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Bernanke's Bubbles

This note was originally published at 8am on April 04, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Early triumph can promote future failure.”

-Nassir Ghaemi


Last week I wrote a pointed Early Look note titled Bernanke’s War. When my Global Macro Process sees Growth Slowing like this (like it did in Q1 of 2008, Q1 of 2010, and Q1 of 2011), I am not shy making a call that’s counter to consensus. We have fought the Fed before, and won.


Fighting The Fed’s conflicted and compromised 0% Policy To Inflate means that, at some point, the man runs out of either political room or the ability to ban Global Macro-economic gravity. If either or both happen, I think I can win.


Bernanke’s Bubbles are vast. That’s why I have a 0% allocation in the Hedgeye Asset Allocation Model to both Commodities and Fixed Income right now. If these bubbles are in the process of popping, why stay in them?


Back to the Global Macro Grind


Dollar up = Correlation Risk On, eh. All it took yesterday was the US Dollar Index arresting its most recent 4 consecutive-week debauchery for US stocks to stop going up. At one point in the day, the SP500 was down almost 1%. That’s only happened 1 other time in 2012 (no, that’s not normal).


Another way to say what happened yesterday, and what’s happening across asset classes in Global Macro this morning for that matter, is what we have coined Deflating The Inflation. Functionally, whether Romney or Obama figures this out or not is left to be seen, but popping Bernanke’s Bubbles at the pump would be most easily achieved by raising interest rates.


What other long-term bubbles are popping this morning?


1.  GOLD (we’re short GLD): down another -2.4% this morning to $1632/oz and finally snapping my long-term TAIL support line of $1652. Over the longest of long terms, no matter what your religion on the subject matter of Gold, it does not act well when Treasury Yields are rising. People look at “risk free” rates of return relative to absolutes; particularly when 0% was the absolute comparison.


2.   US TREASURIES (we’re short TIP): Treasuries are down with 10yr bond yields rising to 2.25%, taking the rip in 10yr yields to +22% from 1.84% (immediately after Bernanke tried his best to ban economic gravity during his January 25th speech, pushing easy money to 2014, sort of).


3.   JAPANESE YEN (we’re short FXY): yes, during a Currency War where the Americans, Europeans, and Japanese are in a race to the bottom to de-value their respective fiat currencies, the US and European Keynesian Policy Makers perpetuated a bubble in the Japanese Yen up until February of 2012. Then kaboom – Yen down -9% in a straight line as the Euro and USD stopped going down.


The popping is a process, not a point. Unless you think that there is political inertia, from here (i.e. throughout the US Election), that allows Bernanke to keep this 0% Policy To Inflate ball under water, you won’t have to take my word for it on hearing the popping.


“Pop, pop, bang!”


Remember that line from Cinderella Man’s Jimmy Braddock (played by Russell Crowe in 2005)? That was one of the many metaphors I used when Fighting The Fed during Q1 of 2008. Braddock was an Irish-American boxer from New Jersey. I am a Canadian-American Fed fighter from Connecticut. And, Mr. Bernanke, I am not going away.


Back to the ring. I have a 73% position in Cash and am in no hurry to add to my 9% asset allocation to US Equities this morning. Why? Well, because US Equities are bubbly too. Not as bubbled up as Bonds and Gold were, but they’re certainly worthy of wearing a bobble head.


The most interesting thing about Equities, globally, is that with the exception of the USA and Venezuela (ran by 2 serial currency debauchers in Chief who think stock market inflations reflect economic prosperity), equity markets around the world stopped going up a month ago. Check out the corrections in markets that have stopped making higher YTD highs:

  1. Greece = down -15.2%
  2. Spain = down -12.4%
  3. Italy = down -9.5%
  4. China = down -8.0%
  5. Brazil = down -6.0%
  6. India = down -5.1%
  7. Japan = down -4.2%
  8. Germany = down -4.1%
  9. Hong Kong = down -4.1%
  10. USA = down -0.4%

The most obvious point here is that the SP500 is only down -0.4% from its YTD peak. It has only had 1 down-day greater than 0.7% in 2012, and is now subject to the only risk management strategy that has held true for the last 40 years – mean reversion.


It’s a good thing we have Apple. Or is it?


Maybe that’s a bubble too. Who knows until it starts popping. But the storytelling about this stock is hilarious. Next to a story that “Home Prices Seen Dropping 10%”, the 2ndMost Read story on Bloomberg is titled “Apple Fever, $1 Trillion Valuation.” Nice.


The thing about bubbles (centrally planned ones and all others) is that they need a darn good story. Apple’s is fantabulous at this point, and so was that of The Ben Bernank.


That said, don’t forget where I started this morning – if that quote from Nassir Ghaemi’s “A First-Rate Madness” comes home to roost, the “early triumphs” of Keynesian Economics could very well lead to Bernanke losing this war.


My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, Japanese Yen, and the SP500 are now $1632-1666, $121.98-126.12, $79.19-79.64, 81.91-83.78, and 1388-1419, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Bernanke's Bubbles - Chart of the Day


Bernanke's Bubbles - Virtual Portfolio


The Macau Metro Monitor, April 18, 2012




According to Jornal Tribuna de Macau, the Macau government and Wynn Macau may sign its Cotai land grant contract within this month depending on the Lands and Public Works Bureau. 



Galaxy says it is doing “some preparatory land works” for phase two of its Galaxy Macau resort in Cotai.  Francis Lui Yiu Tung, vice chairman of Galaxy, said recently that Galaxy Macau’s second phase would double the property’s size and add more non-gaming elements to it, including meetings and conventions facilities and more retail space.



Pier 16 - Property Development Ltd, the owner of Ponte 16 casino resort, announced the signing of HK$1.9 billion (US$245 million) and RMB400 million (US$63.6 million) five-year syndicated loan facilities with 11 financial institutions.  The proceeds will be used primarily to refinance existing credit facilities, to repay shareholders’ loans and to fund the construction of the third phase of the Ponte 16 development.

The loan facilities are guaranteed by the borrower’s shareholders, SJM and Success Universe Group Ltd at the ratio of 51 percent and 49 percent respectively.  The third phase of Ponte 16 will feature a riverside commercial complex with a total floor area of approximately 40,000 square metres.  The complex will also encompass space for the expansion of gaming areas and car parks, with construction expected to be completed by 2014.



1Q 2012 Tourist Price Index increased by 10.15% YoY, attributable to rising price indices of restaurant services and accommodation. Increasing hotel room rate, higher charges of restaurant services and entertainment in the Lunar New Year, as well as dearer prices of gold jewelry pushed up the price index of Restaurant Services (+18.60%); Entertainment & Cultural Activities (+15.09%); Miscellaneous Goods (+14.55%); and Accommodation (+9.20%).
1Q TPI decreased by 2.93% QoQ.  


TODAY’S S&P 500 SET-UP – April 18, 2012

As we look at today’s set up for the S&P 500, the range is 14 points or -0.78% downside to 1380 and 0.23% upside to 1394. 












    • Up from the prior day’s trading of 411
  • VOLUME: on 4/17 NYSE 709.77
    • Decrease versus prior day’s trading of -3.50%
  • VIX:  as of 4/17 was at 18.46
    • Decrease  versus most recent day’s trading of -5.58%
    • Year-to-date decrease of -21.11%
  • SPX PUT/CALL RATIO: as of 04/17 closed at 1.41
    • Decrease from the day prior at 2.15 


  • TED SPREAD: as of this morning 39
  • 3-MONTH T-BILL YIELD: as of this morning 0.08%
  • 10-Year: as of this morning 1.99
    • Down from prior day’s trading of 2.00
  • YIELD CURVE: as of this morning 1.71
    • Decrease from prior day’s trading at 1.73 

MACRO DATA POINTS (Bloomberg Estimates):

  • IMF, World Bank holding annual spring meetings
  • 7am: MBA Mortgage Applications, week ending April 13
  • 10:30am: DoE inventories 


  • President Obama discusses economy in speech at community college near Cleveland, 2:30pm
  • Republican Jess Kelly won primary, will face former Gabrielle Giffords aide Ron Barber in June special election to replace the wounded ex-congresswoman
  • Secretary of State Hillary Clinton, Defense Secretary Leon Panetta attend NATO meeting in Brussels
  • House, Senate in session:
    • House Appropriations subcommittee marks up energy and water appropriations bill. 9:30am
    • Senate Environment and Public Works Committee holds hearing on General Services Administration inspector general’s report, 10am
    • House Foreign Affairs Committee holds hearing on North Korea, 10am
    • House Homeland Security Committee marks up cyber security bill, 10am
    • House Financial Services Committee marks up Affordable Housing and Self-Sufficiency Improvement Act, 10am
    • House Homeland Security subcommittee holds hearing on trade and commerce with the Asia-Pacific region, 2pm
    • House Foreign Affairs subcommittee holds hearing on terrorism, 2pm
    • Senate Appropriations subcommittee holds hearing on the GSA inspector general’s report, 2:30pm 


  • North Korea broke off agreement to halt testing of nuclear devices and long-range missiles after U.S. canceled food aid
  • Argentina rejects Repsol YPF’s demand for $10.5b in compensation after Argentina seized its YPF unit
  • Berkshire Hathaway Chairman Warren Buffett yesterday said he had stage 1 prostate cancer; investors may focus on succession plans
  • Alimentation Couche-Tard agrees to buy Statoil Fuel & Retail for $2.8b
  • Intel, IBM both fell post market after reporting results; Yahoo gained
  • Pfizer said to choose nutrition unit buyer as soon as next week after getting bids from Nestle, Danone
  • U.S. Treasury officials said to lean toward recommending that Fannie Mae, Freddie Mac be replaced with government safety net for mortgage finance system
  • News Corp. to suspend some foreign investor voting rights to get in compliance with U.S. broadcast ownership rules
  • ASML reiterated 2Q sales forecast, sees 3Q orders stable
  • Tesco reports FY trading profit in-line with est., plans to cut capex 


    • Huntington Bancshares (HBAN) 5:55 a.m., $0.14
    • Knight Capital Group (KCG) 6 a.m., $0.30
    • Polaris Industries (PII) 6 a.m., $0.77
    • Bank of New York Mellon (BK) 6:23 a.m., $0.52
    • Textron (TXT) 6:30 a.m., $0.35
    • BlackRock (BLK) 6:30 a.m., $3.04
    • PNC Financial Services Group (PNC) 6:34 a.m., $1.48
    • Quest Diagnostics (DGX) 6:45 a.m., $1.02
    • Halliburton (HAL) 6:51 a.m., $0.85
    • Dover (DOV) 7 a.m., $1.02
    • Metro (MRU CN) 7 a.m., C$0.92
    • Abbott Laboratories (ABT) 7:24 a.m., $1.00
    • St Jude Medical (STJ) 7:30 a.m., $0.83
    • New York Community Bank (NYB) 8 a.m., $0.26
    • First Republic Bank (FRC) 8 a.m., $0.67 (GAAP est.)
    • Qualcomm (QCOM) 4 p.m., $0.96
    • American Express Co (AXP) 4 p.m., $1.01
    • VMware (VMW) 4 p.m., $0.60
    • Cubist Pharmaceuticals (CBST) 4 p.m., $0.43 (GAAP est.)
    • Greenhill & Co (GHL) 4 p.m., $0.38
    • Plexus (PLXS) 4 p.m., $0.54
    • Covanta Holding (CVA) 4:01 p.m., $(0.08)
    • Select Comfort (SCSS) 4:01 p.m., $0.40
    • Wintrust Financial (WTFC) 4:01 p.m., $0.41
    • Albemarle (ALB) 4:05 p.m., $1.16
    • F5 Networks (FFIV) 4:05 p.m., $1.07
    • Lam Research (LRCX) 4:05 p.m., $0.46
    • LaSalle Hotel Properties (LHO) 4:05 p.m., $0.17 (FFO)
    • Polycom (PLCM) 4:05 p.m., $0.22
    • Platinum Underwriters Holdings (PTP) 4:05 p.m., $0.94
    • Kinder Morgan /Delaware (KMI) 4:05 p.m., $0.31
    • Kinder Morgan Energy Partners (KMP) 4:05 p.m., $0.65
    • Yum! Brands (YUM) 4:09 p.m., $0.73
    • eBay (EBAY) 4:15 p.m., $0.52
    • Stanley Black & Decker (SWK) 4:20 p.m., $1.12
    • SLM (SLM) 4:30 p.m., $0.52
    • Umpqua Holdings (UMPQ) 4:30 p.m., $0.18
    • Cohen & Steers (CNS) 4:30 p.m., $0.41
    • Noble (NE) 4:33 p.m., $0.40
    • Marriott International (MAR) 5 p.m., $0.29
    • HNI (HNI) 5 p.m., $(0.00)
    • Crown Holdings (CCK) 5:01 p.m., $0.44
    • RLI (RLI) 6 p.m., $1.06
    • Steel Dynamics (STLD) 6 p.m., $0.21
    • CVB Financial (CVBF) Post-Mkt, $0.20 


COPPER – the Doctor is out. No bounce this morning in either Gold or Copper as Bernanke’s Bubbles continue to pop. Neither of these Commodities look like Nat Gas yet (crashing to $1.94 this morn), but both are in what we call Bearish Formations (bearish across all 3 risk management durations – TRADE/ TREND/TAIL). 

  • Brent Oil Drops on Concern Europe Debt Crisis Will Curb Demand
  • Corn Drops for Fourth Straight Day on Planting; Soybeans Decline
  • Copper Advances for Second Day as Chinese Demand May Improve
  • Tyson Hurt by ‘Pink Slime’ as Peak Demand Nears: Commodities
  • Sugar Advances as Lower Prices May Spur Demand; Cocoa Retreats
  • Gold May Fall in London as Stronger Dollar Cuts Investor Demand
  • Hindu Festival to Revive Indian Gold Demand After Shutdown
  • Waning U.S. Food Inflation May Help Consumers: Chart of the Day
  • Indonesia Readies Ban on Unprocessed Metal-Ore Shipments
  • Exxon Inferior to Pipelines in Energy Investing: Riskless Return
  • YPF Creditors Saved by Nationalization Clause: Argentina Credit
  • Hurricane Season to Provide Little Gas Support: Energy Markets
  • U.S. Feedlots Cut Cattle Purchases as Supply Drops, Survey Says
  • Oil Near Two-Week High on Spanish Debt, IMF
  • Silver-Inventory Surge Means Decline in Prices: Chart of the Day
  • Mitsubishi Boosts Investment Threshold to 10%, Kobayashi Says
  • India Said to Consider 1 Million Tons of Fresh Sugar Exports 





US DOLLAR – hanging in here at its long-term TAIL of support ($76.13) like a champ. Despite all of the fiscal and monetary planning disasters in the US, that’s impressive – and that’s mainly because trading USD in the middle of a Global Currency War is relative (France could vote for a Socialist and Japan is on the fiscal brink).






SPAIN – do up your chinstraps because Spain is officially moving back into crash mode (down -19.4% from its YTD high in Feb where a lot in Global Macro stopped going up – gravity + #GrowthSlowing = nasty combo). Remember, the Germans are on the record saying Spain and Italy are potentially “Too Big To Save”… potentially…














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Europe Assessment, Updated

Positions in Europe: Short France (EWQ); Long German Bunds (BUNL)

European equity markets largely got a big lift today (+200 – 350bps d/d) on improving ZEW economic sentiment numbers from Germany and the Eurozone as well as news that Japan earmarked $60 Billion to the IMF to help firewall Europe’s sovereign and banking crisis, which was followed by a contribution of $26 Billion from Denmark, Norway, and Sweden late in the trading session. Markets seemingly shrugged off Eurozone inflation of 2.7% in March Y/Y versus an expectation of 2.6% and UK CPI jumping 10bps to 3.5% in March Y/Y.


Today’s performance rings true with the investor psychology we’ve witnessed around European capital markets (equities in particular) over the last two years: gains ahead or on positive headline numbers or news followed by selling and rising credit yields on weak underlying fundamentals, a shift in geographic risk, a better understanding of sovereign and banking risk, or the inability of governments to meet their fiscal consolidation targets (to name a few).


We continue to signal that despite all the positives from such programs as the EFSF, ESM, LTRO, SMP, and increased funding to the IMF, programs designed to help firewall and provide liquidity to Europe’s fiscal and banking risks, they do little to bind Europe under a growth strategy.  A positive growth profile is critical for investor confidence to buy equities, countries to pay down their debt and deficits through tax receipts, and more broadly for the market to clearly diagnose that Europe is out from under its dark cloud.


We continue to signal Spain as a risk that may not be fully priced in the markets. Here our focal points are: Spanish housing prices could have another 30% downside; a housing drop would further impair Spanish lenders that are already levered to loan developers and homeowners; Spain’s massive unemployment rate at 23% will not improve anytime soon; and Europe may be underfunded to bailout Spain. 


We’re long German bunds and short France in the Hedgeye Virtual Portfolio. More broadly, we’re comfortable shorting Europe’s PIIGS, at a price, because we think there’s a very long tail of negative to slow growth given their policy of austerity without a growth strategy. And we’re positive on Europe’s fiscally stronger nations, like Germany, but vigilant that the whole can bring down a strong entity. On the EUR/USD, we expect it to continue to be range bound between $1.29 and $1.34. Trade the range.


Below are today’s relevant data points in charts:


Europe Assessment, Updated  - 11. zew


Europe Assessment, Updated  - 11. eurozone cpi


Europe Assessment, Updated  - 11. UK CPI


Matthew Hedrick
Senior Analyst

Is India Out of Bullets?

Conclusion: We think India has little-to-no room to continue easing monetary policy over the intermediate term, particularly in light of the inflationary pressures emanating from the nation’s fiscal policy. Further, its bloated sovereign budget and current account deficits pose a fair amount of risk to India’s currency, equity and bond markets over the intermediate term.


Overnight, the Reserve Bank of India lowered its benchmark monetary policy rates by -50bps to 8.0% on the repo rate and 7.0% on the reverse repo rate. The -50bps cut was a full -25bps deeper than the median consensus forecast of 8.25% and 7.25%, respectively. This is in line with what we have been expecting out of Indian policymakers based upon our read-through of the country’s trailing 3-6 month GROWTH/INFLATION dynamics. Looking forward 1-3 quarters, we anticipate that the reflexive nature of the G/I/P interplay will produce a modest acceleration in both growth and inflation for India.


Is India Out of Bullets? - INDIA


The growth acceleration is supported recent monetary policy action, which should filter through the economy on a lag. In fact, we’ve already seen a measured reprieve in the cash crush that hampered the Indian financial system for much of the past six months, with Indian banks borrowing the least amount of daily funds from the central bank since NOV ’11.


Is India Out of Bullets? - 2


Still, the central government’s aggressive FY13 borrowing plan/incredibly weak fiscal consolidation plan will continue to be a headwind to liquidity in the Indian financial system absent further monetary policy easing. Refer to our MAR 20 note titled, “India Strikes Out Again” for our detailed analysis of how the central government’s FY13 budget is highly likely to contribute to a pickup in inflation, in addition to limiting the scope of monetary policy easing over the intermediate term. Moreover, in cutting rates today, the RBI signaled to the market that it is not willing to sacrifice an incremental slowing of growth to properly reign in the inflationary pressures from its economy; we believe their impatience will ultimately prove to be a mistake.


The RBI did indeed confirm our view that they have limited downside to ease monetary policy further. In the accompanying statement, Governor Subbarao stated that “… upside risks to inflation persist. These conditions inherently limit the space for further reduction in policy rates. Moreover, if subsidies are not contained as indicated in the Union Budget last month, demand pressures will persist, and will further reduce whatever space there is for monetary easing… Though inflation has moderated in recent months, it remains sticky and above the tolerance level [of +4-4.5%], even as growth has slowed.”


As such, the market-based outlook for future rate cuts in India over the NTM is rather subdued:


Is India Out of Bullets? - 3


Continuing our look forward, the Subbarao did say that the central bank’s “immediate comfort zone” for inflation is +5% and “achievable”. As previously mentioned, we are on the other side of this projection, given that 5% is a full 190bps below the latest WPI rate of +6.9% YoY and, more importantly, the tailwind afforded to the Indian economy in the form of currency strength relative to food and energy prices appears to be peaking/have peaked – absent a short-to-intermediate term strong-USD, deflationary shock. Thus, there appears to be limited downside in rates of Indian inflation over the intermediate term – a view in support of our quantitative modeling of the country’s Wholesale Price Index.


Is India Out of Bullets? - 4


Consistent with our 2Q12 Themes, we are, however, calling for a strong-dollar deflationary shock over the intermediate-term TREND. That is consistent with our views that global measures of financial market volatility are poised to break out to the upside over that same duration. No doubt, a further Deflation of the Inflation will eventually be supportive of the Indian economy; that said, however, we think India’s intermediate-term growth outlook, as well as the country’s financial markets are particularly at risk in an a higher-vol. environment over the intermediate term due to its widening current account and fiscal gap. India’s bloated fiscal deficit is of particular importance given that any slowing of capital inflows or outright capital outflows ultimately translates to a crowding-out of private sector funding.


Is India Out of Bullets? - 5


Is India Out of Bullets? - 6


As a rather sizeable net importer of capital India’s equity, currency, and bond markets are all at risk of correcting over the intermediate term – especially given the dramatic run-up in portfolio inflows YTD as consensus speculated on the country’s then-future monetary policy easing. Dramatic inflows are at risk of becoming material outflows, now that the aforementioned easing is largely in the rear-view mirror.


Is India Out of Bullets? - 7


As we’ve seen time and time again over the last 4+ years, demonstrable upticks in global financial market volatility have proven to be a severe headwind for cross-border capital flows – particularly to emerging market economies. Specifically, our proprietary Global Macro VIX is [highly] inversely correlated to the following EM indices (trailing 4yrs):

  • MSCI EM Equity Index: -0.86
  • Morgan Stanley EM Debt Fund: -0.90
  • JPMorgan EM FX Index: -0.62

Intuitively, these quantifications make sense, as in higher-vol. environments, exporters of capital (i.e. global investors) increasingly favor a home bias while importers of capital find it increasingly harder to price deals at favorable rates.


All told, we think India has little-to-no room to continue easing monetary policy over the intermediate term, particularly in light of the inflationary pressures emanating from the nation’s fiscal policy. Further, its bloated sovereign budget and current account deficits pose a fair amount of risk to India’s currency, equity and bond markets over the intermediate term. In what we view as a probable higher-vol. environment over the intermediate term, will be interesting to see whether the RBI decides to support liquidity by ramping up its purchases of sovereign debt or if it decides to bite the near-term bullet in order to promote sustainable economic growth by adopting a currency-supportive (i.e. hawkish) stance.


Darius Dale

Senior Analyst

Earnings Week At Hedgeye: Spotlight On Financials


Our financials team, led by Josh Steiner, has provided their key takeaways for earnings in the financial sector this quarter, which are outlined in the bullet points below.  Based on our quantitative levels, XLF is bearish on both TRADE and bullish on TREND.



Earnings Week At Hedgeye: Spotlight On Financials  - image001



1.            Earnings Season Update. Roughly one third of financial companies have reported earnings so far. 7 of  the 8 large or mid cap companies have beaten estimates on the bottom line. Revenue trends have been more mixed, with just over 1/3 beating estimates, 1/3 in-line and just under 1/3 missing.  However, this is a bit misleading because of Debt Value Adjustment. With DVA, the big banks’ revenue lines are adversely affected by an accounting convention that requires them to recognize negative revenues when their credit default swaps tighten.  First quarter saw sizeable CDS tightening, so the headwind was significant for all the large-cap capital markets sensitive names: C, JPM, BAC, GS, MS.


Other notable trends thus far include the regional banks outperforming the Moneycenter banks on both NIM (net interest margin) and loan growth. Regional banks M&T (MTB), Commerce (CBSH) and US Bancorp (USB) have all posted positive sequential loan growth this quarter, while Wells Fargo, JPMorgan and Citigroup have all posted negative growth. On the margin front, we’ve seen the strongest results from the regional banks where NIM has been flat to up quarter over quarter vs. a mixed bag at the Moneycenters with JPMorgan down 9 bps. Market reaction to the results has been roughly evenly split between gains and losses following the reports.


2.            Looking Ahead. Financial heavyweights yet to report include Bank of America (BAC), Morgan Stanley (MS), Capital One (COF), American Express (AXP), MasterCard (MA) and Visa (V). Thus far we’ve seen strong first quarter results in both mortgage banking and consumer-related credit, i.e. credit card.  Bank of America has sizeable exposures to both these categories, and considering the kitchen sink nature of their 4Q results, we wouldn’t be surprised to see strong results when they report Thursday morning. Morgan Stanley typically mirrors Goldman and JPMorgan, where results were frankly solid, but the reaction in the stocks was lackluster. As a further headwind, Morgan Stanley has less capital markets exposure, which was the source of Goldman’s improvement this quarter.


Looking at the credit card stocks, the playbook is always to look at Discover, as they are off-cycle and so we got their first quarter results a month ago. The big surprise there was much larger than expected reserve release. (Companies release reserves when they believe that credit quality is going to be better in the future than it is today. Released reserves flow through the income statement, adding to reported earnings.) We’d expect to see the same reserve release dynamic at Capital One and American Express. On the card volume side, intra-quarter updates thus far from Amex, Visa and MasterCard have all been reasonably consistent in suggesting activity has been stable compared to strong fourth quarter trends.


3.            Sector Outlook. Financials have been among the strongest performing sectors YTD on the back of European discount reflation and an improving perception of the US economic recovery. The calendar also plays a role: distortions to the seasonal adjustment factors have caused the September through February data to look stronger than it is (and the March through August data looks worse) since the bankruptcy of Lehman Brothers. This is a contributing factor to why the XLF, the Financials sector ETF, peaked on February 21, 2011 and lost 35% of its value by October 3, 2011 and why it peaked on April 15, 2010 and lost 23% of its value by August 25th, 2010. For reference, the XLF recently put in a closing high of $15.98 on March 26, 2012. We think there’s a very good chance that this year plays out like the last two years.

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