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Don't tell people how to do things, tell them what to do and let them surprise you with their results.
~ George S. Patton

For you military history buffs, you’ll recall that Patton was plenty aggressive and controversial. His nickname was actually “Old Blood and Guts”. However, the man was a winner and didn’t have finger pointing in his arsenal of leadership weapons. Letting people be good is my interpretation of the quote above. That’s what winners do.

In order to let people be good, you have to trust them. As importantly, they need to trust you… so you better have an objective and flexible investment process that they can believe in. When trust is violated, teams, relationships, and systems start to break down. If there is one thing that I am seeing in the daily trading expressions of this market, it’s just that – the ultimate challenge to the trust that has been embedded into the American Financial system’s nucleus.

Yesterday’s US trading action was a crystal clear example of impaired trust. Paulson’s bailout plan was always earmarked for his banking buddies, and now the Street is having a hard time swallowing what the foxes will do now that they have the cash in the hen house. “Old Blood and Guts” would have blown up the hen houses, but these are much more politically polarizing times. Blowing things up isn’t cool. US market trading volume reflects that counterparties do not trust one another – it balloons on market down moves and dries up on the “bottom is in” CNBC sponsored rallies. Volatility, as measured by the VIX, remains in nosebleed territory at north of 55, and I think it could very well see 70 again before this war of attrition is all said and done.

The distrust in the American system is clearly not local. To borrow my favorite “Investment Banking Inc.” quote of October of last year, “it’s global this time”, indeed. Even after seeing the biggest cash injections in world history, LIBOR (the rate at which banks lend to one another) won’t budge. If it drops by 25 basis points, that might help the perpetually bullish narrative’s rhetoric, but it won’t do a darn thing for what matters out there on the battlefield – trust.

Tonight, we will watch the final US Presidential Debate. The “Question” on my mind is can the American people genuinely trust what I am now going to start calling “BAmerica”? If the answer to that question is yes, then we have a very positive macro catalyst on the calendar tee’d up for November. For some time now I have been saying that Obama is negative for the market’s immediate “Trade”, but the next macro call may very well lie in answering for duration as to whether or not his new administration could be positive for the intermediate “Trend.” There is no math in the driving factor in that model – just trust.

Do American investors trust Asian and European markets? That answer was yes – today, as regionalism and protectionism rears their ugly heads into the local economic dialogues, the answer is far less clear. In some cases it’s flat out scary. That’s why we shorted Austria’s (via the EWO) ETF yesterday (see note titled, “Eye on Regionalism: Austria's Spreading Xenophobia”, 10/14/08). We are going to be long countries looking to broaden their wings and incorporate free market trade and capitalism into their process. We trust those principles. We are going to be short close minded companies and countries who don’t get it.

The Chinese are starting to make moves towards capitalism. Are they in any way, shape, or form like Jack Welch’s definition? Of course not. But the point is that everything that matters in economic models happens on the margin. On the margin, they are more capitalistic than they have ever been. Unfortunately, I can’t say the same for the USA. Tonight, both Obama and McCain’s populist economic re-regulation rants will remind you of as much. Ronald Reagan these two politicians are not.

Of course, we are long China, and we will be getting longer via our ETF positions in the EWH and FXI this morning. We are short socialist Japan after re-shorting the EWJ yesterday, and we are also short the bureaucrats in India via the India Fund (IFN). India has a Presidential election that is coming up that will make the US populist calls to action look like Shrek. This is going to be the hard core socialist stuff that’s X-rated for we free market folks. India was the worst performing market in Asia overnight, closing down another -5.8%. We are looking at an immediate downside target on the BSE Sensex Index that is 11% lower. I do not trust asymmetric political tail risk.

Overall, I am a bit cheerier these days. Hopefully you are picking up on that in my notes. I definitely don’t want my son Jack to grow up in a neighborhood where his friend’s parents are calling us a family of “old blood and gut” bears. Both my team and yours should not trust an investment process that is perpetually negative. I would not have had a career in this business if I was never bullish. That said, I moved back to 80% cash and 20% stocks yesterday. For the immediate term “Trade”, I don’t trust that the current said leaders of this country get it. However, I am looking forward to November’s changes in the lineup.

Best of luck out there today,
KM