According to the recent TIM (Trade Ideas Monitor) report for the week of November 13-19, 2009, the TIM Sentiment Index (TSI) increased 0.85 points to 55.29, staying within bullish territory (see last week's post and the youDevise website for additional information on the TIM report, a reading above 50 is bullish). On the other hand, the TSI Worldwide Index dropped 4.61 points to 47.13, falling in bearish territory. Only two sectors were bullish, with seven bearish, and one neutral. Total new long ideas as a percentage of all new ideas sent to investment managers by way of the TIM fell to 62.89% from 73.61%.

As for individual securities in the U.S. and North America, TJX Companies (TJX), Baxter International (BAX), and Dick's Sporting Goods (DKS) were stocks with long broker sentiment, while DryShips Inc. (DRYS), Goldman Sachs (GS), and Potash (POT) had short broker sentiment. In general, the information technology and energy sectors had long broker sentiment, while the telecommunications services, industrial, and consumer staples sectors had short broker sentiment.

According to the recent TIM (Trade Ideas Monitor) report for the week of September 11-17, 2009, market sentiment moderated after being bullish last week. The TIM Sentiment Index (TSI) was down 1.86 points in North America to 52.78 (see previous post and the youDevise website for additional information on the TIM report). The TSI Worldwide Index was down 3.89 points to 52.72. Total new long ideas as a percentage of all new ideas sent to investment managers by way of the TIM decreased 0.86 points to 68.36%.

As for individual securities in the U.S. and North America, DryShips (DRYS), Kroger (KR), and U.S. Steel (X) were stocks with long broker sentiment, while Sprint Nextel (S), American International Group (AIG), and Goldman Sachs (GS) had short broker sentiment. In general, the utility, energy, and consumer staples sectors had long broker sentiment, while the information technology sector had short broker sentiment.

Hedge funds increased their stakes in financial stocks during the second quarter according to the Goldman Sachs Hedge Fund Trend Monitor (WSJ). Specifically, ownership in financials increased 55% from Q1 to Q2, growing to $70 billion - representing 3.7% of the sector's market capitalization. Bank of America (BAC) and JPMorgan (JPM) were some of the more popular financial holdings within hedge funds, with Regions Financial (RF) and Citigroup (C) also becoming new long positions for some funds. While the net short position of financials also rose slightly, 8% to $63 billion, the large increase in long exposure has resulted in hedge funds being net long the financials by the end of Q2 (WSJ). Although hedge fund redemption request have decreased, reducing the need for forced selling, it is unclear if hedge funds on average will maintain their net long positions in financials after the nice run these stocks have made since the March market lows.

Meredith Whitney was recently on CNBC (the video is provided below) discussing the banks and financials. Some observations from the interview include:

• This will be a tactical quarter for the banks.
• She has a bullish call on Goldman Sachs, but a bearish call on financial stocks in general.
• A huge refinance wave will create the "Mother-of-all" mortgage quarters, boosting earnings for the quarter for many banks, even though business in general is not getting better.
• Core earnings numbers may not be very good, but below the line numbers will be good due to all the mortgage activity. This will result in huge moves in tangible book value for the banks, even with unimpressive earnings numbers. These stocks trade on multiples of tangible book.
• A move from $18 billion in incentives to $75 billion in incentives to modify mortgages, with less modification liability, could cause some banks move 15% short-term.
• Mortgage modification numbers will increase logarithmically, causing past dues to become current, and allowing the banks to receive fees for the modifications.
• As a result of the fees and less litigation due to the current legislation, banks may even seek to modify mortgages which have not yet defaulted, or are not yet past due.
• Bank of America (BAC) is the cheapest of the banks, based on tangible book value (excluding Citi).
• Bank solvency has been off the table for a few quarters now, but main street has not been helped by the financial bailouts as much. A lot of refinancing is occurring, but not a lot of new lending. The new legislation and increased risk aversion is actually providing less access to credit.
• The next couple of years will be debt market-focused due to the tsunami of debt issuance needed to pay-off current spending.
• She also mentioned in the discussion (not included in the CNBC online video) that unemployment could reach toward 13%.
  
  
  Source: CNBC Video
  

Surprise, surprise. A GAO audit found that more oversight is needed for the $700 billion TARP bailout package (see CNN Money article). Apparently, as a result of lack of oversight, those receiving billions in funds have not been using the money as originally intended. Not only is it amazing that this is a surprise, but it is interesting how as the amount of money increases, the level of monitoring seems to go down.

Time to bailout alternative energy (see Spiegel Online article). Cheaper crude oil is decreasing the demand for clean and efficient energy. The credit crisis is also making it difficult for new renewable energy companies to get the capital they need to expand and continue daily operations. Spain and Germany are already offering incentives, and the European Commission announced a $252 billion recovery plan that included targeted investments for carbon reduction. President-elect Obama is also expected to use some of the $700 billion stimulus package on eco-businesses.

In an effort to survive the current credit crisis, hedge funds are lengthening lockup times in order to reduce the number of redemption requests (see Bloomberg article). In return, and in an attempt to raise more capital, some of the very same hedge funds are lowering management fees from 2 to 1 percent, and further lowering performance fees from 20 to 15 percent, or even as low as 10 percent in some instances.

Goldman Sachs, still adjusting to its new role as a bank holding company, is considering online banking (see WSJ article). The move in being done in part to help increase its deposit base. While a lower-margin business, the increased deposit base will allow Goldman to have a more stable capital base during difficult market conditions, one of the main reasons for changing its status to a bank-holding company.

As the financial musical chairs continue to get shifted, we are now learning that Warren Buffett, who has been relatively silent (investment wise) until last week, is now beginning to see value in the markets (see WSJ article). Is Buffett investing only in small regional banks, as some others are doing. No. Berkshire Hathaway is taking a position in Goldman Sachs, investing $5 billion in return for receiving perpetual preferred shares in Goldman. At the same time, Goldman will also be looking to do a stock offering to raise over $2 billion in additional capital.

This turn of event is significant, in my opinion, in that it signals a couple of important points. For one, by taking a sizable position in Goldman, the richest man in the world is indicating that the financials are in value territory, and that it is time to step up and take a position. This will certainly give a boost of confidence to other investors. The move by Goldman also shows that companies themselves are willing to recapitalize, believing that the market is now stable enough to do so, or at least that there are government and Buffett-type backstops available if times get difficult. Given the recent restrictions on short sales, this also appears to be a good time to do a secondary given that the diluting affects of the offering are less likely to be punished by short sellers and the market. Is volatility behind us, and is this a bottom? No, and probably not. Nonetheless, we may be finally reaching a point where leading companies in leading industries (and even non-leading industries) will finally begin to see their value reflected in the market place. This may not be a bottom, and financials will certainly still see volatile times ahead, but looking through the cloud of bankruptcy does allows potential opportunities to start appearing.

Brazil's Petroleo Brasileiro and Potash Crop. (POT) have been added to Goldman Sachs list of the most popular stocks purchased by hedge fund managers. The Goldman Sachs VIP list (Very Important Positions list) includes the 50 largest holdings in hedge fund portfolios. The VIP list as a group has done better than the S&P 500 during the past year, losing 6 percent during the recent market downturn at a time when the S&P 500 has fallen 9.2 percent. The inclusion of Petrobras is no doubt due in part to the increased interest in the company by George Soros (see previous post). A few more details on the VIP list can be found in a 2007 post at the All About Alpha blog.

As reported in a UK Telegraph article, Goldman Sachs has launched a new proprietary fund to invest in select assets within the Middle East. While just one instance, and coming from one of the stronger U.S. investment banks, this is nonetheless a nice and encouraging reversal of fortune considering the amount of sovereign wealth funds that have come from the Middle East, often to support struggling U.S. banks. The fund, called the Goldman Sachs Middle East Investments, currently has about $300 million to invest, but this figure is expected to grow. While the fund investments will be varied, the focus will initially be on the area's strength in financial institutions and energy assets.

The Washington Post is reporting that sovereign wealth funds are becoming some of the largest commodity speculators. While the CFTC recently told Congress that its internal monitoring did not show influence by SWFs, it is believed by some that the CFTC may not be detecting their influence since the SWFs are working through swap dealers, which are often unregulated and operate through investment banks such as Goldman Sachs, Morgan Stanley, and Lehman Brothers. Officials have requested additional data from swap dealers, with these finding expected in September. It is believed that many of the foreign funds are coming from countries less familiar to SWF investing, such as Norway, Singapore, Kuwait, Australia, Russia, Libya, and even Iran. Estimates believe such funds represented 12 percent or more of investment bank commodity activity. The collective value of such funds is estimated at more than $2 trillion and is expected to increase 5-fold by 2012.

As reported at the Financial Times and the WSJ, discussions have progress to the point that larger banks and dealers should have a central clearing house for credit derivatives by later this fall. The market for credit derivatives is currently near $62 trillion in notional value after being less than $5 trillion as little as five years ago. The goal of the clearinghouse will be to reduce the systemic risk that results from inefficient trading and uncertain counterparty exposure, both of which have increased as the market expanded. Automated trade-matching and electronic processing in other OTC derivatives market was also discussed. Credit derivatives in particular have caused concern as their rapid grown has made it more difficult to both track and measure the exact level of exposure being taken.

Recent credit problems have highlighted the need to better understand counterparty exposure. A central clearing house for credit derivatives should help in this area given that the clearing house will take the risk of a market participant's failure. Any failure would then be absorbed by the clearing house members, reducing the need for the Federal Reserve or Treasury to get involved, and possibly preventing the type of failure that was experienced with Bear Stearns. Like other clearing houses, trades are also likely to be better scrutinized when made, such as making sure that margin requirements are enforced and trades are verified and recorded.

To date the levels of electronic derivative trading in the various markets has been mixed. Currently, about 90% of credit derivatives are traded electronically. The interest-rate derivatives market, which is larger and potentially more worrisome, has also increased electronic trading and now sits at about half of all trades. Equity derivatives trading is bringing up the rear with only about one quarter of all trades executed electronically. Depending on the success of the credit derivative clearing house, plans could be expanded to also include the equity and interest rate markets.

One current hitch for the credit derivative clearing house is the need to make sure that the entire CDS market is integrated and electronic. To facilitate the move, dealers have agreed to reduce the total value of outstanding CDS trades, and to help sort out corporate defaults by incorporating a cash settlement mechanism into CDS documentation. Of note is that the market in many cases would still be private, but more centralized.

Although the details of the clearing house are still being worked out, such as what exactly the dealers and exchanges will control, any move is certain to benefit the exchanges as they will now have a direct link to the lucrative CDS market, while the large investment banks that currently control the credit derivative market will need to start sharing some of the billions of dollars of revenue. For some banks, this line of revenue has been significant. Companies that my be positively impacted include the CME Group (CME) and NYSE Euronext (NYX). Investment banks that may be negatively impacted, at least with regard to losing some of their current credit derivative revenue stream, include Deutsche Bank (DB), Goldman Sachs (GS), and Morgan Stanley (MS).

As discussed in a recent Bloomberg article, the spread between the 3-month Libor and the overnight index swap (OIS) rate, traded forward 3 months, is greater than similar expiring spreads. This recent movement in the spread is signaling that traders are concerned that banks will have difficulties obtaining cash to fund existing assets, as well as putting into question their ability to shore-up their balance sheets. In general, an increasing spread signals that funds are becoming less available. The recent activity appears to be driven more by traders leaving the short-term, closer to expire positions early over worries about Libor and its reliability.

The spread has averaged about 11 basis points over the last 10 years, but has ranged between 24 bps to 90 bps this year, and has gotten as high as 106 bps last December. The activity in the swaps market is worrisome, indicating that derivative traders do not feel that the sell-off of financial companies in March was the low, and that the worst is not behind us. Recent problems/concerns with Lehman Brothers, Wachovia, and UBS, as well as the recent sell-offs in Goldman Sachs, Merrill Lynch, JP Morgan, and Citigroup are also highlighting concerns with the financial companies. As usual, this is not good news for the economy and the market as a whole as it needs a strong financial system to keep greasing the gears of expansion. It may be a long summer until the credit markets start showing a little more confidence.

There has been a recent resurgence in interest in dark pools of liquidity. No, this is not some Star Wars reference (at least I don't think so), but does refer to a procedure and method of trading that is once again causing some concern on Wall Street. For years, crossing networks have been matching buy and sell orders "off-exchange" in what have been referred to as dark pools of liquidity. The advantage of these pools it that they should make the execution of a large order safe, and allow the two market participants to execute the large order without moving price, while maintaining some privacy. While the amount of dark pool transactions is estimated to be a little over 10% (but including more than 20% of all trades in NYSE-listed stocks), it is continuing to grow as hedge funds look for less transparent ways to sell large positions, and brokerage firms look for more ways to generate trading income and possibly tap into the increase in trading revenue streams that the exchanges have been enjoying over the last few years.

Unfortunately, some are worried that gaming is allowing others to profit from the transaction, and of course potentially leaving one side of the dark pool transaction a little worse off. The problem has gotten significant enough that some are considering no longer using the dark pools, with 60% showing some hesitation. As recently highlighted in a Finanial News article, steps are being taken to tackle the problem, such as putting anti-gaming measures in place at both large and small firms. Steps being used and/or considered include physically monitoring patterns of trade abuse using a human element, using computer algorithms to spot trends, developing fair pricing models, and using anti-gaming logic.

While it is true that it may not always be known exactly what is occurring within the dark pools, it appears as if their operations are simply more organized ways to perform crossing of block trades, with a print of the tape after the transaction is complete. Nonetheless, it is still surprising to me how in the current financial environment that the SEC, other regulators, and some of the exchanges themselves have not spoken more about dark pools, their transparency (or lack of transparency), and the affect this has on price discovery. In fact, it seems to me that given current credit issues, this might not be a something the industry wants to advertise. Yet, this is apparently not stopping some.

As recently reported at the Deal Breaker blog, Goldman Sachs, Morgan Stanley and UBS have agreed to share their dark pools, such that each will allow for the secretive trading to take place between their clients. The dark pools include Goldman Sach's Sigma X, Morgan Stanley's MS POOL, and UBS's PIN ATS. The union further threatens to take business from the exchanges and furthers current consolidation of the brokerage industry. Right now exchanges are at a disadvantage when they try to compete with the dark pools since they are being regulated by the SEC, with new rules being put in place over the last year forcing them to share even more information and route trades to the exchange offering the best price and fastest execution. Dark pools have in many instances been able to avoid regulation by keeping trading volumes under a set threshold.

But again, while this is probably a good move for the financial institutions with regard to generating new business, lowering costs, and helping to tap into the monopolies of the exchanges, it is probably not the most public relations friendly move in the current credit environment. As is often unfortunately the case, this will surely cause some in Congress to start talking of new regulation, especially if someone goes way out on a limb and attempts to tie the practice to home foreclosures or high energy cost - adding a new level of regulation with the usual unintended consequences. If this happens, we may end up wishing that a dark pool of liquidity was truly just a Star War reference.

The WSJ has an interesting article that describes a situation of how even the best intentions for hedging risk do not always work out exactly how you had hoped. In an effort to stem the tide of losses resulting from bad real estate and leveraged loans, many firms on Wall Street began shorting vehicles that would allow them to profit as these markets collapsed. Unfortunately, tracking error raised its ugly head, and now many are finding that not only were they not getting close to 1-1 back ($1 loss in assets followed by a $1 gain in the hedge - often unrealistic, but a high goal nonetheless), many are getting much less, with a 70% efficiency being a relatively good recovery. To add insult to injury, some are finding that their assets are continuing to fall in price, even as the tracking index they shorted against has been rallying - causing a double loss on both the falling long asset and the rising short index.

It looks like the company with the worst hedges in place is Lehman Brothers, which is expected have write-downs on BOTH assets and ineffective hedges somewhere in the range of $1.5-2 billion. Morgan Stanley will have about half this amount of losses, with both Goldman Sachs and Merrill Lynch being less effected, so far - Goldman in particular has less real estate, but more leveraged loans than its competitors, and may eventually post some losses from these hedges.

As highlighted in the article, it looks like Wall Street has a long way to go in the area of risk management.

Some firms on Wall Street are actively trying to reassure investors that they are reduced their exposure to borrowed money, given the recent problems at Bear Stearns. Of course, to reduce leverage, firms must either raise money or sell assets. In the current market, both are proving to be costly. Furthermore, reduced leverage means reduced profits, at least in those areas where firms were able to increase profits by using leverage to their advantage. Before the recent credit problems, such firms had ratios of assets to shareholder equity of 30 or more. Goldman Sachs may be one holdout, with a ratio of assets to shareholder equity of 28.2 in their fiscal first quarter, up from 26.2 as of last November. A Goldman Sachs spokesman is reported to have stated that they are comfortable with current leverage levels, and that current measures of financial strength are misplaced. They believe that risk-adjusted capital and the quality of assets are more important measure for performance. They stress that they are focused more on opportunities and observed stresses, and less on leverage compared to liquidity. Of course, shorting sub-prime paper at the right time also helps (the spokesman did not make the last statement, but probably wanted to).

Ticker: GS

An interesting article in this week's Barron's about how fair-value accounting is allowing companies to boost earnings by recognizing "gains" from being able to buy back their declining debt at cheaper prices. As mentioned in the article: "When a company's credit weakens and the yield on its debt rises relative to risk-free Treasuries, the debt becomes worth less to the holder. The financial company, which is the debt issuer, then takes a gain, because theoretically it could buy back its debt below face value." Given the level of exposure, the gains are not insignificant. For the first quarters, widening credit spread allowed Morgan Stanley to report $848 million in gains, Lehman Brothers reported $600 million, while Goldman Sachs reported $300 million. Of course, given that most of the long-term debt matures at par, any gains realized will reverse over time. But in the short-term when losses need to be covered, fair-value accounting allows for higher reported earnings, even though these earnings do not really justify the P/E ratio generated. As the market starts to move up, a reversal of recent accounting gains will be necessary.

Tickers: GS, LEH, MS

Bloomberg is reporting that M&A Advisory fees have fallen about $8.7 billion in Q1 2008 from $13.4 billion during Q1 2007. Goldman Sachs, the leader in M&A, has reported a 47% decline in fees from Q4 2007 to Q1 2008. Given potential lower trading returns (due to the market and less hedging/shorting of subprime as with last year), Goldman could have a more challenging year, even without the exposure and write downs some other banks are taking. Nonetheless, it may still be better position. The stock itself is testing support (double bottom), so we should get some clarity shortly.

Ticker: GS