Obama Channels FDR And Truman

Geopolitics: The Pak Army says that it has control of the three S. Waziristan fortress cities that the conventional thrust was aimed at. Good but not great news. The Army has control of most but not all of S. Waziristan. The conventional phase of the campaign is winding down and the guerilla war is getting bigger. The Pakistani Taliban has stepped up its presence in the Swat Valley and the other tribal lands. The fighting has diminished by about 40% but is nowhere close to stopping. Pakistan is now in a constant state of war. The whack-a-mole effect is being felt. This is a phenomenon were thousands of bad guys leave a collapsing theater of war and move on to other hotspots where the good guys aren’t as ascendant. Friday, a Russian commuter train was bombed by Chechen terrorists, killing dozens of innocent civilians. This was the biggest Islamic terror attack in Russia in 6 years. Chechen fighters are leaving S. Waziristan to fight in Russia and Afghanistan. Sunday, Afghan border police killed 27 Taliban fighters in a huge battle and captured one Chechen Al-Qaeda type for interrogation. This guy is probably a whacked mole from Pakistan. Most of the Pakistani Taliban will set up shop in the many tribal regions of Pakistan and hook up with other Taliban factions and then resume the jihad against their own country. If the Pak Army can capture and kill H. Mehsud it will take a big bite out of the whack-a-mole effect and be very bullish.
Obama launches his new Afghan war policy on Tuesday. This will be the most important speech of his career. This might be the most important speech of the 21st century. He is going to talk about an exit strategy. What we want to see in the speech is vagueness and little emphasis on the exit strategy. The more detailed the exit strategy references, the more bearish the speech. A large amount of time spent talking about the exit strategy is also bearish. If the first sentence includes the words, exit strategy, it would be very bearish. If the speech were to make zero reference to an exit strategy it would be extremely bullish. Of course every word of the speech will be important. The President has to show that he is a warrior. He needs to seize the moment and channel FDR and Truman. He has dithered for 3 months on the troop decision. He needs to step up to the plate and hit a homerun.

Carry Trade Gets Clobbered

Charts: The S&P 500 closed at 1091, down a stinging 1.5%. Volume is always low on a holiday week but there is a big technical problem with the recent drop in volume. Low volume exaggerates price moves and makes chart patterns less meaningful. Low volume is a sign that the big boys are not participating in the rally. The uptrend is under severe pressure.

Fundamentals: The government of Dubai is allowing its state owned investment company, Dubai World, to halt payments on $20 billion dollars worth of debt. Dubai World has another $40 billion in debt that is now at some risk of default, big enough to roil the world’s financial markets. After a long hiatus we are experiencing another “shoe” dropping in the credit crunch. Dubai is a Persian Gulf country with almost zero oil, but it foolishly acts as though it is brimming with oil, engaging in grand projects and huge debt fueled investments. The stock market has always assumed that Abu Dhabi would bail out its sister country within the UAE if there was a problem. Abu Dhabi has oil and could easily afford to bailout its sister, but maybe it is unwilling. This news has weakened the carry trade and in turn global stock and commodity markets. Latvia and even Greece are also close to defaulting on various kinds of debt. Remember, emerging market debt (EMD) is an end point in the carry trade; EMD is one of the major asset classes that shorted (carry trade) dollars are buying and therefore emerging market debt is integral to the entire phenomena.
The market thinks that Abu Dhabi will step in if more Dubai debt goes south and that the IMF will step in to help Latvia or Greece. If Abu Dhabi and the IMF behave as the market expects, then after a hiccup the carry trade will continue and (hopefully) the rally continues as well. Tapping the IMF does not erase bad EMD, it only transfer the debt from (for example) Latvia to Europe, America, and Japan. Abu Dhabi really can erase Dubai’s debt if it wants to. And they are part of the same country. The West is often confused about the United Arab Emirates. On paper, it is eight separate countries jammed hap-hazardously into one. In reality, Dubai is more like a province of Abu Dhabi, the leader of the UAE. The market knows all this of course and assumes that tens of billions of more bad debt from Dubai will get backstopped by the UAE’s leader. If this doesn’t happen, the carry trade will take a bigger blow and so will stock markets.

Mullah Omar Is The Taliban

Charts: The S&P 500 closed at 1111, up .45%. Oil is moving in a band of $75.50 and $80. It is important that oil continues to meet resistance at $80. The dollar carry trade is still fueling the recovery/rally and it is benign as long as oil and interest rates behave, which is the case with yield on the government’s ten-year note under 3.4%, well below the 4% danger zone. We are seeing a Yen carry trade grow next to a dollar carry trade. Professor Roubini has criticized the dollar carry trade as “mindless.” But the Yen carry trade is powered by hundreds of thousands of wealthy households in Japan, not a handful of hedge funds, so it is more discerning, therefore sustainable and bullish. Plus, the yen carry trade uses less leverage, more cash.

Fundamentals: First time jobless claims fell below 500,000, a key psychological number. Consumer sentiment has unexpectedly turned up and new homes sales came in stronger than expected. This creates a triple dose of good fundamental news.

Geopolitics: On Tuesday President Obama is unveiling his decision on McChrystal’s troop request and policy review. The President is expected to say that there will be 35,000 new US troops and 5,000 new non-US NATO troops for Afghanistan. As far as strategy overhaul, McChrystal is already moving troops out of far-flung outposts and into Kandahar and the Helmand River Valley (HRV: right next to Kandahar). This is the beginning of the counterinsurgency surge and a new strategy that will focus on establishing full government control in the Taliban’s birthplace, Kandahar, which is also the largest southern city. The initial strategy also calls for the Marines to take control of HRV, where opium poppies are grown to fund the Kandahar Taliban. In a way it will be like opening up a third front in the Long War because Afghanistan has been neglected for so long its eruption will seem like a new war. Going forward, southern Afghanistan is going to become the focal point of the Long War. Kandahar is Mullah Omar’s hometown. Mullah Omar is the Taliban.

Obama Wake Up!

Charts: The S&P 500 closed at 1106, down .05%. Support at 1100 is holding. Resistance is at 1110. Chart patterns look good. Volume patterns, however, look bad. Monday saw a huge gain but once again on feeble volume. The technical picture isn’t as good as the charts indicate.

Fundamentals: Q3 GDP was revised down from 3.5% to 2.8%. Real Final Sales (RFS) is GDP without inventory adjustments, a government generated number. It could also be called “Real GDP.” RFS showed American GDP growth at 1.9% (all numbers annualized). The Clunker program was in Q3 and had some sort of one-time boost, but let’s be generous and overlook that and say the US economy is growing at 1.9% in the fifth month of recovery. That’s anemic by historical standards. The Euro-zone is probably growing at the same pace as the US. China is probably growing at 10%, with the rest of emerging Asia keeping pace with China. Israel raised interest rates for a second time, the most aggressive tightening move yet by any country, further evidence of emerging market strength. The dinosaur vs. tiger quandary is still alive. ISL is the index for Israel.

Geopolitics: The Wall Street Journal ran an article today describing how the ISI’s pet terrorist organization, LET, has been caught trying to launch several fresh terror operations against India. LET is responsible for the huge Mumbai bombing a year ago. Pakistan has promised to shut LET down but there is evidence that ISI is keeping its pet alive and healthy although on a short leash. A point to bear in mind is that LET is ultra-competent and ultra-deadly, an elite commando terror army. The question that can’t be answered yet is how short is ISI’s leash on LET? What if LET goes rogue and attacks India without ISI’s permission? It would be disastrous if LET did succeed in a big showy terror strike inside India or even worse, a prolonged terror campaign. That isn’t happening yet, the leash seems to be working so far.
The bigger picture is this: America better let Pakistan do what it wants as far as LET is concerned. The Pak Army is a jihadist killing machine that is currently running at full throttle. Pak helicopter gunships are roving the Afghan/Pak border hotspots and chewing up bad guys like threshing machines. Pak infantry and artillery are wading into the heart of darkness and destroying the most powerful Taliban network in the world, the one anointed by Al-Qaeda as the sharp end of the spear.
Meanwhile, On the Saudi/Yemen border, the Saudi Army is running war operations at a steady pace. The Houthi rebels in northern Yemen are being continously pounded by Saudi artillery and F-16 strikes as the Saudi infantry continues to secure its side of the border and preseumably work on establishing its buffer zone. The bad guys are infiltrating the long mountainous border to put fighters inside Saudi Arabia. On its side of the border, the Yemeni Army is also running at full steam. Ominously, the Yemenis are saying that Al-Qaeda in the Arabian Peninsula (AQAP) and the Houthi rebels to the north are cooperating to a much greater degree than previously thought.
The Long War is running pretty hot right now and it does need US involvement even though the Saudi and Pak Armies are doing a good job. Obama, wake up!

Vietnam History Lesson

Geopolitics: The debate rages over Obama’s new strategy in Afghanistan. The word Vietnam is getting thrown around by the peaceniks but in a sloppy manner. To avoid being sloppy let’s review the history of the Vietnam War. The war lasted from 1946 to 1989 (four times longer than most people think). North Vietnamese Communists fought France from 1946-1954; then America from 1955-1973; then South Vietnam from 1973-1975. In 1975 North Vietnam defeated South Vietnam and took control of the entire country. But the war didn’t end in 1975 because that was the year Communist Vietnam went on the offensive, attacking and conquering other countries. In 1975 Vietnam gained control of Laos through a Viet Cong style guerilla war. In 1979 Vietnam invaded and occupied Cambodia in a blitzkrieg campaign. This is the same year that the USSR invaded Afghanistan. The two invasions were coordinated for maximum effect, a global bad guy push of enormous proportions. The Soviets got bogged down in Afghanistan but Vietnam had no trouble conquering Cambodia. A few months after the invasion of Cambodia (still in 1979) China invaded Vietnam because the smaller Communist power had become dangerously expansionistic. The Sino-Vietnam War was short but bloody. China withdrew from Vietnam with the understanding that there would be no more conquests. Vietnam fought a low level guerilla war in its conquered territories until it withdrew from Cambodia in 1989 in unison with the USSR’s withdrawal from Afghanistan; the final hours of the Cold War. Vietnam and the USSR remained highly synchronized until the bitter end. Vietnam withdrew from Cambodia because the Cold War was over. The Vietnam War lasted for the entire length of the Cold War because the Vietnam War was the Cold War and the good guys won the Cold War. We won the Vietnam War and heaven help us if we’d lost because it would have meant losing the entire Cold War. It’s not okay for America to lose a war.
The Long War has not affected stock markets as strongly as the Cold War did, not yet.
If Obama screws up badly enough that could change. America could start losing the Long War. Eritrea has already established itself as an Al-Qaeda ally. That makes one impregnable Taliban nation-state; a country that America cannot touch. If the Houthi rebels in northern Yemen were to hive off a nation-state there would be two. In Somalia all that would need to happen would be a truce between the government in Mogadishu and Al-Shabab and a third fully functioning Taliban state would spring into existence. What if Pakistan wins in South Waziristan but then stops because America has a week-kneed withdrawal timeline in Afghanistan and the Pakistanis don’t want to be left hanging by themselves against a rising tide of Islamic violence? Now there are ten Taliban states plus whatever arises out of Afghanistan. It’s not hard to spin scenarios where the Long War gets very ugly so we need to start seeing some backbone from the Commander-in-Chief.

Mehsud Terror Factory Dismantled

Charts: The S&P 500 closed at 1091, down .3% and under the key 1100 long term resistance level (bearish). The fourth rally leg is under pressure. Volume patterns in this latest rally are worse than the other three. Uncertainty over the carry trade is probably causing the weak volume. Emerging market economies are starting to slap capital controls on foreign investment, which hurts the carry trade.

Fundamentals: The bad US housing numbers that we saw earlier in the week are roiling the market. The numbers were weak because the $8000 Tax Credit expired, but it has since been reinstated and made even bigger. Fine, except that in April and March the new Tax Credit expires and the Fed’s program to buy mortgage backed securities also expires. American housing looks like it can’t stand on its own two feet and the looming expiration dates are scary because the stock market usually looks 6 months ahead. Growth in China remains strong so we are back to the tricky calculation of whether the strong tiger economies can overcome the weak dinosaur economies.

Geopolitics: The Pak Army is dismantling small Taliban towns in S. Waziristan that have been used as training centers for suicide bombers, this is the main thrust of current operations. The Army intends to shut down the Mehsud tribe’s capability for terror strikes within the rest of Pakistan by taking apart the terrorist infrastructure of the Mehsud tribal lands in S. Waziristan. The Mehsud terror factory is probably the largest in the world. Still, there is a lot of bad guy country in the other tribal lands besides the Mehsud territory. Terror strikes could be launched from other (non-Mehsud) Taliban areas and towns. Any non-Mehsud Taliban that launched a new terror campaign would be next on the Pak Army’s invasion list after the Mehsuds are dealt with. Bear in mind that H. Mehsud was Al-Qaeda’s favorite to take over the Pakistani Taliban alliance, the strongest in the country. That makes him the number one bad guy in the world. What this all boils down to is that the Army is correct to strike directly at H. Mehsud.

Powell Doctrine Bad News

Geopolitics: The Obama Administration is apparently saying that before a final decision is made on McChrystal’s troop request there must be a clear exit strategy in Afghanistan. Various leaks and rumors have percolated out of the White House and Pentagon concerning the Afghan strategy deliberations. The leaks are sometimes contradictory, purporting one thing and then another. We of course don’t really know what is going on within these deliberations. Some of the leaks have been positive. The one cited above is negative. The term “exit strategy” comes from the so-called Powell Doctrine. Applied to Long War conflicts the Powell Doctrine is not only irrelevant, it would be disastrous. The PD says all wars should be fought like WW II or a sort of romanticized version of WW II. That is to say that public support (poll numbers) should be sky-high in favor of the war before American forces engage. The expeditionary force must be overwhelmingly huge with total national resources devoted to the war effort; the country must be on the path to full mobilization as in WW II or the war should not be fought. The PD departs from WW II strategy by saying that if US forces start to lose there should be an exit strategy, i.e. the troops should be brought home and not left in the field to fight a protracted lost cause. Truthfully, the core of the Powell doctrine doesn’t even really work for big conventional wars like WW II. Opinion polls were against American involvement for two years once war broke out in Europe. Japan mopped America up in the Pacific for the first several months of fighting, should that have triggered an exit strategy? The US Army was knocked back hard in the Battle of the Bulge, exit strategy?

Powell Doctrine Bad News

Geopolitics: The Obama Administration is apparently saying that before a final decision is made on McChrystal’s troop request there must be a clear exit strategy in Afghanistan. Various leaks and rumors have percolated out of the White House and Pentagon concerning the Afghan strategy deliberations. The leaks are sometimes contradictory, purporting one thing and then another. We of course don’t really know what is going on within these deliberations. Some of the leaks have been positive. The one cited above is negative. The term “exit strategy” comes from the so-called Powell Doctrine. Applied to Long War conflicts the Powell Doctrine is not only irrelevant, it would be disastrous. The PD says all wars should be fought like WW II or a sort of romanticized version of WW II. That is to say that public support (poll numbers) should be sky-high in favor of the war before American forces engage. The expeditionary force must be overwhelmingly huge with total national resources devoted to the war effort; the country must be on the path to fully mobilization as in WW II or the war should not be fought. The PD departs from WW II strategy by saying that if US forces start to lose there should be an exit strategy, i.e. the troops should be brought home and not left in the field to fight a protracted lost cause. Truthfully, the core of the Powell doctrine doesn’t even really work for big conventional wars like WW II. Opinion polls were against American involvement for two years once war broke out in Europe. Japan mopped America up in the Pacific for the first several months of fighting, should that have triggered an exit strategy? The US Army was knocked back hard in the Battle of the Bulge, exit strategy?

Al-Qaeda In Crosshairs

Charts: The S&P 500 closed at 1110, down .05%. Uptrend intact.

Fundamentals: The October Consumer Price Index rose .3%, 3.6% annualized, much worse than expected. Most inflation data lately has been tame but the shaky trapeze-like recovery is highly dependent on super-low interest rates for a long time, so inflation is more dangerous than in a normal recovery. Housing starts plunged 10.6%, worse than expected. The Home Buyer Tax Credit had expired by October but it has since been renewed and expanded. We don’t know yet if the new HBTC will keep housing afloat or not. The recovery is not only dependent on existing government policies, those policies have to work perfectly. And any new big spending government program (like healthcare) is probably destined to cause a double-dip recession.

Geopolitics: The Pak Army is saying that most of the Pakistan Taliban fighters have indeed retreated from S. Waziristan. But the resistance is as strong as ever. The Pak Army is taking the bad guy capital city of Makeen one bloody street at a time. It has killed over 500 bad guys so far. The fighters that are left are mostly Al-Qaeda types: Arabs and Uzbeks, the inner chamber of the heart of darkness. So America’s wish that the Pak Army should take on Al-Qaeda has come true.

Saudi Kill Zone

Charts: The S&P 500 closed at 1110, up 1.5% since Monday, breaking through long term resistance of 1100. The big gain on Monday came in higher volume. This was the first time we got decent volume on a big up day in the current rally leg that started a couple weeks ago. The slavish movement of all asset classes in response to the dollar is breaking down, at least in the last few days. If the rally and recovery can continue without the carry trade it would be good news. Chinese officials warned Obama that they wouldn’t tolerate the carry trade indefinitely. Not only could China dismantle the carry trade at any time, it has to actively keep it going or the carry trade would unwind by itself.

Fundamentals: Japan’s Q3 GDP came in twice as good as expected, almost entirely based on China’s blistering recovery, not internal Japanese strength, which is still very weak. American retail sales for October came in much better than expected but September was revised sharply downward. All these gyrations for US retail data are due to the reverberation of Cash-For-Clunkers. September saw a bigger plunge in auto sales than first thought as Clunkers ended and the October upside surprise was due to autos bouncing back from the freakishly huge September plunge.

Geopolitics: The Saudi Gazette reports that the Saudi Army is in a mopping up phase on its side of the border in the Yemen war, hammering bad guys with Apache helicopters and resuming efforts to build a militarized buffer zone inside Yemeni territory. The Saudis are calling the buffer zone a “kill zone,” an indication that the good guys mean business. On Monday the rebels and the Yemeni Army locked up in a major battle. There is no media presence for this hotspot, so no body count, but the rebels are appealing to the Arab League to intervene and stop the war, which speaks to the rebels not doing that great.

The Pak Army says that it is has slowed down offensive operations and is consolidating all its positions in S. Waziristan. It also says that since Saturday it has killed 36 bad guys in the Swat Valley, an area that has proven to be hotter than expected since the push into S. Waziristan started. The Los Angeles Times reports that the CIA is providing 30% of the ISI’s budget and training ISI operatives in its North Carolina facility. There are ongoing reports that the ISI (Pak version of CIA) is still helping the Taliban in North Waziristan. The two NW Talibans provide safe haven for Al-Qaeda and have a truce with the Pak Army. With the CIA joined at the hip with the ISI, the implication is that the CIA is helping Al-Qaeda. The Obama administration is starting to put pressure on the Pak Army to mount an offensive in North Waziristan. But it’s not as simple as all that. The Swat Valley and S. Waziristan have to be totally stabilized before the Pak Army can even think about pushing into N. Waziristan. And Pakistan has still another mini-rebellion in Baluchistan that must be dealt with. It’s called the Long War for a reason. It’s going to take a long time before the Pak Army can actually go after Al-Qaeda and by then Al-Qaeda will have moved to Somalia or Eritrea. The flare-up in Yemen is a signal that the LW is slowly moving its center of gravity toward the horn of Africa.

Take A Jarhead To Lunch

Geopolitics: Assuming the leaks are correct and the troop decision has been made the market’s attention will turn to the perennial question: will the good guys win in Afghanistan? The answer: Yes, because in the years ahead most of the hard fighting will be done by the Marines, not the Army. Conditions are much tougher in Afghanistan than Iraq and it is going to take longer to sew it up there. It is a good thing that McChrystal instinctively turns to the Marines over the Army for the sharp end of this spear. Fuel has to be trucked hundreds of miles through mountain passes filled with missile toting bad guys in Afghanistan. Soldiers sleep in the dirt in Afghanistan, not in heated and cooled buildings like in Iraq. Frankly, there are conditions on this battlefield that are beyond the capabilities of the US Army.
Put bluntly, the Marines are better than the US Army. Put another way, the US Army is the second best army in the world. Thank God America has the very best and second best armies in the world because we’re going to need both of them, but mostly the varsity team: USMC.
Not only do the Marines produce better soldiers in the field than the Army, it has better people throughout the whole chain of command. Consider the Army Major who went on a killing spree in Fort Hood. The guy had Al-Qaeda on speed deal and screamed, “Allah Akbar!” like a Taliban before firing. That sort of thing would never happen in the Marines.
That’s why USMC has been winning all the big battles so far in the Long War. Iraq turned around after the Marines won in Fallujah because conditions there were too hot for the Army. And today the Marines are in the middle of bad guy country. They are your best friend. The person who you think is your best friend cannot keep your portfolio from crashing. Only the Marines can do that. So take a jarhead to lunch. Do something to show your appreciation.
And the Marines are commanded by a savvy Commander-in-chief. I have been saying that Obama’s track record was nearly flawless in geopolitics until he caved in on settlement building with Israel. I have rethought my position. Obama was right to cave. The original policy of forbidding all settlement building in the West Bank and East Jerusalem would have been more than effective, it would have been hyper-effective; a fully functioning Palestinian state would arise in a couple years if Netanyahu froze all settlement building. Game over. No Likud PM will want to be at the helm when a Palestinian state is formed. Israel will have to hold an election and put a dove in office before that can happen. But Obama has hit on the path forward that will eventually produce the new independent state and take the Long War off boil. And talks are on hold until there is a settlement freeze, which enrages the doves in Israel. So Obama hasn’t caved that much. He is just playing smart poker. Now the issue of settlement building will dominate the next Israeli election.

A Healthy Carry Trade Today

Charts: The S&P 500 closed at 1093, up .6%. Uptrend intact. Resistance at 1100.

Fundamentals: The greatest danger to the dollar carry trade is emerging market countries depreciating their currencies by buying dollars or establishing capital controls or both. China is hinting that it might prevent this from happening by increasing the value of the Yuan. If China allows its currency to appreciate then virtually every other emerging market currency is effectively depreciated and these countries will probably stop attacking the carry trade. China allows its currency to rise by slowing down its purchase of dollar denominated assets like treasuries. In response, the other tiger economies will not step up their purchase of dollars and the greenback keeps falling. There are three dangers in basing the global recovery on an ever falling dollar: 1) Oil will keep going up until it hits $100 and crushes the recovery. 2) The US government has trouble financing its gargantuan debt, causing interest rates to spike. 3) The dollar can’t fall to zero.
Today we saw the dollar down, oil down, and treasury yields down, an atypical pattern. So problems 1 and 2 did not occur at least on the day and we had a much healthier version of the carry trade. We should start thinking of the carry trade in these terms: healthy or unhealthy. Here is the definition of an unhealthy carry trade: the dollar goes down causing interest rates and oil spike.

Geopolitics: The Saudis said that they had cleared all rebels from their territory two days ago. But now fighting appears to have spilled back into the Kingdom because a spokesman for UNICEF (a UN agency) said that 240 Saudi villages along the border are being evacuated, a sign there is fighting again on Saudi soil. Also, the Saudi and Yemeni Navies are intercepting boats carrying weapons and possibly fighters into the border region. These small sea craft are probably sponsored by Iran, so the Ayatollah is taking harder action than I predicted. Long story short: the Yemen war is pretty hot.

And the war in S. Waziristan is getting hotter. 17 good guys were killed and 22 bad guys in extremely heavy fighting Thursday. This was the highest single day body count for the good guys and (unfortunately) a relatively low body count for the bad guys. The Army’s three pronged assault now looks like one huge circle with three smaller circles inside. Three Taliban fortress cities continue to hold out. And fighting is also flaring up in the Swat Valley. Nevertheless, the Pak Army is winning.

Bad Guys Fight Back

Charts: The S&P 500 closed at 1087, down 1%. 1100 is providing tremendous resistance.


Fundamentals: The dollar was up today with predictable results. Emerging market countries across the globe are beginning to defend their currencies. This is beginning to put upward pressure on the dollar, harming the carry trade. Lately all financial asset prices have moved in a pattern against or with the dollar. Short covering on the dollar (unwinding the carry trade) is bad for stocks.

Geopolitics: Enough leaks have occurred for us to know Obama is giving McChrystal 35,000 new troops and 10,000 new trainers. Assuming the leaks are accurate, Obama is doing the right thing. This is good news. Before we get too overjoyed let’s remember that the bad guys get a vote too and there are plenty of hurdles ahead. The fighting in S. Waziristan is no picnic. Despite announcing a retreat, the bad guys are digging in. Pak Army kill ratios are dropping fast as the good guys are forced to crawl into bobby-trapped tunnels a kilometer long and pick through the rubble of bombed out towns to find hidden bad guys armed to the teeth. The bad guys left are fanatics. The SW war started with a 100-1 kill ratio as jets and artillery did the heavy lifting. Now it is only 3-1 as fighting goes practically hand-to-hand against hardened Taliban veterans. The Taliban capital city of Makeen and several other fortress-type cities are still in bad guy hands. The Army is battling just to acquire complete control of all roads leading to Makeen and may be laying the groundwork for a genuine protracted siege. The good guys are pulling more ammunition, weapons, and bombs out of S. Waziristan than anybody dreamed possible, trucking away tons of lethal ordnance. S. Waziristan is, after all, the heart of darkness and it’s not easy to stop the black heart from beating.
Unfortunately, the bad guys have made some progress globally as well by enlarging the battlefield. Steady and unrelenting Long War combat is occurring in Pakistan, Afghanistan, Somalia, Yemen, and most recently Saudi Arabia. The Saudis say that they have now retaken all the lost territory that the Yemeni rebels had seized, but they are still fighting the rebels, still taking casualties.

Al-Qaeda's Worst Nightmare

Charts: The S&P 500 closed at 1099, up .5%. Uptrend intact. Resistance is at 1100.

Fundamentals: The Blue Dogs are talking about creating a deficit commission, modeled on the lines of base closure commissions, which allow only up or down votes on spending cuts. If they can pull it off this would be great news. Industrial production data from China came in stronger than expected. This was the catalyst for the rally’s continued momentum.

Geopolitics: The Saudi Army is establishing a militarized buffer zone inside Yemen similar to the buffer zone Israel maintained in Lebanon from 1985-2000. Also, the Saudi Navy is blockading Yemen’s coast, preventing Iran or any other bad guys from funneling fighters into the combat zone. Iran is talking diplomatic smack against Saudi Arabia and the Kingdom is answering with warships and troop movements. The ball is in Iran’s court and most likely the Ayatollah will wimp out. The Saudi Army has never been used in battle, so the world is unprepared for its massive strength. The power struggle between Iran and Saudi Arabia is currently the biggest factor in the Long War. If Saudi Arabia prevails, slapping Iran and its proxies hard, ending the rebellion in northern Yemen, then Al-Qaeda will have sustained a tremendous body blow. And not just for obvious tactical reasons.
Al-Qaeda’s reason for existence is to reestablish the Great Caliphate of the Middle-Ages. Its greatest fear is that the Saudi royal family will do just that, forge an alliance of Islamic countries that essentially recreates the Great Caliphate. Al Qaeda was created because America saved the holy city of Mecca from Saddam Hussein’s clutches in the first Gulf War, not the House of Saud. The Saudi failure to stop Iraq in 1990 is Al-Qaeda’s number one talking point. America (99% infidels) is currently the guarantor of Mecca’s sanctity, Al-Qaeda’s number two talking point. Al-Qaeda’s worst nightmare is America voluntarily turning over the reins of power in the Mid-East to a newly militarized Saudi Arabia and pulling Yankee troops out of Muslim lands.

Army + Stock Exchange = Good Guy

Charts: The S&P 500 closed at 1093, flat on the day, up 2.2% on the week. The volume on Monday’s big up day was high enough to turn the rally attempt into a genuine rally, signaling the start of the fourth rally leg within the bull market that started in March. The volume pattern is now bullish within the 2-week old rally leg. But only 4.66 billion shares traded on the NYSE Monday compared to the ‘09 average of 5.78 billion. And during the recent correction the average volume on down days was greater than Monday’s total. Volume is becoming a technical issue as the bull matures. As noted yesterday, stock market volume has to be low to allow enough funds to flow into the nearly insatiable government bond market and it’s working, we continue to see stocks and bonds rally simultaneously. Like a trapeze artist the rally and recovery are wobbling along.

Fundamentals: The leaders of the G20 met over the weekend and pledged to keep deficit –fueled fiscal stimulus measures at current levels until a full recovery is under way. The bull market so far has been liquidity fueled and this pledge insures hyper-liquidity for the foreseeable future, inflating financial assets and commodities through the dollar carry trade, this is not necessarily good news fundamentally. But economic data from Germany and China keep surprising to the upside. The global recovery is uneven. America is limping along and Latvia announced another shocking 18% collapse in GDP.

Geopolitics: It’s very simple to tell the good guys from the bad guys among the armies/militias fighting in the Long War. All armies/militias connected to stock exchanges are good and the ones not connected to stock exchanges are bad. The Taliban, Al-Qaeda, and Al-Shabab do not have stock exchanges and are bad. NATO countries, Afghanistan, Pak, Kenya, the African Union, Ethiopia, Iraq, S. Korea, and Somalia have stock exchanges and are good. The Somali stock market is up the most of this group, 500% in the last 3 months. Even though the leading Somali stocks are publically traded sea pirate companies, the country has a corporate structure and some legitimate companies are flourishing. Among the good guy national armies only Yemen does not have a stock exchange. This is a massive weakness in our global alliance. Fortunately, Dubai is working night and day to open an exchange in Yemen and by early 2010 we will be able to buy and sell Yemeni shares. Dubai, therefore, is striking a blow for the good guys through financial engineering.
In Afghanistan, The Afghan Army has killed 130 bad guys in a major battle in the northern part of the country. With NATO air support and help from US Special Forces, the Afghan Army did the lion’s share of the fighting and suffered no combat deaths.
Iran and Saudi Arabia are trading diplomatic threats over the Saudi military operations in Yemen. The Saudi government says it will stop attacking the northern rebels once they retreat 10 kilometers inside Yemen. Saudi jets are still pounding the bad guys at present.

CIA Is Your Last, Best and Only Friend

Charts: Since the bull market began in March its greatest technical weakness has been volume. The 2002-2007 bull market saw a net inflow of $250 billion into domestic equity mutual funds. With nearly a 70% gain since March, this bull market has seen a net inflow of only $7.8 billion. If this were a normal bull market, the inflow would have been $150 billion by now. In recent months and weeks volume has been getting worse to the point where we are now seeing outflows even as the market rises. The rally attempt that we are currently in has seen very low volume, so low that even with big price gains it has not yet qualified as a technical rally. What all this means is that retail investors are not participating in the uptrend and a swath of big institutions are also MIA. Volume this anemic is a hallmark of a cyclical bull market within a secular bear. At some point volume must pick up for a multi-year bull to emerge. But there is a Catch-22 to a volume pick-up. Read on.

Fundamentals: The current bull market can only continue with very weak volume flows because there is so much government debt coming to auction that a massive and continuous flow of funds must keep pouring into treasuries. If volume were to improve to historical levels in the stock market then fund inflows would dry up in the government bond market, jacking up interest rates, clobbering housing, and then tearing apart the balance sheets of the globe’s financial firms who still hold billions worth of mortgage backed toxic assets on their books. We have a fragile Goldilocks recovery where economic conditions are scary enough to keep most investors in bonds but not so scary that a few brave souls are buying stocks.

Geopolitics: The Saudi Army has retaken a key mountain from the Yemeni rebels. The mountain in question straddles the border between the two countries. Media reports say that 6 Saudi soldiers have been killed so far and maybe 100 bad guys. The rebels claim to have shot down a Yemeni fighter-bomber and the Yemeni government admits that a jet did go down in the battle zone but denied that the bad guys were responsible (they probably were). The rebels are fighting both the Yemeni and Saudi Armies simultaneously and it is hard fighting on all sides. Saudi Arabia reached out to Pakistan, vowing to cooperate militarily. Saudi Arabia is waking up to its responsibilities in the global conflict. The Long War cannot be won without Saudi Arabia providing leadership to the Muslim world.
In Afghanistan, Afghan soldiers killed 17 bad guys in a fierce battle Sunday, backed up by NATO jets. This shows good progress on the part of the Afghan Army which numbers about 200,000 soldiers.
In S. Waziristan, the Pak Army is slowly moving into the biggest and most important Taliban cities, including the Taliban capital Makeen. And it is still killing about 30 bad guys a day. Unfortunately, the Taliban is once again stepping up its terror attacks against the non-tribal regions. It killed a score of civilians over the weekend. Pak civilian morale is holding up even under this savage onslaught, so far.
In Somalia, as heavy fighting continues in the north and central regions between the government and Al-Shabab, the super-bad guys are complaining vociferously to Kenya about its training camps that are readying an anti-Al-Shabab militia. There are reports that these camps are paying villagers large sums to have their young men enlist and fight for the good guys. Large sums in Africa mean only one thing: CIA involvement. Scholars call the global conflict the Long War against Islamic Extremists Militias. Someday we will call it the Long War between Islamic Extremists Militias and Islamic non-extremist Militias. When the CIA creates good guy Islamic militias it means that the US Marines will not be taking casualties and enraging American liberals, making America’s role in the Long War more sustainable. The CIA is your last, best, and only friend.

The Mighty Saudi Army

Charts: The S&P 500 closed at 1069, up .25%. The correction has morphed into a rally attempt, not a technical uptrend.

Fundamentals: The monthly employment report was out today. It has two components, Payroll and Household. The Payroll survey was good, it said that in October companies shed 190,000 jobs (15,000 worse than expected) but it revised the two previous months favorably by 91,000 (much better than expected). Payroll also said that temp hiring picked up and factory hours increased, positive indicators. The Household survey includes self-employed people and small firms as well as big firms, so it covers the entire labor force. The Household survey said that 589,000 jobs were lost and unemployment jumped from 9.8% to 10.2%, very bad. The Household survey said that 324,000 workers have stopped looking for jobs, a phenomenon associated with an ongoing recession. If these discouraged workers had kept looking for jobs unemployment would have risen to almost 11% (horrendous). The two surveys gave opposite views of the labor market. Investors are trained to focus on the Payroll survey. The voting public is trained to focus on the Household survey’s unemployment rate. Headlines will be screaming tomorrow: Over 10% Unemployment! The danger here is that Congress will start working on a second “jobs only” stimulus package and blow the deficit even higher. One of the bad side effects of (maybe) the healthcare bill going down in flames is immediate pressure for more spending elsewhere.

Geopolitics: The Pak Army is pushing into the Taliban capital city of Makeen, steadily killing about 30 bad guys a day. Despite the Taliban’s pompous announcement that it is engaging in a fighting retreat, resistance is heavy in this strategic city and the other Taliban towns that the Army is smashing into. The bad guys are fighting back as hard as they can because they don’t really want to become a homeless guerilla army. The Taliban is simply getting beaten by the Pak Army as opposed to executing a clever tactical retreat.
We have a better picture of the fighting between the Saudi Army and the northern rebels from Yemen. The bad guys seem to have actually captured a couple of Saudi towns along the border earlier in the week. The Saudi Army has retaken those towns and pushed the bad guys back into Yemen. The Saudi Army remains massed on the border. It is pounding the bad guys with artillery and flying bombing runs with F-15s. The Saudi Army is not yet moving regular troops into Yemen but continues helping the Yemeni Army in a myriad of ways including Special Forces operations. The rebels in northern Yemen are Shiites and Saudi Arabia has a restive Shiite population near the border region. These Saudi Shiites are always on a low boil, keeping the Saudi Army out of Yemen for now. The Saudis will take ground action in Yemen if they can clamp down on security on their side of the border. Hospitals in the Saudi border region have been ordered to get ready for Army casualties.

Productivity Saves The Day

Charts: The S&P 500 closed at 1067, up 1.9%, punching through 3 resistance levels. Stocks were up, the dollar was up, and oil dropped, all good. For today at least the toxic inverse correlation between the dollar and stocks was broken. So the dollar carry trade unwound to some degree but stocks rallied anyway. Action today was bullish but the market needs a follow through day for a technical rally to resume. The market is in a rally attempt.

Fundamentals: The fundie news today was entirely positive. Retailers posted a 2.2% increase in October, good but not great, better than expected. Work force productivity numbers came in much better than expected. Sky high productivity makes runaway inflation virtually impossible, which mitigates the danger of the vast monetary expansion engineered by the Fed, which in turn lessens the problems that Professor Roubini has been warning on dollar carry trade short covering. Cisco reported good earnings, but more importantly it gave an upbeat forecast. Cisco started the bear market a year and a half ago with a downbeat forecast so its current forecast carries a lot of weight. First time jobless claims came in better than expected today. Maybe the biggest news of all is Senate majority leader Reed saying the healthcare bill can’t pass this year. After the 2 Republican off-year election victories on Tuesday, moderate Demos are scared to push healthcare reform and it could be dead (bullish).

Geopolitics: The Iraqi government is at last signing contracts with outside oil companies to develop some of its gargantuan oil fields. The bulk of the development is going to be done by Chinese firms. This is a sign of a successful end game in the Iraq war. If Iraq’s energy industry were to become as developed as Saudi Arabia’s, then Bush was absolutely correct in starting and prosecuting the Iraq war. An unambiguous American victory in a major war equates with a bull market.
This might be the only clear US victory for a while. And that’s okay because the Long War is shifting away from the US Army and Marines. The Iraqi Army and security forces have over half a million troops and are a well-oiled machine. The Pak Army is even bigger and better. The Long War is more dependent on America’s Islamic allies than the Cold War was dependent on our weak-kneed European NATO allies (who never helped at all). Progress in the Long War is best measured by success or defeat of good guy Islamic armies like Pakistan’s, rather than focusing solely on the US Army.
The major news item for the day proves my point. The Saudi Army is currently massing on its border with Yemen, readying an attack against the Iranian sponsored northern rebels that are tearing Yemen apart. Saudi Special Forces are already inside Yemen. The Saudi Air Force is making massive bombing raids against the northern rebels, firing 100 missiles into a single rebel position. The success or defeat of the Saudi offensive in northern Yemen is more important than Obama dithering on the troop request or the fact that 1 US Soldier was killed in Afghanistan the other day. Unfortunately after decades of studying the Cold War we have reflexively ingrained US-centric thinking into our analysis of the Long War. That kind of thinking ends today.

Taliban Retreat!

Charts: The S&P 500 closed at 1047, up .1%. First resistance is at 1052, the 50-day moving average. Next resistance is 1056, a key retracement level of the correction. Above that resistance is at 1060. Support is at 1040. The market is in a correction. The market made a bearish late day reversal and failed to retake the 50-day line (not good).

Fundamentals: In its big policy statement the Fed said the economy is weak and rates will be low for a long time. America’s ISM service sector index came in worse than expected, registering a slight decline after a series of gains. An anemic American recovery coupled to strength in Asia pushes the dollar down and fuels the dollar carry trade, good for bubble-mentality and bad for fundamentals. Professor Roubinin gave a speech about the asset bubble today. He said, “When it unravels, it’s going to get ugly. Everyone shorting dollars will try to get out of those positions at the same time, and we’d have a stampede.”

Geopolitics: A spokesman for the Pakistani Taliban told reporters that the Taliban is making a tactical retreat in S. Waziristan because it is unable to fight toe-to-toe with the mighty Pak Army in conventional warfare. The spokesman said that the bad guys will complete a fighting retreat and then regroup for an extended guerilla campaign which will hit targets throughout Pakistan. Public opinion polls in Pakistan show that 51% of the population supports the war even though civilians are getting killed every week in large terror attacks (courageous).

Dollar Carry Trade

Charts: The S&P 500 closed at 1045, up .2%. The market is in a correction. The last two days action represent a rally attempt.

Fundamentals: M&A activity buoyed stocks today plus factory orders came in stronger than expected. Besides strong manufacturing data the global stock and commodities rally is also being fueled to some degree by a US dollar carry trade. This means that investors are shorting the dollar on margin and buying emerging market debt/stocks, commodity futures, and other risky assets. The carry trade investors are effectively borrowing at a negative 20% interest rate, making piles of cash so far. But it has become a ubiquitous bet of massive proportions. The link between the dollar going one way and the S&P 500 going the other (inverse correlation) is now about 70% and rising. Historically the inverse correlation is in the single digits. All major global financial movements are taking their cue from the dollar. Professor Roubinin says that this link must break down at some point because the dollar cannot drop to zero. He predicts that when the dollar stabilizes there will be an immense sell-off in risky assets (the bubble popping on dollar short covering) although Roubini does think the bubble may keep expanding for a while. Other economists predict a gradual unwind of inverse dollar linkage and are more bullish. The yen carry trade lasted 5 years in the previous bull market.

Geopolitics: There is evidence that the US Army opened the borders between Afghanistan and Pakistan, allowing perhaps a few thousand extra Taliban fighters into South Waziristan at the beginning of the war a couple weeks ago. The Pak Army made the original assertion and now claims that the US Army has sealed the border and bad guys are no longer streaming in. If all of this is true, then it is certainly was a brutal move on America’s part. It forced the Pak Army to kill more bad guys then they would have otherwise, spilling more good guy blood than initially planned. The alliance got a bit frayed over this move. The Pak Army felt better after India moved a division out of Kashmir.
Team Obama has abandoned its strongest diplomatic effort: The demand Israel halts its West Bank building program. The Team caved in because of problems with its domestic agenda. It couldn’t stick its neck out diplomatically against Israel while healthcare flounders.

Specific Investments: The Ridgeworth ultra-short government bond fund (SIGVX) pays 3.5% interest and is rated by Morning Star as low risk. Only cash is risk free, but cash is paying negative real interest rates.

Pak Army On The March

Charts: The S&P 500 closed at 1041, up .5%. The market is in a correction.

Fundamentals: America’s October national ISM manufacturing index came in today much stronger than expected. The employment and export components were good but new orders softened. Manufacturing data out of China, the Euro-zone (mostly Germany), and S. Korea also came in strong. Combine this data with weak GDP out of Britain and a picture emerges of China leading the fragile global recovery almost single-handedly. Germany is levered to China. S. Korea is highly levered to China. American manufacturing is levered to China. Britain is not levered to China. So we are back to the dilemma of whether or not bad economic policy by America’s government is being offset enough by China to keep the global recovery chugging along.

Geopolitics: The indomitable Pak Army reported Sunday that the war in S. Waziristan is going better than expected after a few early setbacks. The Army has captured 8 Taliban cities and says 3 more will fall this week. In each of these captured cities the surrounding countryside and mountaintops have been 100% secured. The super strategic city of Makeen (capital city of Taliban) is being surrounded once again, but this time the encirclement is much sturdier than the first attempt because of all those mountaintops and forests that are under Army control. The Army says that elite Uzbek and Arab fighters are abandoning their Pak Taliban brothers, perhaps to regroup and wage guerilla war in S. Waziristan at a later date or these foreign bad guys may move on to other hotspots like Somalia. It is important to remember that S. Waziristan is not really a guerilla war at this point. It is more like a conventional war between two countries. And the Pak Army is supremely equipped to win a conventional war. After the conventional phase, a guerilla war will emerge and the formation and efficacy of good guy tribal militias will be important. The Taliban’s terror campaign in the non-tribal regions grinds on but at a slower pace. Terror attacks are increasing in many of the other tribal regions besides S. Waziristan. If the Taliban really is shifting away from attacking non-tribal parts of Pakistan in favor of the tribal regions, then this is a sign that the Taliban is fighting for its life.
The Afghan runoff election is canceled and the moderately corrupt Karzai is now president once again of Afghanistan. This is good news. Liberal pundits and leftwing pinheads will moan that there is no longer any chance that Afghanistan will have a corruption-free, stable and honestly elected government like Switzerland (gasp!). But there was never a chance of that happening. Here is one lesson from the Vietnam War that applies to Afghanistan: the US pulled support from a moderately corrupt S. Vietnamese government in the early stages of that war, causing the government to fall. It was a huge mistake. Big surprise, the next S. Vietnamese government was much worse. In 1979 America pulled its support from the moderately corrupt Shah of Iran and that turned out to be a mega-disaster. Yes, it would be wonderful if S. Vietnam, Iran, or Afghanistan could have been magically transformed into Switzerland. US foreign policy should not be based on magic.