Disclosure: Short the market through SDS (double inverse to SP500)

The DOW punched through 11,000 at the open on Monday, April 12 (after moving through briefly on Friday) and the SP500 will possibly close above 1200 today, on Tuesday. If these two levels hold for the rest of this week, then a new psychological floor will be established.

The round numbers like 1000, 1100 and 1200 are easy for most casual investors to remember and relate to, so they do act as psychological barriers, both up and down. The true technicians can find many shades of grey in between those levels, by using various moving averages like 21 day or 100 day and stochastics / oscillators. But the round numbers are the stronger. Once four days pass, the duration defined by IBD's William O'Neil as having some permanence, the barriers become difficult to break down.

With 11,000 and 1200 setting up as new floors, then the obvious targets become the next round number up, 12,000 and 1300. Given continued good news on earnings and revenue growth, even at a slow pace, economic strengthening, and digestion of problems like Greece, those targets will become a reality by year end.

Jim Paulsen and Ed Keon, two very thoughtful and accurate forecasters, believe that the economy has turned a corner and that revenue growth will take up where profits growth has already gone. It has been a lack of "top line" growth that has kept the market in check. Paulsen and Keon both believe the indicators show the economy strengthning. A stronger economy in combination with high "operational leverage" from very trim corporate operations, will be earnings and cash flow rocket fuel if revenue grows significantly the next 12 months.

This throws a big question on the PIMCO "New Normal" thesis. If the economy picks up due to so much government stimulus and a generally strong global backdrop, US GNP could grow above 5% in 2010, which is of the "Old Normal" recovery variety. This would be a big change from where the market currently values the economic prospects and would take the DOW and SP500 up another 10-15% if it proves true.

The jobs report this morning, April 2, was pleasantly neutral (not too hot and not too cold, but just right) Everyone agreed that the report showed the economy is making progress and the stimulus is working. The markets showed that at the open (bond and futures). There is really nothing to stop the market from moving up another 10%, now. But further out, there is a debate. Today that debate was led between Robert Barbera and Mohammed El-Erian.

Of course, El-Erian was pumping the "New Normal" paradigm of PIMCO. Barbera was maintaining his "Old Normal" posture, for which he has been an outlier the last year (there are a couple others like Mike Darda and Jim Paulsen, our local MN boy). The New Normal states that we are stuck in a stagnant recovery like in the 1930s with high unemployment and low economic growth. PIMCO has been whoring this idea for the past year. PIMCO led by Bill Gross, really thinks they have ALL the answers and everyone else is just wrong. But we have caught Bill Gross being wrong on interest rates in the past. No reason to think they are right this time.

Meantime, Barbera, like Paulsen, has been calling for 4-5% GNP growth this year (same as my call, by the way), with enough momentum to achieve "escape velocity". This is another way of saying the economy will not stagnate near no-growth, but will get back on to a normal cyclical track.

I agree with Barbera and my investing posture shows that. I believe we will get back on a positive economic track and for a lot of good reasons. I have maintained the only thing that can screw up the economy is the government making the wrong moves. But for demographic reasons, I think the Feds will be forced to make the right moves, even against the will of Obama.

Obama is an ideologue. He doesn't seem to care much what happens to the economy so long as he can socialize the country. He wants to "lift up the poor" on the backs of the rich. Unfortunately for him, that is NOT what most Americans want. They didn't want more of the Bush Jr. regime. They did want "change", whatever that means. Now they have found they are getting way too much change. The Dems will lose power in November and that will allow our economy to get back to the "Old Normal".

This is my take and for this reason, I am staying long.

There has been much hand-wringing over Dubai and other countries and their sovereign debt problems since the end of November.  There is a fear that the exposure of this debt might be the tip of the iceberg.  It is feared that the government debt crisis will spread from the small and traditionally weak and underfunded economies of Portugal, Spain, Greece, Italy and Ireland (the PIIGS) to the more substantial and traditionally strong economies of France, Germany, Japan and the United States bringing with it the fear of a global sovereign debt melt-down.  This opinion is emotional and uninformed

All the "sovereign debt default" talk about Dubai, Greece and Spain is old news that is just now getting press because what was already in motion at the top of the debt bubble in 2007 is finally coming to fruition.  Now that the commercial bank crisis has been for the most part averted, the sovereign debt issues that are closely related come to the fore. The Dubai problems were obvious two years ago or more. And Abu Dhabi and other UAE brethren have little patience for the profligacy of Dubai. They will backstop Dubai only after those who overextended get taken out. Then they will ride to the rescue and take control of many of the assets.

Same thing in Spain or Greece. Spain dug itself a deep hole by committing significant debt to aggressive expansion of public works, most notably the 3GW solar power expansion.  The EU will backstop those countries, but only at a price. It is in no one's interest to let the fire burn out of control. I compare this to hot spots after a forest fire. If they don't threaten to flare up and ignite new fires, you let them die out on their own.  Other times you douse them (with financial liquidity in this case) to put them out before they spread. If the infection spreads to Japan, that would be a much more serious event than Dubai, only because of the size of the Japanese economy and the relative importance of the yen. But I think the global central bank leaders have an eye on this and will prevent a Japanese economic collapse. As long as all major economies pull together, there is no reason to think we will have a financial calamity. Economic collapses require the public to panic (and stop spending). Panic is totally a psychological phenomena and can only be brought about by careless or reckless political actions (or inactions).

It is very important to note that the countries that are in danger of defaulting, are not key world economies. The talk of a major economic power like Germany, Japan or the USA being forced into insolvency is from someone ignorant of what it takes to force a financial default. Defaults don't just happen, they are initiated by a creditor. If the debtor is large enough as compared to the creditor, then it is non-sensical or impossible for the creditor to force the default. The punishment will fall as much or more on the creditor as compared to the debtor. To force a smaller debtor to default, though, makes sense. Assets can be seized and held or resold to recoup the investment. Just who would force the USA, Germany or Japan into default? Who could gain? Who could manage the assets that were forfeited for the debt? There is no private money (hedge funds, ala John Paulsen) with the size to force a large sovereign to default.  China is the only creditor nation with the size to force such a default. But China won't do it because it would be suicidal. China, the creditor, needs the developed world as much as the debtors need China and other developing, export-driven creditor nations. It is totally symbiotic, or co-dependent if one wants to be cynical about the situation.

To make my point about the relative size of creditors and debtors as it relates to default: I just made a good return recently on General Growth Properties (GGWPQ.pk) because I understood this dynamic. GGP was in technical default because of the financial crisis and its inability to roll forward short term debt taken on during the two to three years prior to the financial collapse. It was / is still cash flow positive and can cover the costs of its interest obligations, much like sovereigns with their ongoing ability to raise revenue from tax.  But GGP wisely had filed for bankruptcy as a single entity and had pulled all its various mall properties under the single corporate parent umbrella. This made GGP in effect, too big to fail. No single creditor had the legal power to force all the properties into a firesale. The court (Judge Gropper) saw it the same way and made the decision to force the parties to work out the mortgagtes (to refinance). When the creditors found out they were not going to be able to drive a hard bargain and take away the mortgaged property for much less than market value, they had to deal. Now GGP is close to exiting bankruptcy with all its property intact.

Even though sovereigns are unlikely to default in a cascading way, the global economy still remains weak.  It will take consumers and businesses a long time to regain their confidence to buy and bankers to lend.  For the overall American market, from this point on, the economy must improve significantly to get the SP500 much above 1200. But I think that is the higher probability over the next year or two as compared to a melt-down. Politically, I think President Obama is finding out that it isn't prudent to be too anti-business. He seems to have finally gotten the point that the top priority is jobs. Health care and environment are lower priority since there is no money to pay for them if we don't have near full employment and full tax revenues. We aren't hearing too much health care talk from the Admin or Congress the past 2-3 weeks. To demonstrate his new-found love for business, Obama just had T-Sec Geithner spell out the capital gains tax freeze and investment tax credits for 2010. This will help jump start business and improve consumer sentiment as people start getting jobs.

As Obama and other world government leaders turn their attention towards restarting business, the world economy will heal and the markets will respond. Asian stock markets might be a little overdone just because of being the crowded trade, so I have backed off on them, for now. I have moved almost everything back to domestic large cap stocks or energy / commodities. I think 2010 will be a "consolidation" year with only a little index movement, maybe from 1100 to 1250. 2011 might be a similar year, with gradual improvement from 1250 to 1400. That would get us back to May 2008 which was about where the final dive started (down to 666). Maybe we pull back 100 points (10-12%) somewhere in the next 2-3 years. But by 2014 we can pass 1550 and set new highs, if the government continues to be supportive of business and doesn't get too radical (seems more likely right now than 6 months ago).

I am buying up some of the banks that look like they are turning the corner and will be survivors. I have a bunch of the leveraged financial index, UYG, which is weighted towards the survivors like GS, JPM or WFC. But I also am buying some BAC now (as of two weeks ago). Even Citi might be a buy at this point, now that they have a plan to exit TARP. But I am passing on them for now.

Otherwise, my theme is Tech, commodities, energy and materials. Tech is due for a positive replacement / upgrade cycle after 10 years of being down.  Microsoft's (MSFT) Windows 7 should be the catalyst in 2010 once the IT budgets are approved. Just buy the XLK if you don't have any favorites. SMH is the semicon index which has more beta than the XLK. My favorites in commodities tend to the miners and energy stocks, though I have recently picked up some Potash (POT).  I also have call options on (FCX) and (BHP).  This is a better way to play the weak dollar trade than gold, in my book, as operating leverage contributes to performance and generates cash flow which actually has value to an investor.  They have all outperformed Gold in 2009.  Commodities and Energy will benefit from the global economic expansion that is the natural reaction to the collapse. I find it interesting that Suncor (SU) was going up the last two days while oil futures are going down. I find that a very positive sign. I have really loaded up on Pennwest (PWE) and Provident Energy (PVX) .

There is a simple fact that all Goldbugs miss: and that is the American economy, and most all others in the world, have just experienced a massive asset DEFLATION (still underway in some segments like commercial real estate). This deflation in America was about $15T over the past two years according to New York University's Nouriel Roubini (from $40T to $25T). That asset deflation was completely psychological. One day American assets of all types were worth one value in dollars and just a little bit later, were worth quite a bit less. There was no massive physical destruction of assets as in a war (counter to the weak Weimar argument for hyperinfaltion), only economic.

The basis for my opinions on monetary reflation are derived from Hyman Minsky's work. PIMCO's Paul McCulley has written on "The Minsky Solution" many times the past two years. In early January, I featured one of McCulley's articles in a post: http://wealth-ed.com/2009/01/reflation-economics-or-the-minsky-solution/

To deflate assets requires the value of the currency those assets are denominated in to increase as the quantity decreases (this might be counterintuivitive for most). In essence, $15T of dollars were destroyed or disappeared (not physically, but notionally with debt paper markdowns). Less dollar supply at a given demand = higher price / value. Central bankers everywhere understand this dynamic. So, in a coordinated way to restore stability to global assets, currencies are being expanded to replace those notionally destroyed through markdowns during 2008 (the paper that underpinned all those assets, CDOs, RMBS, etc).

The most intelligent dissertation I have seen on repairing a deflation was printed in Barrons last February. Ray Dalio, a rare Barrons contributor, was interviewed. I reference this interview on this blog: http://wealth-ed.com/2009/02/fixing-a-deflation-a-most-intelligent-analysis/

To recap what Dalio said, then, and most presciently: this CB driven monetary expansion is NOT inflationary to the extent that aggregate asset values are being returned to 2007 levels. "How can this be?", say all the skeptics at this point.  My answer: by definition, the reduction of the value of $40T national assets to $25T assets is DEFLATIONARY. In America, $15T of the global reserve "currency" (almost all of it electronic bookkeeping and not "paper") can be created to replace the "paper" that was lost in 2008, with mostly positive effects. There is no deleterious effect so long as the re-creation of the lost currency is done slowly enough as to not be disruptive to global currency flows (currency destruction in 2008 was disruptive enough, don't we all agree?)

$80 Oil and $3 copper is probably in the area of "fair value" vs. the dollar given a mid 2007 USD reference. But $1100 Gold? Unlikely. Gold is now trading on speculative fear of inflation, not the reality of inflation itself. So far, the dollar has not even been expanded (reflated) sufficiently to move asset values back to mid-2007 (check local house prices). Monetary expansion is definitely not inflationary, in America, at this point in time. For gold to be worth $1100, let alone $1500, then global central banks must be unable to stop the expansion that has started in an effort to stabilize asset values. Maybe that is a reasonable speculation, and maybe not (and I own a prudent number of gold shares as a hedge, just in case it is). But like many others, as a more significant inflation hedge, I would rather take my chances with commodities that have fundamental industrial value, and not merely the psychic value of gold.  As is pointed out, gold is worth nothing unto itself. And worse, gold is not consumed, so supply forever increases. This ever-increasing supply dynamic is NOT the hallmark of a good investment.