Russ Feingold, Rally Killer

Charts: September is the worst month for stocks, on average. In August the bosses at the big investment firms take the month off and lounge on the beach. In September they go back to work and have a cow when they see the crazy stocks that their junior associates bought. The bosses then hit the sell button with a vengeance. While October is only the second worst month for stocks, the really big crashes in stock market history usually occur during this month.

Fundamentals: Revised Q2 GDP came in at negative 1%. The headline number is wrong, the US economy actually grew .4% because the government counts declining inventories as a negative and increasing inventories as a positive. So if demand has evaporated and inventories are building in warehouses that boosts GDP and if demand picks up and the warehouses are emptying out that’s a negative. The government’s method is fine in a steady economy but in today’s environment it is misleading. So the recession is over, the economy is expanding, very weakly. That’s the good news and the bad news. The end of the recession is already priced into the market. Investors will now look at the strength of the recovery, which doesn’t look so hot.

Geopolitics: In Iraq, the bad guys are sending suicide bombers into remote villages to force the Iraqi government to spread itself thin. The insurgency has definitely flared up and will continue to flare as the January election gets closer. Recently Al-Qaeda in Iraq has been hitting Shiite targets in an effort to restart the sectarian civil war but the Shiites heroically refuse to bite, so we have this new tactic. Even though our media is painting a dire picture, the Iraqi government is dealing with the insurgency fairly effectively and doing so without inordinate help from US troops.
In Chechnya, last week there were three suicide bombings. The situation is getting very hot in Russia’s North Caucus region. The Russians put a heavy-handed dictator in charge of Chechnya some years ago and through extremely brutal methods he brought the insurgency to a halt with the help of Russian counter-insurgency forces. Russia withdrew its forces a few months ago and all hell has broken out since. The prevailing wisdom in the West is that Moscow must tell the heavy-handed dictator to be nice. The real answer is for Russia to move its special forces back in place. Until and if that happens it will only get worse. Bear in mind that all these hot spots are simply different theatres in one global war. Russia’s problems are America’s problems and bad for the stock market.
In Saudi Arabia, the bad guys tried and failed to assassinate the Deputy Interior Minister, Prince Mohammed bin Nayef, with a suicide bomber, who killed himself and only injured the Prince. Nayef is in charge of destroying Al-Qaeda in the Saudi Peninsula and he has ripped the bad guys apart over the past couple years, the biggest success story in the Long War so far. It is not a good sign that the bad guys got this close to the top good guy in Saudi Arabia.
In Pakistan, bad guys attacked a NATO fuel convoy along the Afghan border, destroying 20 oil tankers. This is the second successful attempt to go after NATO supply lines in the past week, a sign that the Pakistani Taliban is effectively helping the Afghani Taliban and that the new super-chieftain, H. Mehsud, is very capable. In a separate attack, bad guys raided a policy academy in the Swat Valley and killed 16 cadets.
In Washington D.C., Wisconsin Senator Russ Feingold wrote an op-ed piece in the Journal calling for the US to pull all troops out of Afghanistan. Dozens of peace groups are slowly ratcheting up the volume for a troop withdrawal, small peace rallies are occurring here and there with greater frequency. Cindy Sheehan is camping out in Martha’s Vineyard where the President is vacationing, making the same noise that she made against Bush and getting press coverage. So far heavyweight liberal organizations like Moveon.org have not yet called for troop withdrawal because they don’t want to damage Obama and his healthcare proposal. If Obama-Care totally dies the heavyweights will probably jump on the peace bandwagon. The peace movement stirring to life is the reason why Secretary Gates told General McChrystal to hold off on his troop request. Obama and Gates certainly want to give McChrystal his extra troops but they aren’t sure how to handle the resurgent peace movement, which will get stronger if the troop request is granted. Obama and Gates may try to rapidly move 40,000 troops out of Iraq and into Afghanistan and then pitch the move as neutral, simply moving troops from one combat zone to another. I think Iraq can handle the removal of that many US troops.

Geopolitics Dicey

Charts: The S&P 500 closed at 1029, down .2%. The broad index is in the center of a potential trading channel of 1018 and 1037. That looks like consolidation which is good but leadership is horrible. Close to half the trade volume lately has been centered on these iffy leaders: Fannie, Freddie, AIG, and Citigroup. Meanwhile Chinese stocks are tanking again.

Fundamentals: The consumer confidence survey and the consumer sentiment survey both try to measure the same thing and one of them is wrong because they are giving different results. Today the consumer confidence survey came in worse than expected while the other survey was better than expected. Surveys are essentially opinion polls and aren’t as reliable as hard data. Unfortunately, the hard data is mixed. Intel says that chip sales are improving, indicating that electronics are healthy but elsewhere there are no signs of a spending rebound other than heavily subsidized purchases like cash for clunkers. It’s going to take a drop in oil prices to turn the consumer around. So we should be worried that oil remains high and heed Professor Roubini’s warning that the cure is causing a new disease. The price of oil is up because of ultra-loose monetary policies.

Geopolitics: In Pakistan near the Afghan border, a Taliban suicide bomber killed 21 Paki policemen. The police checkpoint was along a NATO supply route and probably represents a probing attack as the bad guys mull the possibility of cutting good guy supply lines. In South Waziristan a CIA drone killed 10 bad guys reported to be Al Qaeda types that were gathering in a camp run by H. Mehsud’s Pakistani Taliban, a sign that the new super-chieftain is consolidating power but also that the CIA has his number. There are lots of reports of drone activity in South Waziristan lately. August is now the deadliest month so far in the 8-year old Afghan war, with 45 US troops killed. Defense Secretary Gates is saying that General McChrystal’s strategic assessment report will not include a request for more troops. McChrystal of course wants more troops but he is being told to make the request separately from his big report and wait until the 8000 surge troops that haven’t arrived yet are in country. McChrystal was given the job because he promised to get the job done with a small number of troops. I see a 50/50 chance that the administration will hold him to his promise. This is bad news. A new ABC poll says that 60% of Americans disapprove of Obama’s handling of the Afghan war. Opinion polls are trending the wrong way as far as Afghanistan is concerned. Stock buying is on hold for me until the geopolitical situation looks better. And I am still underweight stocks at about 20%.

Super Bad Guy Tendrils Reach Into St. Paul

Charts: The S&P 500 closed at 1031, up .28%. Support is at 1018 and resistance is at 1037, so the index is trading in the middle of this range, a sign of consolidation. It plunged after the opening bell on news that China is curbing wasteful excess industrial capacity. It found support where we expected and fought its way up in a healthy manner.

Fundamentals: Professor Roubini says a double-dip or W-shaped recovery is growing more likely and the current upsurge in economic activity is mostly due to global restocking of inventories, which is unsustainable unless consumers start stepping up to the plate. He believes the long term problem is that bank debt has simply been transferred from the private sector to the public sector; which means that meaningful deleveraging hasn’t started yet. Economists agree that deleveraging on the scale needed will take years. His next big concern is that the shadow banking system has disappeared. Shadow banking is mostly based on securitizing debt, which allows banks to pass loans off to investors and then take on more loans. This hole in the financial system is forcing governments to promote excess liquidity. But a lot of that hot money is going straight into commodities like oil and sugar because the tubes of private lending are still clogged. High oil prices are an obvious recovery killer. If oil gets to $100 a barrel he says its curtains for the recovery. Roubinin sees oil prices as central to the big picture. Cheap oil will help the consumer, which will help the banks, and it is our only hope.

Geopolitics: The Long War is all about oil. The good guys winning or losing is not some metaphysical abstraction of right against wrong. If the good guys are winning it is bullish news for oil production. Iraq has the second highest level of proven reserves in the Gulf. But this is extremely deceptive. There has been virtually no exploration in Iraq for over 25 years. What little exploration that has occurred recently reveals if you stick a straw in the ground almost anywhere in Iraq you’ll hit oil. Iraq in reality has way more oil than Saudi Arabia. North/Central Africa also has vast potential for oil production, but it is plagued not only with bad guys but super-bad guys. And even though Afghanistan doesn’t have extensive oil reserves, winning there means everything because it is the heart of the beast. The beast extends its tendrils across the globe. I mentioned the beer drinking woman in Malaysia, there’s a little tendril. In St. Paul, Minnesota, maybe 100 young American born Somali men have left their native land to fight for the super bad guys in Somalia, another little tendril. This is why General McChrystal needs to get a yes from President Obama when he asks for more troops. He needs to chop off the tendrils and stab his Green Beret knife into the heart of the beast so we can have cheap oil and a multi-year bull market. And, oh yeah, that also means the Taliban will stop blowing up and killing little girls in grammar schools.

Specific Stocks: China has thousands of inefficient little steel mills and the news out this morning indicates that many of these little clunkers will get closed. Harsco (HSC) dropped initially on this news since it is levered to Chinese steel mills. But then it rallied strongly as the market realized that it is levered to big modern Chinese mills not the little mills and it will be helped by the little guys getting closed. I bought more HSC on the morning dip.

Obama Acting Like LBJ?

Charts: The S&P 500 closed at 1028, up 0.01%. We are getting consolidation for now, the only possible bullish chart action given the fundamentals. Investor sentiment levels have reached the very high late 2007 levels; this means that any bad news could cause a serious downdraft. When investors are overly optimistic they get flighty when their hopes are dashed by bearish data.

Fundamentals: New home sales screeched up 9.6% in June, vastly exceeding forecasts. Investors are beginning to sense that the recent monster upside surprises in housing are due to the potential expiration of the $8000 tax credit in late November not a return to normal market conditions. While Congress is expected to pass a new bill that almost doubles the tax credit, this is not a sure thing, and home buyers are rushing to beat the deadline.

Geopolitics: In Afghanistan, as the US Marines fought the Taliban in the boonies of Helmand province many more Taliban fighters than anybody knew existed moved into the big southern city of Kandahar and started tearing it apart. They are continuing to tear it apart as I write. The original strategy was to destroy bad guy supply lines and take control of the poppy growing region, denying the bad guys their primary source of funding. That strategy is apparently defunct as good guys leave the boonies, move into Kandahar, and try to simply hold the line there. The Iraqi surge had 100,000 more American troops on the front line than the Afghani surge and it worked. It’s not paradise in Iraq right now, but for the sake of brevity I’ll leave the assessment there as: war over and mopping up going okay. Afghanistan and Pakistan are the heart of the beast, worse and nastier than Iraq. It’s going to take a lot more troops to win. An expanded good guy push into the heart of the beast will mean screaming headlines and probably spell the end of Obama-Care, massively angering liberals.
A recent poll found that only 6% of Israelis think Obama is pro-Israeli. George Bush scored 88% pro-Israeli. Israeli Prime Minister Netanyahu sees his popularity sky rocket whenever he stands up to Obama. This is emboldening the PM to slowly back away from his freeze on settlement building in the West Bank. Recent polls of American Jews show overall approval for the President is still sky high. But his policy on freezing settlement construction polls poorly. Obama needs to keep the heat on Netanyahu but the President is beginning to waver, probably because he has too much on his plate.
There have been two big wars in the Russian regions in and around Chechnya. The Islamic flare-up there has become so intense that a third war looks likely. I would like to combine that piece of information with another that is only seemingly unrelated… The moderate and responsible Islamic government of Malaysia decided a couple weeks ago to cane a female citizen for drinking a beer. Malaysia had never done anything like this before. In the past drinking a beer while illegal would have been more like a traffic ticket. This small move toward Islamic radicalism caused investor outrage and since Malaysia is hard wired into the global economy it backed off and the beer drinking woman will not get caned. Caning a woman in Malaysia and the potential start of another Islamic war in Russia are both aspects of something that scholars have dubbed the Long War against Radical Islamic Militias. The Long War won’t vanish just because the President wants to pass a healthcare bill. Like LBJ, Obama should chose guns over butter, he certainly can't have both.

Roubini Says Double-dip Recession

Charts: The S&P 500 closed at 1028, up .2%. The charts are saying that the bull market is entering its third leg up after a second short and unsatisfying consolidation period. The breakout point for the third leg up is 1018, which therefore is a key support level. Resistance is at 1037. Leadership is very poor for this leg. Fannie and Freddie are the big leaders. Fannie is up over 100% in the last five days. On Monday trading was dominated by the two government entities. Morning Star rates Fannie as insolvent and fair value at zero. But investors are looking at the government’s commitment to infinitely subsidize housing and since the US government supposedly has an infinite credit line they are piling into these stocks.

Fundamentals: The Consumer Confidence Index came in stronger than expected. It had been tanking for the past two months but it ticked up solidly in August. Future expectations were especially strong and surprisingly job expectations were robust. The Case Schiller home price index also came in better than expected. Professor Roubini wrote an article yesterday where he forecasts a double-dip recession; with the next down leg coming a few months from now because super high government deficits will cause tax increases which will crush the recovery as will the ever escalating price of oil and food. A few years ago Roubini forecast the credit crunch and the Great Recession with fantastic accuracy. Central to his past projection was a huge fall in the dollar. This was the only thing he got wrong; the dollar was strong during the recession. Roubini was wrong about the dollar because he doesn’t see American military strength as an economic factor. And Roubini still doesn’t (myopic). So there is at least a possibility that the world’s greatest forecaster is too pessimistic. Although if the geopolitical situation deteriorates we’ll really be in trouble.

Geopolitics: The new Paki Taliban super-chieftain, H. Mehsud, now admits that the old super-chieftain, B. Mehsud, was killed by a CIA drone. Paki soldiers killed 4 bad guys yesterday but they are picking up the bullet-riddled bodies of dead bad guys that somebody else is killing by the truck load. That somebody else is probably H. Mehsud. He needs to purge all the bad guys who are unwilling to accept him as super-chieftain. H. Mehsud is reported to have a leadership style very similar to Idi Amin or Joe Stalin. This style relies heavily on killing any subordinate that even whiffs of disloyalty and ruthlessly eliminating any rival for leadership. H. Mehsud is considered to be more violent and aggressive than his predecessor. He has already killed B. Mehsud’s father-in-law and several other relatives that might have tipped the CIA off and precipitated the drone strike. If he does consolidate power over the network that B. Mehsud built, he will be a formidable adversary for the Marines and all the other good guys. General McChrystal will soon be requesting more troops, probably 40,000 more. If Obama and/or Congress says, “No more troops, we need to get healthcare done first, then worry about the war,” the stock market will be very unhappy.

1300 Years Is Nothing

Charts: The 2002-2007 bull market sure lasted a long time and yet it was only a cyclical bull market within a secular (long lasting) bear market and it was quite anemic in terms of gains. If the secular bear market that started in 1999 actually ended in March 2009, then it will have been the shortest secular bear market ever. Secular bear markets average about 14 years and they always include several cyclical bulls that average about 5 months. No matter how you slice it the current uptrend is more than a mere rally. By definition it is a bull market, we just don’t know if it is a cyclical bull or a secular bull. The 1975 cyclical bull lasted one year and today’s economic conditions roughly resemble the mid 70s. So maybe the uptrend will last another 6 months (or maybe not). When and if the secular bear resumes it should announce itself with virtually all technical indicators swinging sharply negative and credit spreads widening at a breakneck pace. The yield on the 10-year note will be the single biggest indicator of the bull market turning back into a secular bear. The economy is now run by the government and yields on government debt are everything.

Fundamentals: The current bull market is primarily based on the ongoing recovery in US housing. Existing home sales rocketed up 7.2% last month, a record increase. Multi-family housing (apartments) has weakened recently and so has high end single-family. Only cheap single-family is doing well and only because it is heavily subsidized. The government through FHA and Ginnie Mae is backing this segment with loans that feature absurdly low down payments and weak credit scores. By year’s end the government will have facilitated $1 trillion worth of brand new subprime mortgages, much of which will wind up in foreclosure and will require another round of subprime mortgages, etc... The $8000 tax credit is also subsidizing low end housing. It looks as though the tax credit will be expanded to $15,000 and applied to all single-family housing (bullish for now). There is no serious call to stop the government’s subprime lending spree. The stock market is taking all this as a positive for the moment since interest rates on the 10-year are still well under the 4% danger zone. Furthermore, not only are Japan and China still buying treasuries, Americans themselves are buying in larger numbers. The weakness in US consumer spending means higher savings, which means US citizens are buying more government debt. If the US economy could grow at 6% per year or so and no new spending programs were passed, it might not end in tears. America can only deal with a huge government debt hangover by rapidly growing GDP while gridlock simultaneously prevents new spending, never with spending cuts. This could happen.

Geopolitics: If we were to ask Osama Bin Laden when the Long War started he would say 711 AD, when Muslim armies successfully invaded Spain, helping establish the Great Umayyad Caliphate that straddled three continents and was one of the largest and most powerful nations ever. Resurrecting the Great Caliphate is Al Qaeda’s cherished dream. Osama and other bad guy intellectuals would say that the Long War continued after 711 as the Great Caliphate was battered back and crusaders eventually invaded Muslim lands, only to be expelled. More centuries rolled by and Christian colonialists invaded the same lands again but with greater success. The colonialists were kicked out, now they’re back and are getting kicked out again; ebb and flow, the great cycle of the Long War repeats itself. Probably the bad guys would say the Long War is about half over, only another 1300 years to go and the Great Caliphate will be reestablished. Heck, that’s just around the corner, patience my little jihadist, here strap on this suicide vest. I agree with Osama, the Long War is indeed centuries old.
Most Americans would say the Long War started in 2001 and they are losing patience with this lengthy debacle according to polling data. My God, this thing is dragging on for years! Most Americans still support the Afghan War, but support slips with every new poll. General McChrystal says that if he can’t show major progress in Afghanistan in one year, the American public will start clamoring for withdrawal. America can only lose a war if it chooses to lose. The US spends more on defense than ever other nation on Earth combined so we are our only serious enemies. Here then are two other metrics to see if we are winning besides bad guy body counts: 1) Opinion polls showing American support for the war. 2) Whether McChrystal gets the new troops that he is about to request from the White House and Congress. If opinion polls turn south and/or McChrystal doesn’t get new troops it will be bearish.

Good Guys Clobber Bad Guys

Charts: The S&P 500 closed at 1026, up a scorching 1.9%. The index blew past resistance of 1010, crushing our hopes for now of healthy consolidation and forcing us to start thinking about selling some of our big winners to lock in profits. Technical indicators are positive as strength begets strength, except for volume which is very light for this entire multi-month rally. Before we start cashing in our chips we must consider the parallel to the successful 1982 V-shaped rally that was based on geopolitical forces.

Fundamentals: According to Moody’s commercial office buildings showed a price increase in June and commercial real estate as a whole declined by only 1%, as opposed to the 7% monthly declines that the market had been registering. This indicates the freefall in commercial real estate is abating, which helps the heavily exposed financial industry. The government is backstopping commercial real estate with massive guarantees through the TALF program so we shouldn’t get too excited, nevertheless at least the propping up is working. And the same thing can be said about residential real estate, where existing home sales data surprised to the upside today. This was the reason for the monster rally. As the attention of American liberals is focused on the healthcare debate Team Obama is making a few interesting jinks to the right; it has okayed the building of a gigantic oil pipeline connecting Canadian tar sands producers to energy hungry America. Environmentalists hate tar sand oil for its high greenhouse gas emissions. But Team Obama told the tree-huggers tough luck.

Geopolitics: Follow the chain of events: Israel freezes West Bank building. Russia responds by saying it won’t sell air defense systems to Iran, making it easier for Israel to bomb Iran. Yesterday Iran meekly said it will allow increased inspection of some parts of its nuclear program by the UN.
In Somalia, government troops (armed and trained by the CIA) mounted a major attack against an Al Shabab stronghold and killed about two dozen super-bad guys while probably suffering a similar number of casualties. There are also reports of Ethiopian troops entering Somalia and engaging the Hizbul Islam militia, an ally of Al Shabab. And finally several pro-government Somali Islamic militias (good-bad-guys) are also joining the fight. This means that low level fighting has become a full-fledged war. Unfortunately, it is important that the mini-war in the horn of Africa get a lot hotter because Al Shabab and its allies run the world’s only functioning Taliban nation-state and they need to be destroyed. Thank goodness DMU followers own stock in ITT and HRS.
When America promotes third world Islamic democracy is that good or bad for stocks? Let’s open our Cold War history book and see how it worked back in the bad old days. In the early 70s, as North Vietnam was rolling up South Vietnam, the USSR turned its attention to South America. A KGB-linked Marxist politician, Salvador Allende, was freely and honestly elected president of Chile. The CIA assassinated Allende in 1973 and replaced him with a right wing anti-communist dictator, Pinochet, who ran death squads that brutally purged the country of communists plus he built a strong free market economy. This went a long way to stopping Soviet expansion in South America. Today Chile is a liberal democracy with the strongest economy in the region although people there still hate Pinochet for his brutality. Now consider the following: The North African radical Islamic group AQIM got its start 18 years ago when hardcore Islamists won an honest election in Algeria that was then clumsily overturned. The region hasn’t recovered yet and there should never have been an election in the first place. Most experts agree that if there were a free election in Egypt, the Muslim Brotherhood would win; this organization is the forerunner to Al Qaeda. Egypt is the cultural center of the Arab world. Team Obama is opposed to promoting democracy in the Long War and rightfully so. The real lesson from Vietnam and the Cold War is that whole kit and caboodle should have been left to the CIA, with no Congressional oversight.
In Pakistan, in the Swat Valley, 60 bad guys including 2 Taliban chieftains surrendered to the Paki Army.
The Yemen government denies that the Saudi Air Force bombed and strafed bad guys along the Saudi/Yemen border this past week. In Fact Yemen is angry that people are even talking about the Saudi Air Force’s sorties because it is so not true. And anyway, the Saudi jets are gone now so there is no proof one way or the other.

Moving Parts Come Together

Charts: The S&P 500 closed at 1007, up 1%. Yesterday I said a lot of technical moving parts had to work just right for the rally to stay intact. So far so good. Over the past couple weeks the Shanghai index had experienced a harsh correction, verging on bear market territory. In Chinese trading last night it responded to the gain in the S&P 500/Nasdaq and jumped up out of bear market territory, reconfirming the global leadership change from China to America and bolstering global markets. Today’s gains in US trading were a bit much for consolidation, erasing all of the big loss Monday and then some. The broad index hasn’t broken through resistance at 1010, so range bound consolidation is still possible.

Fundamentals: First time and continuing jobless claims both came in worse than expected. Indicating there is no real turnaround in US employment yet (bearish). The Philly Fed manufacturing index for the Mid-Atlantic region came in strong, as have other regional manufacturing indexes and in fact global manufacturing. Most of these jumps are based on restocking and strength in emerging Asia. In Q2 emerging Asian economies as a whole grew by 10% (annualized), which is scorching growth, but we don’t know what will happen when Asian stimulus spending stops. The good news is that China’s stimulus spending will be tapering off in the next few months and the global economy will be like a child riding a bike without training wheels for the first time. We’ll see if the global economy only wobbles or falls down hard. Asian consumers and to a lesser degree OECD consumers will have to pick up the slack left by the cessation of stimulus spending. Consumer psychology will be affected by the geopolitical picture; so, as always, it is paramount

Geopolitics: During today’s election in Afghanistan the Taliban needed to deliver something like what the Viet Cong delivered in the Tet Offensive in Vietnam, a massive hammer blow that killed hundreds of voters. The bad guys didn’t get the job done (bullish). There was slightly less violence today than there has been over the past few days. Through rocket attacks and shoot-outs, the bad guys managed to shut down 11% of the polling stations and turn-out was a smidge lower than the last election in ‘04. Afghani voters are seemingly apathetic and exhausted after the election, but alive. Western media is reporting the election as a failure because all hope for democracy magically ending the war is now gone. For investors the real news is that Bush’s boneheaded mistake of promoting democracy in Afghanistan isn’t hurting the war effort nearly as much as we feared. The Taliban has promised to cut off the ink stained fingers of voters over the next few days in big numbers, so this is the bad guy’s next test and conversely NATO’s next test.
In response to Israel freezing building permits in the West Bank, Russia has agreed not to sell Iran advanced air defense systems. This means that Israel can bomb Iranian nuclear production facilities if it needs to. It is amazing how rapid the domino effect has been from the settlement freezing. Team Obama has really hit a home run with this one.
The Yemeni Army is organizing northern tribes to fight the Zaydi rebels in the Saudi/Yemen border area, a more sustainable solution to having the Army carry most of the burden as the fighting there will probably last a long time. Yeah tribalism. Boo democracy.

Specific Stocks: QQQQ is the index for the Nasdaq 100. The Nasdaq is the global leader so it is a simple bet on whether we are in a bull market or not. ISL is the index for Israel. More risky, it is a bet that Team Obama’s diplomacy is working in the region. Google (GOOG) is bringing out its Android smart phone operating system and handset makers around the world are embracing it. Microsoft’s Bing search engine is doing okay, but its gains are slowing even though Microsoft is spending $100 million advertising it. Most of Bing’s gains have come at the expense of Yahoo.

Outlook Shaky

Charts: The S&P 500 closed at 996, up .7%, exactly at a resistance level, support is at 982. The Shanghai index crashed once again overnight in China. It is now 20% off its August highs. A decline like that would signal the resumption of the bear market in America or Europe, but for China it is only a correction verging on a bear market. Ominously, the S&P 500 swooned in the morning, catching a cold from the Shanghai sneeze. But it fought back to a gain in a very choppy fashion. The global leadership change from China to America is shakily intact. The possibility of continued consolidation in the American index is shakily intact. What we need to see is the Shanghai index stabilizing and consolidating as well or it will tear down all global markets. It needs to respond to the S&P 500’s leadership. There are a lot of moving parts to this technical picture and it is all very dicey.

Fundamentals: Reports from retailers indicate that consumers in America continue to cut back on purchases. The back to school season and Christmas are looking very grim. A welter of housing data recently points to stability in this market; which is good although the housing market is being subsidized by the government to the tune of $100 billion a year or more and it is a judgment call if after that kind of expenditure stability (rather than rip snorting growth) is good enough. Oil inventories today showed an unexpected decline, which the market took as a positive, a sign that Americans are driving more and returning to their normal gas hog ways. But oil analysts said that the big draw down was mostly due to a slowdown in oil imports, not an increase in demand. Overall the fundies are still weak.

Geopolitics: Israel has stopped issuing building permits in the West Bank, freezing its building program there, Team Obama’s main goal for the region. In response, Syria has agreed to increase efforts to stop Al Qaeda fighters from infiltrating into Iraq from Syria. Despite this good news suicide bombers tore apart central Baghdad today with 95 people killed. The attack looks like the handiwork of Al Qaeda in Iraq. US commanders are already saying that offensive operations need to be restarted in the Kurdish region. Today’s monster bombing makes it apparent that America needs to go back on the offensive throughout the country. American public opinion will be sorely tested by any announcement along these lines. In Pakistan, good guys have captured two top Taliban commanders and are now interrogating them, potentially opening a treasure trove of information. In Afghanistan, the election is tomorrow and the Taliban has unleashed a massive onslaught of mortars and rockets recently to keep voters away from polling stations. The Taliban’s goal is to keep Pushtuns from voting in the southern regions that it controls thereby defeating the Pushtun incumbent, Karzai. Most Afghanis are Pushtuns and the Taliban is itself a Pushtun organization. If Karzai loses because the majority of voters couldn’t make it to the polls, then the non-Pushtun challenger (Abdullah) will win but he will have an immediate revolution on his hands from the country’s ethnic majority. This will greatly strengthen the Taliban. It was a mistake for America to place so much emphasis on democracy in Afghanistan 8 years ago. But it is a mistake that we are stuck with and if democracy fails there, the consequences will be dire for global stock markets.

Technical Correction? Not Yet

Charts: The S&P 500 closed at 990, up 1%. Since a technical correction ensues with the broad index crashing through 869 with secondary indicators also crashing, and that has happened yet, we are still in a technical rally. Resistance is now at 992. It is good that resistance held and range bound consolidation is still possible. A big move in either direction is bearish.

Fundamentals: Manufacturing worldwide continues to show strength despite the overall weak fundamental picture. Regional indexes in America like Empire State keep improving. Germany is a proxy for global manufacturing and m/m investor confidence improved from 39.5 to 56.1 (startling). The numbers out of disciplined Germany are the cause for today’s rally just as the numbers out of spendthrift Japan caused yesterday’s crash. The strongest economies have the lowest government debt and are leading the fledgling recovery. For instance, Singapore had the highest Q2 GDP on the planet and a very low fiscal deficit. When and if the global deficit spending ceases, then the global economy may crash and burn. It may all end in mascara-smearing tears. But if the governmental credit cards aren’t cut up soon the resulting debt tsunami will cause a depression so bad nobody will be able to afford mascara. On that score we have Team Obama’s budget-busting healthcare package floundering (bullish). The President says that he is resolutely for a public option but he is also flexibly willing to jettison the public option. Hopefully, this doubletalk will piss off voters even more.

Geopolitics: The Saudi government said that it is increasingly concerned about the situation in Yemen. This is a subtle hint that it may be directly helping Yemen militarily and perhaps the reports that the mighty Saudi Air Force is clobbering the bad guys are true. Yemen itself says that the northern rebels are linked to Iran and that the ground offensive is halted for now. If the rebels are directly linked to Iran, then the Iranian report about the Saudi Air Force could be true; hey, they ought to know.
In Iraq, the top US general says that American troops will probably be moved into the restive Kurdish region and restart offensive operations if the Iraqi government gives the green-light. While we may personally wish and hope for magical peace in Iraq it is bullish for global stock markets if America resumes fighting there. In Afghanistan, suicide bombs continue to kill good guys and civilians at a torrid pace. NATO won’t give a body count but today at least 6 good guys died. NATO says that on election day this Thursday it will suspend all offensive operations and focus on protecting voters. The Taliban says that it will savagely attack voters and after the election there will be a campaign to cut off the ink stained fingers that mark those who voted. In a speech about Afghanistan the President said, “This is not only a war worth fighting. This is a fundamental defense of our people.” As badly as the President sucks at economic policy he rocks at foreign policy.

Specific Stocks: I’ve been buying Harris Corporation (HRS) on dips (see 8/14/09 newsletter). The Army’s extravagant Future Soldier science fiction fantasy has been scaled back to more modest gear emphasizing integrated communication—the exact spot occupied by HRS. Also, I like its civilian communication business.

First Sign of Tears

Charts: The S&P 500 closed at 980, down 2.4%. The 982 support level was violated. This is the breakout point for the second leg of the rally. Next support is 869, the July low. Secondary indicators were ugly today. If 869 is violated and the secondary indicators go along for the ride, then the market will be in a correction. If we look at the long term picture and consider this rally’s resemblance to past bear market bounces, it becomes apparent that a retracement to 667 is possible in the event of a correction.

Fundamentals: Japanese GDP came in weaker than expected. This triggered a global stock sell-off. Digging inside the Japanese numbers reveals an ugly picture. What growth there was came from exports to China and revisions in inventories. Economists have been warning that recent global manufacturing gains have been coming simply from restocking, not genuine consumer demand. Chinese steel prices are now falling as certain parts of China’s stimulus package expire, an indication that the screeching growth in parts of emerging Asia may be due solely to China’s government spending, which is slowly wearing off. The possibility of the recovery/rally ending in tears is now more likely. And the tears will be the kind that really mess up your mascara.

Geopolitics: In Russia, 20 civilians were killed by a suicide bomber in a province near Chechnya. The Chechnya Islamic flare-up is gaining intensity. In Nigeria, Islamic radical group Boko Haram has announced a new leader. He promises a wide spread terror campaign in the coming months. There is a 1930s style run on Nigerian banks going on. A collapse in Nigeria’s economy would be good news for the bad guys. In Niger (country just north of Nigeria), 1500 paramilitary troopers raided an Islamic camp in a surprise attack and expelled 3500 people. The Niger government says that the camp had links to Boko Haram. In Pakistan, Taliban on Taliban fighting is raging throughout North and South Waziristan, killing large numbers of good-bad-guys and bad guys. In Yemen, the government is keeping media away from the fighting in the north, which appears to be continuing. An Iranian news station says that Saudi jets are strafing bad guy positions in the rugged border region. The Saudi government refuses to comment on the report. In Afghanistan, the coming election will be a pivotal moment in the global war. It looks as though NATO does not have enough troops in the war torn country to pull off a smooth election. If this proves to be the case it may bolster bad guys everywhere.

Are The Good Guys Winning?

Charts: The S&P 500 needs a lengthy and healthy consolidation for the rally to become a multi-year bull market. It hasn’t happened yet. There was a consolidation period between the two big up legs. Unfortunately it was short, sloppily volatile, and formed a bearish head and shoulders pattern. Healthy consolidation means tight sideways movement between well-defined support and resistance. We got that last week. This pattern needs to continue so the rally ceases to resemble the famous bear market bounces of the 30s and 70s that I talked about last Sunday (scroll down to the 8/9/09 newsletter).

Fundamentals: Q2 GDP grew in Germany, France, and emerging Asia. The shocker is Germany and France. They grew on exports to Asia and cash for clunker type stimulus programs within their own borders. Western exports to Asia are still dependent on China’s government stimulus program, rather than private sector strength. China’s federal government runs a surplus but its provincial governments run deficits; the net result is that China is now running a combined fiscal deficit of about 3.5% of GDP, which is what spendthrift America was running as recently as three years ago. Germany has a federal surplus and a provincial deficit something like China’s. Outside of disciplined Germany and China, most major economies are running deficits around 10% of GDP. Germany will not renew its clunker program or jam through more deficit spending and China is grimly draining liquidity from its banking system. So the global recovery is built on quicksand. The only counterargument to the rally/recovery ending in tears is that in times of war governments somehow get away with massive deficits. During the long period of Napoleonic War Britain’s deficit peaked at an eye-watering 25% of GDP with no ill effects because the good guys won. Is the world engulfed in a global war and are the good guys winning? Keep reading.

Geopolitics: North/Central Africa is being scorched by an arc of fire. In Somalia, Al Shabab has carved a de facto Taliban type nation-state out of the lawless country. To the west, Tunisia, Algeria, Mauritania, Mali, and Niger form a block that is plagued by a virulent and powerful bad guy insurgency called AQIM (an Al-Qaeda franchisee). AQIM’s strength is its large numbers, ability to earn big money boot-legging cigarettes and illegal immigrants into Europe, and the vast lawless deserts of its host countries. AQIM is mostly comprised of Arabs that are minorities in black North Africa. Below this block is Nigeria with Islamic rebel group Boko Haram. Nigeria claims that Al-Shabab, AQIM, and Boko Haram have recently joined forces and together are growing much more powerful. America is stepping up its involvement in North/Central Africa.
In the Gaza Strip, due to Team Obama’s brilliant diplomacy the once radical group Hamas has morphed into good-bad-guys and a new bad guy group wants to overthrow Hamas and install a Taliban style government. The new bad guys call themselves Warriors of God (WG) and claim to be an Al-Qaeda franchisee. WG and Hamas have recently been fighting a mini-war in Gaza. Saturday, Hamas killed the leader of WG as well as a dozen bad guys. As we’ve seen in Nigeria, swiftly smashing bad guys and publically killing their top leader tends to knock insurgencies for a loop (bullish).
In Lebanon, with the apparent loss of Hamas as an ally, Hezbollah is making grandiose threats against Israel, fearful over its future as the peace process inches forward. Hezbollah for now is all bark and no bite.
In Pakistan, as of Saturday morning, fighting between Taliban chieftain Turkistan’s good-bad-guy militia and H. Mehsud’s bad guys continued but seemed to be winding down with one good-bad-guy killed. Since Friday the Paki Army has killed 12 bad guys. The SV Taliban is stepping up civilian terror bombings in the Swat Valley and avoiding firefights with the Army.
In Afghanistan, a gigantic Taliban car bomb exploded at the gates to NATO headquarters in Kabul, killing 7 and wounding 91. The Taliban has stepped up its terror bombing in recent weeks, as practice for what will probably be a big onslaught this Thursday, election day. They’ve never gotten this close to NATO headquarters before (bearish).
In Northern Yemen, the fighting rages on between the Yemeni Army and bad guy insurgent group Zaydi. The fighting is moving closer to the country’s capital city, San’a (not good). Facing a second Islamic insurgency to the south, the Army is desperate for a quick victory. This forces it to use airstrikes and artillery, wiping out civilians along with bad guys (hurts civilian morale). Osama Bin Laden is actually a Yemeni, not a Saudi, so the Al-Qaeda franchisee in the south is especially dangerous. And Yemen itself occupies a very strategic position. It borders Saudi Arabia and forms a tangent to the arc of fire slashing across North Africa. We don’t know how America and Saudi Arabia are helping the Yemeni Army although they must be helping in some way.
In conclusion, the world is definitely engulfed in a global war and the good guys are maybe winning.

Charts: The S&P 500 closed at 1004, down 0.85%. CAF (Chinese index) closed at 32.65, down 4% on the week. The US market took a sickening lurch in early going, crashing through three support levels, but by the closing bell the broad index fought its way back up through the key 996 and 1000 levels. So only 1010 was violated. 31 is a key level for CAF and it needs to hold the line there. We’ve been talking about America taking the lead role, and that’s all well and good, except China is still the world’s second biggest economy and its stock market is also number two and it needs to hold together.

Fundamentals: The next leg in the global recovery is dependent on America’s back to school shopping season. Speaking to that concern, today consumer sentiment dropped from 66 to 63.2. It was expected to increase. Yesterday we saw retail sales were weak. Wall-Mart is the epicenter of back to school shopping and it reported weak sales. DMU actually did some field work by sending our ace reporter (Martha) on a back to school shopping junket with a typical Midwestern family where the dad is a fire captain, the mom is a nurse, and there are three school kids (a demographic bulls-eye for Middle America). The family was very frugal in its purchases (yikes!). Also, there was a tiny whiff of deflation in the CPI data; that indicates weak consumer spending but is good for interest rates and housing. On the flip side, industrial production came in better than expected and yields on the government’s gargantuan debt came down (bullish). Today the fundies are mixed. One thing to watch: Cit Group (CIT) has a deadline this evening concerning its debt restructuring. If bondholders don’t play ball, CIT will file bankruptcy. This will be like a mini-Lehman collapse. Wells Fargo and other banks have taken over a lot of CIT’s clients, so the danger is getting less and less every day, still there are thousands of retailers that won’t be able to stock up for Christmas in the event of a CIT bankruptcy and the US economy is in no shape to withstand even a soft blow.

Geopolitics: In Pakistan we need a program to keep the various players straight. The dead Taliban super-chieftain was named B. Mehsud. The new Taliban super-chieftain is named H. Mehsud (they’re from the same tribe and have the same last name). The “good-bad-guy” Taliban fighters that we talked about yesterday are led by a pro-government Taliban chieftain named Turkistan. Turkistan’s militia continues to battle H. Mehsud’s militia for a second day. The fighting is fierce and dead good-bad-guys and bad guys are stacking up like cord wood. In a massive air operation to support Turkistan’s militia, Paki Army helicopter gunships are ripping apart the bases of the H. Mehsud network. Thursday alone good guy helicopters killed 12 bad guys (bullish).
In Chechnya, bad guys stormed a police checkpoint and killed 4 good guys. The jihadists then attacked a public bath house and killed 7 innocent civilians who weren’t wearing enough clothes to satisfy Sharia decency standards.
Two platoons of Philippine Army Rangers and Marines in a large operation attacked two Abu Sayyaf (an Al-Qaeda franchisee) camps and killed 31 bad guys. 23 good guys were killed. The camps were essentially factories for making bombs like the ones that were recently used in Indonesia. Abu Sayyaf knew the government’s soldiers were coming and met them from prepared positions, indicating that the bad guys have an effective intelligence arm (bearish).
In Northern Yemen, fighting between the Yemeni Army and radical Islamic sect Zaydi entered its fourth day. Yesterday’s body count: 16 dead bad guys and 2 dead good guys. Zaydi is not affiliated with Al-Qaeda, in fact they hate Al-Qaeda, but unfortunately there is also an Al-Qaeda franchisee rebellion in Southern Yemen. So the Yemeni Army is stretched thin and needs US help.

Specific Stocks: There sure is a lot of fighting by US allies recently. They need high performance tactical radios made by Harris Corporation (HRS). Yesterday HRS reported good numbers and the Philippine Army, for example, is a big customer. I’ve been buying EWS (Singapore Index). EWS took a dive when America made a deal with Switzerland to grab tax evaders' records. Singapore is the Switzerland of Asia with secret bank accounts, etc… But the US/Swiss deal isn’t even that bad for Switzerland, let alone Singapore.

Drones Resume Killing Bad Guys

Charts: The S&P 500 closed at 1013, up .7%. The index smashed into the 1010 resistance level in early going and was battered back. It regrouped and attacked again. It was battered back down. It shook off this blow, gathered itself for one last attempt in the afternoon, smashed into resistance and plowed through. 1010 is now a support level. Chinese stocks were down and are showing a mildly weak double top chart pattern. But almost all other world markets are up, so for now America is providing leadership, which is obviously bullish.

Fundamentals: The Commerce Department reported today that retail sales fell .1% in July vs. an expected increase of .8%. Excluding autos, retail sales fell .6%. Realty Trac reported foreclosures hit an all-time high in July. The NARA says that house prices are still falling, contradicting some data that says the opposite. France and Germany claim that their GDP ticked up fractionally in Q2, indicating that they are no longer in recession, but Euro-zone industrial production unexpectedly fell. The good news is that today’s treasury auction went better than expected as the government continues to successfully roll over its gargantuan debt load. So fundies were mixed.

Geopolitics: The Paki government says that a battle is raging in South Waziristan between an Army backed Taliban group and the core group of bad guys loyal to the dead super-chieftain Mehsud. In other words “good-bad-guys” are attacking regular bad guys and giving them a beating, which is terrific news. Reports of dead fighters range up to 70, probably an equal number of good-bad-guys and regular bad guys have been killed. On Tuesday a CIA drone tore apart a South Waziristan Taliban training camp, killing 8. Ten of the last eleven drone attacks have been in South Waziristan and all seem to have hit pay dirt, an indicator that the Paki ISI is feeding good information to the CIA. In Afghanistan, US Marines attacked a major Taliban stronghold in the south, Dahaneh, a town that NATO forces have not been able to get close to for years. The bad guys are fighting back fiercely with heavy machineguns and missiles. This battle represents that start of a new Marine Corp offensive before the upcoming Afghani election. Somehow we have a body count (gasp); the good guys have killed 10 bad guys so far. In recent days the Taliban has been setting off bombs throughout the country, killing dozens, part of their offensive before the election on August 20.

Specific Stocks: A few years ago Congress stupidly passed a law giving any company that mixed fossil fuels with biofuels to run their operations a 50 cent a gallon subsidy. Paper mills have been burning a pulp extract called black liquor since the 1930s (a biofuel), so recently they’ve started adding a little bit of diesel to their black liquor and voila the government started mailing them boatloads of cash. This year their stock prices have soared and are still soaring. The hitch is that Team Obama is trying to take away the subsidy. Here are three companies rolling in black liquor subsidized cash: International Paper (IP), Glatfelter (GLT), and Buckeye Technologies (BKI). If the subsidy isn’t removed they should keep rocking up.

Will It All End In Tears?

Charts: The S&P 500 closed at 1006, up 1%. Emerging markets recovered and American tech took on leadership. The broad index outpaced emerging markets, so for today the leadership change we’ve been hoping for is working.

Fundamentals: The Federal Reserve said that economic conditions are leveling out and that it will keep interest rates low for a long time (bullish). It also said that the program to buy treasuries (Quantitative Easing or QE) will be allowed to expire after $300 billion has been spent (bearish). This could have rocked the market since investors are begging for super loose monetary policy and it did at first. However, the real QE is coming from the Fed buying $1.5 trillion of Fannie and Freddie debt and mortgage backed securities. The Fed made reassuring noise on this score; that mullified investors after the first bout of panic. Not to mention that Ginnie Mae now holds a trillion dollars of freshly minted subprime mortgages. So the government is using deficit spending and loose mortgage standards to massively support the housing market. It is working for now, which is great. It can’t keep working without overall spending constraint from the government at some point in the next year or two. That’s not going to happen, so long term conditions are similar to 1975 with a recession ending and structural problems remaining unsolved. The market generally only looks 6 months into the future, so fundamentals look okay for now and the rally should continue for a few more months. Watch for yield on the 10-year note going above 4%, because if that happens it could all end in tears.

Geopolitics: Russia has ended its war against Islamic radicals in Chechnya and America has ended its war in Iraq. The two conflicts are very similar and since the big powers have declared victory the course of the bad guy insurgencies have taken similar paths. Neither region is at war anymore but the insurgencies have kicked back up to a very hot level that will probably require increased involvement from the respective big powers. Russia is going to have to put troops back into Chechnya and America is unlikely to really wind down Iraq operations the way civilians back home are hoping. And so goes the Long War. It is a very stubborn, nasty, and permanent fixture to the new century. From an investing view point there are opportunities. My biggest single stock holding is ITT, a defense company that makes gear for infantrymen. And Raytheon (RTN) for missile offense and defense.

Technical Leadership Problem

Charts: The S&P 500 closed at 994, down 1.3%. Support at 996 was breached, next support is 982, and then 869. If both were breached in big volume and our secondary indicators (XLF and CAF) went along for the ride it would signal a correction. Resistance is at 1010. For the time being we have lost leadership from emerging markets as Chinese shares continue to trade lower and the downdraft has spread first to India, then the rest of emerging Asia, and now to Brazil. Last week as China broke down the S&P 500 was led by financials, not tech, so we have a leadership problem. XLF was down 3.85% today.

Fundamentals: Productivity came in higher than expected today. Throughout this recession productivity has increased. This has never happened before. It is helping corporate profitability and keeping inflation tame. However, it means that companies will higher fewer new workers as the recovery sets in because existing workers are becoming extremely efficient. And labor data shows as much. Existing staff is no longer getting fired but new hiring isn’t occurring.

Geopolitics: America’s top General in Afghanistan, Stanley McChrystal, will make a report to the White House in a few weeks assessing the entire war effort. In that report he is likely to request extra troops. He needs at least 40,000 more but will probably ask for half as many. McChrystal is aware that he probably won’t get any reinforcements so he is making a major effort to create an entirely new force of tribal fighters much like the Awakening Council in Iraq. A series of Pentagon officials are making public comments about the situation being tougher in Afghanistan than anybody thought previously. Recent polls show that 64% of Americans favor leaving the troops in Afghanistan until the job is done; but the European public wants to bring troops home immediately. The recent big uptick of Al Qaeda bombings in Iraq highlight how challenging it is to get native troops to fight at the level of NATO soldiers so there probably will have to be a second American surge of at least 40,000 troops, more if European allies bail.
It looks like there wasn’t a shoot-out among top Taliban leaders after the death of Mehsud. Or there was a shoot-out and the very top leaders weren’t hurt because the two top bad guys appeared in public, unscratched. They both claim that Mehsud is alive and only his wife was killed in the drone attack. They say that Mehsud is very sick and will appear in public once he heals up.

2009=1982?

Charts: There have been four other rallies in the past that resemble the current one from a technical perspective.
1) After the monster 1929 crash there was a rally that gained 47% over 5 months. It peaked in April 1930 and the market crashed again for two more years. The chart for the Nov. 1929 to April 1930 rally looks nearly identical to today’s rally (scary).
2) In 1932 there was another bear market rally, which was the strongest rally in the history of the stock market. In 10 weeks the market gained 111%, but it morphed back into a bear market that raged for years and tore investors to shreds. This rally highlights the tendency for bear market bounces to be explosive.
3) In 1975 there was a year long rally that gained 54%, inside that lengthy rally there was a 5 month period with a 47% gain that looks like today’s rally. The 70s bear market lingered until 1982, so the 1975 rally was another trap for investors but not as bad as the 30s as the market bobbed up and down aimlessly for years.
4) The 15-year bear market that started in the late 60s finally ended with a powerful V-shaped rally in 1982 that was not a trap. The market went on to log steady gains until 1999 when, as we all know, another secular bear market developed that may or may not be ending right now.
In summary, there has only been one explosive V-shaped rally at the end of a severe downswing that then turned into a secular bull market and there have been three explosive and long-lasting rallies that turned out to be bear traps. Of the four rallies mentioned above overall economic conditions today are most similar to 1975. In 1975 the country was coming out of a recession that was caused by an oil shock. Industries were restocking after slashing to the bone but long standing structural problems remained that the government was not addressing which caused the rally to fail after one year. The structural problem in the 70s was inflation; today it is the ballooning government deficit. Other than that the two eras are much the same. What’s really different in the 70s was that the Soviet Union was taking the wood to America. Today we are taking the wood to the bad guys but it is not clear that we are at a clear geopolitical turning point as was the case in 1982 where US victory in the Cold War became readily apparent to investors. To shed clarity on the state of today’s Long War let’s skip fundamentals and dive straight into geopolitics.

Geopolitics: Mehsud is dead. While absolute proof is not forthcoming events on the ground make it a near certainty. There have been two shoot-outs among rival Taliban chiefs over who gets to be the new leader, resulting in a bunch of dead bad guys (bullish). The Pakistani Taliban has always been a loose collection of independent-minded tribes/militias held together only by the personality and genius of Mehsud. Now that he is gone the remaining tribal chieftains are at each others’ throats. They probably won’t be able to pick a leader from within their own ranks but these chieftains all have one thing in common: every one of them harbors tremendous respect for the Al Qaeda leaders that they are hiding in North Waziristan. Al Qaeda provides millions of dollars of funding to the Pakistani Taliban and some leadership. Mehsud’s death will probably result in Al Qaeda essentially taking over the Taliban, which of course would be bearish. The CIA and the Paki Army need to move fast before this happens and put the hurt on the bad guys while they are disorganized. Our key barometers will be drone activity and bad guy deaths by the Paki Army.
The real good news over the drone strike that killed Mehsud is not that one super bad guy is dead. No, it is that the average Pakistani voter may be more favorably predisposed toward CIA drone strikes within their country. If it weren’t for the vast reservoir of hatred that most moderate Pakistani civilians have against drones, the CIA would fly ten times more missions. Mehsud’s death may shift public opinion and allow for more flights (bullish).
Eritrea is playing a dangerous game. Bad guys from Afghanistan and Pakistan are finding their way to the tiny Red Sea country that is close to Somalia. Eritrean training camps and supply lines feed these fighters into the ongoing Somali civil war, where the bad guys join Al-Shabab, an Al-Qaeda franchisee labeled as super-bad guys by DMU. Secretary of State Hillary Clinton issued this warning, “It is long past due for Eritrea to cease and desist its support for Al-Shabab. We are making it very clear that their actions are unacceptable. We intend to take action if they do not cease.” Mrs. Clinton is practically declaring war against Eritrea. The situation in the horn of Africa is growing hotter as Al Shabab wears down Somalia’s US supported government. Recent Islamic flare-ups in Algeria and Nigeria complete the picture—sub-Saharan Africa is becoming the next big battleground in the Long War.

CIA Mega Victory

Charts: The S&P 500 closed at 1010, up 1.3%. XLF (financial index) was up a whopping 2.7%. CAF (China) was down 1.8%. The broad index is exactly at the 1010 resistance level. This is okay because it should struggle with resistance. Chinese stocks are down but this may be a case of a switch in global leadership (see below). If this is the case, then it is very good.

Fundamentals: The Labor Department reported that payrolls fell by much less than expected. The unemployment rate dipped but only because discouraged workers quit looking for jobs. This report paints the same picture as yesterday’s jobless claim numbers, companies aren’t firing existing workers in a big way but the long term unemployed aren’t getting hired. On the bright side, the number of hours worked per employee went up for the first time in the recession. Employers will increase the work week for existing workers before they will hire new ones. So overall it was a good report.
There is more evidence that the Chinese government is slowing down the pace of lending to prevent bad loans from snowballing. About 20% of new lending in China is going into the stock market, so obviously the blistering pace of loan growth in China has become reckless and needs to be throttled back. The world is now in a position where America has to start leading the global recovery because China’s economy will probably soften from the unsustainably high 15% growth rate it experienced in the last quarter. Switching horses in mid-stream like this is gut-wrenching and unprecedented, but the dollar strengthened today on the good jobs news. For the past year the dollar would always weaken on similar good news since it had been acting as a safe haven; this in turn would cause oil to go up, limiting upside gains. One day doesn’t make a new trend, but oil dropped today on the strengthening dollar. Today the market is saying that America will retake its traditional role as the global engine of growth with China playing second fiddle.

Geopolitics: It was suspicious yesterday when the Taliban rushed to admit that super-chieftain Mehsud’s wife was killed by a CIA drone but miraculously the world’s number one bad guy got away, especially when we learned that the drone’s missile precisely targeted Mehsud’s personal bedroom. Now we learn that the CIA has pulled a body out of the wreckage that looks just like the super bad guy. What are the odds that another Taliban chief that looked like Mehsud was in bed with his wife? The CIA is running DNA tests on the body but it looks as though the good guys have indeed killed the most evil (and by that I mean most bearish) man on the planet. If the DNA test comes through it is impossible to overstate how big a victory this is for the forces of bullishness. The CIA has officially earned Dave’s Golden Bull award, the highest honor this newsletter can bestow on any organization.
The Pentagon has told Boeing to build the world’s most powerful conventional bombs; they will weigh 30,000 pounds apiece. These bombs will have only one function, to destroy Iran and/or North Korea’s nuclear weapon production facilities. As we’ve seen Obama has much bigger cojones in foreign affairs than anyone expected so it is likely that the Ayatollah has a new worry to fret over.

Big Victory For CIA

Charts: The S&P 500 closed at 997, down .6%. The psychological 1000 level was breached but the technical support level of 996 held. The downdraft was caused by apprehension over Friday’s big jobs report rather than any real news. None of our secondary indexes are sounding any alarm bells. Technicals are still bullish.

Fundamentals: First time jobless claims came in better than expected and the 4-week moving average for new claims keeps getting better. Continuing claims came in worse than expected by a wide margin. Even though continuing claims look bad they are actually worse than they appear because long term benefits have a time limit, so tens of thousands of unemployed workers are no longer filing claims but are still unemployed. There have been several extensions so far and more are in the works. Once the new round of extensions kick in the federal deficit will grow a little bigger. Other “little” programs here and there are also swelling the deficit but not getting much attention. Five days ago Congress jacked upped the prices it pays on the various dairy support programs. The Post Office shocked Congress by announcing that it will lose over $7 billion this year, an all-time record that will keep getting worse as the internet makes the Post Office obsolete. The Clunker program is likely to cost taxpayers $10 billion before it expires, not $3 billion as the government believes. But yield on the 10-year note remains under the dangerous level of 4%; so there is no train wreck yet.

Geopolitics: On Wednesday and Thursday, in Afghanistan, 5 American soldiers were killed. 15 NATO troops have been killed so far in August, notching up an annualized rate of just under 1000 good guy combat deaths. The Pentagon refuses to give a bad guy body count. Despite intense pressure from European voters to remove all troops from Afghanistan, NATO asserted that European allies will stay and keep fighting.
In Pakistan, a CIA drone fired a missile into the house of Taliban super-chieftain Mehsud’s father-in-law. The missile exploded inside the room that Mehsud and his family use when they are visiting the father-in-law, indicating that the CIA has superb intelligence on the number one bad guy in the world. The Taliban confirmed that Mehsud’s wife was killed and four children seriously injured. Apparently Mehsud was not in the house at the time of the attack. Several years ago Mehsud killed the wife of the current Paki President so the death of the top bad guy’s wife has tremendous symbolic weight.

Charts strong. Fundies weak. Again.

Charts: The S&P 500 closed at 1003, down .3%. XLF (financial index) was up 3.5%. CAF (Chinese stocks) was down 2.3%. The broad index showed tremendous technical strength by falling only a tiny bit in the face of bad fundamental news. Financials were buoyed by a short squeeze in AIG, so it might be fluky. We need to watch China carefully since it is the global horse that we all depend on.

Fundamentals: Earlier in the week the ISM manufacturing survey came in stronger than expected because it is levered to Asia. Today the ISM service sector survey came in weaker than expected because it reflects America’s weak domestic economy. Yesterday we saw that US household income and spending are still weak and for now totally dependent on government stimulus. The market would almost certainly be tanking right now if it weren’t for the strong housing data over the past couple months. The market disagrees with my theory that housing will collapse once the first time home buyer tax credit expires in 2 ½ months. Strong housing data is supporting the financial sector.

Geopolitics: In Israel, Hamas and Fatah are holding reconciliation meetings to bridge their differences and present a unified front in upcoming peace negotiations with Israel. The Palestinians are getting very serious about the peace process. The leader of Fatah, Abbas, is setting forth a program of civil disobedience rather than armed resistance. This is an obvious attempt to pacify Washington and a sign that there is indeed a sea-change underway.
In Afghanistan, Taliban rockets rained down on Kabul Tuesday, doing little damage but a sign that the bad guys are serious about disrupting the national elections in August. Other anti-election tactics from the Taliban have been more effective. 77 NATO troops were killed in July, a record. Politicians are unable to campaign in Taliban controlled territory. And the Taliban seems to be effectively framing the debate; if the elections go well America is winning, if they don’t the Taliban is winning. Of course framing the war in these terms gives the bad guys a huge advantage. It’s a lot easier to destroy the elections than to pull them off smoothly. Once again we see that the Afghani Taliban is tougher and smarter than Al Qaeda in Iraq.

Specific Stocks: Foster Wheeler (FWLT) reported solid numbers today. The chart looks okay, although the stock bounced 15% today, a bit much. FWLT is an engineering firm that essentially installs the kind of gear that Flowserve (FLS) builds. So I like this sector.

Market Hangs Tough

Charts: The S&P 500 closed at 1006, up .3%. Charts remain bullish, although Chinese stocks took a small hit. First support for the broad index is at 996. After that support is at 982, the breakout point of the second rally within the nascent bull market. Resistance is at 1010, the October high.

Fundamentals: Pending home sales popped up more than expected. Housing numbers have been good for three months now, with the exception of homes over $750,000, which have been terrible. High end homes do not receive government subsidies. Low end homes get an $8000 tax credit plus FHA, Fannie and Freddie are essentially making subprime loans to support this segment of the housing market. The $8000 tax credit ends in November. Almost certainly we are seeing a rush of buyers coming into the market to beat this deadline. Unless you believe that the housing market is going to do fine once the government takes off these subsidies economic fundamentals within America’s domestic economy remain weak. On a similar note, German retail sales came in very weak. Exports from Germany and America to emerging markets are offsetting this internal weakness. So we are back to the question we’ve been asking for months now, can China and Asia save the world?
The US government’s revisions to the last few years worth of GDP data show that the recession was caused by oil spiking to 147 a barrel just as much as Lehman’s collapse. That spike is what really slammed GDP. More to the point, high oil prices hurt Asian consumers. The global recovery probably can’t take oil over $80 a barrel. We need to see oil production ramp up to be truly bullish. Oil was well behaved today (bullish).
The 10-year note’s yield popped again (bearish), treasury prices were hurt by the good news on housing and this once again shows the built-in dampening effect that might limit the stock market's upside.

Geopolitics: In Nigeria, Boko Haram is best translated as “Non-Islamic education is sinful.” The word Taliban is best translated as, “Students of Islamic education.” So Boko Haram means essentially the same thing as Taliban. And after they just got crushed by the Nigerian Army, Boko Haram fighters are acting like their Taliban counterparts in Pakistan’s Swat Valley, shaving their beards, blending in with the local population, regrouping, and getting ready to fight again. Nigeria is going to need help from the CIA and it will have to cut a deal with MEND (the very powerful non-Islamic rebels) to fully destroy Boko Haram. As oil prices go up Nigeria is going to become more important. It produces the highest grade crude in the world (easy to refine) and could double production if stability were to emerge.

Specific Stocks: Flowserve (FLS) makes ultra-high performance pumps, valves, seals, and automation gear for nuclear reactors, offshore oil rigs, and caustic chemical plants. It is mostly levered to energy. The gear it makes is technically challenging and emerging market countries can’t make this stuff, but need it. Brush Engineered Materials (BW) has a virtual monopoly on beryllium alloy products. These are used in nuclear reactors, nuclear weapons, high power transformers and smaller electronic gizmos like bar code scanners. Again, this is stuff that emerging markets need but can’t make for themselves. BW reported blowout numbers a couple days ago and the stock is on a tear, making it hard to find an entry point, so be careful.

Strong Manufacturing Boosts Global Market

Charts: The S&P 500 closed at 1003, up 1.5%. The Nasdaq closed at 2009, up 1.5%. The S&P broke the key 1000 level and the Nasdaq broke the equally key 2000 level. All other indexes looked good. Technical strength is pronounced.

Fundamentals: Manufacturing reports from America and Europe came in better than expected. The US ISM survey jumped from 44.8 to 48.9 and new orders came in at a blistering 55.3 (over 50 is expansion). Construction spending in America unexpectedly improved. Retail sales in South Korea are strengthening sharply and this is the real story. The US and European consumers are weak but the Asian consumer is getting stronger as China’s boom spreads outward across the continent. The Chinese consumer can’t lift the world alone but the aggregate of all Asian consumers may be able to. Today’s good data from Western manufacturing is a reflection of Asian growth.
Cit Group made progress today in restructuring its debt, which takes a big threat off the table for now. Oil soared and the yield on government debt shot up (bearish) as we once again see that good news has a built-in negative effect that should limit any upside move.

Geopolitics: The Israeli Prime Minister is getting hit by hammer blows from a giant with a superpower’s strength. America is hammering on just one point: Israel must stop building in the West Bank and East Jerusalem. America makes no demands on the Palestinians and no other demands on Israel. America has never used this tactic before. In the past, grand schemes were cooked up that were good for winning Nobel Prizes but could never be implemented. If Israel keeps building settler housing on the West Bank there can never be a Palestinian state because that little sliver of land will eventually be filled with Israelis. But if building there is frozen, a Palestinian state is inevitable. Hard-line Israelis know this and will resist a settlement freeze with all they’ve got. Most Israelis are not hard-line and want a peaceful Palestinian state as a neighbor. If a freeze is implemented it is game over for the low level war between Israel and the Palestinians. Hamas will demilitarize as well Hezbollah and the entire Long War will cool off (super-bullish). Is this going to happen? Professional diplomats say no, team Obama is too unorthodox, too outside the box. But look at the price movement of ISL (Israel stock market). It has shot straight up since Obama started his settlement freeze demand. Who do you think is smarter: investors or foggy-bottom diplomats seeking Noble Prizes?
It sucks to be the Supreme Leader of Iran. The old guy ordered President Ahmadinejad to fire his moderate Vice-president. Ahmadinejad kept the moderate VP and only changed his job title to Chief-of-Staff, close to direct defiance of the old guy. The Supreme Leader is trying to transform his country into a 100% totalitarian dictatorship by staging Stalin-style show trials of dissidents with coerced confessions and other old school Soviet trappings. The show trials are off to a bad start, infuriating every moderate cleric in the country. The Ayatollah’s power is slipping. It seems odd to Westerners but one of his biggest problems is weak Islamic scholarship. He never did make the grade intellectually and this has always hurt him, now more than ever. It is as if the Chairman of America’s Federal Reserve did not hold a doctorate in economics and actually got bad grades in Econ. 101.

Specific Stocks: A.O. Smith (AOS) makes advanced water heaters in China and North America. The demand for water heaters in China is immense. Growth stocks like this should be bought after they break out of a basing pattern. Posco (PKX) will benefit from the new system for valuing iron ore prices that is slowly emerging. The new system favors low grade Australian ore. Posco technology works best with low grade ore.