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April 15th special:

I always look forward the beginning of a new quarter, because it gives me a chance to read STRATFOR’s update of their annual forecast, which I shared with you in January. Their quarterly forecast explores developing geopolitical trends in each region of the world.  In recent months and quarters I’ve noticed a much wider recognition in published discussions of “geopolitical risk” as it relates to investments.  Of course geopolitical risk is nothing new to my long-time readers who’ve been plugged into STRATFOR for years.

This Q2 forecast is a long read, but it addresses everything from China’s battle with inflation, to Russia’s economic opportunity, to the stalemate in Libya’s civil war. They do a fantastic, and usually spot-on, job of telling you what to look out for.  (And when they aren’t spot-on, they’re up-front about what they missed and why).

I hope you enjoy the forecast below, and take advantage of STRATFOR’s current special offer – a free copy of my book, Endgame, to any of my readers who <<subscribe to their intelligence service here>> at a steeply discounted price. I suggest you check it out.

<<Click here to view their special offer.>>

John Mauldin, Editor
Outside the Box

In our 2011 annual forecast, we highlighted three predominant issues for the year: complications with Iran surrounding the U.S. withdrawal from Iraq, the struggle of the Chinese leadership to maintain stability amid economic troubles, and a shift in Russian behavior to appear more conciliatory, or to match assertiveness with conciliation. While we see these trends remaining significant and in play, we did not anticipate the unrest that spread across North Africa to the Persian Gulf region.

In the first quarter of 2011, we saw what appeared to be a series of dominoes falling, triggered by social unrest in Tunisia. In some sense, there have been common threads to many of the uprisings: high youth unemployment, rising commodity prices, high levels of crony capitalism, illegitimate succession planning, overdrawn emergency laws, the lack of political and media freedoms and so on. But despite the surface similarities, each has also had its own unique and individual characteristics, and in the Persian Gulf region, a competition between regional powers is playing out.

When the Tunisian leadership began to fall, we were surprised at the speed with which similar unrest spread to Egypt. Once in Egypt, however, it quickly became apparent that what we were seeing was not simply a spontaneous uprising of democracy-minded youth (though there was certainly an element of that), but rather a move by the military to exploit the protests to remove Egyptian President Hosni Mubarak, whose succession plans were causing rifts within the establishment and opening up opportunities for groups like the Muslim Brotherhood.

As we noted in our annual forecast; “While the various elements that make up the state will be busy trying to reach a consensus on how best to navigate the succession issue, several political and militant forces active in Egypt will be trying to take advantage of the historic opportunity the transition presents.” In this quarter, we see the military working to consolidate its control, balance the lingering elements of the pro-democracy movement, and keep the Muslim Brotherhood and other Islamist forces in check. Cairo is watching Israel very carefully in this respect, as Israeli military actions against the Palestinians or against southern Lebanon could force the Egyptian leadership to reassess the peace treaty with Israel, and give the Islamist forces in Egypt a political boost.

In Bahrain, we saw Iran seeking to take advantage of the general regional discontent to challenge Saudi interests. The Saudis intervened militarily, and for now appear to have things locked down in their smaller neighbor. Tehran is looking throughout the region to see which levers it is willing or capable of pulling to keep Saudi Arabia unbalanced while not going so far as to convince the United States it should keep a large force structure in Iraq. Countering Iran is Turkey, which has become more active in the region. The balancing between these two regional powers will be a major element shaping the second quarter and beyond.

We are entering a very dynamic quarter. The Persian Gulf region is the center of gravity, and the center of a rising regional power competition. A war in or with Israel is a major wild card that could destabilize the area further. Amid this, the United States continues to seek ways to disengage while not leaving the region significantly unbalanced. Off to the side is China, more intensely focused on domestic instability and facing rising economic pressures from high oil prices and inflation. Russia, perhaps, is in the best position this quarter, as Europe and Japan look for additional sources of energy, and Moscow can pack away some cash for later days.

Middle East

Regional Trend: Iran’s Confrontation with the Arab World

The instability in the Middle East carrying the most strategic weight is centered on the Persian Gulf, where Bahrain has become a proxy battleground between Iran and its Sunni Arab rivals. Iran appears to have used its influence and networks to encourage or exploit rising unrest in Bahrain as part of a covert destabilization campaign in eastern Arabia, relying on a Shiite uprising in Bahrain to attempt to produce a cascade of unrest that would spill into the Shiite-heavy areas of Saudi Arabia’s oil-rich Eastern Province. Saudi Arabia responded by sending military forces into its island neighbor.

Continued crackdowns and delays in political reforms will quietly fuel tensions between the United States and many of the Gulf Cooperation Council (GCC) states as Washington struggles between its need to complete the withdrawal from Iraq and to find a way to counterbalance Iran. The Iranians hope to exploit this dilemma by fomenting enough instability in the region to compel the United States and Saudi Arabia to come to Tehran for a settlement on Iranian terms or to fracture U.S.-Saudi ties, thereby drawing Washington into negotiations to end the unrest and thus obtain the opportunity to withdraw from Iraq. So far, that appears unlikely. Iran has successfully spread alarm throughout the GCC states, but it will face a much more difficult time in sustaining unrest in eastern Arabia in the face of intensifying GCC crackdowns.

Iran probably will have to resort to other arenas to exploit the Arab uprisings. In each of these arenas, Iran also will face considerable constraints. In Iraq, for example, Iran has a number of covert assets at its disposal to raise sectarian tensions, but in doing so, it risks upsetting the U.S. timetable for withdrawal and undermining the security of Iran’s western flank in the long term.

In the Levant, Iran could look to its militant proxy relationships with Hezbollah in Lebanon and Palestinian Islamic Jihad in the Palestinian territories to provoke Israel into a military confrontation on at least one front, and possibly on two. An Israeli military intervention in the Gaza Strip would put pressure on the military-led regime in Egypt as it attempts to constrain domestic Islamist political forces. Syria, which carries influence over the actions of the principal Palestinian militant factions, can be swayed by regional players like Turkey to keep this theater contained, but calm in the Levant is not assured for the second quarter given the broader regional dynamic.

In the Arabian Peninsula, Iran can look to the Yemeni-Saudi borderland, where it can fuel an already-active al-Houthi rebellion with the intent of inciting the Ismaili Muslim communities in Saudi Arabia’s southern provinces in hopes of sparking Shiite unrest in Saudi Arabia’s Eastern Province. This represents a much more roundabout method for trying to threaten the Saudi kingdom, but the current instability in Yemen affords Iran the opportunity to meddle amid the chaos.

Read the rest of this entry »

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Jim Bianco has an interesting thought on Cap Gains:

“Since the Tax Reform Act of 1986, capital gains taxes have been highly correlated to the budget deficit. The chart below shows capital gains is a driving force of revenue into the Treasury.  Thanks to the recent financial crisis that affected stocks, bonds and real estate, there are fewer capital gains to tax and government revenues are suffering.  State and local governments have a similar problem (but to a smaller degree) because of their reliance on real estate taxes and the inability to raise assessments because of the slump in home prices.”

This is obviously a correlation issue. The causative factor in budget deficits, at least on the income side, is impacted by the economic cycle. Recessions equal weak earning equals market sell off.

Hence, it is not cap gains, but the underlying causes. Regardless, it is interesting to see Cap Gains as indicative of economic cycles and government tax revenue.

More tax day data porn: These are the 10 companies that have the most untaxed foreign income:

1. General Electric (GE)
Untaxed foreign profit: $94 billion
Tax Haven: US
Strategy: An army of 1000 former IRS accountants keeps GE’s taxes near zero

2. Pfizer (PFE)
Untaxed foreign profit: $48.2 billion
Tax Havens: Global
Strategy: HC Industry keeps more profits overseas than any other industry

3. Merck (MRK)
Untaxed foreign profit: $40.4 billion
Tax Havens: 140 countries
Strategy: Used more than $9 billion from abroad in 2008 tax-free to finance Schering-Plough acquisition

4. Johnson & Johnson (JNJ)
Untaxed foreign profit: $37 billion
Tax Havens: Choose from 60 countries
Strategy: 48 consecutive years of dividend increases.

5. Exxon Mobil (XOM)
Untaxed foreign profit: $35 billion
Tax Havens: Does most of its business on international soil
Strategy: 80% of the company’s 2009 earnings came from outside the U.S.

6. Citigroup (C)
Untaxed foreign profit: $32.1 billion
Tax Havens: Various countries across Asia, the Middle East and Africa
Strategy: Lose Billions i crash; Garner s $45 billion bailout

7. Cisco Systems (CSCO)
Untaxed foreign profit: $31.6 billion
Tax Havens: Keeps $40 billion in cash overseas
Strategy: Lobbying for tax holiday for repatriated income

8. IBM
Untaxed foreign profit: $31.1 billion
Tax Havens: India, China, Brazil and Russia
Strategy: international expansion into smaller emerging markets

9. Procter & Gamble (PG)
Untaxed foreign profit: $30 billion
Tax Haven: China
Strategy: Overseas accounts for 58% Sales

10. Microsoft (MSFT)
Untaxed foreign profit: $29.5 billion
Tax Havens: Ireland, then the Netherlands, then Bermuda
Strategy: Double Irish and the Dutch Sandwich

Data Sources: Bloomberg, Fortune

From Visualizing Economics, we see this spectacular depiction of the top Marginal Tax Rates in the US, from 1916-2010, for Personal Income, Corporate, and Capital Gains tax rates:

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click for larger version

Ginormous version here

After falling 10 pts in March to 67.5, the preliminary April UoM confidence figure was 69.6, slightly above expectations of 68.8. A one point decline in Current Conditions was more than offset by a 3 pt gain in the Economic Outlook. Importantly, one year inflation expectations held steady at 4.6%, the most since Aug ’08. Five year inflation expectations fell to 2.9% from 3.2% and are back in line with the level seen in Feb. Bottom line, consumer confidence continues to be thrown back and forth between an improving jobs outlook on one hand but with an ever accelerating rise in the cost of living on the other hand with modest income growth. As seen in the March retail comps, consumers spent even with a 10 point decline in confidence, thus proving that confidence figures are more anecdotal than anything in gauging the economic outlook. With this said, the Fed looks at inflation expectations and the one yr outlook of 4.6% compares with the 10 yr average of 3.0%.

The April NY manufacturing survey, the 1st April industrial # out, was better than expected at 21.7 vs the estimates of 17.0, up from 17.5 in March and at a one yr high. New Orders jumped to 22.3 from 5.8 but Backlogs were little changed. Inventories fell 5 pts to -1.3. Encouragingly, employment spiked to 23.1 from 9.1 to the best since May ’04. Discouragingly but evident to most of us, Prices Paid rose another 4 pts to the highest since Aug ’08 and Prices Received was up by 6 pts and is just 7 pts from a record (dating back to ’01). The 6 month outlook for General Business Conditions fell for a 3rd month, by 2 pts to 47.4. Mfr’s in the NY region were asked specifically about the Japanese earthquake and “nearly 80% of respondents indicated that the crisis in Japan was having little to no effect on their business.” Likely, the Chicago PMI, because of its focus on the auto industry, will be more impacted by the Japanese disaster and we’ll have to monitor if any other regions feel any impact. The Philly survey is next, next Thursday.

Headline CPI in March rose .5% and 2.7% y/o/y. The core rate was up .1% and 1.2% y/o/y. The headline gain was in line and the core gain was .1% below expectations. The index itself for both rose to fresh record highs. Energy prices rose 3.5% m/o/m and food was up by .8%. Keeping a lid on the core gain was just a .1% gain in OER, the key component I believe will be heading higher this year due to lower apartment vacancies and higher rents. Strangely, apparel prices fell for a 2nd month by .5% and are lower by .6% y/o/y notwithstanding the substantial gain in cotton prices. Either retailers are eating the cost or the 2nd half of ’11 is going to see sharp increases in apparel prices. Commodity prices, 40% of the CPI, rose 1.2% and are up 4.5% y/o/y. Bottom line, inflation is clearly evident at the headline level but statistically and hedonically benign at the core level, the level the Fed is solely focused on. The question though is not if but when the core rate starts to move higher in a more pronounced fashion.

Africa Black and White

China reported that March CPI rose 5.4% y/o/y, above expectations of 5.2% and the most since July ’08. The immediate stock market response was lower but the Shanghai index ended up closing slightly higher on the day. The Indian Sensex though fell 1.6% after wholesale prices rose 8.98% y/o/y, above forecasts of 8.36%. Also in China, PPI, IP, and Retail Sales all gained more than estimated. Today’s WSJ highlights the convoluted process that China goes through in dealing with and adjusting monetary policy. Euro Zone CPI in March was revised up to a 2.7% gain y/o/y vs the initial report a few weeks ago of 2.6% and is up from 2.4% in Feb. Moody’s downgraded Ireland’s credit rating by 2 notches to Baa3 and is now 2 notches below both S&P and Fitch. While signs still point to the sovereign debt issue in Europe being contained for now to Greece, Ireland and Portugal, the Spanish 2 yr yield is rising to a 2 month high and their 10 yr yield is at a 1 month high.