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Bank Of America Caught Frontrunning Clients | Zero Hedge
Bank Of America Caught Frontrunning Clients | Zero Hedge.
Every time a TBTF bank releases its 10-Q, we head straight for the section, usually well over 100 pages in, that discloses the bank’s total profitable trading days.
This is what the most recent Bank of America 10-Q said on this topic:
The histogram below is a graphic depiction of trading volatility and illustrates the daily level of trading-related revenue for the three months ended September 30, 2013 compared to the three months ended June 30, 2013 and March 31, 2013. During the three months ended September 30, 2013, positive trading-related revenue was recorded for 97 percent, or 62 trading days, of which 69 percent (44 days) were daily trading gains of over $25 million and the largest loss was $21 million. These results can be compared to the three months ended June 30, 2013, where positive trading-related revenue was recorded for 89 percent, or 57 trading days, of which 67 percent (43 days) were daily trading gains of over $25 million and the largest loss was $54 million. During the three months ended March 31, 2013, positive trading-related revenue was recorded for 100 percent, or 60 trading days, of which 97 percent (58 days) were daily trading gains over $25 million.
In summary, so far in 2013, Bank of America lost money on 9 trading days out of a total 188.
Statistically, this result is absolutely ridiculous when one considers that the bulk of bank trading revenues are still in the form of prop positions disguised as “flow” trading to evade Volcker which means the only way a bank could make money with near uniform perfection is if it either i) consistently has inside information that it trades on or ii) it consistently front-runs its clients.
In related news, the only more absurd datapoint was JPMorgan’s announcement of how many trading day losses it had in the first nine months of 2013. For those who missed out succinct post on the matter, the answer was clear: zero. The absurdity becomes even clearer when one considers that in the pre-New Normal days, JPM had an almost normal profit/loss distribution in its trading days.
But back to Bank of America, where as we noted, the kind of trading result would only be possible if the bank was aggressively insider trading or just as aggressively frontrunning flow orders in its prop book (a topic we covered back in 2009 as relates to Goldman Sachs, and which the bank sternly rejected).
We now know that at least one of the two almost certainly happened after Reuters report from earlier today that it discovered on the FINRA BrokerCheck page of one of the bank’s former Managing Directors, Eric Beckwith, the following curious ongoing investigation:
WE UNDERSTAND THAT THE USAO (US Attorney Office) -WDNC IS INVESTIGATING WHETHER IT WAS PROPER FOR THE SWAPS DESK TO EXECUTE FUTURES TRADES PRIOR TO THE DESK’S EXECUTION OF BLOCK FUTURE TRADES ON BEHALF OF COUNTERPARTIES, AND WHETHER MR. BECKWITH PROVIDED ACCURATE INFORMATION TO THE CME IN CONNECTION WITH THE CME’S INVESTIGATION OF THE SWAPS DESK’S BLOCK FUTURES TRADING. WE ALSO UNDERSTAND THAT THE COMMODITY FUTURES TRADING COMMISSION IS CONDUCTING A PARALLEL INVESTIGATION INTO THE TRADING ISSUE.
More from Reuters:
The U.S. Department of Justice and the Commodity Futures Trading Commission have both held investigations into whether Bank of America engaged in improper trading by doing its own futures trades ahead of executing large orders for clients, according to a regulatory filing.
The June 2013 disclosure, which Reuters recently reviewed on a website run by the securities industry regulator FINRA, sheds light on the basis for a warning by the Federal Bureau of Investigation on January 8.
The warning, in the form of an intelligence bulletin to regulators and security officers at financial services firms, said that the FBI suspected swaps traders at an unnamed U.S. bank and an unnamed Canadian bank may have been involved in market manipulation and front running of orders from U.S. government-owned mortgage giants Fannie Mae and Freddie Mac.
Only this time it’s different, because a quick check on the background of Beckwith shows that his expertise is not trading MBS but a different product entirely.
First, it goes without saying that Eric would promptly scrap his LinkedIn Profile as the following URL shows.
What Eric, however, was unable to delete was the mention of his name as the Bank of America contact for an “innovative new product created [by the CME and the banks] based on client demand” –Deliverable Interest Rate Swaps Futures, or as some call them Deliverable Interest Rate Products.
What is this newly promoted product, and why is there demand for it? This is what the CME had to say about the benefits of “DIRPs” (even though the technical acronyms is DSFs):
- Capital efficient way to access interest rate swap exposure
- Flexible execution via CME Globex, Block trades, EFRPs and Open Outcry
- Allows participants to trade in an OTC manner:
- Ability to block calendar spreads
- Lower block thresholds and longer reporting times
- No block surcharges
But, as in the case of CDS, and all other novel products, the main reason for DIRPs is simple: an even lower margin requirement compared to Interest Rate Swaps and Treasury Futures (margined together), allowing one to express a position, or better, manipulate the market in Interest Rate products, using the least amount of margin (initial capital) possible.
The following chart explains just this:
Bottom line: if you want to manipulate Treasurys in a reflexive market, where the derivatve almost always drives the price of the underlying (as perhaps explained best by none other than the then-member of the Fed Dino Kos), this is the best product as you get even more firepower for your buck.
Only in this case, anyone trading with the Bank of America DIRPs desk was apparently also being frontrun on a consistent basis.
We are relatively comfortable with alleging that BofA did indeed allow this to happen (whether it neither admits nor denies guilt at the end of the day), because a few weeks after the notice appears in Beckwith’s Brokercheck profile on June 14,2013, he promptly “left” Bank of America in July as Reuters reports: not exactly the course of action an innocent man would take.
In other words, while Reuters is focused on the Fannie and Freddie frontrunning angle, it appears the frontrunning activity spread substantially to involve the entire Treasury curve as well!
So while HFTs frontrun all equity retail trades in open markets, major banks frontrun all institutional block equity orders in their own dark pools, we find out that bankers also just happen to frontrun clients in “you name it” over the counter product, where the only reason to be involved is to take advantage of the low margin – something JPM’s CIO did quite aggressively and quite well until it blew up of course.
But the best news: we finally know how it is possible that every bank reports quarter after quarter of near uniform trading perfection and close to zero trading day losses.
Finally, our question for the regulators: in a Volcker world in which banks are supposedly not allowed to trade ahead of their clients, why are banks, well, trading ahead of their clients!?
* * *
Appendix 1 – the CMEs overview of Deliverable IR Swap Futures
Appendix 2 – Eric Beckwith’s Brokercheck profile
Bailout Architect Runs For California Governor; World Laughs | Matt Taibbi | Rolling Stone
Bailout Architect Runs For California Governor; World Laughs | Matt Taibbi | Rolling Stone.
I want to apologize for this space being blank for quite some time. I actually spent the bulk of the last two days on a long blog post about the “Dr. V.” story in Grantland. But then I got all the way to the end, and realized I was completely wrong about the entire thing.
So, I spiked my own piece. Now I’ve been in Talk Radio-style “This is totally dead air, Barry” territory for about two weeks. I could swear I saw a cobweb when I logged on this morning.
So thank God for Neel Kashkari, and the news that this goofball footnote caricature of the bailout era has decided to run for Governor of California. Never in history has there been an easier subject for a blog post.
If you don’t remember Kashkari’s name, you might be excused – he was actually better known, in his 15 minutes of fame five years ago, as “The 35 year-old dingbat from Goldman someone put in charge of handing out $700 billion bailout dollars.”
Now you remember. That guy! Neel Kashkari when he first entered the world of politics was a line item, usually the last entry in a list of ex-Goldman employees handed prominent government and/or regulatory positions, as in, “. . . and, lastly, Neel Kashkari, the heretofore unknown Goldman banker put in charge of the TARP bailout program . . .”
Kashkari was not just a former Goldman banker handed a high government post – he was a former Goldman banker handed a high government post by a former Goldman banker, in this case former Goldman CEO and then-Treasury Secretary Hank Paulson.
Neel was also the human parallel to the original TARP proposal written by Paulson, which was famously just three pages long.
Paulson’s TARP proposal was essentially the last, unaired episode of Beavis and Butthead,with the three pages of script just containing a single scene in which Butthead walks into the U.S. Senate and says, “Can you, uh, like, give us 700 billion dollars? Uh-huh-huh.”
Kashkari then was more or less an equally blank slate, a little-known tech banker from Goldman’s San Francisco office who somehow ended up being Paulson’s choice to administer a bailout that Paulson wanted to feature no oversight whatsoever. The original three-page proposal specified no review “by any court of law or any administrative agency.”
It never came to that, not exactly – Paulson had to expand his three-page proposal – but it’s worth remembering now that the Treasury’s original plan for the bailout was to give literally unlimited powers to distribute $700 billion of taxpayer money to a low-level banker that prior to 2006, even Hank Paulson had never heard of.
So Kashkari takes the job as bailout czar and starts hurling fistfuls of cash at the banks, in a fashion that turned out later to have been beyond haphazard. Critically, even though the Treasury promised only to give out TARP funds to institutions that were “healthy” and “viable,” Kashkari had no protocol in place to even decide whether a bailout recipient was solvent or not.
They forked over billions in cash to failing institutions and then failed to enforce crucial provisions, like for instance measures put in place to prevent executives from bailout-out companies from giving themselves huge bonuses.
This latter failure was what led to one of Kashkari’s more infamous public appearances, in which Maryland congressman Elijah Cummings raked Kashkari over the coals for allowing AIG executives to give themselves $503 million in bonuses. “I wouldn’t want to be asking my friend for some money to stay afloat,” hissed Cummings. “Then my friend, who can barely afford to go to McDonald’s, sees me in a restaurant costing $150 a meal. There’s absolutely something wrong with that picture!” He added:
I’m just wondering how you feel about an AIG giving $503 million worth of bonuses on the one hand, and accepting $154 billion from hard-working taxpayers. You know, because I’m trying to make sure you get it. What really bothers me is all these other people who are lined up. They say, well, is Kashkari a chump?
After this “chump” episode, and others, Kashkari apparently became despondent. He and his wife reportedly were particularly upset by a snickering item in Gawker. The item read, “Financial Crisis Taking a Toll on Our Favorite Asshole Banker,” and made the neatly cruel observation that that Kashkari, who was a fit/lean/bald banker of Paulsonian persuasion when he arrived in Washington, had begun “putting on classic stress-related weight under his chin.”
The item featured before and after photos. The “after” photo was shot from just below chin level. It was brutal.
Now, a lot of people have been ripped in Gawker. I think everyone with a Q rating above 0.00003 has been ripped in Gawker. I personally remember having to Google-image Peter Beinart because Gawker described me as looking like the computer-generated love child of Beinart and Ashton Kutcher. It’s an Internet-age rite of passage and they give great service – I mean, Gawker’s insults are almost always really good. Probably most people who get ripped on the site flip out at first, and then laugh about it later.
Not Kashkari. He was so mortified by items like the Gawker bit that he literally disappeared into the woods like Ted Kaczynski and committed himself to a vengefully ascetic fitness regimen, apparently determined to return someday to society and have the last word.
This is not a joke. The Washington Post actually tracked Kashkari down in the woods after the bailouts. They photographed the tiny shed he’d built for himself in Nevada County, California. They were shown the incredible list-of-things-to-do he’d written on his way out of Washington. I have to keep repeating this, but this isn’t a joke:
1. buy shed
2. chop wood
3. lose twenty pounds
4. help with Hank’s book
The Post was then invited to watch as Kashkari lived out his hilarious homage to Rocky IV,getting in shape by his lonesome in the woods, fiercely splitting log after log with an ax, recalling a past slight with each blow:
Kashkari raises his ax.
“It felt like I got jumped.”
“Like three guys beat the crap out of me.”
The massive block of sugar pine breaks, the crack bouncing off the mountain.
Kashkari is recalling his testimony before Congress, while splitting logs to feed the stove for the winter. He is down to his last two chain-sawed trees.
“Members of Congress will tell you they agree with you, and then in public they blast you. I understand their anger, but the playing at politics when so much was at stake — ”
Whack. The ax blade flies off its wooden handle.
After enough of this, there was no more stress-related neck-jelly, no sir!
Kashkari, in shape again, soon-re-entered the finance world, taking a high-profile job with the bond fund PIMCO, run by notorious Wall Street insider Bill Gross.
The new choice of employer was significant because as numerous critics havesubsequently pointed out, PIMCO was one of the major beneficiaries of the government’s rescue of Wall Street. In December 2008, the Fed hired PIMCO to be one of four investment firms put in charge of managing a Fed program to buy up the toxic mortgage-backed securities that were threatening to tank the economy at the time.
Gross, at the time, warned that the government would have to “open up the balance sheet of the U.S. Treasury” (i.e. the state would need to cough up taxpayer money) in order to prevent “continuing asset and debt liquidation” (to prevent Wall Street jerks from being blown up by their own bad bets). Conveniently, Bill Gross and PIMCO happened to be sitting on $500 million of mortgage-backed holdings at the time. Which meant, as Babson College professor Peter Cohan put it:
Bill Gross, who manages $830 billion, has convinced the U.S. Treasury to use your taxpayer dollars to bail him out of his bad investments.
So Neel Kashkari was the administrator of the biggest corporate welfare program in history, took shit for it (“Beating on the Hill,” he would pencil for certain times in his calendar), went into the wilderness to get his mind and body right after the experience, then re-emerged to take a high-paying job with a company that was a significant beneficiary of government largesse.
While at PIMCO, Kashkari dipped a little toe in the lake of politics once again by penning aneditorial for the Post (“No more me-first mentality on entitlements,” July, 2010) denouncing government aid programs. He argued – and again, this is no more a joke than the Rocky-IV-cabin-in-the-woods thing was – that even though we have an economy successfully founded on self-interest, accepting government benefits, by which one assumes he means things like Medicare, is the wrong kind of selfish:
Our belief in free markets is founded on the idea that each individual acting in his or her self-interest will lead to a superior outcome for the whole. The financial crisis has reminded us that free markets are not perfect — but they do allocate capital better than any other system we know. A “me first” mentality usually makes markets more efficient.
But this “me first” mentality can also lead to shortsighted political decision making . . .
Kashkari’s solution? People who accept government benefits should take the long view and just say no:
Cutting entitlement spending requires us to think beyond what is in our own immediate self-interest. But it also runs against our sense of fairness: We have, after all, paid for entitlements for earlier generations. Is it now fair to cut my benefits? No, it isn’t. But if we don’t focus on our collective good, all of us will suffer.
Again, this came from a guy who handed out hundreds of billions of dollars of welfare to Wall Street companies, effectively subsidizing the massive compensation packages of Wall Street executives. This same person then went to work for a company that got a fat government contract to help other Wall Street investors unload their bonehead investments on the taxpayer.
Then, after all that rescue money disappeared, Kashkari made the interesting observation that there was not enough left over to pay benefits for other people. So, he effectively said to Americans on benefits, stop being so selfish. Tighten your belts. All of us will suffer otherwise.
This is the person who has now decided to run for Governor of California. It seems Jerry Brown has become his own personal Dolph Lundgren. A friend of mine sent me the news by email and suggested I say nothing at all about his decision, other than to post the headline above the following clip:
Kashkari’s platform seems to be centered around restoring jobs and schools, but also seems targeted at waste – he called Jerry Brown’s $68 billion high-speed rail project a “crazy train” and said it reflected “misplaced priorities.”
Humorously, and predictably, Kashkari’s campaign has already sprouted serious leaks. It turns out he has a somewhat spotty voting record (I do, too, to be honest, but I’m not running for governor), and he’s already had to acknowledge publicly that he has not always voted – although, he says, “I believe voting is very important.”
The Kashkari story is a perfect little allegory about the arrogance and cluelessness of the people who run the American economy. Kashkari talks passionately about free markets, forgetting that he was the individual who was actually in charge of the biggest-in-American-history government program to subvert the free market, bailing out countless institutions that should otherwise have gone out of business due to their own incompetence and corruption.
He talks about how the “free markets” allocate capital better than any system we have, but then again he was the person who had to step in when that system failed and institute a different system of capital allocation, one in which public treasure was unorganically re-allocated from taxpayers to private companies. His complaints about “misplaced priorities” are almost beneath comment – there’s just not much to say about someone who committed public funds to million-dollar bonuses but believes regular people accepting government benefits have a “me-first” mentality.
Anyway, having this guy run for public office is like a gift from the blogging gods. How funny will this get? Will this one go to 11? I’m taking the over.
Nigel Farage Booms “Europe Is Now Run By Big Banks, Big Business, And Big Bureaucrats” | Zero Hedge
Nigel Farage Booms “Europe Is Now Run By Big Banks, Big Business, And Big Bureaucrats” | Zero Hedge.
With Greek Prime Minister Antonis Samaras settling into his role as EU President, UKIP’s Nigel Farage stunned the “Goldman Sachs puppet” with a 150-second tirade of truthiness he has likely never experienced. Farage sacrastically remarks how Greeks “will be dancing in the streets” at Samaras’ ‘successful’ negotiation on MiFiD reminding him that “60% of youth are unemployed and the neo-nazi party are on the march.” Europe is now run by “big business, big banks, and big bureaucrats,” Farage goes on, suggesting the smarmy-looking Samaras should “rename his party from New Democracy to No Democracy.” People do not want a United State of Europe, the outspoken UKIP leader explains, they want a “Europe of sovereign states,” and concludes ominously, “the European elections will be a watershed.”
…And you come here Mr Samaras and you tell us that you represent the sovereign will of the Greek people? Well, I’m sorry, but you’re not in charge of Greece, and I suggest you rename and rebrand your party – it’s called ‘New Democracy’, I suggest you call it ‘No Democracy’.
Because Greece is now under foreign control. You can’t make any decisions, you’ve been bailed out, and you’ve surrendered democracy, the thing your country invented in the first place.
And you can’t admit that joining the euro was a mistake – of course Mr Papandreou did that didn’t he, he even said there should be a referendum in Greece and within 48 hours, the unholy trinity (troika) that now run this European Union had him removed and replaced by a ex-Goldman Sachs employee puppet.
We are run now by big business, big banks and in the shape of Mr Barroso, big bureaucrats…
The US Is Not Switzerland: Weighs Sanctions Against South Sudan | Zero Hedge
The US Is Not Switzerland: Weighs Sanctions Against South Sudan | Zero Hedge.
Despite telling us just yesterday that it would not take sides in the tensions in South Sudan…
- *U.S. NOT TAKING SIDES IN S SUDAN: PSAKI
the US government is on the verge of deciding to… take sides. As Reuters reports, the United States is weighing targeted sanctions against South Sudan due to its leaders’ failure to take steps to end a crisis that has brought the world’s youngest nation to the brink of civil war. Africa, aswe have discussed at length, remains the only region on earth with incremental debt capacity (and therefore growth in a Keynesian world) and so it is no surprise the US wants to get involved in yet another conflict.
“It’s a tool that has been discussed,” a source told Reuters on condition of anonymity about the possibility of U.S. sanctions against those blocking peace efforts or fueling violence in South Sudan. Another source confirmed the remarks, though both declined to provide details on the precise measures under consideration.
No decisions have been made yet, the sources added. Targeted sanctions focus on specific individuals, entities or sectors of country.
The U.S. government was unlikely to consider steps intended to economically harm impoverished South Sudan but would likely focus on any measures on those individuals or groups it sees as blocking efforts at brokering peace or committing atrocities.
As we discussed previously, there is an African scramble so it is unsurprisng the US would choose to take sides and get involved:
While those in the power and money echelons of the “developed” world scramble day after day to hold the pieces of the collapsing tower of cards in place (and manipulating public perception that all is well), knowing full well what the final outcome eventually will be, those who still have the capacity to look, and invest, in the future, are looking neither toward the US, nor Asia, and certainly not Europe, for one simple reason: there is no more incremental debt capacity at any level: sovereign, household, financial or corporate. Because without the ability to create debt out of thin air, be it on a secured or unsecured basis, the ability to “create” growth, at least in the current Keynesian paradigm, goes away with it. Yet there is one place where there is untapped credit creation potential, if not on an unsecured (i.e., future cash flow discounting), then certainly on a secured (hard asset collateral) basis. The place is Africa, and according to some estimates the continent, Africa can create between $5 and $10 trillion in secured debt, using its extensive untapped resources as first-lien collateral.
Africa is precisely where the smart money (and those who quietly run the abovementioned “power echelons”), namely China and Goldman Sachs, have refocused all their attention in the past year precisely because they both realize that Africa is the last and only bastion of untapped credit growth and capacity. But you won’t read about it in the mainstream papers: the last thing those who are currently splitting up Africa into its constituent parts want is for the general public to become aware what is in play. You will, however, read about it on these pages (see here and here and here). Also, if you are a Goldman client, you will certainly know all about it, as the firm ventures out with reverse inquiry indications of interest to its wealthy clients giving them the right of first equity refusal, and slowly but surely providing “financial services” to the last great hope for the developing world, which ironically is what most still consider the poorest continent…
Africa in geographical perspective…
On This Day In History, Gas Prices Have Never Been Higher | Zero Hedge
On This Day In History, Gas Prices Have Never Been Higher | Zero Hedge.
It seems not a day goes by when the mainstream media (or your local friendly asset gatherer) proclaims the drop in gas prices from a Middle-East-turmoiling Summer as “great news” and very positive and an implicit tax cut… as they try to juice hopes and dreams of a better-than-expected holiday spending season. The sad truth – something unusual in this new normal – is that regular gas prices (at $3.258) have never been higher on Christmas Eve. It seems context does matter…
Yesterday, we inched out 2012’s $3.247 and moved to $3.258 per gallon…
This is the first time since March that gas prices have been at seasonally-comparable record highs.
Russia Crisis Haunts Deutsche Bank’s Smith Seeing China Bust – Bloomberg
Russia Crisis Haunts Deutsche Bank’s Smith Seeing China Bust – Bloomberg.
China’s push to open up its economy is winning praise from Goldman Sachs Group Inc. to Morgan Stanley and Jefferies Group LLC, which predicted last month a “massive” multiyear bull run for stocks.
John-Paul Smith doesn’t share the enthusiasm.
When the Deutsche Bank AG equity strategist looks at the country, he says he detects some of the same signs of a financial meltdown that led him to predictRussia’s 1998 stock market crash months in advance. China’s expansion is being fueled by soaring corporate borrowing, a high-risk model that needs to be replaced by the kind of free-market measures and budget cuts that fed Russia’s growth in the aftermath of the country’s default and subsequent 44 percent monthly tumble in the Micex Index (INDEXCF), Smith said.
“There is potential for a debt trap in industrial companies which can trigger an economy-wide financial crisis as early as next year,” Smith said in an interview from London on Dec. 12, a day after he issued a report predicting China’s slowdown will lead to a 10 percent decline in emerging-market stocks next year. “If I am wrong on China, I am wrong on everything.”
Smith’s 2013 call for a drop of at least 10 percent in developing-country stocks has proven prescient. The MSCI Emerging-Markets Index has slid 5.9 percent, trailing the 22 percent rally in MSCI’s developed-markets measure. The Shanghai Composite Index, the benchmark equity gauge in the world’s second-biggest economy, has lost 7.9 percent, heading for its third annual decline in four years. The measure rose 0.2 percent at today’s close after falling for nine days.
The selloff in Chinese (SHCOMP) stocks has eased since mid-November, when the government’s top policy makers pledged the biggest expansion of economic freedoms in at least two decades. Measures included encouraging private investment in state-controlled industries, accelerating convertibility of the currency and liberalizing interest rates, an initiative that helped drive interbank borrowing costs to a six-month high last week.
China’s benchmark money-market rate climbed for a seventh day today, with the seven-day repurchase rate, a gauge of funding availability in the banking system, jumping 124 basis points to 8.84 percent, the highest level since June 20.
Morgan Stanley said the free-market push will boost consumption, technology and health-care stocks while Jefferies Group said companies in industries including auto and insurance will do the best amid the bull market rally. Goldman Sachs upgraded Chinese equities to overweight in part because of the country’s “commitment to reform, which seems quite palpable.”
Smith, who has been bearish on China since he joined Deutsche Bank in 2010 from Pictet Asset Management, said he wants to see how the government carries out the policy changes.
The economy is at risk of expanding less than 5 percent annually over the next few years, he said. Gross domestic product has grown less than 8 percent in each of the past six quarters, down from a high of 14 percent in 2007.
“The proof will be in the implementation,” said Smith, who’s the global emerging markets equities strategist at the Frankfurt-based bank. “It will be very interesting to see if they really intend to go down the same ‘hard state liberal economic’ path that Russia did from 1999 to the autumn of 2003. So far, there is no indication they are prepared” for that.
Smith, 52, has honed his market acumen over a three-decade career. Raised in the English town of Glossop, near Manchester, he studied modern history at Oxford’s Merton College before going to work as a European fund manager with Royal Insurance in 1983. From there, he did stints at TSB Investment Management, Rothschild Asset Management and Moscow-based Brunswick Brokerage, before joining Morgan Stanley in 1995 as a Russian equity strategist.
It was at Morgan Stanley that Smith made the call that he’s still best known for today, a forecast that got its inspiration in part from a visit he made in 1997 to a port city 600 miles (965 kilometers) south of Moscow.
In Rostov-on-Don, he got an up-close look at a combine-harvester maker that surprised him: the company was taking a year to build its planned weekly quota, it was still employing two-thirds of its Soviet-era workforce and it was drowning in unpaid bills and barter deals.
That trip helped Smith understand the growing financial crisis that would lead Russia to devalue the ruble and default on $40 billion of domestic debt in August 1998.
In a June 1997 report, he wrote that investors may not have begun to “really focus on the possible fallout” from companies’ growing financial struggles. Smith highlighted the Rostov-on-Don trip in a January 1998 note in which he reiterated that investors were too optimistic. Two months later, he wrote that Russia had to “sort the situation out” that year or its financing burden would become unsustainable and trigger a devaluation.
In the aftermath of the collapse, Smith turned bullish on Russian stocks at an investors’ meeting in New York in 1999. The market soared 235 percent that year. He calls it the best forecast of his career.
“I suggested that Russia was now cheap and should be an overweight and the meeting ended very quickly indeed amid some expressions of minor outrage,” said Smith, who is underweight Russian stocks today.
Following those calls, Smith spent nine years at Pictet, first as head of emerging markets equities where funds managed by his team almost quadrupled to $9 billion between 2001 and 2005. His Eastern European Trust Fund, with 40 percent of its assets in Russian equities on average, outperformed the MSCI Emerging Market Eastern Europe dollar index by 1.5 percentage points at the end of 2005.
“When he joined Pictet in 2001, it was like the second coming as the savior of our emerging markets business,” Stephen Barber, a managing director at parent company Pictet & Cie, wrote in a farewell note about Smith in June 2010. “He did seem to perform miracles in the years that followed, as our emerging markets business recovered strongly.”
While Barber said that Smith had an ability to avoid getting caught up in the market euphoria, he often made his calls too early.
“When he was with us, he was for a long period bearish on China,” Barber said. “The analysis was absolutely correct but in the meantime, you can miss out on a bull market.”
“When you have a great strategist who has these insights, you have to nurture these insights, not kill them,” he said.
Smith wrote an article for the Financial Times in December 2007 saying he sensed that the worst in the subprime mortgage crisis was over and that the U.S. market was poised to rally. The worst financial crisis since the Great Depression followed.
The analyst, who has also been wrongly bearish on oil since April 2011, says he learned to never take a strong view without obtaining detailed understanding of the underlying fundamentals, such as what types of instruments were being held in the financial industry.
Smith’s China call is another strong view. His colleagues at other banks are underestimating the risks, he said.
China’s total credit, including items off bank balance sheets, climbed to about 190 percent of the economy by the end of 2012 from 124 percent in 2008, according to Fitch Ratings Ltd. That was faster lending growth than in Japan during the late 1980s that foreshadowed two decades of deflation, and in the U.S. before the financial crisis of 2008.
“It is really at the corporate level and at the micro level in China that the fate of the financial market and the economy there is going to be determined,” Smith said. “China is not such a safe haven as most market commentators appear to believe.”