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

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.