GDP a mixed bag

Charts: The S&P 500 closed at 988, up .07%. XLF (financial sector) was up .31%. CAF (Chinese stocks) was up 1.38%. So the broad index, the US economy’s Achilles heel, and the global leader all did well and all look bullish. However, Cit Group floating rate notes have fallen sharply this week, a technical sign that it may not be able to restructure its debt and avoid Chapter 11. Everything looks wonderfully bullish from a technical viewpoint, but if CIT Group goes bankrupt it will be a smaller version of Lehman’s collapse.

Fundamentals: The preliminary Q2 GDP report was a mixed bag. GDP was down 1%, better than the expected decline of 1.5%.Unfortunately consumer spending dropped a scary 1.3%. In Q1 consumer spending rose. So this indicates that the consumer spending uptick in Q1 was fueled by deferred purchases rather than the permanent upswing that a typical V-shaped recovery would usher in. In Q2 household savings popped up to the highest rate in over a decade, again a mixed bag. Savings are good but they take away from consumer spending. Exports in Q2 were better than expected, an unmitigated piece of good news. The real bad news was two-fold: The Q2 GDP beat was powered by unsustainable US government deficit spending and Q1 GDP was revised downward sharply, hinting that today’s Q2 data will probably get revised down as well.
There was very bad news on the Cash for Clunkers program. It worked as originally designed, artificially stoking car sales by handing out stupid subsidies based on government debt. And now the Clunker’s $1 billion funding limit has been hit. The program is supposed to die at this point. But it looks like Congress is going to pour more money into this idiotic scheme. If Clunker keeps getting extended it will create billions more in new government debt. The real issue goes beyond this one program. What happens when the first time home buyer tax credit expires in a few months? What happens when the trillion dollar stimulus package expires in two years? Over $200 billion in Treasury debt was sold this week and overall the auction was very sloppy, foreign buyers were scarce. It is conventional wisdom that China cannot stop buying treasuries because it already owns $1.7 trillion of dollar denominated debt and won’t let the value of this stash fall. But remember last year China stopped by buying Fannie and Freddie mortgage backed securities even though it owned and still owns a pile of F & F debt. Before we all commit suicide there is good news on this front: a New York Times/CBS poll shows that 69% of Americans think Obama-Care will deliver low quality healthcare. So maybe this monster will get killed off.

Geopolitics: Nigerian security forces captured the leader of the Nigerian Taliban and executed him without a trial, using a firing squad in a very public manner. Human rights activists went nuts… but, I’m sorry to say, we have to count this as a bullish event since it probably marks the end (for now) of the Nigerian bad guys’ mini-revolution.
It turns out that the Iraqi Army did not rout the highly militarized Iranian insurgents called MEK as originally reported. MEK still has control of most of its camp and the two antagonists are locked in a stand-off. This has to be terrifying to the Iranian regime because the situation is fluid and unpredictable. The job of Supreme Leader of Iran was already getting tougher before this news came out. Iranian forces cracked down on a funeral of slain political prisoners that the government had released to bereaved families. The Iranian theocracy is under tremendous strain because of all this.
Islamic hotspots in China, Russia, the Philippines, and Indonesia have cooled off recently (good news). Also, Iraq has become very quiet lately. So we’re back to only two Islamic wars: Afghanistan and Pakistan. The fighting is heating up in Afghanistan as an election approaches; in July, 42 US soldiers have been killed. The Pentagon won’t give us a bad guy body count, but it is somewhere in the low hundreds. The Paki Army has killed about 2000 bad guys this year and suffered about 200 good guy deaths. Stepping away from the day to day headlines it pays to remember that the Iraq War is now over and America won. History tells us that America winning a war is always a bullish event. So the very weak fundamental picture has to be balanced against a bullish geopolitical backdrop.

Signs of Fundamental Strength

Charts: The S&P 500 closed at 987, up 1.2%. Even though we had good fundamental news today this is a technically driven market with automated buy programs being triggered as the benchmark conquers resistance levels. Technically driven means the market is going up because its going up, obviously fundamentally driven is better. Today’s action was bullish although there was a late day fade that didn’t look good. There will be psychological resistance at the round number 1000 level. After that resistance will be at 1010.

Fundamentals: Jobless claims came in today better than expected. Continuing claims are trending down (bullish). The American consumer has to at least keep his head above water to allow Asia to do the real work in keeping the fragile global recovery moving forward and the data today suggests that might happen. So we’re back to all eyes on China. The sell-off in the Shanghai exchange yesterday was a result of two giant banks capping their lending for the year. The monster rally in Chinese shares has been partly fueled by banks shoveling loans into the stock market, which is very unhealthy, a sign of a bubble forming. So if the Chinese government can curb this frothy excess without hurting growth then the rally and recovery will be much more sustainable. The huge US government debt auction went well today, even though it was competing with a stock market rally, good news. Tomorrow the GDP number comes out. This will have a big impact one way or the other.

Geopolitics: The Iraqi Army invaded and destroyed the main base of Iranian insurgent group MEK. This base is inside Iraq and MEK fighters are perennially poised to push into Iran and wreak ten kinds of mayhem. The Pentagon is feebly protesting against this move but it is secretly relieved that Iraq took this action. The Iranian government is so weak right now that the last thing we want is armed rebels tearing it apart. The Ayatollah is releasing a couple hundred living political prisoners that were captured during the rioting, a fearful attempt to quiet the opposition. Before that he released the bodies of political prisoners that his people tortured and killed. The families of the dead political prisoners went berserk when they saw how mangled the corpses were. It is unbelievable how clumsy the old guy is at running a police state. Maybe he should read the book Dictatorship for Dummies.
Yesterday I wrote that with the Paki Army tied up in the Swat Valley we need to watch for signs of CIA drones taking up the slack and today there are reports of drone strikes in Pakistan. So good news on this front.
There are no reports of further fighting in Nigeria but big trouble looms in the most populous nation in Africa. The country is home to 70 million Muslims. In 2003 Osama Bin Laden signaled out Nigeria for special attention and that year the Nigerian Taliban was formed. The government permitted Sharia law to be established in the Islamic north and sectarian conflict has been brewing ever since. The government has its hands full dealing with the non-Islamic MEND rebels in the Niger Delta, who steal about $500 million worth of oil every year and keep getting stronger. The Nigerian Army can’t suppress two revolutions at the same time. Global stock markets won’t care too much right now because OPEC has massive spare capacity. When and if the recovery swings into full gear and oil consumption goes up, the situation in Nigeria will start causing problems.

Charts strong. Fundies weak.

Charts: The S&P 500 closed at 975, down .5%. 975 is a support level, so if it is violated there will probably be some further downside. We’ve been fixated on the weak US financial sector via XLF and CIT Group, hoping they don’t drag the index down. We must also look at the strong global leader, the Shanghai market. It dropped over 5% last night. Keep an eye on it through ticker symbol CAF. We don’t have a breakdown in leadership yet by any means but we must remember that all technicals and fundamentals converge with China. Overall technicals are still strong.

Fundamentals: New orders for durable goods fell 2.5% in June, reversing gains from the previous two months and shocking analysts. Transportation gear is usually broken out since it is volatile. Ex-transports the numbers didn’t look so bad, increasing 1.1%. I’m a little uncomfortable saying that weak orders for cars, airplanes, and trucks “don’t count.” The price of oil plunged again as crude inventories rose sharply, pretty unusual in the middle of the summer driving season and a sign that our economy really is undergoing structural changes. While cheap oil is good for the consumer it brings up another issue… The US economy is like a supertanker and a structural change is like a supertanker executing a turn. The turn takes a long time to execute and the supertanker slows down while it is turning. The weak durable goods orders should have helped the mammoth treasury auction today, but it only went so-so with yield on the 10-year note inching up a smidge. It is unnerving that the stock market has to compete with these gargantuan government debt sales. Another way of looking at it is that the private sector has to compete with the government for investor dollars from here on out. Filling the capital needs of both public and private sectors is going to require some stout GDP growth in the months and years ahead. If big growth doesn’t occur the government’s ravenous appetite will gobble everything else.

Geopolitics: The Nigerian Army battled the Taliban group Boko Haram Wednesday with tanks and armored cars, killing 43 people. The Nigerian government says most of the dead were bad guys. The fighting is in northern Nigeria and the Army, known for its ruthlessness wasn’t shy about blowing away mosques and other symbols of Islam. The government is run by Christians and religious tensions between Muslims and Christians is pandemic in Nigeria. This is a major new front in the Long War. Hopefully it dies down but with Nigeria’s huge population and key oil resources this flare-up is not good news.

Technical Strength & Fundamental Weakness

Charts: The S&P 500 closed at 980, down .26%. XLF and Cit Group (our canary in the coal mine) took moderate losses today but are up on the week and are showing technical strength. The broad index plunged hard today on the bad consumer confidence number and then staged a bullish reversal to finish nearly flat. The charts are remarkably bullish considering the weak fundies. Either the collective wisdom of the world’s investors is seeing through today’s serious problems to a brighter future or the market is being fueled by hot money.

Fundamentals: On Monday we learned that new home sales were up 11% in June, much better than expected. Home prices slid according to the Case Schiller index, but at a moderating pace. The Housing data is good but nobody is talking about the fact that the government’s first time home buyer tax credit ends this fall and it is probably artificially driving sales. Also, there is still a shadow supply of 600,000 unsold homes and Fannie & Freddie are losing $100 billion a year. This loss is a government subsidy to the housing market that can’t continue forever. Today’s consumer confidence survey came in weaker than expected. China can’t pull the globe out of recession by itself so weak American consumer confidence is bad news. On the flip side, oil prices plunged today; if they were to keep plunging it will help the consumer. The Treasury is auctioning about $200 billion in fresh debt this week, far and away the biggest auction ever. Today’s auction was a little bit soft, not too bad until you dig inside and notice that foreign buyers were largely absent. Tomorrow’s auction is really massive and if foreigners don’t step up it could get ugly.

Geopolitics: In the Russian province of Chechnya a suicide bomber killed five people, this Islamic hotspot continues to flare-up. In Nigeria, over the past couple days, Islamic bad guys have attacked police stations in 4 cities and killed 150 people. The Nigerian government said it killed 39 bad guys but retracted the statement; probably the original statement was accurate. The bad guys belong to Boko Haram, a chapter of the Nigerian Taliban. This Islamic hotspot is flaring up in a scary way. The Pakistan Army has repatriated 350,000 civilians back into the Swat Valley so far. The repatriation is proving to be tougher than expected. The SV Taliban is moving back into Swat along with the civilians and restarting its terror campaign of beheadings, etc… The Paki Army has its hands full with the situation in Swat and can’t begin the push into South Waziristan any time soon. The recent fighting in Swat saw the Paki Army killing 11 bad guys and arresting 25 with no good guy deaths. So the Paki Army continues to beat the stuffing out of the Taliban, it’s just taking longer than expected to eliminate them.

Charts: It is time to remember that technical indicators are the least important of the three categories that we follow here at DMU. With that said, the charts are very bullish right now. The last big indicator to fall in line was Dow Theory, which charts the advance of industrials vs. transports. If industrials zoom up but transports lag, Dow Theory says that a rally is shaky. And this has been the case until recently. My focus on the S&P 500 vs. XLF is a variant of Dow Theory, i.e. both indexes must be strong for a rally to have legs. I’ve been calling this rally extended or overbought for a while. Bear in mind, a rally that keeps rocketing up when it looks extended doesn’t necessarily mean everything is wonderful, often it means the rally is getting even more extended. In any case our other two categories are far more important than charts.
Fundamentals trumps charts and geopolitics trumps everything.

Fundamentals: 71% of the companies in the S&P 500 that have reported so far have beaten analysts’ estimates. This is the biggest percentage beat ever and it is the reason for the second big rally in the embryonic bull market. Earnings surprises have been the main reason for stock price appreciation throughout the Great Moderation era (1982-present). The market’s reaction to today’s beats even though fundamentals are weak indicates that we are still in the Great Moderation and this makes the current lofty valuations a bit easier to swallow. Still, the beats are based almost entirely on cost-cutting. Revenue is coming in weaker than expected. What strength there is in the top line is mostly based on inventories being rebuilt. After Lehman Brothers collapsed inventories were slashed at a record pace, worse than the Great Depression, worse than anything. Now inventories are being rebuilt. Fine, but the inventory cycle is about 6 months long and the rebuilding started in March, so we are nearing the end of this boost. Tech has been strong and within this sector chips are stronger still, leading the whole group, which in turn is leading the entire market. But chips are levered to inventory rebuilding more than other tech companies. Long story short: the consumer must start spending more aggressively for the rally and the recovery to continue.
This is the picture in Europe and America. In Asia it looks better. China, Vietnam, Singapore, and South Korea have reported strong Q2 GDP growth. These countries are no longer in a recession. China and Singapore experienced freakishly strong double-digit Q2 growth. South Korea had the best growth in over 5 years, still in the low single digits, stout nonetheless. Consumers are beginning to spend more in Asia. Never before have Asian consumers pulled the world out of a recession. Can they do it this time? All of Asia (including dinosaur-like Japan) has roughly the consumer purchasing power of America. Europe and America seem to be moving in lockstep, together they are twice as big as Asia. In the Euro-zone, France and Britain are beginning to report softer numbers. Germany is reporting stronger numbers. Germany is much more levered to Asia than other European countries. So the global economy is at an inflection point. The infant recovery is in fact going to have to get at least some help from the American consumer. The 21st century will be the Asian century but this first decade is still too close to the 20th century for America to not play a significant role in the recovery. As we’ve seen American consumer sentiment surveys have weakened lately. This probably has a lot to do with oil shooting up. Since we can’t just endlessly ask questions and scratch our heads in befuddlement, let’s distill the outlook down to this key indicator: energy prices.

Geopolitics: A while back I wrote that the US Marine’s Battle for Helmand Province in Afghanistan is about like the Marine’s Battle for Fallujah in Iraq in 2006. It turns out that many of the Marines in Helmand are battle hardened veterans from the campaign in Fallujah. The New York Times asked these veterans how Helmand and Fallujah compare. Their answers are sobering. Al Qaeda in Iraq (2006) was not as tough as the Taliban in Helmand (present day). The Taliban is tougher and much smarter. The Taliban employs tactics nearly as sophisticated as the Marine’s own tactics. Ambushes, flanking maneuvers, supply lines, all work at a world class level with the Afghani Taliban. On the other hand, the Taliban has inferior equipment compared to Al Qaeda in Iraq. The Taliban is forced to make crude bombs out of fertilizer while Al Qaeda in Iraq had access to old Iraqi Army stock piles. The Marines say that if the Taliban had gear as good as the Iraqi bad guys, then they would be in for a world of hurt. Again, let’s distill all this down: The war will last another three years and investors will have to perceive that America and NATO are winning for this entire length of time for there to be a bullish effect.

Incredible resilience

Charts: The S&P 500 closed at 979, up .3%. XLF (financial index) closed at 12.42, down .56%. A small gain after massive gains is bullish for the broad index and shows incredible resilience in the face of fundamental weakness. Resistance is at 1010. XLF is our long term indicator and it is still bullish. CIT Group was up today but suffered a bearish late day fade; this single stock is the canary in the coal mine for the whole US economy. Most chartists are more bullish than I am. They point to the 50-day moving average crossing the 200-day line a while back and get very excited. This pattern is called a “golden cross” and typically signifies long-lasting gains.

Fundamentals: Consumer confidence came in today weaker than expected. Consumer spending is 72% of the economy and if it continues to be weak the recovery will have to ride entirely on the back of China as well the other emerging markets and America’s exports to these tigers. The greatest forecaster of our age is economics professor Nouriel Roubini. He said recently, “The over-indebted US consumer—whose deleveraging process has yet to start—will likely continue to put the brakes on consumption, while the savings rate creeps up.” Professor Roubini predicts unemployment will peak at 11%. So there you have it, everything depends on China. This speaks to buying stocks levered almost entirely to emerging markets, like Phillips Morris International (PM).
The Senate majority leader says healthcare reform will not come to a vote before the August recess. This means the Blue Dogs can tear it apart during Congress’s vacation; super good news and a major reason for the market’s resilience.

Geopolitics: The CIA proudly announced that one of their flying robots killed Osama Bin Laden’s son, who was a high ranking bad guy, the liaison between Al-Qaeda and Iran, and perhaps the heir to the throne. Despite short term battlefield victories like this, the primary purpose of the drones is not simply to kill bad guys. The true purpose is to force America’s Muslim national allies to aggressively kill bad guys on their own. Allies like Pakistan and Afghanistan fear the Taliban but they also fear an American overlord with a permanent military presence within their countries. They know that America is very sensitive to the death of its own soldiers but relatively indifferent to the death of foreigners. Americans are only concerned about goodwill in countries that they routinely vacation in. This is why drones are so threatening to our third world allies. Drones allow us to fight wars without any of our soldiers dying. Therefore it behooves our allies to kill all the bad guys inside their borders and avoid becoming vassals to the superpower. This strategy is working and is another source of bullishness.

Strength begets strength

Charts: The S&P 500 closed at 976, up a blistering 2.3%. The index smashed through several resistance levels. The Nasdaq is notching a sequential winning streak that has beat anything in nearly 20-years. While the recent bearish head and shoulder pattern was forming short interest increased and we are certainly seeing short covering now; however, strength begets strength in technical analysis so we have very positive charts right now. The only real weakness is that throughout the rally that started in early March volume has been very low, lower than the start of any other bull market.

Fundamentals: Existing home sales came in better than expected today. This was the cause for the monster rally. Buyers snapped up regular houses more so than foreclosures; investors took this as a sign that normalcy is finally returning to the housing sector. The National Association of Realtors warned that today’s good numbers are deceptive because many of these reported sales won’t close due to tight credit and bad appraisals.
The percentage of companies reporting earning beats is widening as the season progresses, obviously bullish. The earnings beats are still almost entirely due to cost cutting as revenue continues to come in soft. In Asia the data looks very good. Spot prices for iron ore are zooming up as demand is spreading from China out to the other tigers. And this is the big story. It is possible that Asia will pull the global economy out of recession. And it is also possible that stupid governmental mistakes in America will drag the global economy back down again, creating the classic W-shaped recovery. This is what happened in the mid-30s when our government jacked up taxes just as a recovery was taking hold, plunging us back into a “recession within a depression” as economists would later say. This is why the healthcare bill needs to go down in flames; the new taxes that it will bring along with the expiration of the Bush tax cuts will be bearish.

Geopolitics: July has been the deadliest month ever for NATO forces in Afghanistan, with 63 good guys killed. However, July has also brought about a positive change in the war, the Afghan Army and police forces are vastly stepping up their efforts. Tuesday saw the Afghan Army killing 13 bad guys. On Wednesday Afghan forces made scores of arrests. When Taliban fighters give up, rather than fight to the death it is a good sign because guerilla wars are won when insurgents surrender. As noted yesterday, America doesn’t have the manpower to occupy Afghanistan, but our new strategy is to build native forces that can get the job done and this seems to be working.
This week the invincible Pakistani Army has killed so many bad guys from so many different parts of the country that the body count is difficult to tally, perhaps 150 Taliban fighters have been eliminated. Long term DMU readers are familiar with my thesis that America winning wars trumps any fundamental economic data as far as influence on global stock markets. The obviousness of the USSR’s eventual Cold War defeat in 1982 triggered the greatest bull market in history. So we have to ask ourselves if this is a 1982 moment.

Market looks extended

Charts: The S&P 500 closed at 954, down .05%. XLF (financial index) closed at 12.14, up .08%. The broad index continues to fight with resistance at the top of the 922-955 trading channel. As I’ve been saying, it needs to struggle and consolidate, not blithely blow past resistance. The Nasdaq has had its longest winning streak in a decade. The market is looking extended after the massive recent gains but overall the technical picture is bullish.

Fundamentals: Crude oil inventories in America rose to a 19-year high in the middle of the summer driving season and Apple reported blow-away earnings. These two news items are related; they represent permanent structural changes in America’s economy and consumer behavior. Another example of this seismic shift is the company Polycom (PLCM), the maker of video-conferencing equipment. Don’t drive or fly to a business meeting, instead hook into the web and have a virtual meeting. Polycom is up over 70% year to date.
Structural shifts represent creative destruction. Some companies get hurt with these changes. The weakness in commercial real estate that is weighing on the financial sector may be a long term casualty as online shopping replaces mall crawling. On that note let’s take a look at Goldman Sach’s recent earnings report. It took $1.4 billion worth of markdowns in its commercial property portfolio. Because mark-to-market accounting standards have been relaxed other banks value similar assets at twice the value that Goldman does. So this is a hidden danger that we must be aware of.
CIT Group is not out of the woods. The financing that it is securing for its rescue carries an average interest rate of about 13%. The loans it makes to small businesses pay a much lower rate, so it is digging itself into a hole. Over 1 million small businesses depend on CIT. If it goes bust the ripple effect will be bigger than investors seem to think. And finally, Wells Fargo reported today that non-performing loans rose 45% over the last quarter, completing the picture of genuine weakness in the financial sector.

Geopolitics: The US Marine Corp’s offensive in Afghanistan can be translated as “Thrust of the Sword.” The Taliban tells us that its counter-strategy is called “Iron Net.” The bad guys seek to tangle the sword in a net, avoiding set piece battles with the Marines. Instead they are attacking soft targets throughout the country and using hidden roadside bombs to kill Marines. Unfortunately, it is a smart tactic because America and NATO still don’t have enough boots on the ground to truly occupy the country, allowing the Taliban freedom of movement. But in nearby Pakistan the Paki Army does have the manpower to crush the bad guys and truly occupy conquered territory. This week the Paki Army has killed nearly 100 bad guys. The total bad guy body count in Pakistan will soon reach the low single digit thousands. The number of bad guys surrendering to the Paki Army and being taken prisoner is steadily climbing, reaching over 500 in the Swat Valley alone in the last few weeks. Paki authorities report that 90% of these bad guys are Afghanis. Therefore the Paki Army is obviously taking pressure off NATO in Afghanistan.

Rally keeps rocking

Charts: The S&P 500 closed at 955, up .36%. XLF (financial index) closed at 12.13, down .9%. The broad index is at the top of its trading channel and pushing against resistance. Short sellers are unwinding their positions, which is buoying the index. While technicals are very strong we need to keep an eye on the financial sector because it is fundamentally weaker than the charts indicate (see below).

Fundamentals: The rating agency Moodys warned that US banks are facing massive charge-offs for sour commercial real estate loans. The Wall Street Journal says that these losses might reach $30 billion this year, big enough to tank the financial sector. This is the greatest single threat to the economy that doesn’t come from our free-spending Congress. On that score there was some good news: Congress has decided to stop funding the super wasteful F-22 fighter jet after the President threatened a veto. And the recovery-killing healthcare bill continues to lose momentum. There was bad news also on the debt front: the watchdog committee charged with overseeing the TARP bank bailout program announced that total government liabilities under the program equal about $27 trillion, almost twice the size of America’s GDP (scary). While it is virtually impossible for most of these obligations to go south some of them certainly will and these losses will come on top of the $2 trillion worth of government debt that we will see this year and the over $1 trillion every year afterwards as far as the eye can see. CIT Group (the nearly insolvent lender to small businesses) said that it might still have to file Chapter 11. Right there is a potential loss of $3.4 billion under TARP (ouch). And finally, Bernanke promised that inflation will remain low despite all of the above; the markets believed him, which pushed down treasury yields. It is a good sign when the Chairman of the Fed commands this kind of respect.

Geopolitics: In Iran, Supreme Leader Ayatollah Khamenei gave a speech to counter the one given by the moderate cleric Rafsanjani Friday. The Ayatollah warned that if opposition to his regime continues the government might collapse and chaos would follow. Last week President Ahmadinejad tried to promote a moderate to the position of vice-president, fearfully trying to throw a bone to the opposition. This shows how weak the hard-line regime is in Iran after the contentious election. So far so good, the regime is dying by a thousand cuts, not collapsing outright, which would hurt global stock markets. In a way Iran is to the Long War what the USSR was to the Cold War, the founder of a global revolutionary movement. When the USSR collapsed it was impossible for China and Vietnam to turn back to a Stalinist economy and the sole examples of Stalinism (North Korea and Cuba) were destined to eventually change in the same way that China did. A gradual decay and eventual destruction of radical Islamic theocracy in Iran would have a similar but less pronounced effect (bullish).

7/20/09

Charts: The S&P 500 closed at 951, up 1.14%. The broad index pushed through resistance of 946 (the June closing high) and faces next resistance at 956 (June intraday high and the top of the trading channel). 946 is now a support level, under that next support is 935. All the major indexes are above their 200-day moving averages for a week now, a positive long term indicator. Tech and other cyclicals are leading, not financials, which is good, a sign of quality leadership. Ultimate leadership is still emerging markets; everything depends on them technically and fundamentally. With today’s action and the 7% gain from last week the market is getting extended and it still needs consolidation for long lasting gains.

Fundamentals: 71% of S&P 500 companies that have reported earnings have beaten so far. Even in a bull market usually only about 60% beat, so this is encouraging. They are beating this quarter the same way they beat last quarter: by greater than expected cost reductions, not revenue increases. This means earnings are of lesser quality. Eventually revenue has to increase for the recovery and the rally to have legs. However, the incredible and successful efforts at cost cutting mean that these companies are now so lean and mean that when and if revenue does start increasing profits will be robust.
It looks like the private sector will bailout CIT Group with minimal government help. I was hoping the CIT rescue could be 100% private, but it is still a watershed moment. Goldman Sachs raised its yearend forecast for the S&P 500 by 13%. Goldman is the king, so we need to take it seriously. Today’s uptick was a combination relief rally on the CIT rescue, investors listening to Goldman, and the Conference Board’s leading economic indicators popping up for the third time in a row.

Geopolitics: For the first time in two years Paki police have mounted a successful attack against the Taliban in the Swat Valley, killing 1 bad guy and destroying 7 Taliban houses. Up until now the Taliban has batted local police forces around like a cat with a mouse. The Paki Army arrested 54 bad guys over the weekend and killed 12. No good guy deaths were reported.
The Afghan Army killed 35 bad guys in recent fighting. 2 good guys were killed. For the first time the Afghan government has gotten armed villagers to successfully attack the Taliban. If this trend continues it would be incredibly good news. The success in Pakistan against the bad guys is largely based on the general population turning against them. Afghanis carrying on the fight with America and NATO helping (not acting alone) is essential. And this weekend at least saw that kind of action (bullish).

Geopolitics: Russia’s sloppy invasion of Georgia last year and its subsequent problems in holding the tiny slivers of Georgian territory that it occupies have exposed the Slavic giant’s military weakness. This in turn has reignited a nasty Islamic insurgency centered on Chechnya, a Russian republic that borders Georgia. Increasingly Chechen police and government officials are being attacked by jihadists and the nascent insurgency is slowly spreading to neighboring Russian republics throughout the north Caucus region. Chechnya was where Al Qaeda first cut its teeth, its first big battleground outside of Afghanistan. So it has deep roots in the region. The modern meaning of the term “Jihad” arose during the original Chechen War in the 90s. The Russian Army at that time probably killed over 100,000 Muslims, the vast majority innocent civilians that died under the rain of idiotic carpet bombing and mindless rocket barrages, sowing the seeds of a deep and abiding hatred.
The flare-up of this Russian Islamic hotspot is part of a larger picture. In the past few weeks there has been an Islamic flare-up in the southern Philippines, led by the Jihadist group Abu Sayyaf, who has begun a wicked bombing campaign on the outer islands that experts say resembles the work of Jemaah Islamiah (the group that just bombed two Indonesian hotels a few days ago). So the recent Indonesian suicide bombings probably originated in the Philippines and the campaign is seemingly spreading throughout Southeast Asia like a cancer. Abu Sayyaf cut its teeth in the 80s in Afghanistan fighting Soviet Russia and is directly linked to Al Qaeda as is Jemaah Islamiah. Even today the Taliban in Afghanistan claim that any Afghani opposing it is a communist.
The goal of all these Al Qaeda linked groups is to create a “Caliphate,” that is to carve an Islamic dictatorship out of existing countries. And then use the newly created Caliphate as a base for further expansion. America’s job is to prevent this from happening on every part of the planet that is threatened. Regional stock markets will react to the success or failure of the superpower and its allies in this grand endeavor.
On Friday the moderate and powerful Iranian cleric, Rafsanjani, gave a national sermon blasting Ahmadinejad and more subtly, the Ayatollah. This triggered more clashes between Iranian dissenters and government security forces, probably resulting in extensive bloodshed although the media is muzzled so hard there a body count is impossible. This is a bullish turn of events because the Iranian theocracy is suffering a thousand little cuts not one big body slam, raising the possibility of a “velvet revolution.” America must do whatever it can to look like it is not helping Rafsanjani.
Hillary is getting involved in the embryonic peace talks between Pakistan and India, although she is denying any involvement. If these talks succeed and Pakistan can move several hundred soldiers off the Indian frontier and into combat against the bad guys it would be incredibly good news. 7/18/09