Market Participants Felled by Macro Environment

Terry Flanagan

Market participants, ranging from exchanges to broker-dealers, are struggling to gain traction amidst a challenging macroeconomic environment.

Bulge bracket bank JPMorgan Chase is the latest to take it on the chin amid a market that continues to go sideways. The big time broker-dealer posted a surprise $2 billion loss during recent weeks, which was blamed on risky investments gone sour.

“There were many errors, sloppiness and bad judgment,” said Jamie Dimon, chief executive of JPMorgan Chase in a conference call last week. “These were egregious mistakes, they were self-inflicted.”

The bank’s chief investment office (CIO) unit took risky bets on synthetic credit securities that were more volatile than expected, and as a result may cost the bank an additional $1 billion in the coming months, Dimon added. While hedge funds bet against a continued economic recovery, JPMorgan wagered on a continued recovery with a complex set of trades tied to the values of corporate bonds. Things took a turn for the worse when the markets started to decline last month, causing losses in many of its derivatives positions. The loss originated out of the firm’s London CIO unit, according to reports.

“I expect a lot of institutional investors will be very cautious and careful in the wake of this news, and be in the mindset that they have to get liquid,” said one market participant at a New York broker-dealer.

Aside from the $2 billion loss, the chief investment office’s portfolio has registered gains of $1 billion in other areas, and, even after the loss, the bank’s overall profit should be in the $4 billion range for the second quarter, according to Dimon.

The Securities and Exchange Commission has formally opened an investigation into JPMorgan’s financial and accounting practices in the wake of the news.

The loss came as the bank posted $5.4 billion in net income for the first quarter, down just slightly from $5.6 billion last year. It also announced that it would increase its dividend distribution and look to buy back some $15 billion in equity. “We will repurchase equity as deemed appropriate relative to our organic growth, investment opportunities, capital retention needs and the stock price,” said Dimon.

All banks have units that invest excess profits similar to JPMorgan’s CIO unit, and Dimon said that his own has historically performed well. There are currently no plans to cull that division’s business operations in the foreseeable future.

“The original premise of the CIO unit was to hedge the company in a stress credit environment,” said Dimon.

JPMorgan is not alone in struggling amid the difficult market conditions. Canadian exchange operator TMX Group saw first quarterly profits decline 10% from year ago numbers to $56 million from $63 million, as equity trading volumes decreased 28% on TMX’s three equities venues, the Toronto Exchange, TSX Venture and TMX Select.

“Like the fourth quarter of 2011, the first quarter of 2012 proved to be less profitable for TMX Group because of continuing global economic uncertainty,” TMX chief executive Tom Kloet said in a conference call. “Unlike previous economic downturns, this uncertainty has resulted in steep declines in the level of equity trading and financing activities.”

JPMorgan’s Dimon also blamed the challenging macroeconomic conditions as partly to blame for the $2 billion loss. However, he stressed that the main culprits for his firm’s losses were bad judgment and poor risk monitoring.

However, some market participants are experiencing good fortunes despite the economic uncertainty. Overseas, Brazil’s BM&FBovespa exchange reported $209 million in net income in the first quarter from $197 million a year earlier, as trading volumes rose 6% to a record $3.7 billion. The company noted “improved market conditions, new products and a tough stance on costs” for its positive quarter.

The Chicago Board Options Exchange was also up 2% in the first quarter with $33.4 million in earnings, compared to $32.9 million a year earlier.

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