The Well-Timed Strategy

                                                  

Economic & Stock Market Analysis for the Discerning Investor & Executivewww.peternavarro.com Read it and Reap!  

 

This Week: Living in a World of “Rational Expectations”

Market Pulse

The theory of “rational expectations” was developed by conservative, neoclassical economists (primarily the “Chicago School”) to explain why it is fruitless to engage in any kind of Keynesian fiscal or monetary policy to artificially stimulate an economy.   The best way to explain this theory -- which is HUGELY relevant for today’s financial markets -- is with an example.

Suppose, then, that the US government engages in a massive fiscal stimulus to jumpstart an economy in recession.  But also suppose that this massive stimulus will require equally huge budget deficit financing that over time will surely increase both interest rates and inflation.  Since people are rational, they will therefore “expect” the advent of higher interest rates and inflation and behave in ways that will defeat the intent of the stimulus.

In particular, consumers will save more because they know the stimulus will only eventually provoke an even deeper recession.  This behavior will suppress consumption spending, thwarting recovery.  Businesses will also try to raise prices in anticipation of inflation while workers will demand higher wages -- thereby causing an inflationary shock earlier rather than later.  Bond market investors will refuse to buy the bonds needed to finance the deficits because they know as interest rates rise, bond prices will fall.  Stock market investors won’t buy stocks because they know another bear market is coming.  And foreigners won’t help the US government finance its deficits because they know the dollar will become worthless -- along with their US bond holdings.

The liberal critique of rational expectations theory -- think Krugman or Reich -- is that people aren’t really that smart about macroeconomics or that rational to fully anticipate all of the effects so there is a period of time during which a fiscal stimulus can actually work its magic.

So who’s right?

Well, right now, the financial markets are a living, breathing experiment to prove -- or disprove -- the rational expectations argument.  When BOTH the stock and bond markets turned bearish last week, that seemed to be a signal that the rational expectations argument may hold sway.

Of course, readers of this column will know that I’ve been speculating on at least a brief bullish cycle of a few months or even a year or more.  However, readers should also know that I am a secular bear precisely because the Obama-Bernanke-Geithner-Summers Program contains the seeds of its own destruction -- see paragraphs above.

So, with last week’s action, we are back in dangerous waters again ever so quickly.  I’m holding my GE 2011 leaps and 2011 leaps for Dupont because I think that company manages the business cycle well.  However, I bailed on my Delta leaps with a small profit -- I see oil and jet fuel prices on the rise again as the dollar falls.

I may also cash out my Intel and B of A leaps with small losses -- depending on what unfolds over the next week or so.  So stay tuned….

International Notes:

This article of mine appeared on October 12, 2006 in the Chicago Tribune.  It is as relevant today as it was then.

Only China, not U.S., can rein in N. Korea

North Korea is a significant threat to global economic and political security–even without nuclear weapons. Neither the U.S. nor UN sanctions can bring North Korea to heel–only China can.

The North Korean economy, and therefore its political system, is immune to UN sanctions because its primary economic activity is to traffic in illegal arms, drugs, and counterfeit and smuggled goods. It sells weapons to rogue nations and terrorist organizations. North Korea is the primary supplier of methamphetamines to Japan and much of Asia and a significant link in the world heroin chain. Fresh, crisp and decidedly counterfeit U.S. dollars are printed in North Korean government mints and distributed around the world, and North Korea is a major conduit for Chinese counterfeit goods and a leading supplier of smuggled cigarettes.

In this illegal trade, North Korea plays the “wholesaler” to crime” retailers” that include the Russian mafia, the Japanese yakuza, the China-Hong Kong triads and a thriving Thai underworld. This economic activity takes place far below the reaches of any UN sanctions; and each of these activities contributes in its own unique way to global economic, political or social instability.

Add to this volatile black market mix a nuclear weapons capability and it is easy to understand why world leaders are so uneasy. But who might these North Korean nuclear weapons be aimed at?

The answer certainly isn’t South Korea. Even a madman like North Korea’s dictator Kim Jong Il is rational enough to realize that to drop a bomb on Seoul would be merely to invite nuclear fallout back on himself. That leaves other targets like Beijing, Tokyo or Anchorage. It also leaves the worst nightmare of the U.S.: the sale of a North Korean suitcase nuke to a terrorist organization that eventually winds up obliterating New York or Los Angeles or Chicago.

Clearly, this nuclear rat that is now roaring must be dealt with, but the U.S. is totally unequipped to do so. U.S. military capabilities are stretched to the breaking point in the Middle East, and U.S. troops would likely be no match for North Korea’s 1 million-plus army in a conventional land war. A naval blockade is nonsensical, particularly since it would likely trigger a North Korean move to overrun Seoul. That leaves only some type of surgical missile strike aimed at destroying North Korea’s nuclear capabilities, but that would probably provoke either the same type of North Korean attack on South Korea or a sharp confrontation with the Chinese.

Given these grim realities, what’s a world to do? In truth, the only solution is a Chinese one. Just as the Soviet Union once propped up Fidel Castro’s Cuba economically, so now does the Chinese government prop up North Korea. China now provides North Korea on a heavily subsidized basis with much of the food and energy it needs. To withdraw this aid would be to both starve and freeze a wide swath of the North Korean population and trigger a political implosion.

 

Perhaps even more important, China continues to provide North Korea with the same kind of military backup and shield that it once did with such effectiveness during the Korean War of the 1950s. Behind this Chinese shield, North Korea is free to tweak the noses of everyone from the U.S. president to the UN secretary general. Without this shield, it would be truly isolated and at least much easier prey for a joint U.S.-South Korean strike.

China now has a very important choice to make. On the one hand, North Korea provides an important strategic buffer from a U.S.-aligned South Korea and a useful economic conduit for China’s counterfeit activities, which contribute a significant share to China’s booming gross domestic product. On the other hand, China must now face a madman with an arsenal of nuclear weapons that could just as easily be aimed at China as the U.S.–or bring down the world economy with a terrorist nuclear strike. With North Korea’s recent nuclear testing, this hardly seems like a difficult choice.

This Week: Profit-taking Pause or Bearish Reversal

Click here for latest Navarro segment on CNBC -- GM exports Chinese cars to U.S!

Market Pulse

Last week’s market decline must raise the question: Was that simply a healthy pullback on some profit-taking in an otherwise newly established bull market OR a nasty harbinger of bearish things to come?

The analytical driver of this column is that the stock market is a leading indicator of the business cycle.  Under that assumption, the decline looks more like a healthy temporary pullback.  Despite some bad news on retail sales last week, there remains mounting evidence that economic recovery is proceeding apace around the globe and that the “green shoots” will grow sufficiently as to end the recession by the end of the year.

That said, this column also sees the current bullish uptrend as a cyclical bull romping naively in a secular bear market.  It is just a matter of time before the U.S. economy is crushed beneath the weight of its own budget and trade deficits.

The fact remains that the Obama-Bernanke-Geithner-Summers continues to lead us down a path that is as political expedient as it is economically destructive (for you Lefties, be assured that Bush was as bad or worse).  So the only question is when will the secular bear snuff out this latest cyclical bull -- sooner or later?  It is because of this question that bad weeks like last week make investors so rightfully nervous.

Given this perspective, it is critical to keep one eye on the market technicals and the other on the economic fundamentals.  I’m still cautiously long GE, Dupont, B of A, and Delta while my long on Intel is testing my patience.  (I also am holding my usual gaggle of high risk biotechs.)  But I’m ready to fold’em if we break below 8,000 on the Dow.

Below, you will find two bonus items in the newsletter this week in the form of opeds on completely unrelated subjects.  The first is GM’s wacky (or Machiavellian) proposal to build cars in China and export them to the U.S. using some of the taxpayer’s bailout money.  The second oped argues that California poses a very serious threat to the national economic recovery -- watch the results of this week’s California ballot measure carefully!

Selling Coal to Newcastle and GM Cars to Detroit (Click here for CNBC segment2 on this)

General Motor’s announcement that it plans to manufacture cars in China for export to the U.S. as part of its recovery plan must rank as one of the most provocative and absurd corporate decisions in this oppressive season of massive corporate bailouts.

Indeed, it is the high of absurdity for U.S. taxpayers to shell out $16 billion in bailout money (and counting) to GM so the company can outsource jobs to China rather than employ Americans in Detroit.  The only rational explanation for such an “in your face” proposal is that we are being “Fritzed.”

In particular, this cars from China proposal may merely be a cynical bargaining ploy by GM CEO Fritz Henderson to wring more concessions out of the UAW.   If this is so, Fritz ought to be run out on a jackass from Detroit -- he doesn’t even warrant a car ride -- and inducted right into the international CEO Hall of Shame.

If, however, Fritz and GM are serious, this proposal is just plain stupid from a U.S. policy point of view.  Under current anything but free trade rules with China, GM could export its Chinese-made cars to the U.S.   However, any cars that GM made in the U.S. would be very difficult to export to the Chinese market.

It’s not just that China slaps a heavy 25% tariff on American cars imported into China.  As part of its Great Wall of Protectionism, China also imposes stiff domestic content rules so that at least some of the U.S. “imports” into China must contain Chinese auto parts.

On top of these protectionist barriers, China won’t even let a foreign carmaker like GM sell into its market unless it first sets up a local partnership and “voluntarily” turns over some of its technology.  However, such implicit forced technology transfer not only grossly violates free trade rules established by the World Trade Organization.  The transfer of such technology effectively dooms foreign automakers like GM to playing subservient role to China over the longer term as China combines U.S. technology with its vaunted cheap labor force..

Beyond these questions of taxpayer subsidies for outsourcing and Chinese protectionism, there are several broader issues.  One such issue is the safety of Chinese-made vehicles -- or lack thereof.

To date, China’s track record on safety is an abysmal one.  Thus far, American consumers have been subjected to lead-filled toys, pet food laced with melamine, toothpaste laced with antifreeze, Viagra dosed with strychnine, dry wall emitting gases more dangerous than coal dust, and a whole cornucopia of rancid food.

In addition, Chinese cars have routinely failed crash tests.  On top of this, Chinese cars are prone to be riddled with counterfeit parts ranging from brake pads and suspensions to windshields and spark plugs.  If these counterfeit parts don’t kill you by causing a crash, they can violate your warranty.

Finally, there arises the issue as to why car manufacturing is gravitating to China.  The conventional wisdom is that its cheap labor that gives China its edge.

In truth, much of China’s competitive edge comes from anti-competitive practices ranging from currency manipulation and massive export subsidies to the aforementioned protectionist barriers.  In addition, Chinese counterfeiting and forced technology transfer together save Chinese companies tens of millions of dollars in research and development expenditures and thereby convey an additional advantage.  If Chinese companies didn’t enjoy these unfair advantages -- all of which are gross violations of free trade -- Detroit and the American Midwest would be far more competitive and prosperous than it currently is.

Peter Navarro is a business professor at the University of California-Irvine, a CNBC contributor, and author of The Coming China Wars. ( www.peternavarro.com)

California’s Budgetary Car is About to Drive Off a Cliff

This time the wolf will really be here -- if California voters fail to approve all four measures on May 19’s special ballot.  The major problem now is that there are no really credible politicians or political organizations to deliver that critical message to a rightfully cynical and jaded public.  Hence, all of the measures are lagging badly in the polls.

To be clear, the wolf we should all fear is the transformation of California’s already severe recession into a bona fide depression.  Put simply, a failure to pass these ballot measures will result in widespread government layoffs and a dramatic cutback in government expenditures -- including deep cuts in education, police and fire protection, prisons, and other essential services. 

In the political gridlock and chaos that is likely to ensue, the combined effect will be a severe shock to an economy already reeling.  That the state already has one of the highest unemployment rates in the country should not be lost on any voter entering the polls next Tuesday.

Any such economic meltdown will likely not be confined to California’s borders.  With the California economy constituting close to 15% of the nation’s GDP, a strong contractionary shock within the Golden State would ripple first through the West and eventually across the nation.  With the current economy recovery hanging by a thread, California’s fall could, in turn, trigger the dreaded “double dip” recession nationally -- just when the country and its financial markets were beginning to breathe a collective sigh of bullish relief.

In fact, we’ve already seen how a faltering California economy can help take down the country.  The current national recession was largely triggered by a housing market collapse that had a major source of origination in California.

That this message is not credible to the general public may be laid directly on the doorsteps of politicians across the ideological spectrum.   At the top of this sad and sorry list is a governor who has become a caricature of his own persona.  While Schwarzenegger is still generally liked, he is increasingly simply not believed and all too easily mocked.

As for the California legislature, there is not a single individual in either chamber of government that has not been tainted by the collective failures of the institution.  To the general public, California’s senators and assembly members to a man and a woman represent a gaggle of squabbling and squawking Lilliputians more concerned with their own advancement up the political ladder than the welfare of the state. 

A similar lack of credibility exists among many of the organizations that voters used to trust.  At the top of this list are the now largely discredited police and fire unions.  After using their badges of honor for years to grub for hefty pay raises and fat pensions at the expense of other public employees and the goal of fiscal responsibility, few voters are now swayed by their endorsements.

The tragedy of all of this is that only the richest and most insulated few in this state will go unscathed if these ballot measures fail to pass.  School classrooms will be slammed shut.  Local governments will be stripped of funds.  Deep cuts in police protection will collide with rising crime in a deteriorating economy.  Fire fighting budgets will be slashed in a state that would keep Nero fiddling round the clock.  And taxes will eventually have to spike to pay for all the mayhem that likely will ensue.

That this profound message can be so lost on an electorate that has become so angry, numb, or skeptical suggests a much broader failure of our entire democratic system in the state. 

Peter Navarro is a professor at the Paul Merage School of Business, University of California-Irvine.  www.peternavarro.com

Selling Coal to Newcastle and GM Cars to Detroit (Click here for CNBC segment2 on this)

General Motor’s announcement that it plans to manufacture cars in China for export to the U.S. as part of its recovery plan must rank as one of the most provocative and absurd corporate decisions in this oppressive season of massive corporate bailouts.

Indeed, it is the high of absurdity for U.S. taxpayers to shell out $16 billion in bailout money (and counting) to GM so the company can outsource jobs to China rather than employ Americans in Detroit.  The only rational explanation for such an “in your face” proposal is that we are being “Fritzed.”

In particular, this cars from China proposal may merely be a cynical bargaining ploy by GM CEO Fritz Henderson to wring more concessions out of the UAW.   If this is so, Fritz ought to be run out on a jackass from Detroit -- he doesn’t even warrant a car ride -- and inducted right into the international CEO Hall of Shame.

If, however, Fritz and GM are serious, this proposal is just plain stupid from a U.S. policy point of view.  Under current anything but free trade rules with China, GM could export its Chinese-made cars to the U.S.   However, any cars that GM made in the U.S. would be very difficult to export to the Chinese market.

It’s not just that China slaps a heavy 25% tariff on American cars imported into China.  As part of its Great Wall of Protectionism, China also imposes stiff domestic content rules so that at least some of the U.S. “imports” into China must contain Chinese auto parts.

On top of these protectionist barriers, China won’t even let a foreign carmaker like GM sell into its market unless it first sets up a local partnership and “voluntarily” turns over some of its technology.  However, such implicit forced technology transfer not only grossly violates free trade rules established by the World Trade Organization.  The transfer of such technology effectively dooms foreign automakers like GM to playing subservient role to China over the longer term as China combines U.S. technology with its vaunted cheap labor force..

Beyond these questions of taxpayer subsidies for outsourcing and Chinese protectionism, there are several broader issues.  One such issue is the safety of Chinese-made vehicles -- or lack thereof.

To date, China’s track record on safety is an abysmal one.  Thus far, American consumers have been subjected to lead-filled toys, pet food laced with melamine, toothpaste laced with antifreeze, Viagra dosed with strychnine, dry wall emitting gases more dangerous than coal dust, and a whole cornucopia of rancid food.

In addition, Chinese cars have routinely failed crash tests.  On top of this, Chinese cars are prone to be riddled with counterfeit parts ranging from brake pads and suspensions to windshields and spark plugs.  If these counterfeit parts don’t kill you by causing a crash, they can violate your warranty.

Finally, there arises the issue as to why car manufacturing is gravitating to China.  The conventional wisdom is that its cheap labor that gives China its edge.

In truth, much of China’s competitive edge comes from anti-competitive practices ranging from currency manipulation and massive export subsidies to the aforementioned protectionist barriers.  In addition, Chinese counterfeiting and forced technology transfer together save Chinese companies tens of millions of dollars in research and development expenditures and thereby convey an additional advantage.  If Chinese companies didn’t enjoy these unfair advantages -- all of which are gross violations of free trade -- Detroit and the American Midwest would be far more competitive and prosperous than it currently is.

Peter Navarro is a business professor at the University of California-Irvine, a CNBC contributor, and author of The Coming China Wars. ( www.peternavarro.com)

California’s Budgetary Car is About to Drive Off a Cliff

This time the wolf will really be here -- if California voters fail to approve all four measures on May 19’s special ballot.  The major problem now is that there are no really credible politicians or political organizations to deliver that critical message to a rightfully cynical and jaded public.  Hence, all of the measures are lagging badly in the polls.

To be clear, the wolf we should all fear is the transformation of California’s already severe recession into a bona fide depression.  Put simply, a failure to pass these ballot measures will result in widespread government layoffs and a dramatic cutback in government expenditures -- including deep cuts in education, police and fire protection, prisons, and other essential services. 

In the political gridlock and chaos that is likely to ensue, the combined effect will be a severe shock to an economy already reeling.  That the state already has one of the highest unemployment rates in the country should not be lost on any voter entering the polls next Tuesday.

Any such economic meltdown will likely not be confined to California’s borders.  With the California economy constituting close to 15% of the nation’s GDP, a strong contractionary shock within the Golden State would ripple first through the West and eventually across the nation.  With the current economy recovery hanging by a thread, California’s fall could, in turn, trigger the dreaded “double dip” recession nationally -- just when the country and its financial markets were beginning to breathe a collective sigh of bullish relief.

In fact, we’ve already seen how a faltering California economy can help take down the country.  The current national recession was largely triggered by a housing market collapse that had a major source of origination in California.

That this message is not credible to the general public may be laid directly on the doorsteps of politicians across the ideological spectrum.   At the top of this sad and sorry list is a governor who has become a caricature of his own persona.  While Schwarzenegger is still generally liked, he is increasingly simply not believed and all too easily mocked.

As for the California legislature, there is not a single individual in either chamber of government that has not been tainted by the collective failures of the institution.  To the general public, California’s senators and assembly members to a man and a woman represent a gaggle of squabbling and squawking Lilliputians more concerned with their own advancement up the political ladder than the welfare of the state. 

A similar lack of credibility exists among many of the organizations that voters used to trust.  At the top of this list are the now largely discredited police and fire unions.  After using their badges of honor for years to grub for hefty pay raises and fat pensions at the expense of other public employees and the goal of fiscal responsibility, few voters are now swayed by their endorsements.

The tragedy of all of this is that only the richest and most insulated few in this state will go unscathed if these ballot measures fail to pass.  School classrooms will be slammed shut.  Local governments will be stripped of funds.  Deep cuts in police protection will collide with rising crime in a deteriorating economy.  Fire fighting budgets will be slashed in a state that would keep Nero fiddling round the clock.  And taxes will eventually have to spike to pay for all the mayhem that likely will ensue.

That this profound message can be so lost on an electorate that has become so angry, numb, or skeptical suggests a much broader failure of our entire democratic system in the state. 

Peter Navarro is a professor at the Paul Merage School of Business, University of California-Irvine.  www.peternavarro.com

Market Pulse 

The U.S. stock market is now in a clear upward bullish trend.  The fundamentals of “green shoots” coupled with some bullish technicals (moving averages, accumulation/distribution, etc.) all point to a rally for now. 

On the fundamentals, both the ISM Manufacturing Index and Consumer Confidence are off their bottoms.  In addition, the ECRI Weekly Leading Index is trending up and pointing to a recession “moderating or ending later in the year.” 

Now is the time to make some money on the long side.  If you did your research while you were sitting in cash as I suggested, then you likely know where to deploy your funds.   

The role of this newsletter is, however, much like that of what William McChesney Martin once said the role of the Fed was, i.e., “to take the punch bowl away just when the party is getting good.” In that spirit, what we will be on the lookout for will be any signs that the recovery may falter. 

My two big concerns now, which I discussed on May 8, 2009, on CNBC, are Europe and the “seeds of the recovery’s own destruction” planted by the “cures” from the Obama Administration.  (CLICK HERE to view the CNBC clip.) 

There can be no global recovery without a strong Europe.  Europe has been severely weakened by the easy money policies of the Bernanke Fed which caused the euro to rise and European exports to fall.  Now, Europe is having a very hard time getting off the recessionary deck and is the “weak sister” in the global recovery. 

My second concern is the wave of inflation that inevitably must hit because of the huge Obama budget deficits from the fiscal stimulus and TARP coupled with the printing money machine Bernanke is operating at the Fed.  (For the record, Bernanke is the WORST chairman in Fed history and is almost singlehandedly destroying our currency.)

So let’s watch this carefully.  All the global stimuli have to give us all a good bullish rush.  The question will be for how long.  Just don’t get caught fully invested when things head south -- so watch this column weekly. 

Last take: My BoA buy looked dismal at its issuance, but it is roaring now.   See my analysis in the Street.com for a rationale as to why I think BOA, Wells Fargo, and JP Morgan all are good buys -- but bad for the mortgage market.     CLICK HERE to access article entitled “This Mortgage Market Mess Can Be Traded.” 

SOME NEWSLETTER TRACK RECORD HIGHLIGHTS: 

Nov 2007 -- Called for a move to cash.  Hit very close to top and maintained cash position for over a year as market fell by more than 40%.

Feb 12, 2009: With Dow just below 8000 (7,932), called for the Dow to head down to as low as 6000.  By March 9, it closed at a low of 6,443

March 10, 2009: When market hit 6,500ish, I Issued a buy for GE at 8 bucks and Dupont at $16.50.  GE is now near $14 and Dupont is at $28 for gains of 75% and 70%, respectively.

Other stocks or ETFs I indicated early April that might be good longs: Delta Airlines, Bank of America, Intel, and QQQQ.