The Relationships Between Wall Street, the Fed, and Politicians Are Crumbling

People often ask me how I can remain bearish when stocks continue to rally.

For one thing, I want to note that one can be bearish, but still profit from the “current game,” or short-term trends that are in place. For example, while I am ultimately very bearish on the economy and on the markets, I positioned my clients to profit from the various trends of 2011 so that we saw a 9% return for the year vs. a 0% return for the S&P 500.

Having said that, the big picture reason why I’m bearish can be expressed as follows: the current situation that is allowing the market to rally is based on relationships and policies that are crumbling.

The relationships that most matter for stocks are those between the Federal Reserve, Wall Street, and the White House.

The policy that matters most is the Fed’s ability to convince the market that it can and will keep the markets up without letting inflation get out of control.

Regarding the relationships that matter, I’ve averred for months now that we are going to see them crumble. This process has already begun in the sense that we’ve seen:

1. Key Wall Street players hiring famed defense attorneys (Lloyd Blankfein of Goldman Sachs)
2. The Fed distancing itself from its responsibility for the Crisis by:
   
   1. Suing Goldman Sachs
   2. Opening itself to Q&A sessions and townhall meetings
   3. Having “pro Fed” editorials written in the Wall Street Journal
   4. Putting the blame for the Crisis and the US’s financial weakness on Congress’s shoulders
3. Various members of Congress (especially Ron Paul) and GOP Presidential candidates taking aim at the Federal Reserve

Do not, for one minute, believe that the folks involved in the Crisis will get away with it. The only reason why we haven’t yet seen major players get slammed is because no one wants the system to crumble again. And the only way for the system to remain propped up is for the Powers That Be to appear to have things under control and be on good terms with one another.

However, eventually things will come unhinged again. Whether it’s Europe collapsing, or the US facing runaway inflation, or another stock market crash, etc, something will break and the Financial Crisis of 2008 will begin anew.

When this happens, the relationships between Wall Street, the Fed, and the White House will crumble to the point that some key figures are sacrificed.

Indeed, this process is already starting.

            Fed Fights Subpoena on Bernanke

The Federal Reserve is fighting a subpoena from lawyers in a civil lawsuit who want the central bank's chairman, Ben Bernanke, to testify about conversations he had with Bank of America Corp. executives before the lender completed its purchase of Merrill Lynch & Co.

The three-year-old class-action suit alleges that the Charlotte, N.C., bank and Kenneth D. Lewis, then its chief executive, misled shareholders about ballooning losses at Merrill before the $19.4 billion acquisition was approved. The government provided $20 billion in U.S. aid after Bank of America officials told Mr. Bernanke and then-Treasury Secretary Henry Paulson in December 2008 ...

http://online.wsj.com/article/SB10001424052702303717304577277712160795098.html [19]

I’ve stated before that I believe Bernanke will face legal troubles in the coming months. The only reason he got a free pass before was because he was thought to have saved the system and capitalism. So, when it becomes evident that he actually didn’t do either of these things (another Crisis hits), expect to see Bernanke in the hot seat.

Indeed, things may already be accelerating here. Consider JP Morgan’s moves yesterday in which it announced ahead of the Fed’s release of its stress tests that it would be raising its dividend and issuing a $15 billion buyback program with Fed approval.

Jamie Dimon played this one beautifully. By including the “with Fed approval” phrase he made it appear that the Fed is in charge of JP Morgan’s business. However, by announcing that he wanted to raise JPM’s dividend and issue a buyback program he:

1. Implicitly stated that JPM was in great shape and would pass the Fed stress test with flying colors.
2. Indicates that JPM was depleting its capital, which goes against the Fed’s supposed claims that it wants banks to raise capital.
3. Shows who’s really running the show in the markets (the Fed had to speed up the release of its stress test results as one by one the large banks released similar leaks to the press).

This last factor is key. Wall Street just publicly stated “we’ll do as we like, thank you very much” which undermines the view that the Fed is the one in charge of the markets. This is yet another illustration that the relationship between Wall Street and the Fed is not what it used to be.

This is a major political trend that needs to be watched closely as we approach the next Crisis as well as the Presidential election. Just how it will play out remains to be seen. But it is certain that dynamics these three groups (Wall Street, the Fed, the White House/ politicians) will be changing dramatically in the months to come. And when push comes to shove, eventually someone(s) will be sacrificed so that others can maintain control.

For more market and geo-politcal insights, swing by www.gainspainscapital.com [20]

Best Regards,

Graham Summers

Chief Market Strategist

Phoenix Capital Research