FROM THE BONNER-DENNINGS LETTER

a grinding bear market has begun.
A pandemic triggered the popping of the bubble, which in turn triggered a financial crisis. That crisis is going to play out over many years. Here are some of the key events we spotted this week:

• $2.3 trillion in more liquidity. Using another $200 billion it received from the Treasury as capital, the Federal Reserve announced another nine facilities to add liquidity to the credit markets. They earmarked $750 billion for municipal bonds and “fallen angels.” The “fallen angels” are corporations that have recently lost their investment-grade credit rating, and for whom funding in the market has dried up. This liquidity is also meant to help state governments and cities who may struggle to refinance or raise money as the economy grinds to halt.
  
• Student loans and auto loans next up for a bailout. The Fed also expanded its Term Asset-Backed Securities Lending Facility (TALF). That allows the Fed to buy assets and make loans in markets like auto loans, student loans, collateralized debt obligations (CDOs), and commercial mortgage backed securities (CMBS).
  
• $14.5 trillion in household debt. Between mortgage debt ($9.5 trillion), student loans ($1.5 trillion), auto loans ($1.3 trillion), credit card debt ($1 trillion), home equity lines of credit ($400 billion), and “other” ($450 billion), U.S. households have $14.5 trillion in debt, according to the Fed’s Quarterly Report on Household Debt and Credit.
  

I won’t belabor the details. My point is simple: The Fed is going to need a bigger bazooka. Its balance sheet went over $6 trillion this week as it provided liquidity to these various corners of the credit markets. But it hasn’t begun to address the household sector. Which brings me to a question.
What happens when tens of millions of people can’t pay their rent, their mortgage, their credit card bills, their auto loans, or their student loans? Neither the Fed nor Congress has done much to help those people. Their first step was to bail out creditors and shareholders who, in real capitalism, would bear the losses instead of getting free money.
That’s how it’s supposed to work in capitalism. To get the rewards from equity, you bear the risk of losses. (It’s what we call the equity risk premium.) But not in today’s perverted capitalism. In today’s capitalism, stocks go up while the real economy goes up in flames.
You can argue that the Fed’s primary role in the financial system is as a lender of last resort in the credit markets and, increasingly, a buyer of last resort in the equity markets. But as Main Street gets left behind and Wall Street toasts a huge rally, how long will it be before there’s a political backlash that makes Occupy Wall Street (2009) look like a tea party?
Long story short: The Fed’s going to own a huge portion of the government bond market before this is over. It will also own a big portion of the corporate debt market, the muni bond market, the junk bond market, and the market for securitized loans (student, auto, mortgage). The balance sheet (money it creates from nothing) will grow to at least $10 trillion, and more likely $15 to $20 trillion before all is said and done.
On that note, keep an eye out for April tax receipts to the U.S. Treasury. April is traditionally the biggest monthly haul for the Treasury. Americans pay their taxes. But if my suspicions are correct, that’s not going to happen this year. And it will blow a big gaping hole in the government’s financing, forcing more “debt monetization.” (Debt monetization is when the Fed buys new debt issued by the Treasury.)
The good news is, it’s setting gold up perfectly…

Stocks and Gold

While all this plays out, the stock market has broken down as a reliable signal of future earnings and economic activity. The Fed’s intervention has obliterated the market’s ability to engage in “price discovery.” And in any event, there are a lot of unknowns about the rest of the year. So why are stocks rallying?
As I said above, the Fed is driving everyone out of bonds. The equity market is bound to benefit. As institutional investors take the cash the Fed has given them for their bonds, they have to do something with it. They buy stocks.
We haven’t changed our view that the market has much further to fall (and for much longer). The only stocks we’re looking at are gold stocks. (At least until the Dow-to-Gold ratio – which you can read more about here – goes below 5. It’s at 13.6 as I write.)