Huge Taliban Victory

Charts: The S&P 500 closed at 1115, down 1%. The key 1120 support level was violated (bearish). Yield on the 10-year popped above 3.8% (not good).

Fundamentals: First time jobless claims came in much better than expected. Today the good news was bad because it caused interest rates to spike on fears of Fed tightening. Rates might go up even if the Fed doesn’t tighten. The mammoth treasury auctions this week ended okay, but foreign buyers stayed on the sidelines. If China and Japan don’t aggressively buy US debt, rates will skyrocket and crush the global recovery. Team Obama picked a bad time to escalate its trade war with China. US stocks levered to China were hit hard again today as investors try to guess how the Asian giant will retaliate. Team Obama’s first salvo in the trade war was against Chinese tires. China responded with a mild move against US automobiles that was purely symbolic. It is logical to assume that China will have to get tougher this time to teach Team Obama a lesson.

Geopolitics: The Taliban scored a huge victory in Afghanistan by killing 4-8 top CIA officers stationed in a forward base. The CIA said the loss was immense. President Karzai is unrelenting in his criticism over Special Forces strikes that he claims kill women and children. Karzai is triggering anti-American demonstrations across the country. He needs to be muzzled by the White House, not the Pentagon. President Obama is only good at foreign policy when he focuses. After Pearl Harbor, FDR said “Dr. New Deal” was giving way to “Dr. Win-the-War.” Only a short while ago Obama decided America’s strategy for fighting the Long War will be based on the McChrystal counterinsurgency plan, analogous to Harry Truman’s decision in 1948 to begin America’s multi-decade long containment strategy in the Cold War. Unlike Truman, Obama has focused on healthcare and nothing else since making his momentous choice. On that score, Sen. Nelson of Nebraska is seeing his approval ratings in state-wide polls plummet after casting the deciding vote to end debate on healthcare. Fighting for his life, Nelson is launching a massive ad campaign in Nebraska to salvage his career. Healthcare reform probably resides on the outcome of Nelson’s campaign. Whenever there is one-way choice between guns and butter, the stock market always wants guns. Obama wants guns and butter. It might not be possible.

Go To Disneyland

Charts: The S&P 500 closed at 1126, up .02%. The stock market is treading water, waiting for the New Year. The yield on the 10-year came down slightly (bullish).

Fundamentals: The Chicago PMI survey of Midwest manufacturing activity came in much stronger than expected. With this strong industrial data as a backdrop it is ironic that the US government is getting ready to impose huge tariffs on Chinese steel imports. While this risks igniting a trade war and is very bad news for the world economy it is good news for US steel producers like US Steel (X). It is bad news for US companies levered to Chinese steel mills like Harsco (HSC). Other US companies levered to China fell hard today on the protectionist news.
Team Obama has decided to put together its third multi-billion dollar bailout package for GMAC, the troubled auto and mortgage lender. Combine this with the ongoing bailout of Fannie and Freddie and we see a pattern of the government throwing everything but the kitchen sink at housing.

Geopolitics: In Nigeria, earlier in the week, a little known group of Islamic radicals attacked several other rival Islamic militias, which resulted in a confusing multi-party bad guy on bad guy melee. Nigerian police shot first and asked questions later, resulting in 38 dead bad guys and 1 dead good guy. Separately, security measures are being beefed up at all Nigerian airports after the Christmas AQAP terror attempt on a flight that originated in Nigeria.
More information is coming out concerning the AQAP terror attempt. The plan was hatched by bad guys released by the Bush Administration several years ago from Gitmo. In fact, AQAP is run by bad guys released from Gitmo. These releases were done to pacify America’s peacenik allies in Europe. Going forward, America has to stop worrying about its image in Europe. Yes, it is possible that a French waiter will spit in your coffee while you are vacationing in Paris. Maybe go to Disneyland instead?
In Iran, opposition leaders have fled the capital city, Tehran, and are probably in hiding somewhere in the countryside. More images pour out from the internet of state security forces actually getting beaten back by anti-regime insurgents. The possibility of the Iranian government falling is real. Like it or not it is up to America to make sure that a failed state like Somalia does not arise from the ashes of the Iranian government’s downfall. The US needs to engineer a velvet revolution.

A Typical Day In The Long War

Charts: The S&P 500 closed at 1126, down .14%. We saw a bearish downside reversal today but essentially the market is treading water until after New Year’s Day. Volume will go up in January and the charts will become very important; more important than they have been in months. January will almost certainly set the tone for 2010.

Fundamentals: The Consumer Confidence survey came in slightly better than expected and the Case-Schiller housing price index was in line, showing a fractional month over month gain. Fannie said that serious delinquencies have risen from 1.89% a year ago to about 5% (not good). Today’s treasury auction was better than yesterday’s. The yield on the 10-year went back down to 3.8%.

Geopolitics: The Pak Army killed 17 Taliban fighters and 1 leader on Tuesday. Pak security forces arrested 60 bad guys. Civilian terror strikes continue at a steady pace. This was a typical day.
In Afghanistan, the Taliban briefly captured a village in the north but were repelled by the Afghan Army; 10 bad guys killed and 1 good guy killed. A Taliban fighter who had infiltrated the Afghan Army killed an American soldier. President Karzai is complaining about NATO Special Forces strikes that kill women and children as well as bad guys. Unfortunately there is such a thing as bad children and bad women to go along with bad guys. Special Forces do not give bad guy body counts but we know they have been busy lately. Another typical day.
The Yemeni Army attacked Houthi rebel positions in the rugged northern mountains backed up by the Saudi Air Force. The rebels claim to have captured a Saudi Army outpost in these same mountains, which is probably true. The rebels have been able to capture Saudi outposts but not hold them for long. Neither side provided a body count for today’s combat. The Saudis are no longer breezily talking about building a buffer zone in Yemen, with their hands full trying to actually win an ongoing war. And in this theater we also had a typical day in the Long War.

Delta Force = WAM

Charts: The S&P 500 closed at 1128, up .1%. Yield on the 10-year note inched up to about 3.84%. Resistance for the 10-year note yield is 3.95. The danger zone is 4%.

Fundamentals: Industrial data out of Japan came in stronger than expected due to exports to China. China revised its GDP upward. American holiday retail sales are coming in slightly better than expected and margins are sturdy. That’s the good news. Here’s the bad: This week the US Treasury is auctioning off an eye-popping $118 billion in debt. Today’s auction was very sloppy. Yields popped up again. China and Japan did not buy as much as expected. The announcement Christmas Eve that Treasury will pour an unlimited amount of money into Fannie and Freddie is hurting US debt sales. Words like “unlimited” and “US debt” don’t mix well.

Geopolitics: The NY Times reports that US Special Forces have been drawn down in Iraq and funneled into Afghanistan. At the same time conventional US forces have been removed from remote rural Afghani outposts, which made the Taliban act predictably, seizing the outposts. But then Special Forces hit the bad guys hard in remote areas and in Helmand Province. If this action has been big enough to leak out to the NY Times, then the bad guys must be taking it on the chin. CIA drone strikes and continued Pak Army actions have also hurt the bad guys just across the border. When the heat gets turned up on bad guys in Af/Pak, it triggers the whack-a-mole (WAM) effect. We are probably seeing the biggest WAM yet as bad guys pour into Yemen from Af/Pak. The Fort Hood Massacre had links to Al Qaeda in the Arabian Peninsula (AQAP), which is the Yemen Al-Qaeda franchisee. And the thwarted airline terror attempt on Christmas was also an AQAP plot. AQAP is now the biggest Al-Qaeda entity outside of Pakistan and growing rapidly. Sporadic media reports are filtering out of Yemen of US Special Forces engaging bad guys. Reports of CIA activity in Yemen have become a veritable deluge. This is all good news.
The Iranian government is in big trouble. Over the weekend student protestors took to the streets, high-jacking a national religious ceremony and turning it into an insurrection. The Revolutionary Guard and riot police came down hard on the protestors, killing about 8 and hospitalizing hundreds. But the hospitals were also filled with battered cops. At least one police station was totally overrun and torched. The protestors are fighting back harder and more effectively than ever before. Because it would be enormously disruptive for the Iranian government to fall, Team Obama at first did not help the protestors. Now, however, the US is helping them by enabling internet access and perhaps in other ways.
Last week we saw 11 Iranian soldiers “invade” Iraq and plant a flag on an oil well. This is an example of how desperate the Iranian regime has become. It was trying to scare its people into believing another war with Iraq was looming and they sure as heck better stop trying to overthrow the government because the last war killed over a million Iranians. The market wants the Iranian government to die slowly and without very many death spasms. So far so good.

Bull/Bear Debate Part 2

Special Note: Today we continue the Bull/Bear debate by giving the bear point of view.

Charts: The only rallies as strong as the current one were the huge cyclical (short term) bull markets of the 1930s, which lasted from several months to about two years. In 1929 the Dow saw monthly trading volume of 4.3 million shares. But in the bear market bounces of the mid-30s trading volume averaged only 1.2 million shares per month, similar to today’s low volume rally. The ‘30s bulls gained on average about 70% before peaking, similar to today’s gain. Most chartists are bullish right now. Those that are not point fearfully to the charts from the 30s and gnash their teeth in chagrin.

Fundamentals: America’s Q3 GDP has been revised from an initial 3.8% gain to a 2.2% gain. Real Final Sales (GDP without inventory adjustments) showed a puny 1.5% gain. Either way it is one of the weakest recoveries in history, so far. The consensus is for 4% GDP growth in Q4 and then about half that in 2010 as stimulus programs end. Corporate profits have stabilized but aren’t growing except at banks, whose profits are artificially propped up with the steepest yield curve ever, housing subsidies, debt guarantees, TARP, and more. Despite these props bank lending is very weak, profits are engineered by Uncle Sam not private sector loans. The corporate bond market has greatly expanded during the recovery (thank God). This is how big companies are getting funded, directly from retail bond investors, bypassing banks altogether. Small businesses aren’t so lucky. They still depend on banks and generate most of the jobs growth in America. Banks will need government life support for several more years. Treasury just lifted its $400 billion cap on bailout money for Fannie and Freddie. It now has an infinitely open-ended commitment to support the ailing mortgage giants. That being the case the government needs to cut spending and debt elsewhere, not pile trillions onto trillions with Obama-Care. Since that isn’t happening interest rates are moving up and mortgage applications are starting to decline. The government could easily get into the position where it throws more money at housing only to see interest rates jump up and then housing gets worse so more debt is floated to throw at housing which causes interest rates to go up and a vicious cycle ensues resulting in a double-dip recession. The growth period between double-dip recessions has generally been about two years, which is why bear market bounces can last a pretty long time. This one could be shorter. The 2009 stimulus package was twice as big as FDR’s 1930s stimulus as a percentage of GDP and America went into the Great Recession with much more debt than it did going into the Great Depression.

Geopolitics: This is the bright spot. Geopolitics is bullish and there is no point in pretending otherwise. So today I am exploding the liberal myth that Afghanistan is the “Graveyard of Empires.”
Through most of the ‘80s the Soviets fought CIA supported Mujahedin rebels in Afghanistan, the forerunners to Al-Qaeda and the Taliban. The Soviet Army lost 15,000 soldiers and the Mujahedin lost 1.5 million. Like America in Vietnam, the Soviet Army won every major battle. Unlike America, the Soviets withdrew from Afghanistan in good order and left behind a relatively strong communist Afghan national army in 1989 (mission accomplished). The Afghan communist government and army were so strong they held off the Mujahedin quite handily even after the Soviet Union collapsed, taking us into the early ‘90s. But of course communism itself collapsed everywhere except Cuba and North Korea and the USSR’s puppet state in Afghanistan was no exception. After the communists left, the Mujahedin/Taliban was unable to even conquer all of Afghanistan.
The British Empire also included Afghanistan at one point. After being mauled by Germany in two World Wars, the global British Empire collapsed. Afghanistan was no different from the hundreds of other colonial outposts across the globe that no longer flew the Union Jack. Alexander the Great’s empire also included Afghanistan 2300 years ago and he is no longer in charge (big surprise). Liberals always throw in Alexander to round off their “Graveyard” argument.
Let’s consider Egypt. It was a Soviet client state from 1955 to 1970, with the Soviets virtually running the Egyptian military at the peak of their influence. Egypt was also part of Alexander’s empire and Britain’s empire, plus the Roman and Ottoman empires (that makes 5 dead empires and 1 live Egypt). Is Egypt some kind of “Super-Graveyard?” Today Egypt is an American military ally and part of America’s global military empire. Is America doomed because of Egypt’s mystical Super-Graveyard status? Of course not.
Places like Egypt and Afghanistan are on the edge of continents; they stand at the crossroads of big empires, ancient and modern.

Goat Herding or Al-Qaeda?

Charts: The S&P 500 closed at 1126, up .5%. This is the second day above the key Fibonacci number 1120, so far so good. The American Assoc. of Individual Investors said that 38% of its members are bullish on stocks. The lower the number the better because excessive optimism from retail investors is a sign of a market top. 38% is a good number, showing plenty of healthy skepticism.

Fundamentals: The weekly jobs report came in strong and durable goods orders were also strong. The dollar seems to be stabilizing. Commodities and emerging markets were strong and with a stable dollar we can better trust these moves to be fundamentally based. The only bad news is yield on the 10-year note keeps sky-rocketing. It started the week at 3.5% and ended at 3.8%, a nasty jump. Thank you Sen. Harry Reid (what a jerk) and Obama-Care.

Geopolitics: Let’s say you make a good living leading a small but profitable Islamic insurgency in a third world country. The greatest question you face is whether to become an Al-Qaeda franchisee or remain independent. Al-Qaeda raises hundreds of millions of dollars for their franchisees, provides fighters, weapons, advice and leadership. Becoming a franchisee could catapult your insurgency into the big league and is probably your only chance at genuinely carving a Taliban-style nation-state out of your home country. But there is a downside. Signing up with Al-Qaeda puts you on the CIA and US Special Forces radar. The superpower will start tearing into your network if you sign on the dotted line. And this new enemy makes you more dependent on Al-Qaeda. The Arabs might try to take over your rebel group, put someone else in charge, and kill you. This is the dilemma facing the Islamic insurgency in southern Thailand. Unlike the nearby Philippines, the bad guys in Thailand are thought to have no connections to Al-Qaeda, strictly homegrown with all the pluses and minuses that implies. If Thai insurgents chose to remain independent it would be bad news for Al-Qaeda, weakening their brand.
Recent events in Yemen would speak to refusing to sign on the Al-Qaeda dotted line. On Wednesday, 25 Al-Qaeda operatives were arrested in targeted sweeps. Today CIA directed airstrikes killed 30 Al-Qaeda leaders and fighters in various parts of Yemen. Al-Qaeda in the Arabian Peninsula (based in southern Yemen) is taking it on the chin. How would you like the Thai Air Force bombing your rebel movement to Kingdom-Come? Independence is probably the best choice. Maybe even cutting a deal with your home government and going back to goat herding would be smart.

Yemen War Rages On

Charts: The S&P 500 closed at 1121, up .2%. It is sitting right on top of the 50% retracement level. Holding above that level for several days will be technically significant.

Fundamentals: Yesterday existing home sales were great and today new home sales were horrible. The difference is due entirely to the First Time Home Buyer Tax Credit. The long and short is that housing can’t yet stand on its own two feet and the government will probably keep extending the subsidy. How much debt can the US float? One thing we can be certain of is that healthcare reform will cost at least three times what Congress claims, which amounts to trillions of dollars. A half-dozen or so states are getting special health insurance tax exemptions, as well as waivers for state Medicaid expenses, plus big Federal subsidies for state hospitals. There is no way the other 40 or so states are going to pay higher insurance taxes and higher Medicaid expenses to subsidize the chosen few. The Senate bill gives Nebraska, for example, unique tax privileged insurance companies and a big Medicaid kiss. But Nebraska is a wealthy state with super-low unemployment. Also, there are health insurance tax exemptions for certain unions but not others, which will never stand. All these unique giveaways will be applied to all 50 states, all unions, all state hospitals, etc… The yield on the 10-year note has rocketed up since the breakthrough that supposedly assures passage of this monster. 10-year yield is about 3.7%. 4% is getting into the danger zone.

Geopolitics: Saudi Arabia admits that it has lost about 100 soldiers so far in the Yemen war, indicating that the war is bigger than mainstream media reports have suggested, but not bigger than reports from DMU. The successful air raids against Al-Qaeda last week in southern Yemen were so obviously directed by the CIA that the bad guys are organizing huge anti-American rallies near the cites that were bombed. In northern Yemen the CIA is apparently directing Saudi Air Force strikes and helping the Saudi Army as it advances on key rebel controlled towns. The Army is using massive artillery barrages to soften up the bad guys and civilian casualties are certainly very high. The CIA is benefitting immensely from the lack of media attention.

R.I.P. $ Carry Trade. We Hardly Knew You

Charts: The S&P 500 closed at 1118, up .4%. The Nasdaq has broken away from the hard resistance of 2200 that has plagued it for two months. The Nasdaq and small caps are providing leadership, which is good. The broad index is feeling resistance at 1120, a Fibonacci number.

Fundamentals: American existing home sales came in much better than expected while Q3 GDP was revised downward. The good and bad news is a wash for today’s fundie outlook. The big news is the ongoing unwind of the dollar carry trade. As investors rush to cover their short dollar positions we are learning more about the carry trade. The Brazilian large cap index (EWZ) has been clobbered while Brazilian small caps (BRF) have held up. The Brazilian small caps must not have been on the carry traders' menu while large caps were; it is worth noting that a weaker currency helps Brazilian large caps on a fundamental basis. American small caps (IWM) are benefiting from the demise of the carry trade because they weren't much of a carry trade destination, but American large caps are doing pretty good. This could mean that US large caps also were never much of a carry trade destination, but it is more likely that carry trade investors are covering dollar short positions while at the same time holding their US large cap long positions. This speaks to the carry trade being less leveraged than we thought, more cash based. Chinese stocks are getting slammed since the Yuan is pegged to the dollar and it is now rising, potentially hurting Chinese exports. The Yen is moving inversely to the dollar, helping Japanese exporters but it is difficult for American investors to capitalize on Japanese stocks right now since Japanese stock appreciation is offset by Yen depreciation.

Specific Stocks: Just because emerging market currencies are falling doesn’t mean that emerging economies are slowing down. It does mean that emerging market growth should be played differently. Consider Bucyrus (BUCY), it is the best of breed manufacturer of super-heavy mining equipment such as titanic electric shovels used in strip mining. It just bought the mining division of Terex, a rival that makes heavy mining equipment such as gigantic trucks and cranes. BUCY is levered to emerging market mineral consumption but it really doesn’t care too much about currency fluctuation since it is a quasi-monopoly (especially now after the Terex purchase). Whenever I buy shares of BUCY I also buy the global steel index (SLX) as a simple hedge against BUCY’s Achilles heel: high steel prices. SLX is levered to emerging market growth in its own right. There is no futures market for steel, therefore steel prices rise because of fundamentals, not the carry trade (unlike copper). Now think about Coca-Cola (KO). It is highly levered to emerging markets, but it is adversely affected by a strengthening dollar since it is not a monopoly (anybody can make fizzy sugar water). In general then, US companies that make products for emerging markets that cannot be easily substituted are the way to go.

Bull/Bear Debate Part 1

Special Note: As part of a two series bull/bear debate today’s newsletter gives the most bullish possible spin on the current state of the three categories we track every day. Next Sunday I will give the bearish counterarguments.

Charts: At the end December 2008 the market had dropped only 38%, a harsh but not historically bad bear market. In 2009 from January to March the market kept plunging until it bottomed with nearly a 60% loss, a bear market of historic proportions. The 2009 plunge was due to the view that TARP wouldn’t work, against all odds TARP did work; banks are indeed bailed out and profitable again. Therefore the sharp downward spike in early 2009 doesn’t count. Erase the spike and draw a straight line across it and we had about a 40% down bear market followed by a stout but not freakish 24% gain, in line with the first year of most Great Moderation Era (GME) bull markets. P/E ratios are only slightly elevated for a GME bull, but multiples are extremely elevated if we are no longer in the GME and are still part of the 100-year average. For the last two months the market has moved sideways, this action allows multiples to catch up to stock gains. This is bullish action only if we are still in the Great Moderation Era.

Fundamentals: Academia says that the GME is due to superior Federal Reserve policy from 1982 and continuing today. We now know that Greenspan’s policies sucked. Bernanke is better but he’s made some mistakes. Of the 3 GME Fed Chairmen only Volker was truly superior and he was top dog for just 1/6 of the GME. Furthermore, Fed policy in the 50s and 60s produced lower and more stable inflation than during the GME as well as more stable growth, better overall policy. All the 50s and 60s Fed Chairmen were as good as Volker. Multiples stayed within the depressed 100-year average in the 50s and 60s. Only in the GME have they been permanently elevated. It obviously isn’t because of superior Fed policy.

Geopolitics: The real reason for the high GME multiple is geopolitical. From 1870 until 1982 the world order of a single Anglo-Saxon superpower (Britain then America) was continually threatened by a continental superpower (Germany then Soviet Russia) and over that time period the instability of two rival superpowers on one planet caused low multiples. The lowest multiples ever recorded were during the period where there was no Anglo-Saxon superpower, i.e. when dominance of the English-speaking world was being handed over from Britain to America in the 1930s. In 1933 stock market multiples hit the lowest level in history. This is the year that Hitler became Chancellor of Germany and at that point there was only one superpower: Germany. The next 6 years and most of WW II saw a world dominated by a single continental superpower; it marked the greatest departure ever in the industrial age from the market-friendly model of a single Anglo-Saxon superpower. The decade of a single German superpower generated the lowest multiples of any decade in history.
From 1815 until 1870 there was a single and uncontested Anglo-Saxon superpower after Britain destroyed that other continental superpower, Napoleon’s France. Records are spotty but I believe that 55-year stretch starting in 1815 produced GME-like elevated multiples. That stretch of unrivaled British superpower status carried a high P/E ratio that is relevant to today’s market, not the lower multiple from the 112-year stretch of bifurcated superpower status. With the Long War going well the world is clearly back in the grip of a mono-polar Anglo-Saxon geopolitical order and multiples over 18 for the S&P 500.

CIA May Win 2nd Golden Bull Award!

Charts: The S&P 500 closed at1102, up .6%. By pushing past the 1100 resistance level the broad index looks better technically.

Fundamentals: The dollar continues to rise as the carry trade falls apart. This is causing short term pain but in the long run it is good news because once the dust settles we will be able to once again engage in traditional fundamental analysis and invest long term without our fingers constantly hovering over the sell button because we can’t figure out what crazed hedge fund managers are doing with the #@%& carry trade. When and if it is over we can all say good riddance.
Obama-Care is running into strong opposition. Howard Dean is denouncing it. Labor unions are denouncing it. And Senator Nelson of Nebraska (the last Blue Dog with an intact set of cojones) is digging in his heels. If it doesn’t get passed before Christmas the thing faces a rocky future.

Geopolitics: A squad of 11 Iranian soldiers crossed into Iraq and seized part of an oil field, raising the Iranian flag over an oil well. On the surface this seems to be an act of war between Iran and Iraq but probably these soldiers have gone rogue or Iran is posturing due to its deteriorating grip on power at home.
The CIA sent 7 of its advanced Reaper drones into N. Waziristan, Pakistan, home of Al-Qaeda, and in the biggest drone strike ever killed over a dozen top Al-Qaeda and Taliban leaders. Rumors are flying that Osama bin Laden’s brother-in-law was killed. The DMU awards committee is debating still another Golden Bull for the CIA over this incident.
In an impressive show of force, the Yemeni Army and Air Force attacked several Al-Qaeda in the Arabian Peninsula positions in southern Yemen, killing 34 bad guys and 17 bad women and bad children. As horrible as it sounds, the lack of media coverage in the Yemen war allows Saudi Arabia and Yemen to bomb refugee camps that contain combatants and non-combatants alike. The Yemen Army calls their offensive “The Scorched Earth Campaign” an example of truth in advertising. Yes, it is horrible, but allowing Al-Qaeda to build a nation state on the Arabian Peninsula is more horrible. The Yemen Army strike has the CIA’s fingerprints on it and is one of the reasons why a second Golden Bull award is being debated.

Savage Unwind Of Carry Trade

Charts: The S&P 500 closed at 1097, down 1.2%. The broad index crashed through two support levels and the Nasdaq lost the key 2200 level in big volume. The rally is under extreme pressure but small caps actually dropped less than large caps so the recent improvement in leadership is intact. Financials were slammed hard and represent an ongoing problem technically.

Fundamentals: Weekly jobs data came in soft but the real cause of today’s sell-off was a savage unwinding of the dollar carry trade, the worst unwind that we’ve seen so far in the bull market and a continued response to the Fed’s seemingly innocuous statement that it still intends to end Quantitative Easing someday. Also, Greek sovereign debt is still getting hammered, which is hurting the carry trade. The carry trade is based on shorting the dollar and the problem with any short position is that traders are sometimes forced to cover shorts en masse in a so called short squeeze. A long position can only lose so much, only the initial investment and no more, but a short position can entail infinite losses, which can force short investors to hastily unwind as they stare into the abyss of total financial destruction. Nobody knows how big the carry trade is, how much leverage it commands, or how it will affect global financial markets if it totally collapses. On a positive note, if the carry trade does indeed dissipate we will be able to invest once again on fundamentals.

Geopolitics: Iran successfully tested a missile that can hit Israel. This caused oil to jump yesterday, a reminder of what the Long War is all about: black gold. Iran has been caught providing technology to Shiite rebels in Iraq that can track American drone flights. As we know Iran is also supporting Shiite rebels in Yemen as well as Hezbollah. There are two kinds of guerilla armies, those without state sponsorship and those with. The latter kind is much more difficult to defeat. So it is disquieting that Iran is supporting so many bad guys across the globe. Geopolitical news has been good overall but not so much as far as Iran is concerned.

Poppy Production Not Super Profitable

Charts: The S&P 500 closed at 1109, up .1%, failing to break resistance at 1110. The Nasdaq held above the key 2200 support level. Since late last week small caps and tech have outperformed big cap and defensive sectors, improving leadership that has been very bad for about 2 months. When bull markets have come as far as this one resistance hardens on Fibonacci ratios. Nobody knows why natural systems from plants to spiral galaxies fall into Fibonacci number sequences but they do and the stock market is no exception. We are a heartbeat away from the 50% Fibonacci retracement of 1120 for the broad index. The next Fibonacci retracement is 61.8%, which is about 1250. Conquering 1120 will be a major milestone.

Fundamentals: Consumer inflation came in today slightly cooler than expected, easing some of the fears from yesterday’s hot wholesale inflation numbers. In response government bond yields inched down a smidge. The Fed ended its big policy meeting and made its statement, which contained no surprises, although it did repeat an earlier message that Quantitative Easing measures are slated to end in a few months and the economy will have to stand on its own two feet at that point. Like a baby whose security blanket has been stolen, the market sold off on fears of QE someday going away, turning a big gain into a tiny one. The dollar turned up for the same reason: fear that the so-called “new normal” of super loose monetary policy will someday go away.

Geopolitics: The Pentagon is spelling out exactly how the surge strategy will unfold. Pockets of stability have already emerged in certain cities and farmlands in Afghanistan. These pockets will be strung together by securing roads. Safe roads are vital to beefing up the non-opium agricultural sector. Today the Taliban goes directly to a farmer’s house and pays him for poppies. Regular crops actually fetch about as much profit as poppies but farmers can’t get through Taliban controlled roads to markets and sell produce. Therefore securing roads deals a big blow to Taliban drug profits. Also, the Pentagon is not going to expand the Afghan national police, but instead will weed out the Taliban sympathizers, improve training, give them heavy weapons and armored humvees. This is also smart policy. In Iraq the war went south as the Army tried to rush local security forces too fast and too hard. Counterinsurgency takes a long time and can’t be rushed.

Vigilantes Most Powerful Force On Earth

Charts: The S&P 500 closed at 1108, down .6%. The broad index failed to hold above resistance at 1110, which it had pierced on Monday in good volume. The Nasdaq broke through 2200 on Monday and barely held above that level today. It had tried 6 times recently to break above 2200 and needs to keep holding above this key support level. Financials have long since given up leadership, which is okay because they are fundamentally horrible, but the financial index (XLF) has traded below its 50-day line for 26 days and is so weak that red flags are being raised. Charts for the government bond market don’t look very good. A steepening yield curve is bullish and a flattening yield curve is bearish for bonds. Up until a few days ago the yield curve had been getting steeper; in fact reaching record levels of steepness. But it is now flattening, as bond vigilante’s drive up interest rates on the short end faster than the long end.

Fundamentals: Wholesale inflation data came in hotter than expected today. Inflation has been tame so far in the recovery and one data point doesn’t make a new trend, but with the entire recovery and bull market based on low interest rates/low inflation, this single data point is scary.
On Monday, oil rich Abu Dhabi bailed out its sister country Dubai with a $10 billion injection. Bond vigilantes forced this move by hammering Abu Dubai’s credit market. UAE bond yields have since come down. The Greek Prime Minister gave a tearful speech in front of his parliament and government unions, ineffectively begging them to lower spending. Vigilantes jacked up Greek bond spreads on this pitiful display. Greece will eventually cut spending whether it wants to or not. In the US, Blue Dogs are watering down the healthcare bill, but not derailing it. Because of this vigilantes are remorselessly pushing up US government bond yields every day. Other than US government spending cuts, the only power on Earth that can stop bond vigilantes from jacking up US interest rates is the Fed’s hammer of Quantitative Easing. The Fed cannot swing this hammer if inflation is rising. Therefore, global bond investors are stronger than the Fed or Congress or anybody and could kill the bull market.

Geopolitics: One way to score the Pentagon and CIA in the Long War is oil production increases/decreases in countries torn by Islamic insurgencies. In the last couple years Iraq has gone from 1.7 million barrels a day to over 2.5 million. Over the weekend Iraq signed a dozen contracts with outside energy companies that will eventually increase production to 12 million barrels a day. Nigeria is ramping up oil production at an even faster pace. Nigeria’s Islamic insurgency has been crushed for now and its non-Islamic insurgency is also being rapidly unwound. Yemen’s oil production is flat despite the ongoing war. So the Pentagon and CIA get an A on their report card. Speaking of Yemen, 50% of Gitmo detainees are Yemenis, an indicator of how important this theater is in the global war.

String Them Up!

Fundamentals: In the late 1990s America ran a fiscal surplus because earlier in the decade bond vigilantes forced austerity down Congress’s throat by bidding up treasury yields in direct response to government spending. Last week every heavily indebted country on the planet saw government bond yields rocket up in classic vigilante fashion (including global titans America and Japan). Greece is the worst big spender among developed countries. Its bond yields soared last week by the greatest amount ever recorded. Greece offered the vigilantes a smoke and mirrors austerity plan. Unimpressed, vigilantes savagely pushed up Greek interest rates into the final hours of the trading week. Among the debtor countries only Ireland offered a credible austerity plan, slashing government worker salaries by 8%. Satisfied, the vigilantes lowered Irish interest rates in the latter part of the week. If Greece fails to take similar action, its interest rates will keep climbing until the possibility of default looms. At that point the IMF will step in, put together a bailout package, and take direct control of Greek finances. The Greek budget will then face cuts similar to the ones in Ireland. If the situation gets that far out of hand financial markets will probably take a big hit since Greece is a member of the EU.
America’s Congress did not offer the vigilantes even smoke and mirrors. Fat and stupid, it is passing an omnibus spending bill that increases discretionary spending by 12%, including a fat pay raise for Federal employees. This is on top of the trillion dollar healthcare bill, Obama’s 200 billion dollar second stimulus plan, and the Afghan military surge. America is not Greece. If Congress won’t cut government spending, then the Fed can step up Quantitative Easing (QE: the government buys its own debt by printing money out of thin air). In a normal economy QE will lower nominal interest rates but stoke inflation, thus raising real interest rates, doing more harm than good. Historically QE only works if an economy is stuck in low gear, mired in a severe recession, which is no longer the case.
All of the above is the reason why the stock market is no longer trading up on good news. Since March bulls have been talking about a “new normal” of permanently low interest rates and a very weak but steady recovery that pushes fiscal and monetary stimulus into asset price inflation, not genuine inflation. But the market is not trading down on good news either. Good news has weakened the dollar carry trade, bolstering the greenback, which has clobbered the price of oil, diminishing the threat of inflation. Does this mean that the events of last week represent a “new-new normal” where QE magically enables our spendthrift government to pile debt on top of debt forever or at least a couple more years? The answer resides in the action of bond vigilantes, which we can see by watching the yield on the 10-year and 30-year note. Trouble begins when the 10-year yield hits 4%. In the Wild West the original vigilantes liked to have hanging parties. String them up!

Nancy Pelosi: Public Enemy # 1

Charts: The S&P 500 closed at 1106, up .4%. Small caps outperformed large caps, good leadership. The Nasdaq, however, should also be leading and it is not. 2200 has become a very serious resistance level for the Nasdaq. Today’s trade showed a lot of sideways movement, mirroring the sideways slide for the past month. I am hopeful that this consolidation will continue and if so it will be bullish. Low volume is a good thing in a consolidating market, which we are seeing. High volume in a sideways market is called “stalling” and is very bearish.

Fundamentals: America’s November consumer spending came in twice as strong as expected (on a percentage basis) and consumer sentiment was also very strong. Chinese industrial production beat expectations. America’s trade deficit narrowed on low oil consumption and strong exports. China’s gigantic trade surplus shrunk with domestic consumption up and exports down. The Chinese and American trade data indicate that the global imbalances (which caused the Great Recession) are easing. The dollar strengthened but miraculously stocks eked out gains without being artificially boosted by the carry trade. Everything is wonderful except US treasury yields continue to rocket upward as investors dump US government debt with both hands, mainly because the healthcare bill is gathering steam. All the polls show voters hate this thing; only about 35% like this monstrosity. House Leader Nancy Pelosi admits as much but says she is willing to lose up to 20 seats in the coming midterm elections as a penalty for passing this unpopular legislation. She thinks only Blue Dog Democrats will get booted out. The Dogs are itching to elect a different House Leader, so losing them will shore up Nancy’s power base. Obama must also be willing to jettison the Blue Dogs and tilt his party to the left. What’s puzzling is how the Dogs are rolling over, allowing themselves to get slapped around by the liberals. Yo, Blue Dogs, grow a set!

Geopolitics: Chairman of the Joint Chiefs, Mike Mullen, said that Army engineers are working at a furious pace to build facilities for the surge Marines that are hitting now in Afghanistan. Morale is up and the Pentagon is putting the pedal to the metal to get ready for the influx. The CIA is also hitting on 8 cylinders as a Reaper drone vaporized a vehicle speeding out of S. Waziristan and into N. Waziristan (Pakistan) that was carrying the infamous Al-Qaeda leader Abu Yahya al Libi, who carried a five million dollar CIA bounty on his head. So a Pak citizen is now collecting a huge sum and receiving help on relocation as well as a new identity. The drone strikes are unpopular in Pakistan, to everybody except those collecting multi-million dollar bounties.
Yemeni rebels say they have captured a Saudi Army base and continue to occupy it. The Saudi Army has not yet denied the claim. A Saudi newspaper says that the Army has captured and detained 1805 Yemeni rebels inside Saudi Arabia and implied that it is all hands to the wheel trying to stop the influx of bad guys surging up out of Yemen into the Kingdom. The Yemen war doesn’t seem to be going very well and the US needs to get more involved. Our team of geopolitical analysts here at DMU will spend the weekend combing Middle-East news sources for evidence that Uncle Sam is on the job.

Government Out Of Control

Charts: The S&P 500 closed at 1102, up .6%. The broad index reclaimed the key 1100 level, but on weak volume. Overall the technical picture is that of a Great Moderation era bull market that is about 3-years old because the sleepy mega-cap Dow index is the strongest and the growth oriented small-cap Russell 2000 is the weakest. Defensive stocks like utilities are outperforming as we would expect in a very old bull market on its last legs. This bull market is moving about three times faster than normal. If this pattern were to stay in place until a new bear started we would have about 6-8 more months of stock market gains.

Fundamentals: Weekly continuing jobless claims dropped by over 300,000. But strength in the private sector is tempered by an out-of-control government deficit machine. The Senate’s healthcare bill originally contained a provision for a “public option,” a government healthcare system to compete against the private sector as Fannie Mae competes with private mortgage companies, squeezing many of them out of existence since Fannie’s growth is fueled by government debt. The public option has now been replaced by a byzantine scheme to expand Medicare coverage from 65-year olds to 55-year olds. Obviously the next step is to lower the age to 45 and then 35, etc… Also, Team Obama has figured out how to spend the $200 billion of unused TARP money without Congressional approval, arguing that unused TARP money is a kind of surplus that didn’t exist before. Of course the Federal government does not have a surplus here and a deficit there; it simply has one gigantic deficit. The stock market will ignore Federal deficits until the bond market forces the issue through higher interest rates. This week’s treasury auctions have been very sloppy, interest rates have jumped up and overseas buyers are stepping away from US government debt.

Geopolitics: Earlier this week Yemeni rebels attacked a Saudi border village and may have held it for awhile. By Thursday the Saudi Army had pushed the bad guys back into northern Yemen, unleashing 37 separate air strikes and firing 310 missiles. Fighting continues on both sides of the border. In southern Yemen, mass demonstrations are ratcheting up as Al-Qaeda in the Arabian Peninsula takes advantage of the northern war to rabble-rouse. Yemen’s oil is located in the south and the bad guys would dearly love to get their hands on it.

Geopolitics Looks Good

Charts: The S&P 500 closed at 1096, up .4%. Support is at 1085 and holding. The broad index needs to drop through 1085, 1079, and 1060 in big volume before serious technical damage occurs. The recent break below 1100 did occur in big volume so caution is advisable.

Fundamentals: Spain joined Greece in suffering a nasty credit rating downgrade today. Japan’s Q3 GDP growth was revised down to 1.3% from 4.8%. Iceland’s Q3 GDP was negative 7.2%; it is still mired in recession. Japan is the second or third largest economy in the world. Iceland is number 101. Iceland has already been bailed out but Greece and Spain have not, nor have they defaulted on sovereign debt yet either but this is the next big problem for the global recovery to overcome. Greece, Ireland, Spain, Hungary, Latvia, and Dubai all have monster debt problems that they may or may not be able to grow out of. There is only so much global credit and America weakens the planet’s creaky credit market when it keeps mindlessly issuing new and massive amounts of treasury debt. Yesterday’s news that Obama wants a second $200 billion stimulus program and the scary march forward of his healthcare bill will make sovereign debt defaults in countries like Latvia more likely. However, these two new American spending nightmares haven’t been enacted yet. There is a chance they will flame out in Congress.

Geopolitics: Al-Qaeda in Iraq executed a big terror attack in Baghdad, killing 130 citizens yesterday. This doesn’t change the overall good geopolitical picture in Iraq. Every four months Al-Qaeda in Iraq mounts a big one day bombing campaign against government facilities and kills about 130 people. The pace of civilian terror deaths in Pakistan is about 7 times worse than it is in Iraq. Both of these Long War hotspots will continue to suffer civilian and military casualties at roughly the current pace for a long time. Other hotspots are seeing predictable and sustainable casualties.

Carry Trade Under Extreme Pressure

Charts: The S&P 500 closed at 1098, down 1% and below the key 1100 support level. Ever since the good jobs report came out Friday the dollar has gained ground, hammering the carry trade. The broad index has been in a trading range for about a month, which speaks to consolidation. Unfortunately, throughout this bull market we have yet to see consolidation pan out in a healthy manner. 1085 is the next meaningful support level under 1100. The 50-day moving average is 1079, this is next support. The 20-month moving average is 1060. If 1060 were violated the technical picture would be very bad.

Fundamentals: Dubai state owned corporate bonds and Greek government bonds were downgraded today, sending shock waves through credit markets. Moody’s threatened the UK and US governments by saying their bonds may “test the boundaries of AAA rating.” The strengthening labor market in the US means that governments across the globe need to curb deficit spending. But Obama gave a speech today promising a second gigantic stimulus program, which would throw the US fiscal deficit into even higher gear. And finally Senate leader Reid says that he has the votes to pass the monster healthcare bill which will of course cause the US government deficit to skyrocket. The private sector is healing itself but the world’s governments have gotten into the habit of mindlessly piling debt on top of debt. The Catch-22 is that a recovering world economy will nudge up interest rates while governmental debt loads are so high that any increase in the carrying cost of all this debt could be catastrophic. The US will spend only about $400 million in 2009 servicing the interest on its federal debt because short term interest rates are currently negative in real terms (accounting for inflation). Stock market bulls call these negative interest rates the “new normal,” implying super-low rates will last forever or at least several years. If the bulls are wrong, markets are unlikely to tread water in a healthy consolidation but crash.

You Go Girl!

Geopolitics: On Friday, in Helmand Province Afghanistan, 1000 US Marines along with hundreds of British and Afghan soldiers launched Operation Cobra’s Revenge, marking the first time that Osprey tilt rotor aircraft have ferried troops into combat. So far the Marines have cleared away 300 Taliban landmines and roadside bombs and killed 16 bad guys. They are fighting in a valley nicknamed “landmine alley” because it is densely packed with the explosive devices. On the other side of the border in Pakistan, the Pak Army is stepping up operations and killing bad guys at a similar pace to the Marines. Military experts are saying that once the surge troops are in place the Marines and the Pak Army will finally be able to work together with “anvil and hammer” tactics. To make these tactics work the CIA is being authorized to radically step up drone flights deep inside Pakistan. This is wildly unpopular with Pak voters and civilians but the Pak Army wants the extra drone flights. Hillary is telling the Pak public that there is no timeline for US withdrawal in Afghanistan, hinting that talk of an exit strategy is a smokescreen to distract American peaceniks. You go girl!
In the USA, conservatives are comparing Obama’s surge speech last week to similar speeches given by Winston Churchill and JFK at turning points in WW II and the Cold War, saying that Obama’s speech wasn’t as stirring and inspirational, especially with all the references to an exit strategy. Conservatives are entirely missing the point. In the Long War the American population does not need to be inspired or motivated. It is best for the stock market (and the Pentagon) if the American public ignores the Long War. The less attention American voters and the media pay to it the better. Consider the only conflict in US history that truly resembled the Long War, the 14-year long Philippine Insurrection of the early 20th century. The US signed a treaty after 2 years of war and told the public that the conflict was over, even though it continued to rage for 12 more years. Americans were much easier to hoodwink in the old days (bullish). The lack of public attention in that ancient conflict allowed the Marines to fight and win over a course of time so great that the public would surely have revolted if they’d been aware of what was happening.
In the same vein, after Obama’s speech there was a big peace rally in San Francisco (several hundred people). The peace march was only four blocks long because many of the protesters needed canes to walk. Most of them had protested the Vietnam War and are in their 60s and 70s. The peace movement is un-cool, a bunch of aging hippies trying to recapture their youth. Today college kids protest tuition hikes and trees getting cut down on campus, not war. Obama is cool. Peace is not.

A Strong Dinosaur

Charts: The S&P 500 closed at 1106, up .5%. The broad index broke above the key 1100 level in big volume, so the uptrend looks to be intact. It hit 1120 and retreated. 1120 is a big resistance level since it represents a 50% retracement of the bear market losses.

Fundamentals: The government’s monthly employment report came in much stronger than expected, shocking the market profoundly. Unemployment dropped to 10% from 10.2%. The Household Survey said over 200,000 jobs were added, blowing away forecasts. The Payroll Survey said that only 11,000 jobs were lost. Revisions to the two previous months added 159,000 jobs to the Payroll survey. This data challenges the entrenched view of weak dinosaur economies vs. strong tigers, which could utterly demolish the dollar carry trade. A stronger than expected US economy will raise interest rates and cause government borrowing costs to skyrocket. If the dollar carry trade unravels in an orderly manner, then domestic stocks like those in the Russell 2000 small cap index (IWM) will benefit. Also, emerging markets not levered to the carry trade will do better, such as Mexico (EWW).

Geopolitics: In Somalia, Al-Shabab has pulled off its biggest and showiest terror attack yet, killing a number of government ministers along with two dozen civilians at a graduation ceremony with a suicide bomber. An influx of Al-Qaeda types is bolstering the bad guys in Africa and is another example of the whack-a-mole effect that comes from the US and Pakistan taking the wood to the bad guys in the Af-Pak region. The far corners of the Earth that will suffer from the whack-a-mole effect are the responsibility of the CIA. It is a good thing that Secretary Gates is a former deputy director of the CIA. He is the right man at the right time and is able to harmonize the Pentagon and the CIA.

Carry Trade Gets Clobbered

Charts: The S&P 500 closed at 1100, down .8%. Failure to hold 1100 puts the uptrend under pressure.

Fundamentals: The US national ISM service sector index came in weaker than expected. The only strong component was exports, although employment didn’t look too bad. Once again, this data reinforces the picture of strong growth in tiger economies and anemic growth in dinosaur economies. The ECB made some remarks suggesting that it would like to see a stronger dollar, which hurt the carry trade, which in turn hurt stocks.

Geopolitics: Obama’s homerun is looking more like an out of the park, bases loaded, homerun. Today Defense Secretary Gates swung a club against peaceniks in Congress concerning the new Afghan strategy and surge, beating them like a rented mule. He told them that there was no exit strategy, coalition forces will leave when the Taliban is defeated, troop withdrawal may take 18 months or it might take 18 years. Liberals exploded in white hot rage. Team Obama has its ducks lined up in Congress for funding, however, with super-peacenik Rep. Murtha saying he will grease a supplemental surge spending bill through the House. Team Obama’s cunning co-opting of Murtha deals a body blow to the congressional peace caucus, turning a powerful dove into a screeching hawk. It is now up to Sen. Carl Levin to lead the peace movement. But Levin seemed confused. He didn’t say that he would try to defeat a supplemental surge spending bill. Instead, he (bizarrely) quoted a few parts of the Army counterinsurgency manual to Obama, trying to prove that McChrystal’s plan runs against established doctrine. In other words, the peace movement is rudderless.
The surge will consist of 33,000 US troops and 5,000 non-US NATO troops. The only actual revision to McChrystal’s original plan is that the President demanded that the surge troops be deployed more swiftly than first envisioned.

Obama Hits Homerun

Charts: The S&P 500 closed at 1109, flat on the day. Resistance is at 1110. After that 1120 should provide heavy resistance because it represents a 50% retracement of the bear market’s losses.

Fundamentals: October industrial production rose 2.2% in Brazil (very good). Australia’s economy is so strong it has raised interest rates for the third time. Australia is not an emerging market, but it is an Asian tiger economy. Meanwhile, Japan’s central bank is doing the opposite of Australia’s, loosening monetary policy to prevent a slip back into recession. The specter of deflation has returned to haunt Japan. The pattern of strong tiger economies and weak dinosaur economies is becoming entrenched. I have been buying SLX (the global steel index) because of this dynamic.

Geopolitics: Obama hit a homerun with his Afghanistan speech, managing to piss off hawks and doves alike, but mostly doves. He made the point that Al-Qaeda and the Taliban are inextricably linked and promised to crush them both. He hinted broadly that after the war in Afghanistan was sewn up Yemen and Somalia would be next. This is heartening because it shows that he grasps the nature of the Long War. At one point he was describing the new strategy and was practically quoting the US Army counterinsurgency manual, very bullish. He also quoted the Gettysburg address, which got a big cheer from the West Point cadets. Hawks were angry that he is insisting on an exit strategy; US surge troops will begin to be withdrawn in 18 months. But the exit strategy is very vague, light on specifics. General McChrystal says that he is satisfied with the decision and this is the final word on the new policy. Doves are upset about the surge and are promising a war tax. This will never fly but it will increase gridlock, which the market loves. Getting the troop request nailed while healthcare is still being debated is great for gridlock. If healthcare fails because of the troop surge, liberals will be incandescent with rage. When President Clinton’s healthcare package failed his liberal base abandoned him, allowing a jog to the right, setting up a huge bull run.

Obama Hits Homerun