Thursday, June 12, 2008

Morgan Stanley: Buy Financials, Sell Energy

Last week, Morgan Stanley said oil was going to $150 by the 4th of July. Now their macro call is to sell energy, and to buy the financials.

The catalyst? Everyone is looking at the details of the financials balance sheet and not their earnings. But the balance sheet data won't be released until weeks after the earnings are reported next week.

Without this hard information, you can now rally the financials into their earnings, as the people short won't be able to pick out what's real and what is bogus.

They'll have to just trust management.

Here's today's WSJ "Heard on the Street Column."

Ever since the credit crisis began, investors have been hungering for as much detailed financial information as they can get about the strength of Wall Street's biggest investment banks.

That especially will be the case next week when Goldman Sachs Group Inc., Morgan Stanley and Lehman Brothers Holdings Inc. release earnings for the fiscal second quarters ended in May. Lehman already has announced that it expects to post a $2.8 billion loss, and investment-bank shares, along with other financial stocks, have taken a pounding in recent days.

But investors won't really get the data they need next week. That is because the earnings releases from investment houses don't include balance sheets, which now trump income statements in terms of importance for investors in financial stocks. That information won't be available for several more weeks.

Since investors have lost confidence in markets generally and in financial stocks specifically, this should change. For a start, the firms need to provide fuller information about their finances, namely a full balance sheet, even if it causes them to take a bit longer in getting information out to investors.

"I don't see how you're doing the markets right by delivering iffy information sooner rather than by requiring better information all at the same time," says Jack Ciesielski, editor of the Analyst's Accounting Observer newsletter.

Indeed, a recent report from a committee advising the Securities and Exchange Commission on financial-reporting issues called for corporate and investor groups to consider "recommending that companies include in their earnings releases the income-statement, balance-sheet and cash-flow tables."

As things stand now, investors get only the financial red meat they seek when the banks file their actual quarterly results with the SEC -- weeks after the earnings releases.
As long as banks file these results within 40 days of the quarter's close, they are abiding by SEC rules.

By that time, though, analysts' one chance to publicly question executives on the quarterly conference call has passed and markets have moved on to forecasting the next quarter.

The firms say that a balance sheet takes more time to nail down than an income statement. While there is some truth to that, these are also firms that claim to have the world's best technology and risk-management systems.

In light of that, it is tough to see how the firms can claim to be able to know exactly how much of their capital they put at risk on a daily basis, yet can't come up with a balance sheet for weeks.

As things stand, the firms create an information gap for investors. This has already become a point of contention at Lehman, where questions have arisen over a $1.1 billion difference between values the firm ascribed to hard-to-price assets in its call connected to its first-quarter earnings release and actual quarterly SEC filing.

During an investor call Monday, Lehman's chief financial officer, Erin Callan, noted that values for such hard-to-value assets can change between the close of a quarter and the time the firm files its results with the SEC. That may be true. But such swings still undermine investor confidence.

In hard times, investors need hard information. If they don't get it, investors will rightly continue to look skeptically at the firms' finances
, and share prices.

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