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Tuesday, November 23, 2010

The Socratic Method..........

Today the investing world’s focus has been distracted by the events on the Korean Peninsula and their shot(s) broadcast round the world. While there is no way to know for sure but it would appear that the North Koreans are posturing as the shelling unleashed made headlines and killed a couple of unfortunate South Korean Marines on an island, but did not inflict real damage on the mainland. As usual the Western media was firing on all cylinders hyping the Korean situation as the prelude to Armageddon, however, it appears to me to be more of a statement trying to lend a bit of the Kim Jong Il toughness to his son and soon to be leader Kim Jong Un. This seemed to me as a tactic to be used as a bargaining chip when North Korea ends up in six way talks with its neighbors and the US. Not surprisingly the Russians were out screaming the sky is falling and this situation could escalate; of course the Russians have been aligned and extremely supportive of North Korea even dating back to Kim Il Sung II in 1959 so it is not surprising that they would pull out the stops to help create the illusion of impending catastrophe to strengthen their allies bargaining position and also subtlety stick a thorn in China’s side as a bonus.

Instead of catastrophe I believe it is much more likely that North Korea under new management wants something possibly to help alleviate the deplorable conditions in country as they know that to retain power they need to feed their people. The quote from Napoleon, “An Army marches on its stomach” comes to mind, but  the North Koreans have modified it to “the ruling class retains its power on the public’s stomach”. There is much fear that the North Koreans who purportedly have nuclear weapons might use them, however, just as the theory of MAD (Mutually Assured Destruction) gave pause to the US and USSR in the cold war, the North Koreans would do the calculus and realize they would not survive a retaliation. If the North was to utilize nukes it would not take much to retaliate and fuse the entire peninsula in to a giant hunk of glass. The net result  was the Koreas were one factor weighing on investor’s minds today, however, I think this will amount to little more than “news cycle” drama that will have little to no lasting investment impact.

Also weighing on the markets was the FOMC (Federal Open Market Committee) minutes because the FED lowered its expectations for economic growth. The FED’s statement cited tight credit conditions, weak residential and commercial real estate and a “high degree” of caution by consumers and business.  All I can say to the FED’s statement is Duh!

Dear reader if you have been following this blog the FED minutes are not at all shocking.  If you have looked around your neighborhood, talked to people and just lived your life outside the vacuum of the phony baloney media happy land you already knew what the FOMC disclosed today, so it is no surprise. The fact that even a revision of the third quarter GDP upwards to 2.5% from 2.0% did nothing to juice the markets leads me to believe that the FED will continue on the QE path to ensure that assets don’t slide too far down in to the feared deflationary spiral, dissenters be damned.

Meanwhile across the pond investors are relived that it appears that the Irish eyes may not be smiling but at least they will be smirking since the budget cutting and both the EU and IMF bailout plans appear to be taking hold in the Celtic country. While questions still abound there is positive momentum in Ireland.

This brings us to the next worry which is Portugal since I believe this is but a warm up for the big one…Spain first then Italy. Portuguese Prime Minister Jose Socrates has a tough job. He is trying to institute austerity measures in the country as a result of Portugal having the fourth largest deficit in the EU. Portugal initially took the ostrich approach and buried it head in the sand so they have been slow to react. Socrates has been battling the unions who are upset and looking to take to the street in protest of a hiring freeze, a 5% wage cut for those making € 1,500 or more per month as well as raising the VAT 2%.

By the numbers Portugal’s deficit is comparable to that of Germany at 4.6%, however, unlike many of its neighbors economic growth has been virtually at a standstill and is projected to shrink 1.4%. So even though Socrates is making the hard choices it comes as no surprise that there would be protests and strikes that will hobble the country just like occurred in France. While Socrates has announced these solutions to combat Portugal’s budgetary problems the bond markets appear to be wagering that his methods are far from certain in their implementation, resulting in a pretty dramatic rise in credit default swaps.

It is my contention that Portugal will also receive a bailout plan of sorts and the contagion will march through the Piigs. As the situation gets deeper growth estimates will be cut particularly since the EU relies on exports and with one of their largest consumers the US scaling back the EU will be forced in to their own QEuro (QE). It is only a matter of time before things get unsustainable in EU land as you can see by the reactions of the populace it is fine to talk about budgets and austerity as long as you are imposing it on someone else; it is no different than in the US when there is talk about raising taxes or cutting benefits it is fine when it affects someone else but raise my taxes or cut my entitlements … no way!

So in light of all that transpired today it was interesting to see that both Gold and the Dollar rose. Gold rose in the face of options expiration which has tended to create pretty good downswings in the past, but today it showed strength instead. I found it fascinating that the bubble heads on CNBS (aka CNBC)  were blathering on about how the risk trade was now off and the safety trade was on; a new dynamic must be in play then because it was not even a couple months ago when the safety trade was considered to be only the US Dollar and gold would be sold. It seems to me that we could be entering a phase that is supportive of both gold and the dollar rising at the same time which would be a negative for the markets. Of course tomorrow is another day and we will have to see what comes out of this abbreviated business week as short weeks like this can be anomalies more often than trend setting. Here is to cooler heads prevailing tomorrow.


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