Stock market pushed, pulled by geopolitical developments

Fibonacci Forecaster

We’ve have to talk geopolitics this week. I’ve told you in the past that Morsi was trouble, and the early days of his administration resembled the early days of the Third Reich as far as foreign policy is concerned. Lucky for the world, he’s only an amateur despot with none of the charisma of the really dangerous people in history.

I’ve probably studied World War II as much as anyone who hasn’t been published on that subject so there’s a certain expertise. Morsi tried to play peacemaker while at the same time scheming in the background how to be at the forefront of a new Pan Arabic movement that would not stop until Jerusalem became its capital. That’s right, there’s no way of sugarcoating it. I’ve seen several of the speeches. How serious the true threat is hard to say, but the world didn’t take the Nazis seriously in the beginning either. So a threat is removed. The difference here is the Egyptian people were not supportive, while the German people of the 1930’s stood by in silence and allowed it to happen.

But let’s not bury our heads in the sand. There’s an element of Islamic Jihad active as they are in all the Arabic countries to the Middle East. They are not going without a fight. The problem going forward is the Egyptian military looks good, has the weaponry, but they are not trained very well in the field. Are they fat and lazy? Perhaps a little bit, but they will get tested by the Muslim Brotherhood. The best tweet of the week was “take the Army and give the points.” So I’d give them the edge. A lot of the future is going to depend on how much support the Muslim Brotherhood gets from the Russians and/or the Chinese. Later on, if it gets to that point, they still must have another election.

What we found out this week was the market seemed to like the removal of Morsi yet the initial knee-jerk reaction was fear and that’s reasonable. Who knows what could happen in a coup? What amazed me is that gold nearly collapsed during this event. In the old days, any geopolitical threat was a reason to buy precious metals. How times have changed. Today, many people view the drop in gold (COMEX:GCQ13) as a sign the economy is improving. They are right to a point; the economy was good in the 20-year bear market for gold. But the yellow metal skyrocketed in the last decade when the economy was supposedly good, even if it was powered by smoke and mirrors.

At this point I think gold is dropping because there’s a potential threat of deflation. The Greenback is pushing higher and the kicker is going to be how the stock market responds. During the 1990’s in the better economy, the dollar and equities skyrocketed. An economy where the equity market grows with the currency means its increasing in wealth. If its increasing in wealth there’s no threat of deflation as we saw in the '90’s. It was a low inflationary cycle. The actual term was disinflation. But if we continue to get an inverse relationship where the dollar accelerates at the expense of the stock market, we’ll have a problem.

For me, the problem has been when the Greenback pushed the 90 handle. Each time it did, the stock market was in serious correction mode. So if the dollar keeps going up, gold continues to decline and the stock market backs off we’ll move closer to deflation. If the stock market stays in gear with an increasing dollar and a declining yellow metal we’ll have an economy similar to the 1990s, except for one thing: We won’t have a bubble.

In certain circles, I’ve seen there are people who think the stock market is about to be a bubble. Nothing could be further from the truth. We are in a bull market, a secular bull market where the pattern has reached the path of least resistance: up. Why does that have to be a bubble? Remember earlier in the year when I told you people would have a problem with a market that goes to new highs? They don’t know what to think about it. We haven’t had to deal with this sort of thing since the '80’s and '90’s. Most market participants are used to dealing with markets that top when they get to all-time highs. But there’s very little euphoria out there. If anything, there’s a wall of worry concerning the Fed and interest rates. If anything, the market has to prove it can go up without help from Fed stimulus.

So Europe closed the week lower as the DAX got blitzed. Now for the first time in 8 months we must make the determination of whether Europe is leading to the downside or North America is the new leader to the upside. If we go by the Russell, we get a very bullish message because small caps have been leading to the upside for the first time in a long time. Judging by the small caps our end of the world action from 2 weeks ago Monday gave us an excellent trading bottom. It’s hard to imagine Europe is ready to violate it so soon. Europe could also be sending a different strange message. Last week the ECB diverged from the Fed by suggesting they intend to keep rates low for a long time, perhaps even exploring real negative rates. We also have political and financial unrest in Portugal. Finally we have the situation in Egypt. Perhaps European traders have not sorted out how they should feel about these 3 events. We could see a month of instability and perhaps a trading range which diverges from our bullish leg up.

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