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) .

Tags: Aggressive Expansion, BAC, Backstop, Bank Crisis, BHP, Debt Bubble, Debt Crisis, Debt Default, Debt Issues, Debt Problems, Deep Hole, Deflation, Depression, Dubai, FCX, Forest Fire, Germany Japan, GGWPQ.PK, Global Economy, Government Debt, Greece, Greece Italy, GS, Ireland, Italy, Japan And The United States, Japanese Economy, JPM, PIIGS, Portugal, Portugal Spain, POT, Power Expansion, Profligacy, pvx, PWE, SMH, Sovereign Debt, Spain, su, XLK

One thing about Doug Kass, is that he is willing to stick his neck out. But it sure seems he will get it cut off this time. I don't know why he says that the advance is narrowing; instead, I see that it is rotating and broadening which is very bullish as sectors left behind are now beginning to catch up. If the break above 1000 on the SPY holds, as it did today, for another couple days (William O'Neil of IBD says 4 days are needed to confirm a breakout), it will probably head up to 1100 on its way to 1300. I don't know if it can get there by year end, but there are some that do.

Leadership is narrowing, speculative stocks are erupting, and shorts are pulling their hair out.~I still say the advance has a relatively small and finite life now....

A burgeoning fiscal deficit and the financial instability of our state and local municipalities are among two of the most significant of a number of nontraditional headwinds that consumers, corporations and investors face in the future. Though the bulls generally agree with these intermediate-term challenges (especially the spiraling deficit and a nervous U.S. dollar stalemate), they generally dismiss them both over the short term, favoring the belief that the current upside surprises in earnings will dominate the market landscape in influence.

I would argue that the aforementioned challenges are ever more predictable in consequence and will serve as a governor to further gains in market valuations. Not only are they inhibiting but they are also potentially oppressive influences that have been too readily put on the back burner in the face of a relentless market advance over the last five months.

An avalanche of spending by the public sector is now following an avalanche of spending by the private sector. In essence, we are (perhaps necessarily) fighting the slowdown with the same sort of incendiary kerosene that put us into the mess.

Profligate spending comes at a cost, a cost that we will experience sooner than later.  -  Doug Kass, August 3, 2009

There was a big move in financials and RE the past two days. Industrials are also perking up (I made a quick profit on Fluor, but would now like to get a little more before earnings on Monday). GE is both an industrial and a financial, so it has done very nicely the past 10 days, going from $12 to $14, which is almost a 20% move. I am adding to GE. Its 200 day EMA is 14.93 and if it breaks that barrier, I see it going to $20. I am using call options to add to my position (GEWLA). I also sold the Sept $17 puts today for $3.10.

Another stock to look at is the ETF for industrials: XLI. I sold puts on that today, but would also look at buying the stock or buying calls. Industrials are early cyclicals and are just now starting to move. Rather than buy BAC, I am adding to UYG by purchasing March 2010 calls at the $6 strike. UYG has a lot of BAC in it, plus the other big financial names like JPM, WFC and USB. They are at $0.70 a contract right now. If UYG goes to $10 by Jan. 1 (it was $20 last Sept), the return will be $3 on a $0.70 investment per share, which is a 400% return. But if it goes to $10, I will probably hold it till expiration because I think it might go back up to $20 while BAC is moving from $15 to $30.

Kass is stuck on his huge multi-year trading range theme (800 - 1000 on the SP500), just like Bill Gross. But if the Feds continue to support the economy and the Asian market continues its great growth and puts demand on our exports, there is no reason that the RE sector can't repair itself and unemployment can't move back down to around 6-7% over the next 12-18 months. That will ruin the bear arguments and will support a 1300 market as earnings continue to come back.

Keep an eye on the Feds. They are most important in the next 12 months in the market.

Tags: BAC, Doug Kass, Financials, FLR, Fluor, GE, Industrials, JPM, Real Estate, USB, UYG, WFC, XLI

This market is looking very strong. Every day there is another challenge by the bears, and every day, the bulls shake it off and drive the market further up.

Today, the challenge was to Intel (INTC). It reported good earnings (well above consensus) and also decent future prospects, which is a big change for people in the tech space. The future prospects, though, were less than what some analysts expected, so the stock was sold off on profit taking. But now it is bouncing back along with the tech sector and the whole market.

Same thing happened with the financials this week. Goldman reported great earnings on Monday, stock sold off from $140 to $115 by this morning, and has now bounced back to $120 as of noon. JPM reports tomorrow and we may see a big day after the knee-jerk sell-off.

I am positioned for all of this as I have bought more Proshare Ultra Financials (UYG) today at $3.33 (sold off 1000 shares on Monday at $3.58 to take some profit, after buying for $3.15 last Friday). I have another order in at $3.05, should it fall that far, but I don't think it will. I also have an order in for INTC at $15.05 trying to catch a bounce down from a high of $16.40 yesterday leading up to earnings. To catch more of the tech rally, I also have another order in for both XLK (tech ETF) stock at $16.30 and XLK put options for the May 17 (XLKQQ) at $1 a contract.

I am still of the belief that we will trade up like this in sawtooth fashion with a bullish trend through April and into May. Then, we will bump into the 200 day EMA for SP500 at around 970. That will represent long term resistance coinciding with the typical summer selling season. We will then move down to around 760 through the summer selloff. But until then, we have another 15% to rally and good trading opptys.

Tags: BAC, Bear, Bullish, C, DOW, EMA, ETF, Financial, GE, Gold, GS, INTC, Intel, JPM, OR, Put options, Tech Stock, UYG, XLK

This is a pretty crazy market, but then it has been since last summer. I have been working hard just to stay even with my portfolio. With your fresh funds from the sideline to bring in gradually, you should do very well over time.

Regarding the Fed / JP Morgan / Bear Stearns situation, I suspect there will be more of those down the road. Lehman may be one, Washington Mutual might be another. Even Fannie Mae and Freddie Mac may go that route. This is really the only way for the Fed to get the market restarted. It is a variation on a theme that has been recommended by many financial market experts.

The basic idea that is being implemented is that when a financial company like Carlyle Capital (failed on Wednesday) and Bear Stearns (almost failed Thursday), which are both loaded with mortgage and commercial securities that are below AAA (subprime, Alt A or other), freeze up and have their loans called back, the Fed will orchestrate an asset rescue. With Carlyle, the Fed just let that private banking company fail. Carlyle had to turn over its loan portfolio, which was collateralized by its value, to the banks to whom it owed short-term money. It had a 30:1 leverage ratio, so it was bound to fail in this environment. Carlyle, like many private banks and hedge funds, had played the "carry trade" game, which is to borrow high quality paper short term at lower rates, and then lend long term, for poorer rated debt at higher rates, and earn the spread between the two.

If the borrowing is at 4% and the lending is at 6%, then the spread is 2%. 2% does not impress wealthy clients. So, the private bank or hedge fund borrows 30 times its capital short term from bigger banks and now it can show a leveraged return of 60%, which does impress those clients. This works as long as the short term money stays cheap and the banks continue to renew the loans. But if the merry-go-round ever stops and the bigger banks refuse to renew the short term, low rate lending, then the game is over.

Bear Stearns is a much larger publicly traded banking company that the Fed did not want to see fail because of the negative psychology it would create in the Market. Apparently, the Fed approached JP Morgan Thursday night and asked it to rescue Bear. Bear had margin calls on Thursday it could not cover (just as Carlysle did on Tuesday). The Fed said it would guarantee all the loan securities that Bear sold to JPM, and it would loan JPM funds from its new TAF program to pay for those loans that were acquired. This is a way for the Fed to help Bear without a tax payer "bail-out", without violating the requirement that the Fed only accept AAA rated paper as collateral for loans under the TAF program. JP Morgan will carry the lower rated paper on its books, but it will be "insured" by the Fed. Bear will still have some equity value (it has not been wiped out but was cut in half today) and has another 28 days to try and get itself straightened out. The public is supposed to be reassu red by all of this.

But instead today, the public saw through the entire situation and showed concern that this was the first of many bank failures that must be rescued by the Fed. There are much bigger banks in trouble (Citi, BAC, WM, Wachovia, Fannie, Freddie), so the concern is "where will it all stop"? It is a legitimate concern / question. I personally feel that the Fed's moves will eventually clear the deck on the worst of the problems. Once those problems are in the open and secured by Fed guarantees to the more sound banks, it should free up the better loan securities to begin trading at something near normal prices. If the banks start trading those securities again, they will be able to gradually mark up their books and improve their capital ratios and move away from the brink of failure.

But there is a slim chance that the Fed will not be able to stop the snowball. If that happens, there will be general carnage in the banking industry and in the economy. We will have a depression (or the modern day equivalent).

Because all of this is creating so much uncertainty in the banks, I shorted several on Thursday and Friday (C, BAC and WM) to protect some of my long positions. I will take the shorts off when it looks like this gets resolved convincingly.

The high yield CEs like BDJ, VVR or DHG do have exposure to the financial stocks. Those are normally the source of higher dividends than the market average. There are also REITs in these high yield funds, along with pharma, industrial and energy stocks. As I have been suggesting, I think high yield CEs are a decent risk because of the diversity and the dividends. All the banks will not go bust with the current Fed strategy. They will be consolidated by the Fed, the weaker to the stronger. There will be winners and losers. So, the diverse CE's will have their share of each as well and will eventually prosper.

I agree that Oil and Gold must be near short term highs. They can't go to the moon, at least without a breather. What will turn them around is some success in the financial markets with clearing up the problems that are undermining the economy and the dollar. I agree that a pullback to at least $900 is likely for gold and to $90 for oil, and maybe 10-20% less for each. But we are in a long term bull for commodities, so any pullback would be a buying oppty, though it will probably not feel like it at that time.

The Canroys should be going along for the ride right now. Chesapeake is setting new highs and it is very similar in its business mix (oil and gas) to the Canroys, except it does not issue much of a dividend. If the tax situation in Canada does not get resolved, the Canroys may eventually look like Chesapeake by converting from LLCs to incorporations. They will reinvest their profits in additional production to minimize taxes. They can do so by increasing amoritization and depreciation with the new production investments.

Tags: BDJ, Bear Stearns, BSC, DHG, JP Morgan, JPM, VVR