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"Human history is a brief spot in space, and its first lesson is modesty."
                                            Will and Ariel Durant

Commentary & Analysis
It’s “all good”?

I have a good friend named John who has a very poignant expression when things look bleak and markets rally, as soon as he gets short. He will say to me, ―Hey don’t worry. It’s all good,‖ sardonically making light of those making money on the long side when he (and I) think the market is staring into the abyss. The magic of Mr. Market’s discounting process can be extremely frustrating.

All you have to do to forecast markets is get inside the heads of every individual player and understand his rationale and irrational side…that’s all. According to F.J. Chu, from his book, ―Paradigm Lost,‖ he reveals how easy this game really is…

The unique and fascinating nature of the markets is due to the centrality of Being—the mind of the investor, many investors, and in its totality the mind of the market. Its uniqueness has to do with the way the investor stands out within time an in relation to time. In every trade (or every click of the mouse) the past, present, and future all converge in one instant in one physical space. The unique character of each investor’s mind—in infinite variations of reason and emotion, fear and greed—finds its expression in the cascade of market prices.

We know that Mr. Market, through the minds of all these individual players, is continuously discounting what we know:

  • Japan disaster
  • Libya civil war
  • Egypt unknown
  • Ireland banking problems
  • Greece debt
  • Portugal debt
  • China growth deceleration
  • Emerging market inflation
  • US money madness
  • Somali pirates
  • Eurozone politics

…so far that discounting process this morning is leading to a marking down of prices…across the board…

S&P 500 Futures Daily: Now below the 22-day moving average; the 200-day moving average is all the way back at 1170. A case can be made that some type of intermediate-term top may be in place. But then again, that case has been being made for many moons, as the market plows through those worry walls.

In the next chart, we kept the S&P 500 Futures and overlaid the premiere risk appetite currency—the Australian dollar (AUDUSD) – the maroon line:

If you think Mr. Market will continue to react negatively to the ―known unknowns‖ to come, and looking for a currency that will likely fall on risk aversion spreading in some type of multi-day or multi-week affair, Aussie is likely the one among the majors.

I realize all the talk is rightly focused on Japan. In fact, I would expect you are becoming bleary from the simple and consensus analysis that reiterates all the stocks that will benefit from the rebuilding. In addition to the mantra of repatriation driving the yen higher in value is the only game in town.

It’s not what we see right in front of us that matters most in markets, it is the stuff we glimpse out of the corner of our eye. And though the following ―unknown knows‖ have drawn more than just a glimpse, I don’t think Mr. Market has quite yet discounted the depth of the danger…

In fact, I heard an analyst confidently say (as they do), ―…there is no way the Saudi’s will let an Egypt happen.‖ Hmm….

  • The Bahrain – Saudi Arabian – Iran Connection

From today, in an article titled, ―History Repeats Itself in Eastern Arabia ― [our emphasis]:

For the second time in less than two years, Saudi Arabia deployed troops beyond its borders to contain Shiite unrest in its immediate neighborhood. In late 2009, Saudi forces fought to suppress Houthi rebels in the country’s Shiite borderland to the south in Yemen. This time around, a Saudi-led force, operating under the umbrella of the Gulf Cooperation Council’s (GCC) Peninsula Shield Force, deployed forces to the Sunni-ruled island kingdom of Bahrain to suppress Shiite unrest.

The Saudi royals, highly dependent on the United States for the security of their regime, do not deploy their forces without good reason — especially when they already have their own simmering Shiite unrest to deal with in the country’s oil-rich eastern region and are looking at the potential for instability in Yemen to spill into the kingdom from the south.

From the Saudi perspective, the threat of an Iranian-backed destabilization campaign to reshape the balance of power in favor of the Shia is more than enough reason to justify a deployment of forces to Bahrain. The United States, Saudi Arabia and its GCC allies have been carefully monitoring Iran’s heavy involvement in fueling Shiite protests in their Sunni sheikhdoms and understand the historic opportunity that Iran is pursuing.

From the Saudi perspective, the threat of an Iranian-backed destabilization campaign to reshape the balance of power in favor of the Shia is more than enough reason to justify a deployment of forces to Bahrain.

The historical attraction of Bahrain lies in its geography. Bahrain is a tiny island nestled between the Arabian and Qatar peninsulas. It is vulnerable to external interference and valuable to whomever can lay claim to its lands, whether that be the Shia, the Sunni or any outside power capable of projecting authority to the Persian Gulf. Control of the island together with the Strait of Hormuz allowed for domination of the Indian Ocean trade along the Silk Road and the Arabian trade route from Mecca to the Red Sea.

The isles of Bahrain, along with the oases of al Qatif and al Hasa (both located in the modern-day Eastern province of Saudi Arabia), have been the three key economic hubs of the eastern Arabia region since antiquity. Bahrain sat atop a wealth of natural pearls while all three of these areas traded dates and spices and later on, oil, with buyers abroad. Critically, Bahrain, al Qatif and al Hasa have also been heavily populated with Shiite peoples throughout their history.

… It remains to be seen how this latest chapter unfolds, but if history is to serve as a guide, the question of whether Bahrain remains in Sunni hands or flips to the Shiite majority (currently the less likely option) will serve as the pivot to the broader Sunni-Shiite balance of power in the Persian Gulf.

And back to Mr. Chu:

The market does not simply wait for news and then react to it. Rightly or wrongly, it tries to anticipate events using rumor, reason, and emotion. In the process, investors often either get seduced into chasing rising prices or get trapped selling in unjustified panics.

I emailed my friend John this morning and asked him if he had any comments to the events so far today, he wrote back; ―Sell everything.‖

Well, maybe everything except what Mr. Bill Gross so publicly sold the other day—US Treasuries—they are soaring in price and playing their normal role as safe haven:

US 10-yr Treasury Note Futures Daily: Zoom-zoom!

Interesting how everyone’s perceived safe haven—gold—is reacting today…tank!

"In the past one hundred years, every major asset class that experienced a sharp, dramatic rise in valuation in a short period of time eventually lost all its gains. This statistical reversion to the historical norm includes stocks, bonds, commodities, and currencies. There have been no exceptions," according to FJ Chu.

This is not to say this market is done. This is not to say it won’t look past all and rally again. But it is to say we don’t know. And it seems we are at a level in which most analysts think they do in fact know. Every bad rationale is justification for a good one, just a few examples of late that I have heard:

  • Slow growth in Japan—buy emerging market because inflation will recede
  • Japan funding needs—sell US bonds
  • No nuclear—oil must go higher

In short, "it’s all good."