July 28, 2012 Stimulation

Risk/Reward Vol..129

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

"Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. To the extent the size of sovereign premia (borrowing costs) hamper the functioning of the monetary policy transmission channels, this comes within our mandate"---quote of Mario Draghi, head of the European Central Bank 7/26/12

"We haven't really come to a specific choice at this point, but we are looking for ways to address the weakness in the economy should more action be needed to promote a sustained recovery in the labor market."---quote Benjamin Bernanke, chair of the Federal Reserve 7/18/12

"China's employment will become more complex and more severe. The task of promoting full employment will very heavy and we must make greater efforts to achieve it."---quote Wen Jiabao, Chinese Premier 7/18/12

This past week I met with subscribers at a golf outing in Indianapolis and over dinner in Minneapolis. At both functions, I was asked why I was so optimistic about the stock market--me, the guy who bailed completely in July, 2011 and again in mid-May, 2012. I directed them to Vol. 127 (www.riskrewardblog.blogspot.com) wherein I stated: "...faced with overwhelming negativity the world's economic and political leaders remain generally and genuinely concerned about a worldwide recession. There is a real sense of urgency to stimulate economies..."

This concern has been on display for the past two weeks, and never more so than in the past few days. On Monday and Tuesday of this week, the Dow Jones Industrial Average fell 100 points on each day on news that Spain's sovereign borrowing costs were exceeding 7%, a dangerous level which makes access to the public bond markets virtually impossible. On Wednesday, the Spanish finance minister was in Berlin meeting with his German counterpart who refrained from uttering his normal accusations. More importantly, on Thursday, Mario Draghi, the head of the ECB, made the above pronouncement---the most direct and unambiguous statement yet that the ECB would do anything and everything (presumably even purchasing bonds directly from sovereigns such a Spain) to preserve the Eurozone. The impact was immediate and enormous. The DJIA closed up 213 points on Thursday and 188 on Friday as support for the statement came from the ever contrary Chancellor Merkel.

On the home front, last week Ben Bernanke made the above quoted statement to Congress, signaling that the Fed, too, would soon be in the stimulus mode. Unfortunately, not even Uncle Ben can remedy the Fiscal Cliff (end of the Bush tax cuts, expiration of the extended unemployment benefits and imposition of across the board spending cuts) which occurs on December 31, 2012. This Cliff will have a significant, negative impact on the US economy. Only Congress and the President can fix it, and they will do nothing until after the election. Strange, is it not. Just like last July during the debt extension "chicken" game, the most irresponsible leaders are the Americans!

Not so the Chinese. Indeed, the statement from Premier Wen above has made me even more optimistic. Here is why:
1) Contrary to popular belief, China is a very unstable country. Indeed, in 2011, there were more than 150,000 (that's not a typo fans) significant civil disturbances in China. Recall, if you will, the revolt in the city of Wukan where the citizenry rioted and violently overthrew the local government which had corruptly sold community pastures to land speculators. The grand bargain in China is that peace will be maintained so long as everyone is employed. Thus the importance of the above statement.
2) It is extremely important that there be no major civil unrest this year. In October, the reins of the country will pass out of Premier Wen's hands. Transitions are always dicey in a totalitarian regime, but especially so in China (notice the recent arrest of the Mayor of Chunking's wife).
3) In 2008-9, when the Chinese export-based economy was threatened by the world wide recession, the central government embarked on a massive domestic stimulus program, promising improved housing and infrastructure. The result was a superheated economy and a real estate bubble which caused China to decelerate its rate of growth in 2011---a deceleration that has now gone too far. Remember, however, that it was this massive internal stimulus in 2009-2010 that drove a huge run in commodities (copper, iron ore, etc.). In 2010, China consumed 20% of the world's non-renewable energy, 23% of the world's agricultural production and 40% of all base metals. The 2009-10 Chinese stimulus also helped propel the profits of those US companies with a major presence in China (Caterpillar, McDonald's, Yum, GM, P&G, etc.)
4) Politically mandated to promote growth and sitting on a huge amount of foreign reserves, China is once again prepared to stimulate its economy. Indeed, on Friday of this week, the city of Changsha (7million) announced a $130billion stimulus plan which includes a new airport, road construction and improved housing.

With the ECB speaking with real resolve (let's hope Draghi can follow through), with Uncle Ben ready to pull the QE trigger and with China needing to keep its masses employed, I see a stable if not increasing stock market. During the market swoon early this week, I bought more COP, LINE, WIN, ETP, SDRL, BACpL, EXC, NYB, AFC and AHTpD. In the words of my favorite stock picker, BOOYAH!