Thursday, June 21, 2012

When Moody’s Downgrades, Markets Rise!

What are the implications of the rating cuts of 15 banks by Moody’s on Thursday?

Given the credibility and timing of Moody’s past forecasts, what the downgrades imply is that the U.S. economy is bottoming out and stock markets are likely to start on a bull run within the next few months in anticipation of a recovery!

Take a look at Moody’s performance during the 2008 crisis.

Moody’s downgraded Citibank by two notches in December 2008 and Bank of America and Wells Fargo by a notch each in March 2009. That was right at the bottom of the cycle, as Citigroup started posting positive results immediately after the downgrade and the U.S. markets started on a bull run in the first week of March after hitting a capitulation bottom.

Now, if Moody’s had started with widespread downgrades in late 2007, that would have been some really admirable foresight. Keep in mind that economist Nouriel Roubni had come out with a very uncanny step-by-step analysis in 2006 of how the housing bubble would burst and the crisis would unfold. As for Moody’s, here’s what it had to say in a Reuters update in August 2007.

“Moody's Investors Service on Friday said widespread rating downgrades are not expected for the world’s banks as a result of the current market turmoil. Third-quarter earnings will likely decline for a number of banks, however, and a handful of banks may be downgraded, Moody's said in a report. ‘We are unlikely to change bank ratings because of temporary liquidity problems,’ said David Fanger, a managing director at Moody's.”

By the time Moody’s started with major downgrades, the recovery cycle had already begun.

Here’s another point that dents the credibility of the current downgrades: Out of the 15 banks, 11 were downgraded by two or more notches. That’s ridiculous! Did a tsunami hit the U.S. that a sudden two-notch downgrade was required? No, nothing catastrophic has happened in the U.S. or the global economic scenario that would deserve an overnight two-notch downgrade. Issues around the temporary U.S. slowdown and the euro-zone crisis have been known for a while now.

On the credibility side, take a look at what blogger Tyler Durden had to say around the current downgrades.

… CNBC, which apparently is where Moody’s leaked all its data … . So ... this leaves Morgan Stanley with the dreaded 3 notch cut.”

And there you have it – the reason for the delay were last minute negotiations, most certainly involving extensive monetary explanations, by Morgan Stanley’s Gorman (potentially with Moody’s investor Warren Buffett on the call) to get only a two notch downgrade. And Wall Street wins again.”

Here’s what Christopher Whalen, of Tangent Capital, had to say: “Watching the latest move by Moody's to downgrade various global banks, one can only be impressed by the lagging nature of the major ratings agencies’ financial prognostications.”

Again, I don’t mean to pick on Moody’s. It’s just that this was the latest news. In fact, my previous analysis suggests that firms like S&P, Morgan Stanley and Goldman Sachs are all in the same boat as far as credibility of their ratings and reports are concerned.

My analysis further suggests that global economies are in various stages of bottoming out and recovery. With S&P and Moody’s downgrades starting to come in, it further confirms the bottoming out scenario and a high possibility of stock markets breaking out upward in the next few months.

Related Analysis
Be wary of S&P ratings
Be wary of Marc Faber’s public forecasts
Global recovery robust – Part II