Mutual assured destruction, M.A.D., is the term du jour out of Washington and Wall Street over the past 3 or so years. Regardless of who is in charge there seems to be fear mongering for every situation in today’s world. The latest MAD scare is over the debt ceiling and if it is not raised the world will stop and we all will die. I can assure you that none of this is true and the sun will surely rise and set the day after if the debt ceiling is not increased.

I am not saying that by not increasing the debt ceiling everything will be fine, but I am saying it is not as bad as we are all being told. It is insane to believe that the world will shut down if the debt ceiling is not increased and the fear mongering must stop. If the debt ceiling is not raised it simply means that government spending would slow down and be limited to what the Treasury Department collects everyday and no debt can be issued in excess of the designated debt ceiling. However, the debt that matures, since most interest is paid before maturity (I am simplifying this) the debt that has matured can in fact be rolled into longer term bonds. Basically, nothing major would happen right away but in time there may be issues.

What would happen is many federal employees would be fired and many agencies would close. Obviously this is not good news, but it is not horrible news either. The government collects some $200B in taxes or fees a month which means that all our debt servicing costs would be covered in just one month’s tax collection, obviously interest payments are spread out, but you get the idea. Interest rates will not rise out of control and we are not defaulting on our debt, don’t forget the Federal Reserve is our largest creditor and they hand over 95% of their profits to the treasury which reinforces my point since the government is paying interest to itself on over a trillion dollars of our debt.

If the debt ceiling is not raised things will be tough and unemployment, from government employees, will rise but life will go on and much of the private sector will remain untouched. In fact the private sector might just flourish since many regulations could not be enforced because government agencies are closed down. Subsidies would end and waste would be purged from the system, again I see no downside here. The government would be forced to live on what it collects and this clearly bothers the powers that be since they are buying political favor through wasteful spending.

Contrary to popular belief Social Security checks would go out and Medicare payments would still be paid since FICA withholdings cover these costs for now. Well, in theory that is what would happen, but since the government raids those programs excess reserves all the time they are not technically solvent. Even though these programs are safe through their own taxation Washington is telling you the exact opposite which is a lie unless they used those tax withholdings for something else. This is how MAD works though, scare you to death so you don’t question anything and do what you are told.

You see if the debt ceiling is not increased the house of cards begins to waver and that is the problem. The government and the powers that be do not want you to realize that this whole thing is very wobbly and unsound, meaning our economy. They do not want you want you to know that money is debt and the Federal Reserve cannot print money without being paid interest from the treasury department. They do not want you to know that things can get done on less money. They want to scare you into keeping the status quo which is on its last leg anyhow because debt cannot increase forever. Eventually everything comes to an end, look at Greece and Ireland.

Ultimately the debt ceiling will be increased without much of a fight some grandstanding of course, but no real resistance will come and the vote will come and go quietly. What is so crazy is the use of the MAD policy that is used for everything nowadays. No matter what is happening we are told that we are all going to die if so and so bill is not passed which is not true, ever. Why we all fall for this is beyond me, but most Americans do and insist that the wrong decision be made, i.e. preserving the status quo. However, the status quo is unsustainable even in the short-term and is completely evident when one looks at the value of the dollar and the price of commodities.

To be clear on my stance, I know longer term the debt ceiling must be increased as we would eventually default, but I am confident that the US could make it much longer than anyone thinks without issuing new debt. It is just most people who depend on the system for their survival would not like this and that is why the MAD card is being played. We should all be appalled that our leaders are using the MAD card so often and it should be perfectly clear to everyone that when the MAD card is played it is to preserve our leaders and it usually is not in our best interest to continue with their status quo. In time we must start to call our leaders out and see what would really happen if they do not get what they want and I am very sure that MAD will not happen.

Much has been made about the death cross of late, the 50 day moving average crossing through the 200 day moving average, although I think and know it is a significant event it is nothing compared to something else I have noticed. We are all aware of the primary reason of the bull run over the past 12 months, massively oversold markets, combined with marginally better economic data and, most importantly, a weakening dollar. Why the dollar weakened is important to note, quantitative easing via the Federal Reserve’s asset purchases or the printing of money. Although we will not know the long-term implications of QE for some time to come it is safe to assume it accomplished its goal, weaken the dollar and boost the economic data through negative interest rates, essentially.

We all know the market action of late, a horrendous selloff which was only a surprise to the parade of bulls on CNBC and those who kept their heads buried in the sand, but those out in the real world knew it was coming. What was unexpected was the 4^th of July rally that took us back up some 7% on the backdrop of pretty bad economic data. Some of the bounce was because of a technical bounce and some of it was because of the expectations of stronger earnings which started last week. I fully expected 2Q10 earnings to be good, but I expected to see more top line misses and the outlook from CEO’s to be downgraded as well. So far, it is a mixed bag, but the outlook or guidance remains very bullish for many firms, however, a look back through prior earning announcements, particularly 2000 releases, as Mark forwarded to me, shows that Intel did not foresee a slowdown there either, so trust the economic data rather than CEO guidance going forward.

Back to what is going on in the equities market and why the dark cross is less important than the other ‘grey swan’ that is going on. First, everyone and their grandmother knows or knew about the dark cross, not that it takes away from its importance, but when everyone knows about it very rarely does the market deliver the results we are looking for. Except the market kind of did deliver, but stopped short and rallied all the way back to some important moving averages where it failed to break through, very bearish from my lens. At the same time we saw the selloff begin the dollar was moving towards the 89 mark on the DXY, but it stalled after a dramatic breakout and reversed course. Not only did the DXY reverse course, but it got crushed moving down from 89ish to about 82.5, not an insignificant move.

Exhibit 1-1 2 Month DXY Chart

Why is this a big deal? It is a big deal because stocks went up on a weak dollar trend which meant a better environment for U.S. companies to sell products abroad. Basically, a weaker dollar is better for U.S. exports and sales as we become more competitive in the world. It made sense for the markets to not like the move of the DXY from the low 70’s to 89, but to not like the move from 89 to 82.5, well, I am perplexed. The market should love this and we should be flying to at least 1,100 on the S&P 500, but we are not. This is a huge warning sign that stocks cannot rally on a weak dollar and it means more than the dark cross.

Exhibit 1-2 1 Year S&P 500 and DXY

The charts show the trends pretty clearly, lower dollar higher equity prices, higher dollar, lower equity prices, but over the past couple of months things have been out of whack. What else is going on during this time period? Treasury yields are collapsing to historic lows. We have the 2 year treasury under .60%, the 10 year under 3% and the 30 year under 4% which is a sign of 2 things, risk aversion and fear of deflation. My belief is deflation is the clear danger as of right now, it is fairly evident from my lens and the market is pricing it in as we speak. The credit markets have been pricing it in for some time and will continue to, I am bullish on debt securities, have been for some time now, but the equities markets, well, it has not priced in any real deflationary pressure at all.

Exhibit 1-3 Yield Curve

Granted, we have not seen total deflation yet, just the beginning sign of it, but the evidence is pointing towards it. Here is the rub, everyone says the Fed will do QE2, but they won’t do it. See my other posts as to why they will not do it, but from my lens they would be insane to even attempt QE2 at this point. The problems in the U.S. economy has nothing to do with what is happening in Europe, a little I suppose, but not directly related. My past posts about Europe relate directly to actual defaults by countries and to corporate earnings. I think anyone will find it hard to believe that the Jones’s are not buying that new car because they are worried about Hungary being kicked out of the IMF-EU rescue package. They are not buying a car because they are worried about their job and do not want to take on much debt or because their credit score is so lousy they cannot get financing, 25% of Americans have a credit score below 600 now. Instead the Jones’s are paying off debt and buying what they need, not what they want which is deflationary.

This trend will continue and so far only the credit markets are pricing this in, the equity markets are in La-La Land, still. The DXY – S&P cross is very bearish if the trend continues and will mean a big correction in the near future especially if commodities head lower as well. Commodities are not performing well and that is reflected in the Baltic Dry Index and combine that in with the above information and it is putting the explanation point on the whole theory. So far the only strategist I know for sure who is putting all of these pieces together, and has been ridiculed relentlessly by the bulls on CNBC and such, is David Rosenberg. All of the rest of the strategists are telling you to buy the dips even when they see everything I presented to you, they know what it means and, to top it off, they know the ECRI is rolling over and housing is going down the tubes. It is incredible to say the least. Be ready for some fireworks soon unless this trend breaks.

What works in a deflationary environment? Income and dividends, pure and simple. I like (and own) the following: CTL, MO, PM, WM, PFE, MRK, LLY, BPT, RYU, PEY, INB, DNH, CGO, VZ, high quality corporate bonds, strategic income bond funds, emerging market debt funds (PCY has been good to me), short and intermediate term treasury funds. Many of the above mentioned stocks have underperformed, which I like, and pay very nice dividend yields, which I love, but may not do well in an inflationary environment. This is why one has to hedge with precious metals or, at the very least, TIPS.

Just a week or so ago the overnight LIBOR rate, this is the rate banks loan money to each other at (such as prime plus LIBOR or similar), was a paltry .17% and today it is a whopping .22%. While this is might not seem like a huge issue, and it is not on its own, it is a signal of something. Perhaps it is signaling that the wall of liquidity is coming to an end or that there is more risk lending to institutions than originally thought. Or, perhaps, Zero Hedge’s rumor mill was right and some of the GSE’s cut off 10 European banks from lending which caused the overnight rate to shoot up, it looks like they had it nailed.

I typically do not act or comment on rumors because some 90% are not true, but this one I watched because LIBOR was one of the signals preceding the credit crisis beginning in 2007 to 2008. If this rumor ends up being true, and it looks that way, I think there will be some negative implications for the equity markets as the rally is liquidity driven. However, LIBOR at .22% is nothing to worry about, at all, and unless it climbs higher I would not be worried, but it is on my ‘watch’ screen as it has implications. Also, the LIBOR rate is outside of the Fed’s control, frankly, as they already spent all their ammo in that department.

Well, let me rephrase that, they would need to start up recently closed programs and institute new programs in order to bring down the interbank lending rate. The markets are not fully healed and credit is still tight meaning that trust is still lacking in many areas. Credit is merely trust and, frankly, would you really trust a European bank right now? Who knows how much Greek debt they hold or other PIIG debt they have on the books. If you do not know you cannot trust them. If you can’t trust them you do not extend credit to them or you charge them more for credit to cover the potential risk. It is a vicious cycle and the system cannot handle any other shock or it will be in jeopardy again.

I am not saying there is much to read into, yet, but keep an eye on it as little things like the LIBOR usually signal or are the first sign of potential larger problems. It also looks like the Zero Hedge rumor mill was on to something, I am going to email them to see if they have a follow-up on the story. In the mean time, do not look for anything exciting from the Fed meeting, nothing will happen and the language will not change, which should concern you as well. Trade carefully and the market that is in front of you, I bought August VIX calls today as volatility is way too cheap, historically the VIX is at 20, and there seems to be no one betting it will go down, look at the put action.

The Fed just raised interest rates to .50-.75% on the discount window. What does this mean? Nothing. It is simply just a measure to shut people like me up and to encourage banks to go to the private markets for capital. Essentially, this was a populous encouraged move and will have a negative impact on equities, but do not concern yourself with this.

This hike will not hurt corporate bonds, but treasuries and equities, ouch! The bottom line is that the Fed is not selling its assets so, again, this is meaningless at best. If they raise rates above 1% then be worried, but other than that, who cares. Ben, apparently, has just had enough of the negative mean people like me. However, this could prove difficult for Treasury as they have to place so much paper on to the Street. It is also a move to “prove” that this statistical recovery is for real, which it is not. A meaningful rate hike would be well above 1%, don’t hold your breath for that anytime soon.

To kick off the New Year you should go read this guy’s silliness. It is no wonder why he has been largely discredited and why he completely missed the housing bubble in 2005-06, he was the guy laughing at Peter Schiff when Schiff told him lending standards were nonexistent, guess who was right?

What I found amazing is that Mike Norman actually thinks that issuing treasuries is not borrowing money. Furthermore, he actually states the following, this blew my mind because it is utter nonsense:

Some would argue that the vote simply gave the government the right to “borrow” $290 billion more, so it did not really increase its spending power at all, only the amount it could take from others. This argument would be wrong.

Government spending, by definition, increases the amount of reserves in the banking system and those reserves are the funds used to buy Treasury securities. Therefore, it is correct to say that government spending itself provides the money to buy the debt.

How else can you explain how the national debt went from $900 billion to $12.4 trillion over the past 30 years with interest rates falling to historic lows or even zero? If the issuance of government debt were truly “borrowing” then rates would have climbed to astronomical levels.

If this made you say, what!? You are not alone. I know what he is saying and on the surface he is kind of right, but it is also the words of a true idiot. I will explain this in a very simple way for Mike to understand, if you issued your own debt and could control your interest rates, would you keep interest rates, the amount you pay, high or low? Clearly you would keep the amount you pay low, unless you like paying a lot more for what you borrow. Now, that is a very simplistic way of approaching the total issue and it is much more involved than that, but I fear if he reads this getting into details would probably confuse him.

Apparently Mr. Norman is one of these people who thinks you can issue unlimited debt or “increase the amount of bank reserves to buy treasury securities” and we never have to pay the piper. I find this fascinating that one can think that investors will never, ever, want their money back or that even though we have to pay interest on the amount of money we spend it is still not considered borrowing. I am not sure how that is not debt or borrowing nor am I sure how one can borrow their way to prosperity, but I find this disturbing among many economists in the US, including one Nobel Prize winning economist who writes for the NY Times a lot.

The last time I checked those who tried to borrow their way to prosperity, Dubai, Argentina, home owners, Eastern Europe and so on all ended up not doing so hot or defaulting. I am not suggesting the US will default on its debt, that would be crazy, we will simply inflate our way out as that is the game plan. Well, I guess I am early in giving out my 2010 Contrarian Award to Mr. Norman for going against all conventional wisdom and basic economic teachings when we examine debt and prosperity. Debt, for a lack of a better term, is good. I gotta stop, my head hurts.

While I am convinced there is no pricing power for retailers and deflation is here to stay for the foreseeable future today’s PPI data was not encouraging. Of course, Steve Liesman has no idea how to look at the data and refuses to acknowledge that this data shows higher prices in any form. Whether you believe it or not, and I do not believe much in terms of government data anymore, this data shows higher prices.

However, Liesman does not seem to understand higher prices and ignores any inflationary numbers. He seems to think that zero interest rates is a great thing. He also claims, in the clip below, that all the data is getting much, much better, huh? Yes, the data is marginally better, but it is still bad news and Liesman just simply has no clue. After all, this is the same Steve Liesman who missed the Russia meltdown as it happened in front of him, only to take credit for calling it later when he took the Pulitzer later on. Mr. Liesman, I had respect for you 1 year ago, but now you are just a clown.

Santelli really hammers Liesman, rightfully so. Keep in mind this is the same morning show where they hammered Ron Paul for the audit the Fed Bill, which the media, most Liesman, has grossly distorted and framed as taking the Fed’s “independence” away. That is a joke and totally inaccurate as the bill merely removes secrecy away from the Fed, nothing more. Read the bill Mr. Liesman, you idiot.

Watch the video and judge for yourself.

What started out as a huge bull run today floundered big time by the end of the day which is a sign of something big to come, in my opinion. At first I actually thought that the Fed might tighten by .25%, why not rates are at .13% at it would merely be a ceremonial move, but most thought I was nuts as it was a black swan event. Not only that, but any rate increase would mean the Fed would actually be interested in defending the dollar and we know that will never happen. However, I was wrong, but I knew one thing was going to happen, the market was not going to like what it heard no matter what.

I was not 100% sure I was going to be right so it is not as if I doubled down or anything, but initially I was right and the market sank. That turned and reversed course, for whatever reason, only to have the most spectacular close in a long time and a close that should make anyone long a little nervous. To have a reversal of that magnitude on news that would keep the reflation trade going is not good news. In fact, the dollar sank and stocks reversed this also happened yesterday as well. Yesterday the dollar had some strength, somewhat at least, but stocks reversed higher by the end of the day, for the most part.

First, I believe we are at the point were too much of a good thing is just that. We all like candy, but if you eat too much you are going to get sick and I think this is the markets issue with just stupid low interest rates and reckless monetary policy. I also believe we are diverging from the weak dollar, strong stock trade which is really all the bulls had, besides mildly better economic data, anemic data at best. This could prove disastrous for the markets as it will end the carry trade, possibly, simply because of this divergence.

Second, the transports had zero follow through today which is not good. Sure, the index was saved by Mr. Buffet’s bold buying spree yesterday, but Con-Way quickly brought reality back to that index, the economy stinks. The theory is as goes the transports goes the rest of the markets and guess what happened today? The transports spent most of the day negative and the markets followed by the end of the day. Tech stocks are also struggling as the NASDAQ closed negative, that was the bulls leadership, but Cisco released good earnings, I am sure most of the positive growth was from Asia, but somehow that is a US green shoot.

Third, the technicals look pretty terrible, to me at least, with the S&P 500 rejected at 1061, multiple times, it eventually rejected 1052 and even 1047. That is not good news at all for the bulls, baring any really good news of course, as it looks like the S&P 500 will test 1021 soon, but only time will tell. Of course, the NASDAQ looks terrible as do the transports, so pick your poison as to what will weigh down the market. What really caught my eye today was Goldman, it got clobbered today which caused further bleeding in the financials, SKF did very well actually. I am not sure what caused them to decline almost 2 points, but that is another leader gone, for now.

The market looks and is acting toppy and failed to hold a rally on, presumably, good news. If that is not a warning sign than I do not know what is, but it could reverse with a good initial claims report tomorrow, doubtful though. I also fully expect the employment report, depending what kind of magic the BLS works into it, will be higher than expected, perhaps +210K for October with a revision up for September, which is far above estimates. Watch for Goldman’s last minute employment revision tomorrow, they blew it with the GDP, but they are great with the employment report. If they up their estimates, I would run for the hills because that will push the market lower, in my opinion.

The bottom line is that today was as bearish as you can get there is no other way to describe it. That was a huge reversal in 22 minutes I might add which is reminiscent of how things traded last year, but I guess last year never happened. Perhaps it was the FHA news in the WSJ that has people concerned or the fact the WFC is turning a ton of upside down loans into interest only loans for 10 years, smart move guys! Who knows what the reason is, but the one thing that is for sure is that this reversal plays into the bears favor and, although it was a whacky call, I was kind of right, even though I had no real conviction.

Disclaimer: I own various puts on the S&P 500, SDS and SKF.

As expected the markets opened to the downside and has been volatile today. Although the volatility is more reminiscent of years past rather than the 4% swings we have seen in the previous weeks.

With only a 200 or so point swing it reminds us of the good old days before the FMOC revealed their interest rate decision. This is good news and even better news is the fact that the Dow is holding above 9,000. While the decision is still 45 minutes away we do suspect that the Fed will cut only by .50%.

Anymore would signal that the Fed is panicking and any less would send the markets plummeting. We believe only a .25% rate cut is enough, but the Fed has gone from making monetary decisions to now accommodating the equity markets. Even upon the news of the .50% cut we suspect that profit taking will ensue as the markets tend to buy on the rumor and sell on the news.

The pundits will be out saying that they should have cut more, but that is an opinion based on greed rather than necessity. Banks carry the US government backed guarantees now, they have plenty of funding and the last thing the Fed wants to do is take all of its recession fighting power away with one single huge cut, of the 1 – 1.25% some nut jobs say they should do.

So, as far as the markets, no matter what the decision it will more than likely lead to a selloff today. We could be wrong, but with the huge run up from yesterday before the news it is a pretty good bet that negativity will take over.