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Mark's Market Blog

4-7-13: Korea!

By Mark Lawrence

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Wow, just as I called the markets to continue going upwards uninterrupted for all time and eternity (that was sarcasm, btw), they changed: in the last two weeks the markets have changed direction each and every day, a feat they had not previously accomplished in over 25 years. Recent jobs and employment numbers, the threat of war in Korea, and continued deepening recession in Europe have everyone spooked and it would seem the market's unstoppable climb has hit an immovable reality. I expect looking back from a few months from now, the market high on April 2 will prove to be the high for a while.

S&P 500 October 8 2012 to April 5 2013

North Korea shut down their border town Kaesong that they share with South Korea, a manufacturing complex that serves as the two countries best joint efforts and employs 53,000 N.Koreans working for S.Korean companies for low wages in hard currency. S.Korea has been told the complex must be evacuated by April 10. This action has been on everyone's watch list as a trip wire. Friday N.Korea told Russia and other embassies that they should consider evacuating their staff by April 10, as N.Korea could not guarantee their safety after that date. This is actually probably a good sign: if N.Korea thought a war was imminent, they would want the embassies in their capitol to help prevent bomb and missile strikes.

UN Secretary-General Ban Ki-moon, a former South Korean foreign minister, says North Korea appears to be "on a collision course with the international community" that could lead to war. Fidel Castro, in an essay in Cuban state media, warned ally North Korea against war, describing the situation on the Korean Peninsula as "incredible and absurd" and "one of the gravest risks of nuclear war since the Crisis of October (Cuban Missile Crisis), 50 years ago. China is massing troops on the N.Korean border - they're recently complained about Kim Jong-Un's "bellicose rhetoric" and the N.Korean nuclear tests less than 100km from China. China believes N.Korea's nuclear program is a greater threat to them than to the US. I agree. N.Korea's nukes threaten the stability of Asia, and China's continued economic development requires this stability. The point of the Chinese troops is almost certainly to secure N.Korea's nuclear weapons in the even of serious conflict, and to establish themselves on the ground in N.Korea as a show to the US to stay out. The US government is saying to ignore the rhetoric, but CIA analysts say they expect a missile launch. The navy has moved two Aegis destroyers - famous for their ability to track and down missiles - to N.Korea's western shore, and missile defense systems are being installed in Guam. Meanwhile the N.Koreans have moved a couple of their mobile missile launchers to their eastern shore. It seems to most that Kim Jong-Un has painted himself into a corner, and some sort of terrorist sneak attack that kills some people is his only way to maintain face and power. The curious part to me is that apparently the N.Koreans think after committing this hypothetical terrorist act, they will then get better treatment from their adversaries.

A typical N.Korean government worker makes 3,000 won per month. The official exchange rate is 100 won to the US dollar, so officially that's $30 per month. The black market exchange rate is 8,000 won per dollar, so that's about 37¢s; per month. We should all get N.Korean housekeepers.

Bird flu is breaking out in China again, like every spring. A new strain, H7N9, has appeared and killed six people to date, and perhaps more that aren't being reported. In south east China people have chickens and pigs living together in their homes. People cannot catch a virus from chickens, but pigs can; and then the virus can easily mutate in the pigs to something that people can catch. Several billion people world wide have died of the flu throughout history because Chinese cannot get clear that you can't share a house with chickens and pigs. To stop the spread the Chinese are rounding up suspect birds and killing them; an ineffectual policy carried out every year. This year 21,000 have been slaughtered to date. Also they have closed down their live bird markets. One of these years a new strain will appear that is a bit more virulent and we'll see a Hollywood style catastrophic contagion.

Francois Hollande's government in France is under extreme pressure. Their budget deficit is growing and outside the EU legal limits. He just had to sack his budget minister for tax fraud spanning two decades. Hollande's popularity is down to 31%, dropping at a record rate. His only piece of good news: French bonds are trading at a record low 1.94%, so financing his deficit is cheap. Right now.

Portugal diligently did as required by the EU and passed an austerity budget that cuts spending. But. The Portuguese Supreme Court just found major portions of the budget unconstitutional. They said cutting pay and benefits for the public sector is unfair. The EU quickly issued a statement saying in delicate diplomatic speak that Portugal had better find a way to make those same cuts somewhere else or the deal is off - explicitly saying no more support for their bonds if they break their promise to cut their budget. All of Europe is watching to see what happens next. Bottom line: in the southern EU countries budget cutting has probably hit the limit. It's now unelected Brussels bureaucrats and Super Mario v. the voters and courts in Portugal, Italy, Spain, Greece, Cyprus. This is shaping up to turn into a heavy weight prize fight.

All though it seems all is quiet on the Italian front, in fact under the surface their banks are in trouble. Italian bank stock prices have dropped by 30% in the last two months and their bond prices have dropped too, leading to a mini bank funding crisis. Italian banks are tasked with buying up Italian government debt, so in the face of this funding problem they're selling foreign and corporate bonds and reducing private sector loans, which is only making the Italian recession worse. Non-performing loans in Italy are rising from a pre-crisis level of 3% to 7%, putting further stress on the banks. And the 7% number is the official number: in Cyprus it turned out the actual number was far worse than the reported number, why should we think Italian banks are any less creative? It would appear an Italian banking crisis is simmering, and when it's done cooking it could prove to be more than the European Central Bank can handle. This week ECB president Super Mario Draghi was asked what happened if a future crisis exceeded his mandate or legal abilities. He responded "There is no Plan B." People who have large deposits in Italian or Portuguese banks are, imho, running a very real risk of seeing much of their money confiscated to help resolve this growing problem. After all, deposit confiscation is the new "blueprint" for Europe.

The European Commission is currently drafting a directive on bank safety which would incorporate the issue of investor liability in member states' legislation. depositor liability will be carried out in case of a bank restructuring or a wind-down. But there is a very clear hierarchy, at first the shareholders, then possibly the unprotected investments and deposits. However, the limit of 100,000 euros is sacred, deposits smaller than that are always safe." Up until a month ago all deposits were sacred, in 147 previous IMF actions not a single depositor dollar was taken. But now there's a new line for what is sacred. It seems to me a god who changes his mind once can change his mind again.

Venezuela has elections next week to replace Hugo Chavez. The week after Hugo's death his hand picked successor looked pretty good. Today, Henrique Capriles, the opposition candidate, is looking pretty strong. It will be mildly interesting to see how Venezuela votes, if that vote is clean, and if that vote is respected.

Here in the US unemployment claims leaped up to their highest level since Thanksgiving. New jobs were half what was expected, with retail jobs dropping by 24,000. The labor participation rate is the lowest its been in 35 years. Obama's favorite number, the unemployment rate, dropped to 7.6%, but that was due to a drop in the labor participation rate, not due to jobs creation. One day the US will have one worker and one job and Washington will claim unemployment has been ended. The participation rate is now back to the time when women were entering the work force. This is primarily due to an aging population: people over 50 are a growing segment of our society and dropping out of the labor force en masse.

While I'm still not prepared to call a recession, I'm not buying that our economy is growing either. However, some on Wall Street are now calling a recession, saying the sequester and tax increases are showing up as lowered spending and employment. And the full effects of the sequester haven't kicked in yet, it will get worse. Why in the face of this continuing poor data does the market remain at or near all-time highs? Almost two years ago I noted that as Europe deteriorated and China continued to have these troubling real estate bubbles, the US would wind up the last man standing. It's nearly here now. Europe is at least in a major recession and on the edge of yet another banking crisis, China is struggling, and even in the worst interpretation our economy is doing more or less ok. All this money being printed has to find a home somewhere, and our stock market is the only one in the world in which people have confidence right now. Meanwhile US, German, Japanese and French bonds are hitting all-time low interest rates. Like a group of heroin addicts just getting started on sharing needles and shooting up, major governments all over the world are printing money like mad and feeling great.

March is the month when arctic ice is the largest. This year the maximum seems to have happened around March 15. How's it look? From a satellite, pretty normal. It's a little spotty around Newfoundland, and a little larger than normal between Alaska and Russia. Normally this time of year you can't get within a couple hundred miles of the St.Lawrence seaway; this year you can get into it and halfway to Quebec City at it's mouth. However there are reports that the ice is particularly thin this year with much of the ice first year ice, meaning there is little ice that's been around for several years. I see nothing to help predict what the minimum, due in September, will look like. It's easy to find such predictions on the net; it's a little harder to find predictions that don't seem politically motivated.

Talk is starting about the future of Fed policy. Sometime late this year or next year the Fed will have to start cutting back on their QE purchases, their money printing. This will be a very sensitive time, as if done incorrectly this could lead to either massive inflation or a crash. Right in the middle of this program, in late 2014, Bernanke will retire and be replaced. While its true that Bernanke is the guy we all love to hate, he has built up a level of respect and trust in the markets for his measured, careful actions. His successor will have no such reputation. A couple decades ago Fed Chairman Volker was replaced by Greenspan during a similar time, and the markets promptly dropped 35%. It doesn't help that this appointment will be made by Obama, who is considered nearly economically illiterate.

There's a Pakistani restaurant near me where I like to eat a few times a month. They play Pakistani TV non-stop. It's interesting to me: Pakistan and Afghanistan are 3rd world countries mired in poverty, but the people shown on TV in the news are all pretty well fed, some bordering on obese. This is due to the new genetically modified wheat, dwarf wheat, which got its creator Norman Borlaug the Nobel Prize for saving over a billion people from starvation. Modern dwarf wheat has ten times the yields of older wheat. And it's also been linked to obesity and diabetes, among other things. Since the introduction of dwarf wheat there are now 30% more obese people in the world than malnourished people. And this has become readily apparent on Pakistani TV. It's unfortunately even more apparent here in the US.

Breaking news: Hell has been found! Next time someone tells you to go to Hell, you can go to a precise destination. A team of archeologists working in the ancient Phrygian city of Hierapolis in southwest Turkey claims to have located the Plutonium, or Pluto's Gate, an ancient pilgrim site considered the "entryway to the underworld." A small cave near the temple of Apollo, the Plutonium became associated with death from deadly gases it emitted. Francesco D'Andria of the University of Salento announced the discovery: “We could see the cave's lethal properties during the excavation. Birds died as they tried to get close to the warm opening, instantly killed by carbon dioxide fumes.”

At the time of 911 there had been 147 skyscraper fires in the history of the US. Precisely three of these fires resulting in the building collapsing: all three collapsed on 911, World Trade Center 1, 2, and 7. Two airplanes, three buildings go down. WTC 7, called "the Salomon building," was never hit. Here's a couple skyscraper fires since 911. Last week a WTC-7 sized skyscraper in Chechnya burned for several days and didn't fall down (below, left). In 2009 the Hotel Mandarin, another WTC-7 sized building, burned for several hours and didn't fall down (below center). Perhaps building codes in NYC are not as strict as codes in Beijing or Chechnya? However, apparently the buildings were well enough understood to correctly predict their collapse: below right, WTC-7 shown live on BBC 26 minutes before its collapse, with the announcer saying it had just collapsed. Now we know, the BBC is 26 minutes better than CNN.

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