July 3, 2013

Market Commentary
By Art Cashin
Statistics Fair Value Buy Program Sell Program = = = N.A. N.A. N.A.

Prepared by UBS Financial Services Inc.

Cashins Comments An Encore Presentation
On this day in 1863, two civil war battles were reaching climactic moments. Their outcomes would change the course of the war and the history of the nation. They shared something else beside their timing and importance. They also shared a name or at least part of a name. They were the burgs Gettysburg and Vicksburg. Following the Confederate victory at Chancellorsville, Robert E. Lee decided to take the campaign north. He hoped to threaten Harrisburg or even Philadelphia. By placing a northern city at risk, he hoped the people and politicians would force Lincoln to sue for peace. The fact that the battle took place at Gettysburg was somewhat of an accident. The two armies bumped into each other and the battle ensued. The battle began on July 1st and on that day things went well for the Rebels. They routed Union forces, who fled through town. On the second day both sides were fully deployed. The Confederates mounted an assault on the left flank of the Union forces. Taking heavy casualties, the Union forces buckled but did not break. On the third day (today), Lee determined to break the deadlock. Originally, the plan called for General Longstreet of the Confederates to attack the Union on its left flank but that plan had to be changed. Instead, they sent 12,000 men across an open field for three-quarters of a mile to attack the Union forces. Less than half those 12,000 would return. Despite the withering fire in the open field, the Rebels temporarily broke through and Union forces began to fall back. Reinforcements were quickly sent in and Rebels were beaten back. The three day battle was over with nearly 50,000 casualties. Lee and his forces headed back to Virginia, never to come north again. Nearly a half continent away, Confederate General John C. Pemberton was preparing to surrender the besieged city of Vicksburg and his 30,000 men to his Union opponent, Ulysses Grant. The surrender would propel Grant to take over the Union army. Those two days, July 3rd and 4th of 1863 were devastating to the Confederate cause. Some believe that if Stonewall Jackson had not died at Chancellorsville, Lee might have been victorious. It is one of those historical what ifs that never happened. There were lots of what ifs in the stock market yesterday. They all combined to produce a Kiddie-land style roller-coaster that produced a 100 point reversal for the third session in a row. Bond Yields Yield To Greenback As Director Of Market Action Last week, traders watched a market that developed a Pavlovian reaction to the 2.5% level in the yield on 10 year treasuries. Below 2.5%, bids came in. Above 2.5%, buyers boycotted. It was simple, certain, and apparently short-lived. Yesterday, the geopolitical developments moved yields from center stage and moved the dollar to the forefront. It was more a stroll to safety than a flight but the cause and effect relationship was apparent nearly tick for tick.

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While Egypt filled up the TV screens and dominated the pundit palaver, as we noted in the pre-opening Comments, Greece and Portugal were catching attention again. As U.S. stocks were opening, headlines talked of the Troika, delaying or withholding Greece's aid package. Further, there were further resignations in the Portuguese cabinet. That sent the dollar index (DXY) to the +40 level and took all the air out of the pre-opening U.S. futures. Stocks opened mixed. The dollar rally began to fade, paring the DXY gain to +20 and sparking a rally in U.S. stocks. The dollar-directed rally to the Dow toward the day's highs (Dow +75) where they cruised into mid-day, helped by a still docile dollar. I discussed the relationship in a note to some friends: Early trading dictated by dollar moves. Strong dollar and Europe held opening back. As dollar softened a bit, stocks lifted. Bulls still restrained by 1624/1626 in the S&P. Run rate slower again. 1:00 projects to 590/670. (The final volume would swell to 720, unfortunately driven by volume on the afternoon selloff.) In early afternoon, headlines suggested that Merkel favored delaying Greek aid. They also suggested more resignations in the Portuguese cabinet. The dollar index (DXY) rallied back to +40 and stocks began to fade and rather rapidly. I sent another email, pointing to the moves: As noted earlier, stocks dollar driven. DXY rallies back to +40 (same as NYSE opening) and stocks fade. Dollar responding to several stimuli. Around 2:00, the Egyptian thing began to swell like a real showdown and the DXY shot to +60 and a trapdoor seemed to open in stocks. Stocks stabilized as the DXY eased back toward that +40 level. There was about $600 million to buy on balance for the close and that gave a bit of a boost as we headed to the bell. A "turn around Tuesday" other than the one the bulls ordered. Failure To Achieve Escape Velocity The FoF Trading Division (Local 410) was in a bit of a frenzy yesterday as they circulated a chart from the St. Louis Fed showing that monetary velocity continued to fall and had slipped to a level lower than at the depths of the recession in 2009. I have been greatly concerned about this lack of velocity for years. Here's what I wrote back in 2010: Pushing On A String The Feds Frustration Chairman Bernanke may not be sleeping well. In 2002, he famously said that to stave off inflation, the Fed could even drop tons of money from helicopters. That was hyperbole, of course, but the Feds version of the helicopter plan has not been working out very well. Its as though they dropped the money on the lawn and the homeowner raked it up and put it all in a garage and then went back to bed. The Fed has tripled its balance sheet. Banks are sitting on nearly a trillion dollars of excess reserves. Corporations are sitting on over a trillion dollars in cash. Yet, the monetary base has remained stagnant for months. The broad money supply (M3) has actually fallen significantly this year. Money has no velocity today. The money supply can only grow if you spend it or lend it. Instead, it sits idle in that garage Recently, my friend, Barry Ritholtz, did an extensive and enlightening review of those stagnant free reserves in his terrific blog The Big Picture. Here is a bit from the opening: Robert D. Auerbach an economist with the U.S. House of Representatives Financial Services Committee for eleven years, assisting with oversight of the Federal Reserve, and now Professor of Public Affairs at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin notes [1] today: There is a massive misconception about where the Bernanke Feds stimulus landed. Although the Bernanke Fed has disbursed $2.284 trillion in new money (the monetary base) since August 1, 2008, one month before the 2008 financial crisis, 81.5 percent now sits idle as excess reserves in private banks. The banks are not required to hold excess reserves. The excess reserves exploded from $831 billion in August 2008 to $1.863 trillion on June 14, 2013. The excess reserves of the nations private banks had previously stayed at nearly zero since 1959 as seen on the St. Louis Feds chart [2]. The banks did not leave money idle in excess reserves at zero interest because they were investing in income earning assets, including loans to consumers and businesses. This 81.5 percent explosion in idle excess reserves means that the Bernanke Feds new money issues of $85 billion each month have never been a big stimulus. Approximately 81.5 percent (or $69.27 billion) is

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either bought by banks or deposited into banks where it sits idle as excess reserves. The rest of the $85 billion, approximately 18.5 percent (or $15.72 billion) continues to circulate or is held as required reserves on banks deposit accounts (unlike unrequired excess reserves). Wow! 81% of all the QE is sitting in a vault as stagnant as if it were in that proverbial garage. (It's a terrific review and if you can access it, read it thoroughly over the holiday or on the weekend.) Sort of puts "tapering" in a slightly different perspective doesn't. Velocity is essential in a fractional banking system. Overnight And Overseas Egyptian standoff continues and tension builds. Western leaders loathe to openly opine lest crowds show up in their nations, calling for their resignation. (Tea Party could be painting placards now.) Europe While Tuesday's Euro fall looked to be 50% Greece, today it is nearly 100% Portugal. Converted to Dow equivalents, the morning score-sheet is: Lisbon - 810; Spain -405; Italy -300; Germany and France down about 200. Other geo-politics Bolivia President's plane finally takes to the air after being grounded in Europe on a suspicions Snowden was aboard. Rumors abound that Venezuelan President is in Moscow. (Anyone have James Bond's cell number?) Consensus Stocks close at 1:00. Bonds close at 2:00. Watch the dollar closely as well as the newsticker. Stay very nimble and Have a Fifth on the Fourth. Be thankful for our Freedom! Trivia Corner Answer - The tablet was intended to commemorate the Signing of the Declaration of Independence and thus simply contains that date - July 4, 1776 with the numbers written in Roman numerals as befits a great edifice or monument. Today's Question - Great Caesar's Ghost! Gentilius was born on January 15 in 30 B.C. He was elected pro consul on January 15 in 30 A.D. How old would he be when he became pro consul?

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