Sunday Nov 28 2010
Running on Empty
No one would have anticipated the steps the EU has been forced to take to shore up the euro.
Angela Merkel, WSJ A9 11,24,2010
Prime Minister Merkel’s comment is self-serving and defensive at best. One only had to do some minor analysis of budget deficits or observe that France and Belgium entered this downturn with 9% unemployment, about where the US is now. If one connects the dots in this Wednesday 11/24/2010 WSJ, it is not hard to see where all this is going, if you have the paper I suggest reading the articles, if not, it is easy enough to see where this is going.
In Ireland Bailout Triggers a Wave of Anger Page A 9
Anger is the social mood of bear markets. As the perennial weak sister of the British Isles, the move from Celtic Tiger two or three years ago to Bailout Now is especially galling. (On the way to page A 15, notice on page A 13 that Argentina actually wants ‘help’ in creating a new inflation index. If there is anything the Argentines ought to be able to create on their own, it is an inflation index, the one thing they have consistently produced this past century is inflation. ) The Irish Domino on A 15 puts the outcomes plainly.
Either Germany will ‘loan’ Ireland $115 B which the Irish will struggle to pay back for years and years. But like Greenspan bailing out Long Term Capital Management, this really just encourages the high spending countries to revert to their usual ways. The parallel is that after Greenspan bailed out LTCM, Lehman, Bear et all assumed he would do the same for them. Who was more stunned when the end came, Richard Fuld at Lehman in 2008 or Gorbachev in 1989, I wonder. The more likely outcome is that politicians in Ireland, Portugal, Greece, et all will renounce the Euro. There will be a call to revert to a ‘sovereign’ currency, safe from the meddling of Brussels’ Bureaucrats who claim to run our country better than ourselves! (Not a bad sound bite I must say.) And so the indebted countries default as they have in the past, go back to separate currencies, and Germany and the Netherlands for a new union between the two adult countries in Europe.
Sometimes an anecdote can tell us more about reality than all the economic data and economists as the saying goes, laid end to end. On page B5, Campbell Soup reports ready to serve soup sales slid 13% in the quarter ended Oct 31. The shift comes as heavy supermarket promotions of such simple meals as boxed macaroni and cheese have battered Campbell earnings in recent quarters. So there you have it, even the purveyors of the soup line are suffering price competition, i.e., deflation.
In Section C, spreads for Ireland, Portugal, and Spain widen over German yields as ‘Investors Dump the Euro for the Dollar.’
Bernanke’s plan to flood the banks with Dollars has only put dollars on balance sheets and created unintended inflation. La Z Boy reports higher material costs and a 34% lower second quarter profit (recall this was one of or short recommendations). At Cracker Barrel, the CEO warns higher commodity costs will impact earnings the rest of the year.
China
China like Bernanke is attempting to print prosperity.
Financial markets tend to focus on one feature at a time; this feature becomes an obsession. After Milton Friedman won a Nobel for his work on Money Supply, that was followed in micro detail in the press. Today the FED does not even report those numbers. In the 1980s, the question was, how much of the US debt would the Japanese purchase at each Treasury auction. Now the Chinese have supplanted the Japanese as the world’s growth engine. And the press wonders, yes, how long the Chinese will purchase American Treasuries.
China has grown by becoming the manufacturing engine for America and other countries. Now that purchasing has slowed in America, the Chinese have artificially created ‘growth’ in Asia with various construction projects. This ‘work’ is represented as growth. There is no way the Chinese consumer can replace the American consumer. The result is that China continues to build not only empty projects but also entire empty cities. Here is an article reflecting this attempt at substituting building for manufacturing. Be sure to watch the interview with Chanos.
These three links cover some of the same ground. Yet the parallel between the building boom in the US pre 2008 and what is happening in China will be clear after you read and watch all the links.
Chanos reflects on his short China position.
http://globaleconomicanalysis.blogspot.com/2010/11/chinas-economic-treadmill-to-hell.html
Here is a video, from AlJazeerah no less, of an empty city in Mongolia.
Mongolia is Las Vegas
http://www.youtube.com/watch?v=0h7V3Twb-Qk
Ordos, Mongolia surely has as its counterpart the empty condos of Florida and particularly Las Vegas, a city built on gambling. Readers will recall that prior to 2008, Las Vegas was the fastest growing city in the US. Note that speculators own the apartments in Ordos. This of course is an echo of recent US real estate activity. Not long ago 25% of all US mortgages were on second homes. Today of course FNM and FRE are broke. In other words the same story is playing out in China but a few years later, and it will end the same way. And the market knows it…

In the clip, Ordos, Mongolia is compared to Shanghai, so this picture of the SSEC is most relevant. The US equivalent the SPX is at bottom. Despite all the money spent by both governments, the bear market continues. One can see the failure at the pink downtrend line. In November the SSEC failed at its 200 week MA. This led me to suggest this past week that the bear market had indeed resumed. The fact that the defensive markets of US long bonds and the Dollar have also come to life confirms this view in my opinion. The British FTSE has managed to move above its MAs but I suspect the 50 week MA will not bet much above the 200, if at all, China
Another non-confirmation.

The Stock Market – The Bear Market Resumes

Our centerpiece as always is the internal condition of the stock market. The summation index for the New York Stock Exchange Index peaked a year ago. Since then it has traced out lower highs, which means fewer stocks participate on each rally. Yet the overall market is higher! This is clear in the first segment below the actual NYSE index. This is a massive non -confirmation that shows the market is tiring with less breadth on each rally.
As I looked at the chart a second and third time, it occurred to me to draw the intersection of the green uptrend and the pink downtrend lines. And sure enough, when drawn this intersection occurs just before what increasingly appears to be a November peak worldwide, see SSEC and FTSE on previous page. Remember stock indices are now volume weighted, so participation by giant companies masks the fact that many smaller companies are already off the radar screen so to speak. This is why it is vital to examine the internal action. Finally we put the Bank ETF the XLF in the lowest segment. Despite all the literal trillions spent, the XLF is breaking down,
Euro zone
Greece and Portugal have about the same sized populations, 11.5 million. Pennsylvania has 12.6 M by comparison. Ireland is rumored to have 4.5 M though Wikipedia puts it around 6.2 M in 2008. Spain however, the S in PIGS, has 46 M population. Now if the Irish bailout were estimated to cost $115 B, what size would Spain be? 
STD is a large Spanish bank traded on the NYSE. This past week it shares broke a two-year uptrend. Need we say more about the expectations?
Spanish Credit Default Swaps Increase
The PIGS of Europe have cousins in the US, which are the states of CA, NY, IL, and NJ not to mention the real estate graveyards of NV FL AZ. Already Prime Minister Merkel is rightly calling on bondholders to shoulder the burden, i.e., take less money from the PIGS. In the US CA and NY have stayed afloat by selling Build America Bonds. The Federal Government guarantees 35% of the interest. But I suspect that Germany will balk at bailing out everyone and even if it does not, the citizens of those countries are already protesting against even modest austerity measures. Either way defaults loom. Here the new Republican Congress is unlikely to approve bailouts for CA and NY, These are Democrat controlled states and will their defaults will likely be a centerpiece of Republican strategy in the 2012 elections.
The Dollar

Need we say more? We have a third year of a higher low; note how the Dollar has jumped the last three weeks on a flight to safety amid Euro woes.
It was a close race as to which was getting more negative publicity, Lindsey Lohan or the US Dollar. Both ended up out of jail. Market bottoms are marked by excessive negative publicity. We wish Ms. Lohan a sober and healthy life as well as our positive outlook for the Dollar. We regret being way early and ignoring our PAR SAR sell signal. This led to some serious disappointment; we will not ignore a short-term market turn that way again.
Gold
Gold has advanced too far too fast above its 200 day MA. Price appears to be curling over past a right shoulder of an H & S pattern. A measured move top to bottom would take the price back to the 200 day MA at 1220. And note the blue arrow, this corresponds to the breakout point for this last rally. So going back to re test that seems logical.
Remember that gold and silver rallied strongly before the last collapse, but the last man standing was crude oil. Let’s take a look.
Crude Oil
While oil has not experienced the same sort of rally as gold, it does exhibit the same H & S pattern. Top to bottom would indicate an $8 pullback from the neckline to around the 72-74 area.
Could there be a repeat of the 2008 rally? Let’s take a look back.

Oil is trading for about the same price now as then. It pulled back and then was the subject of massive speculation. It was the last market to make a high before the collapse. We would not be surprised to see a pullback to 72-74 and then a rally into this next year. Putting a number on that now would be as pointless as guessing it would double to 145 in 2008. But we certainly do not discount the possibility of last minute fireworks. The banks have put lots of money in circulation to fuel another speculation.
Bottom Line
The Government is investigating Hedge Funds and ‘insider trading’ at a time when it needs; you guessed it, liquidity from hedge funds and insider trading to keep the market up. The Government will likely get what it wants in reduced trading. Muni bond traders note that the loss of Lehman and Bear Stearns has meant less liquidity for that increasingly weak market, fewer bids mean wider spreads and so prices fall. SSEC is predicting the failure of China’s ‘stimulus efforts. Other world stock markets are much the same. Participation or breadth is failing in the US market again portending an end to the counter trend rally from 2009. While the overall market has higher index prices since April, Bank of America has been cut in half (19 to 11) and Citi trades lower than in April as well. We recently noted the big banks are trading for less than book value. Bonds and the Dollar are now rallying further confirming the negative outlook for stocks and commodities.
Still we expect a last gasp leg up for stocks and perhaps particularly for commodities in early 2011.