In another confirmation of the power of expectations, Morgan Stanley's (NYSE: MS ) shares rallied in yesterday's after-market trading following a two-notch ratings downgrade from Moody's (NYSE: MCO ) .
If you're scratching your head as to why the stock would be up more than 3% on such news, know that prior to Moody's laying down its decision, it was widely expected that Morgan Stanley would be slammed with a three-notch downgrade. Morgan Stanley's CEO James Gorman had set himself up for a foot-in-mouth gaffe after saying it'd be "somewhat stunning" if the bank was hit for a full three notches, but even after this "victory," he wasn't ready to go quietly. In a press release following the downgrade, the bank asserted: "We believe the ratings still do not fully reflect the key strategic actions we have taken in recent years."
This is a pretty bullish view from MS management. But it also shows an increasing disconnect between what MS thinks and what everyone else seems to think. Yes, Moody's did hold back an extra notch from its downgrade, but The Financial Times quoted a Moody's managing director saying "We incorporated a notch of uplift from the moderate possibility of support from [Mitsubishi UFJ Financial Group]." So essentially they missed out on the worst-case downgrade mainly because there's somebody with deep pockets that may be willing to plug holes in a leaky MS balance sheet.
It's not just Moody's view, either. The simple fact that MS shares are fetching less than half of the bank's book value suggests that few investors think that there's much to like about its current position.
Not that Morgan Stanley is alone. Bank of America (NYSE: BAC ) , Citigroup (NYSE: C ) , Goldman Sachs, and JPMorgan Chase (NYSE: JPM ) were among the other U.S. banks also downgraded by Moody's and every one of them trades at a significant discount to book value.
In the tug of war of setting expectations, the management teams at these banks are losing badly. It's hard to blame investors for their skepticism of banks, but there's good reason to think that the pessimistic overhang may be creating opportunity for investors with a longer time horizon. If you're looking for a time to worry, wait for the next time that management's glassy-eyed optimism actually carries some weight with investors.
Of course, stepping back, Morgan Stanley and its not-so-bad downgrade may not even be the real story here. The real story may be why, after some of the worst blown calls in financial history, investors still care so much about what Moody's has to say.