In early March I turned quite bullish for the first time in 2009. My reasoning behind the bullishness was relatively simple. The market had overshot the mean to the downside and psychology was far too negative. This created a market that was like a loaded spring. All it needed was a catalyst. That catalyst came in the form of the M2M rumors. In other words, the government was going to directly intervene in the market and stop the bleeding. What resulted over the ensuing months was even larger than I ever could have expected.
At the end of March I began referring to the rally as the “government run rally”. Although the actual underlying fundamentals were not improving, the government had created a series of events and catalysts that forced the shorts out of positions and changed the psychology of the market:
The last of these well crafted maneuvers were the capital raises and the stress tests. This series of events created a foundation for a market bottom and helped form the most important portion of the current rally in stocks. It would sound conspiratorial if it weren’t entirely true. What has ensued since has confounded even the most veteran of traders. The market has continued higher in a nearly straight line.
There is no doubt that the economy has rebounded sharply from the days of ISM 35 and GDP -6%. The overshoot to the downside was extreme to say the least, but what is less clear is why the market has rallied an astounding 60% off its bottom and effectively priced in 20%+ earnings growth and 4% GDP going forward when the real underlying problems that caused this entire mess are still apparent. We have simply implemented the failed Bank of Japan policies of the 90’s combined with the failed bank policies of Maestro Greenspan – crank up the “printing press”, turn on the liquidity spigot, implement quantitative easing and let the banks earn their way out of their problems. It sounds great in theory, but Greenspan’s policies failed miserably as did the Bank of Japan’s. Neither approach proactively attacked the root of the problems. The results speak for themselves.
Mr. Bernanke has declared an end to the recession, but we continue to see mounting consumer credit losses, 500K jobless claims weekly and stagnant wages. Meanwhile, the banks are back to their old tricks and the banking bonuses are back to record highs. While the consumer struggles and banks flourish the market continues higher despite the fact that the consumer is a far larger portion of economic growth. So what is driving the market higher now that the government has stepped out of the way? Moonraker Fund Management lays out the scenario we have long believed, but been unable to prove:
Moonraker Fund Management, the independent investment boutique, is concerned that banks may have been using their bailout money to buy equities, helping to fuel a rally that is vulnerable to a major correction if they consequently sell in thinly traded markets.Instead of lending to businesses and homebuyers, banks may have been using some of their bailout money to buy stocks from an oversold base in March, Moonraker believes. The British Bankers’ Association’s own figures show that gross mortgage lending by the banks has fallen from a high of £21.5bn in June 2007 to £9.1bn in August 2009, while new term lending to small businesses was £796m in July, compared with around £900m last October.
Jeremy Charlesworth, Chief Investment Officer of Moonraker and manager of the Moonraker Commodities Fund and Global Opportunities Fund, commented: “Little of the bailout money given to banks seems to have been passed on to businesses or consumers. But it must have gone somewhere and it might have gone to the proprietary desks of the banks to punt the markets. Given all the calls for more transparency, it would be good if the banks could clarify this.
“The banks have every right to use the money they borrow in any way they choose. But it would be good to know how much of the bailout money has been used to buy equities. Clearly, someone has been buying, and given that it hasn’t been ordinary investors and the institutions that does just leave the banks.
“The banks’ balance sheets will certainly have benefited from their equity holdings. If they could sell these investments into a rising market then they would be in a better position to repay their debts. But there will be a problem if the public and institutions do not join the rally and the banks have to sell equities into a vacuum.”
In essence, the government has passed the baton on to the banks so they can keep the party going. This phenomenon has been most evident in bank earnings. Banks are in the business of lending, but an odd thing has occurred while bank earnings soared – they were doing no lending! Banks have been hoarding record amounts of cash as the government floods their balance sheets via various programs and bailouts. Many assume that the banks are either attempting to loan the money or simply letting it sit on their balance sheets earning nothing. But Moonraker’s analysis raises a more nefarious possibility – the banks are effectively creating a ponzi run stock market in which they use the bailout money to drive various market prices higher and thereby juice their own earnings. It’s quite brilliant when you think about it – until the music stops.
All of this of course, has created an environment of false positive psychology. Investors truly believe the crisis is over and that all of our long-term structural problems have been solved by the government. Unfortunately, should this nefarious action be even remotely true, it’s only a matter of time before the banks stop buying for their own accounts and begin to take profits. If the economy continues to flounder and consumers remain wary of the recovery it’s unlikely that the rally will find legs to continue on. The banks will have once again taken advantage of the U.S. taxpayer who so kindly lent the hand that allowed them to survive. But alas, such is the way of the boom, bust manipulated capitalist system that the Federal Reserve has been running for the last 25 years….
Perhaps most important is the role of the Fed in this matter. I have long been critical of Dr. Bernanke and his boom, bust policies, but perhaps the person we should be more critical of is Mr. Obama who has announced that his government will be the most transparent in history. If we are trying to create transparency then why do we have no idea where the Fed has wired all of the taxpayer bailout money? If there is more nefarious action performed by the banks why do we not know about it? Do the citizens of this country deserve to sit around while we are spoon fed this recovery propaganda while at the same time investing our retirement savings in a market that is essentially nothing more than a Fed induced ponzi scheme?
Of course, there is the distinct possibility that the banks are not using the bailout money to drive markets (though highly doubtful). There is the distinct possibility that the banks learned their lessons and will not create another disastrous scenario for the economy (don’t count on it). If this is the case then what does the Fed have to hide? But if it is not the case then every investor in this country and in the global economy deserves to know that the markets are being driven by false demand.
In summary I bring you thoughts by the always pragmatic, Richard Russell:
Back to the Fed. The Fed created two trillion dollars of assets and debts to rescue banks from their stupidity and mistakes. American taxpayers, to whom the Fed is beholden, have no idea how the money was spent and who it went to. The Fed’s answer is that US citizens have no right to question or audit the Fed. The Fed has resisted all requests for an accounting or an audit.
Under the Freedom of Information Act, Bloomberg filled suit to force the Fed to reveal what it has done. When the case went to court, the judge ruled that the Fed is obligated to release records of its lending on behalf of taxpayers. The Fed is now considering an appeal.
On his second day in office, President Obama in a letter to ALL agencies wrote, “Transparency promotes accountability” because “information maintained by the federal government is a national asset. My administration is committed to creating an unprecedented level of openess in government.
So why not audit these arrogant basterds at the Fed. What are they hiding? What are the “dangerous secret”?
Indeed, what are you hiding Mr. Obama and Mr. Bernanke?
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.