Market Snaps Back

Charts: The S&P 500 closed at 1066, up 2.3%. The asset-bubble re-inflated violently today. The dollar dropped while oil, gold, and stocks jumped with emerging market stocks outperforming massively. During the recent downturn the dollar strengthened and assets plunged. The stock market is still technically in a correction and today’s action was a rally attempt.

Fundamentals: America’s Q3 GDP grew at 3.5%, proof that the recession has ended and higher than the 3% forecast. The government is quirky and wrongheaded in the way it uses inventory changes to calculate GDP. Strip out inventory distortions and GDP grew by only 2.5%. Investors are trained to only look at headline GDP. America’s so-so Q3 GDP was boosted by Cash for Clunkers and the expired Home Buyer Tax Credit; if we strip these two government programs out and the inventory distortion, then there would still have been growth, maybe 1-2%. The Home Buyer subsidy is probably going to be re-instated and expanded so let’s factor it back in and we get American GDP growth of 2%. So the US economy is expanding weakly out of the Great Recession. The world economy looks better. Germany today said that its unemployment rate dropped, which means that it is further into the recovery cycle than America. And since Germany didn’t enact huge deficit fueled stimulus programs its recovery is more sustainable. Norway raised central bank interest rates, following Australia and Israel. The global economy is tip-toeing into a fiscal and monetary tightening cycle.

Geopolitics: In S. Waziristan, the Pak Army is grinding forward on its 3-pronged offensive, killing 1.5 bad guys every hour around the clock. The Taliban is killing Pak civilians at about the same pace in the non-tribal regions, although civilian terror deaths come in bursts, not a steady drumbeat as is the case with bad guy combat deaths. About 300 bad guys and 300 civilians have been killed so far. Good guy combat deaths number somewhere around 30 or more. The Army does not have troop lifting helicopters so it slogs up mountains on foot under fire from the bad guys. The Army made its first attempt to raise a good guy tribal militia in S. Waziristan this week and failed. The tribes won’t play ball until they know the Army is winning for sure. Once the tribes come to this realization, a militia can be formed, trained, equipped and turned loose. Then the bulk of the Pak Army can withdraw and low level fighting between the good guy militia and what’s left of the bad guys will continue forever. At that point economic growth will be the Pak government’s most potent weapon against the bad guys in the tribal regions, peeling young men away from the Taliban with jobs.All Islamic counterinsurgency campaigns must go through this process to be successful. Advanced armies must bear the brunt of the fighting until a tipping point is reached. Local militias then carry on the fight. The advanced army draws down troops but it must always maintain some presence in the combat zone to oversee the low level war forever. This must happen in Afghanistan. After that America must begin the process in Somalia/Yemen. Does Obama know all this? Probably. Will he abandon healthcare reform in favor of the war? While mulling the troop request he has met with every half-backed peacenik in the country. Friday he meets with the Pentagon leaders. They will hammer him mercilessly to do the right thing.