The Geopolitics of a Reserve Currency

     My conclusion is that it makes no sense to cut one dollar from defense spending or to reduce our nuclear arsenal by one more warhead. In 1973, Nixon persuaded Saudi Arabia to exclusively accept dollars in payment for oil from any and all countries and to agree to buy US bonds with the money they received. In exchange they were to receive US military protection from any regional or global power.  By 1975, a year after the 6 month oil embargo ended, all members of OPEC agreed to do the same, effectively making the US dollar the world's reserve currency. I haven't calculated the numbers, but I wouldn't be surprised if the monetary benefit of being the world's reserve currency has been worth enough to pay for all US military spending since WWII. Whatever the figure is, it is monumental. And this privilege will only remain intact as long as the US possesses overwhelming world military superiority, including control of the seas ( as in "Britannia Rules the Waves").

    Wasn't it you who speculated that the US attacked Iraq in 2003 because Sadam Hussein threatened to stop accepting dollars in payment for oil? You will never see this discussed openly by any Western Government official because it is too explosive of an idea. It makes it clear that the US is a modern Roman Empire or a 19th Century British Empire. Nations never admit their real geopolitical/economic motives but always disguise their actions in lofty moral terms. But Realpolitick drives the world much more than the pursuit of idealism. Conversely, without economic and military power, it is impossible to pursue any altruistic policies and actions even if a nation does desire to do so.

     There is much anguish among various economists and writers that the USA's deficit spending will turn the dollar into a "banana republic" currency unwanted by other nations as a store of value and thus not of value to measure a unit of economic exchange. Of course that is a real danger if "money printing" is carried far enough. 
   But the allies and trading partners of the US know full well how expensive it is to maintain a top-flight military establishment, and they factor this in to their evaluations of our deficit spending. Just consider how empty France's posturing was during it's intervention in Libya. France has some excellent aircraft and military technology, but they couldn't even supply enough ordnance for their planes to last for more than a few bombing runs. The US had to supply them after about the first week or two. This analysis does not imply that I think the intervention in Libya was even a good idea. I believe it was ill-conceived right from the start for many reasons. However, that discussion deserves an article of it's own, which Stratfor.com has probably already written.
   I believe that Obama's desire to reduce our nuclear arsenal reveals a profound strategic incompetence (assuming he does not learn better).The amount of radioactive hazardous waste produced by the process of creating these warheads is a price this country will never be willing to pay again in the future if there appeared to be a necessity for building more warheads again. So the sensible thing is just to store the ones we have, not dismantle them. Even in the thoroughly unlikely eventuality that there is never again a serious threat to the Western world from a dangerous adversary, there are other hazards which may need to be countered by the use of nuclear warheads. The most obvious is the deflection of asteroids from paths that could lead to a collision with earth. In my thinking, this should be the next great priority for a NASA- Air Force project.

Public Pessimism and Professional Optimism

     First of all, I want to admit that my April 21, 2011 blog, a speculation about the possible formation of a cup and handle, obviously did not develop as I had hoped. In fact April 30 was the top of the market. The potential cup and handle was in reality a double top in the process of forming. Now I am going to venture to propose another potential bullish scenario evolving out of the recent market decline. This letter makes reference to William Schmidt's TigerSoft system as well as to the Dow Theory.
      Perhaps we can view the weakness in public buying as a contrary indicator, like new highs in the odd-lot short selling to purchases ratio. At bottoms, the public tends to be bearish and they don't become bullish until the uptrend is well under way. Under the Dow Theory, the first psychological phase of a bull market is where informed money in strong hands comes in to buy and the public is still afraid of the market. This corresponds to professional and insider buying in the TigerSoft system. In the second psychological phase the public joins the informed money (and professionals) in buying. Economic news tends to improve in the second phase. In the third, speculative phase, the public becomes the main driver of stock prices as professionals and informed money accumulate less and distribute more. If we are in the first phase of a mini-primary bull market, the TigerSoft Accumulation Index should grow stronger as insiders join the professionals.
     The weak link in my analogy is that while professionals are bullishly buying, the corporate insiders, as measured by the TigerSoft Accumulation Index, have not yet decisively done so. They correspond to the "informed money " under the Dow Theory. Of course, I really think that this is all taking place on a miniature scale; realistically the best we could expect would be an intermediate term rally coming out of a sharp correction which could be called a mini-primary bear market. My small cap mutual fund declined about 25%, which is over the 20% threshold that many analysts use to demarcate a bear market. But the sharpness of the decline as well as the terrible surrounding economic news has been enough to generate these "cyclical" psychological dynamics which the Dow theory describes and Tigersoft  indicators measure.
 

Cup and Handle Pattern

Most of the major indexes formed a potential cup and handle pattern from Feb. 22 2011, when the top of the left side of the cup was formed, to April 7 2011 when the top of the right side of the cup was formed. On the DJ Industrials, the left high side of the cup reading was 12,391 and on the right high side of the cup the number was 12,450. The low point of the handle came in at 12,200 on a closing basis. On April 20 The DJI rallied 187 points, after advancing 65 points on April 19. If the DJI can decisively move, on a closing basis, above today's closing peak of 12,453 with no more than a nominal loss intervening, it will have successfully broken out above the cup and handle pattern and be in technical condition to move significantly higher. According to the Stockcharts.com tutorial on the William O'Neill Co. (Investor's Bus. Daily, Daily Graphs) tool on the subject, the price target would be about 13,350 before another pattern needed to materialize. I haven't read the Investor's Business Daily for a few years, so they might have recently covered the current technical situation with a cup and handle analysis. You can find the StockCharts.com tutorial at this web address: http://stockcharts.com/help/doku.php?id=chart_school:chart_analysis:chart_patterns:cup_with_handle_cont. You can view the Dow Jones Industrial chart at Stockcharts.com on the Market Summary page.
    Volume on April 20 was above its 60-day exponential moving average. I consider this quite positive in view of the fact that this mini-bull has advanced on unimpressive volume since its inception on March 10, 2009. But it does need to break out decisively above the C & H pattern if we are to be spared another indefinite period of uncertainty with its attendant hand-wringing.

2000-2009 Secular Bear Market?

Letter to Richard Russell of Dow Theory Letters:

Richard:  I think it is clear that both the 2000-2002 and the 2007-2009 declines were primary bear markets. I think the important question is whether the period since 2000 has been a secular bull period or secular bear period. Remember, "secular" refers to whether PE's and valuations in general are increasing or decreasing, not just whether prices of stocks are rising or declining.
   You state that you now believe that the 2007-2009 bear market was just an exceptionally severe correction, not a primary bear market. The "mini-bull" market high of 2007 ended up at a lower PE by far than the PE at the bull market high of 2000. The "min-bear" market low of 2009 produced a lower PE than the the bear market low of 2002. Thus, even though the market averages at the 2007 highs topped out above the market highs of 2000, we can still call the 2000-2007 period a secular bear market because these are defined by PE, not price. The rise and fall of valuations is what the classical Dow Theory called a "primary" bull or bear market, but the Dow Theory seemed to assume that valuation highs would correspond to price highs and valuation lows would correspond to price lows. Thus the mechanical signals given by price movements were assumed to have no possible conflict with valuation readings.
     But we find at market extremes that there is some divergence between these two measurements, at least in terms of the cycle high and low points of each successive bull and bear market. Thus there is a need to distinguish between "primary" bull and bear price movements, and "secular" trends, which are based on PE ratios.
    It appears that future peak of this mini-bull cycle has a chance to exceed the maximum PE of the 2007 market highs. If that happens, it will reveal that the secular bear market ended at the March 2009 lows.
    I attempted to post the Case-Shiller S&P 500 PE Chart onto this blog but it would not fit. You can look at it at the following site: http://www.multpl.com/
                                                         

                                                       The Unraveller

                             

Market Indecision & China Comment

     I observe see that the Big Money Breadth Index compiled by Richard Russell  of Dow Theory Letters is showing great strength while the A-D line has been weakening by showing resistance to making new highs. New highs in the DJ Industrials and S and P 500 confirm that the blue chips are currently the predominant Indexes. Does this indicate that the next rally, assuming it comes before a major decline, will be one led by the blue chips with the majority of stocks lagging? In the past, this has been a formula for the creation of major market tops. One thing I have puzzled about is how the type of scenario described above comports with the observation that a major rally in "cats and dogs" also is the harbinger of a longer-term market peak. Can the "cats and dogs" experience an upside explosion while the A-D line is weakening?

     Of course it is quite possible that the A-D line, which has led the market up since the March 10, 2009 lows, is simply undergoing a much-deserved consolidation after which it will resume its strength. I hope that this is the case for it would portend a longer extension of this mini-bull market. This uptrend is drawing closer to equaling in length the 1970-1973 mini-bull advance, which has been a sort of longevity benchmark for me.

     Simply because it has such a large population, it is well to remember that China needs to surpass the US in absolute GDP just to raise its per capita income closer to that of the "developed" nations . Especially ironic for a "Communist" country, China has huge disparities in the distribution of wealth.

Emerging From Correction

      The action of the last 3 weeks is exactly what I was hoping for. That is, the market is slowly working its way up toward the June highs in a steady, "consolidating" manner. There will probably be a DJT non-confirmation which will result in a sell-off to relieve the overbought situation by sending the McClellan Oscillator back down towards the 0 area. Then a little sideways action will occur in the area of the short term decline lows. Then I would hope for more strong upside action up to the April 26 highs. Then, some corrective action should transpire which will create a head and shoulders or "saucer bottom" for the major averages. This latter action would be taking place in the late summer/early fall time zone which is a weak seasonal period.
    Then in the strong seasonal period I would hope for a powerful rally to take the market in the direction of its 2007 highs.  This rise might be the conclusion of the mini-bull, but it is going to be a challenge to correctly identify the final top, which could occur in the late spring or summer of 2011. Interestingly, the S and P 500 is also currently lagging the DJI while the A-D index has already soared well above its June high area. The McClellan Summation Index is showing a classic rising pattern out of the area of its recent lows. So this market is essentially being led primarily by the A-D index and secondarily by the DJI.
     The discussion on whether the market reacts to news or is always looking ahead to something else is an interesting one which I may write up on Unraveller's Spool in the future.
                                                                             

A-D Ratio Strength

     Some analysts have stated that the A-D has been weaker than the Dow for a couple of months and that this is an evil harbinger for the market, meaning that a rally that has only a relatively few large cap stocks advancing while the majority of issues languish is a vulnerable market. If that were actually the case, it would be a precarious situation. I would describe the market action/price relationship between the A-D line and the Dow like this: On April 23 the Dow and the A-D line both made new highs. The next trading day, the 26th, the Dow was unchanged while the A-D was slightly lower. On May 3 the Dow completed the right shoulder of its its 2 1/2 week Head and Shoulders pattern by closing 50 points lower than its closing peak. On this same day the A-D ratio made the right peak of a double top. On the rebound from the May 7 low, the A-D line has performed, from what appears on the charts from Stockcharts.com posted on that site May 13,  about equally strongly as the Dow, if not actually a little more powerfully. It is really the A-D ratio which has been leading the price indexes up during the entire rally from the March 10, 2009 lows. I really can't see any basis for saying that the A-D ratio has been lagging the Dow for even the last few weeks, let alone the last few months.

     Having said that, I certainly agree that the number of distribution days is a matter for deep concern, as is the related problem of high volume on down days and lower volume on up days that has been in evidence pretty much during the entire rally from the March 10, 2009 lows. That is why I have dubbed this the "Paul Dysart Market", a reference to Dysart's Negative Volume Index which nobody believes in anymore. Dysart believed that the "big and smart money" preferred to accumulate stocks on quiet days of declining volume so as not to attract attention and make it more expensive to accumulate its positions. This resembles the way large gold accumulators are operating in "the stealth gold bull market", as Richard Russell has described it. However, the stock market rally had come to attract much more attention and belief than the gold bull market in the weeks preceeding the recent mini-crash.  I admit that this Negative Volume concept does contradict the supply/demand logic of the on-balance volume theory and its indicators in their various incarnations. This paradox raises the question of how stocks can advance when more shares are sold on declining price trades than on advancing price trades. But somehow, it does seem to manage to work for particular time periods.

     The A-D derived McClellan Oscillator made a low on May 9 of 2009, the lowest it has fallen as far back as the Decision Point Chart shows, which is May of 2009. The Summation Index, which is the cumulative total of the the daily McClellan Oscillator Readings, is still 450 points above its Mid-February 2010 lows but steepened its downward direction May 13 with a wider downside "gap" between plotted points. For the Summation Index to fall to a deeply low area, the McClellan Oscillator itself must persistently remain in negative territory for many days. And for the McClellan Oscillator to do that, there must be frequently recurring strongly negative days of declines over advances without much of an intervening rally in the A-D line. If the McClellan Summation Index were destined to fall to the 0 area or below, that would imply to me a further significant loss in the price Indexes, given what I have seen, in the context of this particular correction, of most indexes' propensity to decline sharply in proportion to a given extent of A-D decline.