Uncle Sam Will Get His Wish

Charts: The first half of the bull market saw a gain of about 60%. The second half has seen a gain of less than 2%. Graphic chart patterns no longer resemble the monstrously huge and short-lived bear market bounces of the 1930s. We have almost the exact gains at this point in the current bull as we did at the same point in the 1982 bull. As the ‘82 bull entered its second year earnings and GDP growth ceased moving the stock market, replaced by various credit spreads and interest rate yields as the most important technical indicators. Back then investors only cared that borrowing costs stayed low, nothing else mattered. And so it is today. Stock markets are being led by credit markets, which in turn are being whipsawed by spreads on Greek, Spanish, and Portuguese debt. The credit crisis is still with us. Primary concern has moved from insolvent banks to insolvent countries on the periphery of the Euro-zone. The technical picture is volatile and unpredictable.

Fundamentals: Foreign held Greek debt totals about $300 billion, roughly half as much as the realized losses from Lehman Brother’s collapse. Much of this debt is held by big European banks and insurance companies. Big German banks are also heavily exposed to Credit Default Swaps on Greek debt. This is a déjà vu of Lehman Brothers. The exposed debt of all the other weak countries on the Euro-zone periphery and the handful of weaklings just beyond the periphery (such as Latvia) plus Dubai (its credit spreads are soaring once again) are about ten times greater than the Lehman Brothers losses. If these sovereign weaklings start defaulting in domino fashion (contagion), the global economy will implode.
That’s the bad news. Here’s the good. Greek public opinion polls show overwhelming support for slashing government spending and increasing taxes. Greece has always had a culture of tax evasion. Some Greek taxpayers are now voluntarily paying back taxes. Heavily subsidized Greek farmers and bloated public sector unions are battling mightily to keep the gravy train rolling. The general population hates them and is pushing back. Still, there will literally be blood on the streets of Athens before this is over.
Spain and Portugal are not doing enough fiscal tightening yet to avert disaster but will probably end up doing whatever Greece does. The clock is ticking on a global sovereign debt bomb, a Maalox moment for investors.

Geopolitics: The Battle for Marja has begun. NATO candidly told the Taliban that the battle would start with a huge helicopter airlift of good guys into the town’s center. The bad guys were totally freaked out when this happened exactly as promised. The first few hours saw key road junctures, bridges and the town center seized by air-dropped NATO soldiers. Next, hundred-ton bulldozers carved paths in Marja’s labyrinthine minefields, laid down anti-landmine rocket barrages, and good guys poured into the battle zone. The Marines threw portable steel bridges across canals to avoid bobby-trapped bridges. Reaper and Predator drones circled overhead, firing Hellfire missiles into bad guy positions. Cobra attack helicopters fired more Hellfire missiles. B1 bombers dropped 500-lbs. bombs into larger bad guy positions. Harrier jets stitched the ground with heavy caliber machineguns. The bad guys recovered from their initial shock and are now fighting back fiercely. Causalities are mounting on both sides with a 14-1 kill ratio favoring the good guys (of course).
Gen. McChrystal has an Afghan “government-in-a-box” which will be opened and put in place once the battle is over. In other words, there is a hand-picked cadre of Afghan administrators plus battalions of elite paramilitary Afghan policemen ready to take over and run the Marja region once the NATO task force is removed.
Western media is aggressively reporting every civilian death and human rights organizations are treating these deaths like war crimes, as if they were intentional. So the Taliban’s human shield policy is bearing propaganda fruit for the bad guys. The Marines call Marja “The Heart of Darkness” for good reason. The inevitable loss of Marja’s vast opium production will be a terrible financial blow to the Taliban and will trigger a big Whack-a-mole effect; so we need to pay attention to the other little wars.
In Yemen, the truce between the Houthi rebels and the Yemeni/Saudi Armies is progressing nicely. The Houthi army has released several Saudi soldiers that it had taken prisoner. During the war the Houthis had completely encircled a forward element of the Yemeni Army; that encirclement has been relaxed and the trapped Yemeni soldiers are escaping. A Yemeni helicopter crashed, killing 10 soldiers, but it looks like a technical malfunction, not Houthi fire.
The CIA-led battle against Al Shabab in Somalia is heating up and a fresh battle against AQAP in Yemen is on the horizon. It will take a while for the Whack-a-mole effect (WAM) to funnel bad guys out of Afpak and into Somalia/Yemen. By the time the WAM swings into full gear, the US hopes that the bad guys will be entering a meat grinder, not a comfortable and cozy safe-haven. Looks like Uncle Sam will get his wish.