The Barking Lot

“One dog barks because it sees something; a hundred dogs bark because they heard the first dog bark.”
-Chinese Proverb

Thank God for Chinese proverbs and the cash on their balance sheet. As consensus continues to doubt China’s economic resolve, the Shanghai Stock Exchange continues to run the consensus short sellers right over.

When this week’s cover of The Economist is titled “Asia’s Shock”, the notion that being short China is a unique concept renders itself quite reckless. The Chinese own the two things that American investment bankers need most, cash and liquidity. They are putting that cash to work, surgically via stimulus, and seeing some impressive results. Last night, stocks in China added another +2.3%, taking their 3-day Year of the Ox move to +5.8%, and putting the Chinese stock market up +15.5% for 2009 to date. Yes, as the great Tim Russert would say, “This is BIG.”

Why is it big? Could there be fundamentals supporting McCullough’s China barking? Aren’t the Chinese making up the numbers like Madoff did? These are all questions that inquiring momentum chasers would now like to know the answer to…

Everything in global macro that really matters happens on the margin. The delta in the Chinese PMI report last night improved significantly. China printed a real time manufacturing reading for January of 45.3 versus 41.2 reported in December and, importantly, significantly above the November lows. China’s central bank governor, Zhou, followed up with comments to the world’s media that the $586B stimulus plan is proving to have “initial positive results.” Indeed, Mr. Zhou, indeed…

This Chinese re-acceleration is not a surprise to us. We have been calling for both a sequential and seasonal lift in Q1 (versus Q4’s lows) for China for some time now. Greenspan and Clinton taught China this “go to” fiscal/monetary dance move – should that move work for America and no one else? Of course not – that’s silly. The reality is quite simply that this is one of the largest domestic stimulus plans in economic history – and it will have an impact!

Cutting rates, cutting taxes, and infusing stimulus is not the trifecta that an investor should be shorting AFTER a stock market has crashed. However fleeting the fundamentalists believe the “re-flation” trade may be, stocks can go up, a lot longer than the short seller can remain solvent. We know this - we have learned that lesson the hard way. We also know that being one of a hundred economic dogs barking about the same negativity is as dangerous a place to be as when they were chasing each other’s tails in the land of positivity.

Stocks in Brazil seem to be starting to discount that the government could start to provide aggressive economic stimulus as well. Brazil’s stock market raced +2.8% higher yesterday, taking the Bovespa Index to 39,746, and +5.8% for 2009 to date. While Brazil is underperforming the Chinese gold medalists, they are “re-flating” just the same.

Back to America, the question remains – can the US stock market continue to “re-flate” from her November lows? So far, at every opportunity to be proven wrong, The New Reality bulls have run the bears right over on that front. After yesterday’s +1.6% move, the SP500 is now trading +11.4% from that November “Liquidity Crisis” low of 752.

Impressively, this US portfolio “re-flation” has occurred with some of the horse and buggy whip US Financials all but going away. Can the US stock market continue to make higher lows without the financials? Yesterday it certainly did. In the face of a great move in Consumer Discretionary and Healthcare, the XLF (SP Financials Sector) was down another -1.8%.

The reality is that once you take stocks to zero (and make no mistake, Obama will let more banks go there), the mathematical probability of putting higher lows in an index containing those zeroes goes UP. While it may be entertaining for the manic media to keep you abreast of the daily malfeasance of investment banking executives, they represent less than 5% of the SP500 at this point. Been there, done that – let’s get on with the capitalism show before the Chinese really leave us behind.

I continue to worry that the Chinese will leave some Americans behind – mostly because they should. Some of the broken handshakes that our bankers issued to Chinese officials will never be forgotten. This is partly why the US Bond market is shaking right now (we are short US corporate bonds via the LQD etf; see our virtual portfolio at www.researchedgellc.com), and yields continue to push higher. When the largest US customer of Treasuries stops buying American, and invests their cash savings at home, it affects the math!

In a roundabout way, this is great for the next generation of American capitalists. Those who haven’t been barking with the dogs in the crowd – those who haven’t levered themselves up and own both their own liquidity and duration of their investments. As the bond market goes down, and the US yield curve steepens, that good ole fashion American industry of borrowing short and lending long starts to work again – if I am the only dog barking up that big ole oak tree of capitalism, I’m cool with that.

Into the US market’s weakness earlier this week I moved my position in US Cash back down to 79%. I know, call me wild and crazy getting all invested and stuff… patience will continue to pay dividends – unlevered returns on cash will remain king of The Barking Lot.

Best of luck out there today.

The Barking Lot - etfs020409


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