Reuters Reports Massive Cash on Sidelines

Investment Capitalist

LINK to Original Article

(Reuters) – Judging by the recent flurry of share buyback announcements, Corporate America is increasingly confident the worst of the economic slump has passed.

After two years of belt tightening, stock buybacks are running at their highest level in two years as companies start to look for ways to deploy the record levels of cash on their balance sheets.

Buybacks are viewed as sort of a way-station to the more aggressive ways to spend: acquisitions and capital expenditures. Those expenses imply a long-term strategic bet by a company on earnings potential and growth.

“It’s just a sign that more companies are confident in the economy going forward,” said Rob Leiphart, market analyst at Birinyi Associates in Stamford, Connecticut. “Buyback authorizations are cyclical and do tend to move with recessions and expansions.”

In recent weeks companies announcing authorizations for buybacks include Philip Morris (PM.N), which unveiled a $12 billion share repurchase plan, and Lowe’s Cos Inc. (LOW.N), which plans to buy back up to $5 billion worth of its stock.

Other bellwethers announcing big buybacks include WellPoint Inc (WLP.N), Colgate-Palmolive Co (CL.N), UnitedHealth Group Inc (UNH.N) and Amazon.com Inc (AMZN.O).

New stock buybacks have been particularly robust in the latest earnings reporting season, averaging $1.6 billion daily, the highest level in almost two years, according to data from investment research firm TrimTabs.

Buybacks reward shareholders by reducing outstanding shares, driving up the price of existing stock, and improving earnings-per-share figures. But they can be canceled more easily than a big acquisition.

Investors tend to be forgiving if companies suspend buybacks when the going suddenly gets tough, unlike cutting a dividend or abandoning capital expansion plans.

BIG BUYBACKS, BIG CASH PILE

In the week through February 26, the amount of authorized share buybacks by U.S. corporations hit $13.2 billion, compared with $1.07 billion of authorizations announced in the week to Feb 27, 2009, according to data from Birinyi Associates.

The year-to-date tally is $68.5 billion, compared with $125 billion of authorizations for all of 2009, a year that saw a 65 percent drop in buyback authorizations from 2008’s $359.8 billion.

The hoards of cash for buybacks also spells good news for the broader equity market.

“There is no question in my mind that we’re at the early stages of a major stage of more stock buybacks and merger and acquisition activity,” said Carmine Grigoli, chief U.S. investment strategist at the equities division of Mizuho Securities USA in New York.

“That should keep stock prices rising…. It’s powerful enough to keep the equity market moving higher.”

JPMorgan estimates that S&P 500 companies currently have $3.2 trillion of cash sitting on their balance sheets. Excluding the financial sector, the cash pile is $1.1 trillion, or 11 percent of assets, a 60-year high and well above the long-term average of 8 percent.

This makes it likely 2010 will mark a big turnaround in share repurchases, and the revival in capital expenditures and M&A should follow after a muted 2009.

Stock repurchases, M&A and the ramping up of capital spending and dividends have historically been inversely correlated with cash balances.

“We believe one catalyst to buy (equities) is the eventual deployment of the excess cash held by S&P 500 companies,” said Thomas Lee, JPMorgan chief U.S. equity strategist. He said confidence in the sustainability of the recovery will be critical to more purchases.

Some of the cash is already making its way into deals this year, with Coca-Cola Co’s (KO.N) clinching a deal to buy the North American operations of its top bottler for about $13 billion and Schlumberger Ltd (SLB.N) agreeing to buy Smith International Inc (SII.N) in a $11.34 billion all-stock deal.

Global M&A has reached $400.8 billion in 2010 so far, up 4 percent on the same period last year, according to Dealogic’s latest review of February M&A. The top 10 M&A deals in February have involved six U.S. corporations as acquirers.

Capital spending could also rise. JPMorgan’s Lee estimated that there was a $107 billion potential increase in capital spending, and the largest sectors likely to deploy that cash were discretionaries, industrials and healthcare.

But, as expected, the damage sustained by the financial services sector over the past two years and scrutiny from Washington makes it unlikely that banks will be announcing share repurchases or other major capital expenditures anytime soon.

Not every company is thinking this is an appropriate time for buybacks.

Apple Inc (AAPL.O), under intense scrutiny about how it would use its $40 billion cash pile, said it would rather save the money for bolder risks like acquisitions instead of buybacks or cash dividends.

A rumor of a potential Apple share split stoked a frenzy last week, helping stocks reverse a sharp drop late in the day.

Biotech is in Play – OSI Pharmaceuiticals

The 50% premium being paid for OSIP by Astellas, which is roughly $52/share, was actually rejected by the board. The market is pricing the stock at $56, and I think the stock climbs another $10 from here. There will be another bidder.

The M&A attention is bullish for the sector. There are some good plays out there.

The big gap to the left on the below chart of PDLI is one reason to be long this stock. Another reason is the Green indicator at the top, which is a modified Money Flow indicator. The lower Blue line is a modified Accumulation indicator. Notice how both have turned up sharply while the stock has barely budged out of this tight range since mid-Feb?

PDLI -Proteign Design Labs
Click on the image for Higher Resolution

Now, take a quick peak at the Biotechnology Index going back to 1992. Seriously, click on the link and take a look. This is a monster chart. She’s in new all-time territory. The blue and green lines are Fib. projection and retracement lines. I’ll let you guess which one’s. Swing Traders should be lurking in these stocks.

Disclaimer: Author is a shareholder of PDLI.

Essential Reading Material

There are TWO absolutely essential books in every Trader’s library. Remember when you were 18? Getting ready to jump into this business? 20 years later, think what the 2 most essential books are in your ever expanding library. To me, they are, in no particular order:


Buy the 7th Edition of the above book. Nothing changed to warrant an 8th Edition, nor a doubling of the price, except for the passing of Edward McGee, the co-author whom always provided incredible insight into the markets. I don’t blame Robert D. Edwards though (the living co-author). Publisher’s are evil and greedy

AND


This is the first Market Wizard’s book of many more to come, but only the first one really moved me, and ever since, I’ve been called MW. The great legends Schwager talks to are immensely inspiring, and every time I read through it, I continue to learn about what I see, in a more granular way, a way that only time can bring about. Helps me understand human nature.

Good Trading and

    NEVER

stop learning! See You In the Markets: MW

Global Macro Perspective

A BRIEF Monday Morning Playbook

  • Nasdaq and Dow are at 2/3 retracements of their pullback from mid-January. What happens here is crucial. Is there follow-thru? Or will there be a test of the February Lows first, or even perhaps a higher low? Did the Fed tip its hand and give the all clear sign with the surprise discount hike?
  • Special Treat of the Month: Schweitzer-Mauduit (SWM) – Barely missed the entry parameters and/or the $70 stop kept you safe on this (phew….), but now the stock appears ready to close the gap at $36, 60% cheaper than where we first looked at it and $39 is the 61.8% retracement of the move. Most important of all, nothing has really changed. The collapse was mid-day. The company can’t figure it out. They’ve issued many releases since. The reiterated contract renewals coming up in 2010 but they are the only supplier. The collapse, intraday imbalance looks to me like a forced liquidation, or an unwanted one. A fund had to meet a call somewhere else, and the first to go is the best performer in the portfolio. Keeping a very close eye on it.

• Long:

o MSCI (Moody’s Commodity Sector)
o Defense Sector
o Internet Software & Sales
o Tech Hardware Vendors
o Vertical Tech Giants (e.g. IBM)
o Chip Stocks
o ISRG and PCLN both possible breakaway upside gaps

• Short:

o Gold
o Oil
o Hang Seng (e.g. FXP)

Investment Capitalist Called the Bottom

Let’s not forget that Investment Capitalist called the market bottom on March 9th as a day that would go down as the easiest reversal signal in history. That’s the day our readership exploded. I want feedback from all of you and I want to hear your ideas as well so feel free to post your ideas now that I’ve changed the policy so that all readers can post their analysis of the markets.

Invitation to Readers to Write for Investment Capitalist

After much consideration and several suggestions from Investment Capitalist readers, I’ve decided to open Investment Capitalist up for members to write their own content, post ideas, analysis and share their charts; in addition to my content which I will continue writing.

I would also love to comment on readers trade ideas and their technical analysis work or fundamental perspectives. Especially you young ones out there, like Angel, Jason, Brian and dozens of others, who would love to post their analysis and charts and get my feedback as well as the valuable feedback from other viewers of the blog. Especially after, or during, your attendance at one of the T3 Live Immersion Training Programs.

Make sure you visit T3 Live and take advantage of their Free Trial.  Once you sign up for a trial, email me your username and I’ll make sure you get access to the restricted areas unavailable to other free trial members. Then when you’re ready to join as a full member, I’ll make sure you get a price available only to Investment Capitalist members.  As the Director of Institutional Development for T3 Capital Management, LLC, I have a little pull in these things. :lol:

Until now, readers have not been able to post their own analysis, but readership has grown enough to where I think this experiment will actually prove to be a good decision. I trust many of you and respect your analysis. In fact, many times you’ve emailed me  ideas that I’ve written about.

So without further delay, I invite all readers to post their analysis for others to follow, read, learn from and just share ideas with each other. Just a few points to remember:

  • If you post a chart, make sure it’s small and fits within the borders.
  • If you post anything but analysis, or comments on analysis already posted, it will be deleted, and so will you:  the  one responsible for the post
  • No links of any kind will be permitted in posts. So no subtle attempts at trying to advertise a porn site or something. ;-)
  • Make sure you check mark the appropriate Category Boxes based on the content of your post

You are going to see additional commentary from me on the T3 Live blog and I don’t want duplicate content on the internet. So make sure you visit T3 Live where you’ll see some more of my analysis going forward, as well as analysis from some of the top proprietary traders in the world.

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Short and Long Plays Popping Up All Over the Place

The desk I run is an Institutional Long/Short Equity desk which tries to maintain a “market neutral” book. This doesn’t mean “buy 1000 shares of IBM and 10 puts”. What market neutrality means is that one need not be concerned about the overall direction of the market, as momentum traders are, but rather have long positions as well as short positions comprising their overall book. You will never catch a market neutral trader with positions pointing only in one direction. So with that said, let me share some of my ideas with you:

Aside from the macro backdrop that may or may not be causing a pending market correction, there are several trades popping up on my proprietary models on both sides of the market. So there are NO excuses to be purely directional when you’re proclaimed to be a market neutral Long/Short trader.

On the macro front, I’m generally in-line with the coordinated re-inflation of global economies via the debasing of their respective currencies. Therefore, I’m bullish long-term on things like Oil, definitely Gold, Dry and Wet Bulk Carrier fleets, Railway stocks, and Silver (perhaps more than Gold). But I’m not bullish on base metals that go into manufacturing, such as copper, aluminum, steel, etc… There’s WAY TOO MUCH production capacity or acquisition debt added at or near the top of the credit bubble, and the adjustment, although already taking place, is going to be a painful one and has a ways to go. If you want to be truly market neutral here, you would be long the producers, oil futures, gold futures, and silver futures, while short the Steel producers, copper, and base metal producers in general.


SHORT TRADES

ADI: Has moved way above all of its major averages on consistently declining volume: negative divergence #1. Money Flow turned down on Friday’s new high: negative divergence #2. Momentum Oscillator failed to make a new high relative to the new high made in early December ahead of this consolidation: negative divergence #3. The Secondary Trendline is around $34 while the 10-period daily EMA is at $31. So there are actually two ways to play this: If there is a fall in the market early in the week, pick up a small lot near the $31 level and use the 10-period as your stop. The other way is to short the stock as it approaches the $34 level.

ATHR: This telco play is directly on its all-time highs, which haven’t been broken since November after a series of six tests. This is the seventh (lucky number perhaps)? The only odd thing about my model on this is that it shows money flow collapsing while the stock has been rising for the past several sessions. That could be a false signal due to holiday trading, but it’s worth keeping in mind. On the other hand, all momentum indicators have turned up sharply. I never buy stocks after they’ve rallied several sessions, so a pullback to $30 should be followed by one more attempt at a new high at least. I don’t think we’ll see a break above $35 on this move, so there’s no rush, and if the stock does break above $35, I’d be a seller, legging into my short position and not a buyer, with the intention of covering my short position at or near $35. $30-$31 is a great entry on this stock.

CRM: Although I rarely suggest stepping in front-of a runaway train (i.e. bull market), Salesforce.com appears ready for an extremely short term pullback, ideal for the daytrader. The prior breakout high was 67.72, which directly coincides with the 10d-EMA. But remember, this stock is in a bull market, so when it’s time to close out that short, consider reversing and going long instead of just patting yourself on the back. The actual trade here is on the long side, but the MACD, Doji, and declining volume create three powerful negative divergences.

LONG TRADES

AMZN: Going into the Christmas season, Amazon’s channel checks were bringing back some unbelievable results. In other words, their sales went through the roof. Now we won’t know the extent of the returns they’ll face, but historically, Amazon has been one of those stocks that doesn’t react to the “item returns” line item in their following quarter. The 10p-EMA just crossed the 24p-EMA on Wed. Don’t let the declining volume on Friday fool you, with what appears to the “technician” as a Doji. This is classic chart painting for those that follow technical analysis like it’s their dogma. Friday was a ghost town on Wall Street, so one could have pretty much done whatever they wanted in terms of end-of-day chart painting. That’s why I don’t put too much weight into Technical Analysis as a valid tool in understanding market theory, especially when it comes to the markets’ micro-structure. If anything, it must be used within a much larger plethora of quantitative tools. With regards to Amazon, the stock spent the past 2 months consolidating the move from $92 to $125. Above $140 it’s a potential buy, using the 10p-EMA as your stop.

BCS: As I said before, I’m not a huge fan of Technical Analysis, but that doesn’t mean I’m not going to make myself an expert at it. It’s just another tool in my arsenal. Barclays bank, if it hits $15, will have corrected 40% since its’ October highs. Remember, this is the ADR so it’s thin. Not a daytrading stock at all! I think $15 is a low-risk entry point, perhaps risking $0.70 to make about $3 to $5.

BRCM: Something tells me this stock wants to test $35-$36. For a long position, use the 10d-EMA, leg into your long position, and leg out as it approaches the whole number.

CEO: Something of an anomaly in China, with a P/E of 16 and an EPS $9.57 per share, their 5-year growth rate is phenomenal but their most recent numbers aren’t all that great, but which oil producer didn’t suffer this past year? The anomalies lie in their TTM growth rate of almost 56% while their debt to cover ratio is 2.6 with their peer group being closer to 1.26! I wish American companies were run as tight as CNOOC. Their costs of revenues have shrunk while their income has stayed relatively flat in spite of the dramatic collapse in oil prices. As a long-term position, I would start building a line around the 155-157 level and hold it until at least $200. However, during that time, you should always trade around your core position to lock in Alpha. Here are some ratios for CEO:

CP: Watch the $55 level. Having closed $.25 below it, I’m fairly certain it will bust through $55 in order to clear out the stops resting there, then will fall back down below to nail the ensuing protective stops established on the prior buy through $55. Nonetheless, the stock is in a powerful long-term uptrend which will prevail for the foreseeable future, if not the next several years. For short-term traders, the $55 level will provide for rapid trading on both sides, for the long-term swing/position trader, wait to see what happens. These stocks don’t move like tech stocks, although last year a few did. I actually look at this stock, and the sector, as a growth sector. So for them to have low double digit P/E’s and paying out dividends makes this a solid play, especially with the macro backdrop I mentioned. Lastly, as the Great Sage of Omaha likes to say: “Does it generate cash that ends up in their bank accounts? If it does, I’d like to take a look at the stock”.

CSX: Another railroad breaking into new 52-wk highs. Everything looks good here except the fact that the market broke above the 52-wk high on the day after Christmas, which means a lot of stops were just cleared out and the next step is likely down before ultimately resuming its uptrend. So if you’re a daytrader, feel free to trade the short side and then reverse. All you others out there, keep an eye here and go long when you see the whites of their eyes.

CYOU: Remember this Chinese stock went public May of this year. Once the majority of lock-ups expired, insiders cashed out, as expected. Now, 28-30 has become a major accumulation zone and the stock appears ready to break out. Yes we were on Christmas schedule last week, but the Chinese are communists. First upside target is $40

DRE: Duke Realty bottomed around $12 in March and after regressing back to the $10 level where it should have been if there weren’t a liquidity crisis, the stock seems to be poised for an extended up move. All my models have triggered on this one, which is rare and actually makes me a tad more cautious rather than feeling like I should go all-in. However, the stock has had 7 green sticks in a row, so be patient and buy it on a test or break below $12 and keep legging into the trade until $11.

EQIX: This is the trend followers dream stock. Every single metric is growing at an impressive pace, and the company is throwing off cash by the truck-load, and almost all of it is being plowed right back into the business. Obviously, the stock has the benefit of every single moving average below it, with the most consistent being the 10d-EMA (as always). Since $100 is a whole number which has yet to be tested following the recent break above that level, I’d like to buy it around $100, legging into my position as always.

ESLR: Another potential high flier when it gets wings is Evergreen Solar. The chart below shows a very sensitive and potentially explosive move. However, although I put the odds in the favor of an upside breakout, there is a chance there will be a quick spike down to shake out all the weak hands, so be careful and watch.

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Global Macro Themes for the Proprietary Trader

30-year Treasury Yields are about to spike along with a dollar rally. I feel this is the catalyst to trigger a sustained pullback in equities, which will reflect our rising unemployment rate and all the stimulus plans that are slowly phasing out.

Equity Long/Short Market Neutral traders will have an edge in this market over Momentum traders waiting for an expansion in the VIX.

For example, convertible bonds are the “paper of last resort,” and the airlines are desperate for cash (when aren’t they?). So it’s not a surprise Continental is in the market to raise some expensive capital and a $200 million deal (if the green shoe is exercised) is nothing serious. But the devil’s in the details.

I think the coupon is going to float around 4.5%, literally a 25% premium on a five-year maturity. The bonds at this issue price are a clear advantage over the common and set up an ideal trade, again at the issue price. I keep emphasizing this because the hedgies will be buying up the offering and shorting the stock to capture the premium so the spread should narrow really fast.

My bet is that most, if not all of this offering is going to the hedge funds. A few back of the napkin calculations, and after the offering, it’s quite possible that up to 60% to 65% of the common will be short.

Since the deal is for $200 million (including the $30 million green shoe), with a 25% conversion premium, this means about $184 million of stock will be controlled by the bonds. Around $120 million of stock will need to be sold short to hedge the deal. This means somewhere in the neighborhood of 7.5 million shares.

With this in mind, the sell-off in the stock should continue. So hit the rallies and hit them hard. The sell-off began with the deal’s announcement but it’s not over. I wouldn’t expect it to settle in much higher than $13.50 or $14. Perhaps even closer to $12 on an overshoot. In fact, if the common does overshoot through $13 and then through $12, look for a dead cat bounce trade of a couple quick points.

I’ll do some research over the weekend and post some more ideas. I know I haven’t updated the blog recently but I think the weather in New York is going to give me an excuse to stay in and write more often than before. It is absolutely, insanely, unbearably cold here.

MW

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Macro Signals…

Gold went over $1000 and sustained a rally to $1020. A dip to test, and re-test $1000 is likely. This magical number will continue to be used as the line at which bulls and bears continue to thrash each other relentlessly like a tug-of-war match in an Ultimate Fighting chained rink.

I’m watching the 70.50 level like a hawk in Oil, as are several prominent hedgies I dialogue with on a daily basis. Right now, until Crude breaks above $71, I really like the spread of Short Crude vs Long Nat. Gas. I would lift the short side on a sustained break above $71 in Crude and get long and strong the entire energy complex, including equities.

The Dollar is beginning to weaken across all currencies rather than isolated instances, as was the case throughout the summer, when the Greenback showed strength against many majors. However, it now appears the floor for the US Dollar is being tested and probes are underway to see where the Federal Reserve will likely begin to increase its open market activities along with the US Treasury. It’s too early for a “strong” dollar in this economic bounce. Too many talking heads came out and said the worst is behind us. Which of course means that it’s not.

Keep an eye on Copper. China opened its mouth at the start of summer and swallowed this base metal like a wild boar, which threw off a lot of macro models because Copper is, of course, watched as a leading indicator of economic recovery. However, being that China was behaving like the gluttonous behemoth that it is, it could have just been a strategic build-up of reserves, or a hedge gone bad that needed to be covered. With China, we never know these days. Capitalism being so new to them, they’re like an over-grown kid on a high school football team that’s never played the sport but the coach puts him in there because he’s so big. Clumsy and stupid at times, ultimately very bad at playing their cards close to the chest and equally bad at not giving out the wrong signals and then chasing their own tale ex-poste.

Invitation to Join New LinkedIn Group

With all of the clutter and insanity due to groups turning into recruiting grounds and advertising forums for esoteric and mindless products, I was compelled to launch my own LinkedIn Group which is being emphatically embraced by the systematic and discretionary proprietary trading universe, to my delight.

I know many of you are Prop. Traders, whether equities or swaps or paper, or whatever. It doesn’t matter. The forum is to exchange ideas and share trades and various perspectives from highly qualified and advanced traders around the world (including myself, of course).  It goes without saying that if your LinkedIn Profile indicates you are a recruiter, or unrelated to content of the group, your request to join will sadly but most assuredly be declined.

With that being said, I invite you to join Discretionary Proprietary Traders Worldwide

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US Economy is ON FIRE According to US Stocks…

The US Economy, according to the behavior of key market sectors, is on an absolute tear and within six to nine months, the data is going to be screaming “expansion” at a breakneck pace. Bond market behavior over the past several weeks suggested the same except the talking heads tried to rationalize it as “bond vigilantes” wreaking havoc on the President’s fiscal policies. A monkey could have rationalized better than them.

And those taking credit on for “sending a signal” to sell Oil around early June?  One day before an upside explosion that is about to go parabolic. Well, ask yourself who it was giving the signal, and whether or not that “analyst” should even be passing judgment on macro data sets.  We all know daytraders sell a monster bull market at the first sign of weakness. Then quickly realizing their error, they jump back on the train like a monkey chasing a banana boat. No different than the sell-side analysts fresh out of school and green as a cricket.

Moving on…

Nasdaq breaking out on rising volume. All momentum and breadth indicators confirm this is real. Big cap tech has been leading the way, so don’t be surprised to see the generals outperform.

S&P 500 could break away from here, but experience tells me there may be at least one, perhaps two, head fakes designed to drive daytraders and weak-handed swing traders absolutely batty.

Commodity stocks possibly near a short-term top though. Only caveat here is the greenback. There has been a monster dollar rally which began in the early morning hours of Wed. June 4th. After a temporary pause mid-day Thursday, the Greenback exploded again in overseas markets. For us equity bulls, we want to see continued weakness in the Yen/Dollar cross, and strength in the Euro/Dollar cross. If the dollar can just stabilize, equities will rally as a group. If the dollar collapse resumes, we’ll see commodity stocks go into overdrive as the short interest is most definitely building up because of the speed of the rally. Watch big-cap tech run and you’ll be disappointed you don’t own a chunk of this group.

Focus on the following sectors:

  • Building materials
  • Casinos
  • Coal
  • Footwear
  • Internet commerce & services
  • Specialty semiconductors and equipment manufacturers.

Open Letter Response to Stratfor

The Stratfor article, presented in its entirety at the end of this letter, has failed to take into account historical precedents that are now having significant sway over the outcome of the popular uprising in Iran. Moreover, suggesting this to be “isolated to students at elite universities in Tehran proper” is grossly inaccurate. As a deeply concerned citizen of the world with very close Iranian contacts in many of the cities throughout Iran, I have first hand footage from Tabriz, Shiraz, Rasht, Esfehan, Mashad, Bandar-Abbas, Karaj and other areas showing brutal repression of popular protests. Although this started out as isolated demonstrations in support of the losing candidate, it has since transformed into a broad rejection of the political system and widespread calls for a political referendum. This is no longer about who won the Presidency.

Seeing this as a narrow struggle between corrupt clerics and revolutionary hard liners is a sad and unacceptable disregard for the hundreds of thousands of young and old protesters, religiously conservative and socially liberal clerics, and those students that have died for want of basic and inalienable rights and civil liberties. The 1979 revolution was started by the students at Tehran’s “elite” universities. It took them two months to elevate their chants and slogans to include “death to the Shah”. This time around, it took only nine days for the chants to elevate to “death to Khamenei” by name.

Iran will always be an advanced culture and civilization that places great emphasis on moral and ethical standards and beliefs. From the first declaration of human rights in the history of the world by Kurosh the Great circa 539 BC, which is the founding principle of the United Nations and is on display for all to see, to America’s founding fathers referencing Cyropedia vs. Machiavelli when drafting America’s constitution (Jefferson kept two personal copies with him at all times, one for himself and one to share DOWNLOAD FULL TEXT HERE), Iranian influence upon the collective minds and hearts of civilized societies, including its own people, has always prevailed, and will continue to prevail. The clerical establishment’s historical role is to provide “spiritual guidance” and to protect society against the corruption of political leaders. That the past 30 years has turned this concept on its head, with the clerical establishment becoming corrupt after becoming the governing body does not alter a tradition dating back over 2500 years, with the role the Magi played during Zoroastrian Iran. A tradition continued even by Alexander’s brief conquest, throughout the Sassanid Dynasty, and even the post-Islamic Safavid Dynasty, which was founded in 1502 and ruled Iran during one of its most prosperous cultural renaissances until 1752. Throughout Persian history, every ruling faction that deviated from the spiritual guidance of a devout and humble supervisory body empowered to protect the people from the corruption of politicians once they tasted the opium of power ultimately failed. That in the 21st century, the corrupt class is the same body entrusted to protect the people from political corruption, does not change the dominant ideology in Iranian minds: When the people fear their government, there is tyranny. As Thomas Jefferson stated, “The tree of liberty must be refreshed from time to time with the blood of patriots and tyrants.”

The final outcome will be a complete transformation of Iran’s political structure that will take the shape of ideologies expressed by members of the clerical establishment none-the-less, such as Ayatollah Montazeri, which is more in line with Iran’s constitutional revolution of 1906, the 1952 Mossadegh led uprising which was sadly thwarted by Kermit Roosevelt and the United States, and the white revolution of 1963. See this for what it is: a budding revolution that will ultimately find support from the West. I have read your book “The Next 100 Years” and have extremely high praise for it. However, it is impossible not to notice the glaring lack of foresight regarding the situation in Iran, the outcome of which shall greatly influence the geo-political trends in Central Asia, the Caucuses, Eastern and Central Europe, and ultimately, even the United States. All areas for which you made brilliantly thought out predictions. It is therefore not surprising that you appear to be under the influence of “group think” and are seeing what you want to see because you have your reputation riding on a specific outcome. It is not too late to check your sources in the intelligence community and reassess the situation with more current intelligence from operatives on the ground, as I’m sure you are one of the most resourceful institutions in the world when it comes to geo-political feedback from the international intelligence apparatchik.

By George Friedman
Stratfor.com

Successful revolutions have three phases. First, a strategically located single or limited segment of society begins vocally to express resentment, asserting itself in the streets of a major city, usually the capital. This segment is joined by other segments in the city and by segments elsewhere as the demonstration spreads to other cities and becomes more assertive, disruptive and potentially violent. As resistance to the regime spreads, the regime deploys its military and security forces. These forces, drawn from resisting social segments and isolated from the rest of society, turn on the regime, and stop following the regime’s orders. This is what happened to the Shah of Iran in 1979; it is also what happened in Russia in 1917 or in Romania in 1989.

Revolutions fail when no one joins the initial segment, meaning the initial demonstrators are the ones who find themselves socially isolated. When the demonstrations do not spread to other cities, the demonstrations either peter out or the regime brings in the security and military forces — who remain loyal to the regime and frequently personally hostile to the demonstrators — and use force to suppress the rising to the extent necessary. This is what happened in Tiananmen Square in China: The students who rose up were not joined by others. Military forces who were not only loyal to the regime but hostile to the students were brought in, and the students were crushed.

A Question of Support

This is also what happened in Iran this week. The global media, obsessively focused on the initial demonstrators — who were supporters of Iranian President Mahmoud Ahmadinejad’s opponents — failed to notice that while large, the demonstrations primarily consisted of the same type of people demonstrating. Amid the breathless reporting on the demonstrations, reporters failed to notice that the uprising was not spreading to other classes and to other areas. In constantly interviewing English-speaking demonstrators, they failed to note just how many of the demonstrators spoke English and had smartphones. The media thus did not recognize these as the signs of a failing revolution.

Later, when Ayatollah Ali Khamenei spoke Friday and called out the Islamic Revolutionary Guard Corps, they failed to understand that the troops — definitely not drawn from what we might call the “Twittering classes,” would remain loyal to the regime for ideological and social reasons. The troops had about as much sympathy for the demonstrators as a small-town boy from Alabama might have for a Harvard postdoc. Failing to understand the social tensions in Iran, the reporters deluded themselves into thinking they were witnessing a general uprising. But this was not St. Petersburg in 1917 or Bucharest in 1989 — it was Tiananmen Square.

In the global discussion last week outside Iran, there was a great deal of confusion about basic facts. For example, it is said that the urban-rural distinction in Iran is not critical any longer because according to the United Nations, 68 percent of Iranians are urbanized. This is an important point because it implies Iran is homogeneous and the demonstrators representative of the country. The problem is the Iranian definition of urban — and this is quite common around the world — includes very small communities (some with only a few thousand people) as “urban.” But the social difference between someone living in a town with 10,000 people and someone living in Tehran is the difference between someone living in Bastrop, Texas and someone living in New York. We can assure you that that difference is not only vast, but that most of the good people of Bastrop and the fine people of New York would probably not see the world the same way. The failure to understand the dramatic diversity of Iranian society led observers to assume that students at Iran’s elite university somehow spoke for the rest of the country.

Tehran proper has about 8 million inhabitants; its suburbs bring it to about 13 million people out of Iran’s total population of 70.5 million. Tehran accounts for about 20 percent of Iran, but as we know, the cab driver and the construction worker are not socially linked to students at elite universities. There are six cities with populations between 1 million and 2.4 million people and 11 with populations of about 500,000. Including Tehran proper, 15.5 million people live in cities with more than 1 million and 19.7 million in cities greater than 500,000. Iran has 80 cities with more than 100,000. But given that Waco, Texas, has more than 100,000 people, inferences of social similarities between cities with 100,000 and 5 million are tenuous. And with metro Oklahoma City having more than a million people, it becomes plain that urbanization has many faces.

Winning the Election With or Without Fraud

We continue to believe two things: that vote fraud occurred, and that Ahmadinejad likely would have won without it. Very little direct evidence has emerged to establish vote fraud, but several things seem suspect.

For example, the speed of the vote count has been taken as a sign of fraud, as it should have been impossible to count votes that fast. The polls originally were to have closed at 7 p.m. local time, but voting hours were extended until 10 p.m. because of the number of voters in line. By 11:45 p.m. about 20 percent of the vote had been counted. By 5:20 a.m. the next day, with almost all votes counted, the election commission declared Ahmadinejad the winner. The vote count thus took about seven hours. (Remember there were no senators, congressmen, city council members or school board members being counted — just the presidential race.) Intriguingly, this is about the same time in took in 2005, though reformists that claimed fraud back then did not stress the counting time in their allegations.

The counting mechanism is simple: Iran has 47,000 voting stations, plus 14,000 roaming stations that travel from tiny village to tiny village, staying there for a short time before moving on. That creates 61,000 ballot boxes designed to receive roughly the same number of votes. That would mean that each station would have been counting about 500 ballots, or about 70 votes per hour. With counting beginning at 10 p.m., concluding seven hours later does not necessarily indicate fraud or anything else. The Iranian presidential election system is designed for simplicity: one race to count in one time zone, and all counting beginning at the same time in all regions, we would expect the numbers to come in a somewhat linear fashion as rural and urban voting patterns would balance each other out — explaining why voting percentages didn’t change much during the night.

It has been pointed out that some of the candidates didn’t even carry their own provinces or districts. We remember that Al Gore didn’t carry Tennessee in 2000. We also remember Ralph Nader, who also didn’t carry his home precinct in part because people didn’t want to spend their vote on someone unlikely to win — an effect probably felt by the two smaller candidates in the Iranian election.

That Mousavi didn’t carry his own province is more interesting. Flynt Leverett and Hillary Mann Leverett writing in Politico make some interesting points on this. As an ethnic Azeri, it was assumed that Mousavi would carry his Azeri-named and -dominated home province. But they also point out that Ahmadinejad also speaks Azeri, and made multiple campaign appearances in the district. They also point out that Khamenei is Azeri. In sum, winning that district was by no means certain for Mousavi, so losing it does not automatically signal fraud. It raised suspicions, but by no means was a smoking gun.

We do not doubt that fraud occurred during Iranian election. For example, 99.4 percent of potential voters voted in Mazandaran province, a mostly secular area home to the shah’s family. Ahmadinejad carried the province by a 2.2 to 1 ratio. That is one heck of a turnout and level of support for a province that lost everything when the mullahs took over 30 years ago. But even if you take all of the suspect cases and added them together, it would not have changed the outcome. The fact is that Ahmadinejad’s vote in 2009 was extremely close to his victory percentage in 2005. And while the Western media portrayed Ahmadinejad’s performance in the presidential debates ahead of the election as dismal, embarrassing and indicative of an imminent electoral defeat, many Iranians who viewed those debates — including some of the most hardcore Mousavi supporters — acknowledge that Ahmadinejad outperformed his opponents by a landslide.

Mousavi persuasively detailed his fraud claims Sunday, and they have yet to be rebutted. But if his claims of the extent of fraud were true, the protests should have spread rapidly by social segment and geography to the millions of people who even the central government asserts voted for him. Certainly, Mousavi supporters believed they would win the election based in part on highly flawed polls, and when they didn’t, they assumed they were robbed and took to the streets.

But critically, the protesters were not joined by any of the millions whose votes the protesters alleged were stolen. In a complete hijacking of the election by some 13 million votes by an extremely unpopular candidate, we would have expected to see the core of Mousavi’s supporters joined by others who had been disenfranchised. On last Monday, Tuesday and Wednesday, when the demonstrations were at their height, the millions of Mousavi voters should have made their appearance. They didn’t. We might assume that the security apparatus intimidated some, but surely more than just the Tehran professional and student classes posses civic courage. While appearing large, the demonstrations actually comprised a small fraction of society.

Tensions Among the Political Elite

All of this not to say there are not tremendous tensions within the Iranian political elite. That no revolution broke out does not mean there isn’t a crisis in the political elite, particularly among the clerics. But that crisis does not cut the way Western common sense would have it. Many of Iran’s religious leaders see Ahmadinejad as hostile to their interests, as threatening their financial prerogatives, and as taking international risks they don’t want to take. Ahmadinejad’s political popularity in fact rests on his populist hostility to what he sees as the corruption of the clerics and their families and his strong stand on Iranian national security issues.

The clerics are divided among themselves, but many wanted to see Ahmadinejad lose to protect their own interests. Khamenei, the supreme leader, faced a difficult choice last Friday. He could demand a major recount or even new elections, or he could validate what happened. Khamenei speaks for a sizable chunk of the ruling elite, but also has had to rule by consensus among both clerical and non-clerical forces. Many powerful clerics like Ali Akbar Hashemi Rafsanjani wanted Khamenei to reverse the election, and we suspect Khamenei wished he could have found a way to do it. But as the defender of the regime, he was afraid to. Mousavi supporters’ demonstrations would have been nothing compared to the firestorm among Ahmadinejad supporters — both voters and the security forces — had their candidate been denied. Khamenei wasn’t going to flirt with disaster, so he endorsed the outcome.

The Western media misunderstood this because they didn’t understand that Ahmadinejad does not speak for the clerics but against them, that many of the clerics were working for his defeat, and that Ahmadinejad has enormous pull in the country’s security apparatus. The reason Western media missed this is because they bought into the concept of the stolen election, therefore failing to see Ahmadinejad’s support and the widespread dissatisfaction with the old clerical elite. The Western media simply didn’t understand that the most traditional and pious segments of Iranian society support Ahmadinejad because he opposes the old ruling elite. Instead, they assumed this was like Prague or Budapest in 1989, with a broad-based uprising in favor of liberalism against an unpopular regime.

Tehran in 2009, however, was a struggle between two main factions, both of which supported the Islamic republic as it was. There were the clerics, who have dominated the regime since 1979 and had grown wealthy in the process. And there was Ahmadinejad, who felt the ruling clerical elite had betrayed the revolution with their personal excesses. And there also was the small faction the BBC and CNN kept focusing on — the demonstrators in the streets who want to dramatically liberalize the Islamic republic. This faction never stood a chance of taking power, whether by election or revolution. The two main factions used the third smaller faction in various ways, however. Ahmadinejad used it to make his case that the clerics who supported them, like Rafsanjani, would risk the revolution and play into the hands of the Americans and British to protect their own wealth. Meanwhile, Rafsanjani argued behind the scenes that the unrest was the tip of the iceberg, and that Ahmadinejad had to be replaced. Khamenei, an astute politician, examined the data and supported Ahmadinejad.

Now, as we saw after Tiananmen Square, we will see a reshuffling among the elite. Those who backed Mousavi will be on the defensive. By contrast, those who supported Ahmadinejad are in a powerful position. There is a massive crisis in the elite, but this crisis has nothing to do with liberalization: It has to do with power and prerogatives among the elite. Having been forced by the election and Khamenei to live with Ahmadinejad, some will make deals while some will fight — but Ahmadinejad is well-positioned to win this battle.

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