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Mark's Market Blog

12-21-14: North Korea now runs Sony.

By Mark Lawrence

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Stocks started a another rough week due to fears about Greece and Russia and oil, but then recovered nicely as it was realized that no one actually cares about Greece and Russia. The big question: Is this Saudi Arabia attacking Iran, Russia and Fracking, their three big threats? Or is this a world-wide recession causing a huge drop in demand? (hint: it's not the demand thing.)

S&P 500 June 29 2014 to December 19 2014

The government did not shut down. Wall street decided that if Greece and Russia implode it's not their problem. So the markets are back on track to finish the year up. I continue to look for S&P 2150 by the first week of January. Perhaps we won't make it, perhaps I'm too optimistic, but I'm pretty clear we'll be closer to 2150 than to 2000. As I see it we're in a hot air balloon playing strip poker and burning our clothes. It's up, up, up and very exciting right now; later we'll be out of clothes and things to burn and it's going to be a memorable combination of scary and embarrassing. In the meantime confidence in the US is high and the economy is doing fine. Stock market crashes are precipitated by high interest rates or recessions and we're not close to either.

Half the 50 states now have gas below $2. Not including the People's Republic of California, I assure you. We're still paying $2.50 for our specially formulated gas that means we get 10% - 20% worse mileage than anyone else in the country. I'm taking a couple long road trips in the next couple of weeks and the gas is going to be a lot cheaper than I budgeted. My son and I are visiting six states that we're considering as alternatives to the P.R.Ca after he graduates university in June. We're both engineers so we're going about this methodically - he wants to live somewhere where it snows a bit and gets regular rainfall. I want a decent university nearby and a place highly rated for livability. I'm concerned about pensions and won't choose a state with hugely under funded pensions like Illinois, Kentucky or Kansas - most unfortunate, as Kentucky is otherwise one of the most beautiful states. Illinois, that could be traded to Cuba for a couple baseball pitchers as far as I'm concerned. Our statistical work is here.

Sony Pictures made a movie, "The Interview," a comedy about a couple idiots who are invited to interview N.Korea's Kim Jong-Un and then recruited by the CIA to kill him. N.Korea has been screaming for several months that this movie constitutes an act of war. Last week a group of hackers calling themselves the Guardians of Peace (GoP) apparently working out of Thailand hacked into Sony's servers and released huge amounts of data to the public: emails about negotiations, employee salaries, future movie plans, pay for stars, and even several up coming movies. Apparently this was an inside job: a Sony employee gave them their initial access. No software can protect against this. The GoP put a statement on several other servers threatening theaters that show the movie and warning people to "remember the 11th of September, 2001." Sony is backing down under the onslaught and canceling the movie's Dec.25 release. I think this is being handled poorly - I see this hacking as an act of war to which we much find a way to respond. I think it also points to a future where someday soon a major US corporation is all but destroyed by such hacking. Although the US has several groups that can do similar damage - the NSA obviously has some major hacking capabilities - we have no government organization at all that works to defend us against hacking. As a result it's believed that hackers could also shut down a huge fraction of our power grid, water supply and communications. This is the new "asymmetric warfare:" the US and Europe are very vulnerable to such hacking; most third world countries have no assets to hack. I'm one who believes you don't negotiate with terrorists. I'm also tired of N.Korea, their nukes, their missiles, their bombing of S.Koreans, and their constant threats to the world. I would support taking action against them. N.Korea now says they're innocent and they want to help the US find the hackers.

How does N.Korea do it? Probably 98% of N.Koreas have never seen the internet. Owning a personal computer is illegal in N.Korea, and besides the hackers only several hundred N.Koreans have global internet access. N.Korea has a school for hackers and is estimated by S.Korea to have 2500 to 4000 of them. They got started and keep current by sending students to China and Russia to study. They regularly infiltrate S.Korean businesses and military installations looking for secrets. In 2011 they crippled a S.Korean bank, Nonghyup, so badly that the bank's on-line services were down for two weeks. In 2013 they did it again, wiping out hard drives on about 30,000 S.Korean computers, freezing ATMs and shutting down on-line banking for several days. If you're looking for retribution, N.Korea doesn't have on-line banking and has very few internet connected PC's. It's hard to do cyber attacks on an iron age economy, an economy where a third of their children are chronically malnourished.

Russia is in complete crisis. Prices are rising daily on most goods. The ruble is now about 75 per dollar; two weeks ago it was 50. Their base interest rate is 17%. They're entering that deadly combination of recession and runaway inflation. Dollars are getting scarce and we're already more or less at de facto currency controls - it's almost impossible to buy more than $2000 in a single day. Due to inflation, Apple, Opel, GM and Calvin Klein have stopped selling to Russia. More western brands will certainly follow - it's going to get very hard to buy much of anything in Russia in the next month or so. What's next? A hard winter which will only get harder if the price of oil continues to decline - oil accounts for 70% of their exports and 50% of their government revenues. Russian officials guarantee that oil prices will firm up by the end of the year. I have no idea how they think they can predict that. The Russian central bank raised rates from 1% to 10.5% earlier this week, then a couple days later to 17%. This had no effect. The Russian banking system is now pretty much completely shut down - no one will save rubles at the current inflation rate, and no one will borrow money at 19% interest. Russia will survive this. It's unlikely this will lead to bond defaults, but Russia is going to have a severe recession. Even the Russian central bank is projecting a 5% drop in GDP, which I think is optimistic.

Switzerland is having just the opposite problem - the Swiss Franc is getting too dear too fast as money flees to safety. So their central bank dropped commercial rates to -0.25%, matching the ECB. The US dollar is appreciating quickly, but we're told negative rates are not in our future, we expect the Fed to raise rates sometime next year.

There's a facility in Belgium, SWIFT - the Society for Worldwide Interbank Financial Telecommunication. If you want to send money from bank to bank across country lines, the money goes through the SWIFT system. All such transactions are reported to the US under the theory that they are all denominated in dollars and therefore backstopped by the Fed (our aptly mis-named private bank that pretends to be a government facility.) We also like to use SWIFT to cut people out; for example Iran was tossed out of the system as part of their sanctions and it's been discussed to toss Russia out over Ukraine. So Russia has announced they're starting their own system denominated in Rubles. Iran, or anyone else, could buy rubles, transmit them through the Russian system, then convert them back to dollars at the receiving bank. The US would have no idea this transaction had ever happened. Other people including Americans could use this system to transmit money to "non-compliant" banks, meaning banks that don't report deposits to the IRS. This leaves the US in the awkward position of claiming that a system competing with SWIFT would harm capitalism, and the Russians claiming that SWIFT's monopoly on international transactions is bad for capitalism.

Venezuela 2-year bonds now trade at a 60% interest rate. This is not about interest, this means traders expect a default within about 18 months.

Remember Obama's strategy for ISIL? No boots, just bombs? We're done. We've bombed pretty much everything in Iraq and Syria in ISIL territory that's worth bombing. They're still there. In fact ISIL supporters say the bombing has helped recruit fighters and win support of residents, and it has predictably driven ISIL to move assets into hospitals and schools.

Fitch lowered France's rating from AA+ to AA. EU rules say budget deficits must be no more than 3%; France's official deficit is 4.1% and it appears their 2014 deficit will come in at 4.7%. They say they will be compliant by 2017. German officials, who flaunted this same rule several years ago when it suited them, predictably objected saying this sets the precedence that countries can say they'll be compliant at some future date then push that date out in perpetuity. I think the whole point of the EU budget rules is not to obey them, but rather to promise to obey them someday.

Ford and GM are spending major money to figure out how to sell cars to Generation Y - those born between about 1980 and 2000. Gen Y's aren't getting married in any hurry, aren't very interested in owning a house, and value a top of the line smart phone and data plan over a car payment. There's a huge debate here: in the car industry it's believed they simply haven't found their message yet, that eventually these people will also buy cars by the millions. Others think Gen Y will be into ride sharing - they'll be the first to embrace using their smart phone to call a driverless electric car to taxi them across town. I'm in that latter segment, I think Ford and GM are fighting the tide. However, for as long as bad boys are desirable, so will be Harleys. And the whole driverless - ride sharing model just won't work on a Harley.

Malaria, one of the biggest killers in the world, seems to be becoming drug resistant in Myanmar. Signs of drug resistance have also been observed in Cambodia, Laos, Viet Name and Thailand. If this is a new superbug that's spreading it will cause a serious number of deaths - several million per year in Africa and Asia.

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