare for the next 2-3 years. I don't think they'll be able to do any more deals for a while (not that they need to!)

- The financial sector has had a nice rally since 'BSC Monday' (which helps the SPX), but I've been asking myself: "What does BSC's fall have to do with the economy?" I love the Fed's moves to protect the financial system from cascading failures, and I agree that it's reasonable for that sector to rally in recognition of the Fed's 'line in the sand.' But if the recession that I think we're already in deepens and/or if further credit tightening delays the housing recovery, I expect it'll be bad for the banks. Not terrible, just bad.


So I dunno... maybe the market drifts in a range or goes down a bit between now and the election, with less volatility than we've had recently? I really have no clue... :)

tnt

Felix said...

Forgot to mention, this is an example of the kind of article that I both like (for some of the content) and am troubled by (because it fuels the 'Is this the bottom?' debate).

Any article about Becky Quick, on the other hand, even this one, I'm all smiles about. Ms. Quick one of the few talking heads on CNBC I can stand to listen to -- unlike many of her anchor and reporter co-workers she doesn't try or pretend to be a pundit, she focuses on getting the news instead of editorializing or trying to show how smart she is (and she is 'quick', sharp as a tack) -- and she's a
major hottie besides! :)

tnt

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