Market Update

Market Commentary:

The bad news today is that the unemployment number came in at 10.2%, the highest unemployment number officially released since early 1983 and significantly higher than expectations of 9.9%.

This headline number will continue to weigh on the market for a few days as the man in the street will hear it discussed on virtually every news channel over the weekend, suggesting that consumer sentiment will drop going forward. Expect to see a disappointing Michigan Consumer Sentiment number next week.

The good news was that the markets did not tank on this shocking jobs report. In fact, the lows of the day were set fairly early and after chopping around the unchanged mark for most of the day, some late day buying pushed most indexes into the black, though minor. Of the major indexes only the small caps finished in the red, and fairly minor at that. I guess we could say it was a “minors” day.

So what does this all mean?

Beyond the impact of the total unemployment percent was the monthly jobs number, coming in at a respectable -190,000 from -219,000 for the previous month. Job losses are getting smaller and smaller each month. At least it is going in the right direction.

There was other good news in this jobs report. Temporary employment increased by 34,000 jobs, the average work week held steady at 33 hours and the hourly earnings increased 0.3% versus 0.1% the previous month. These are all indications that companies have cut labor about as far as they can and are now using temporary services and increasing payroll earnings to meet their labor demands.

As these details are digested in the coming days, the shock of this number will likely wear off and the market should continue to advance – for a while. The daily indicators suggest that there is a little more upside before the markets reach short-term oversold conditions.

The longer term negative implication for today’s number is that the Fed has been put into an even tighter bind, perhaps exactly where they want to be. With total unemployment at these dizzying heights, the Fed will be hard pressed to show any evidence of support for a falling dollar by raising interest rates.

In fact, when you look at “real” unemployment, including those who have dropped off the unemployment benefits yet still cannot find jobs even though they are willing to work, the figure goes up to an official 17.5% with many analysts suggesting it could be in excess of 20% for actual unemployment.

Lost in the headlines of 10% unemployment was an important vote taken late yesterday on a bill to extend unemployment benefits by 14 weeks. We will probably hear the administration tout this over the next few days as the bill makes its way to Obama’s desk for signing.

Tacked on to this bill were provisions for extending the $8,000 first-time homebuyer credit with a twist allowing a $6,500 credit for refinancing of homes where the owner has lived in the home for at least five years. I told you they would keep us sucking on the bottle as things appear to worsen. Will this bring even more future demand forward, pushing out the inevitable day when no more incentives exist to encourage additional spending? I expect more gravy like this before the year ends.

Let’s return to the impact of today’s jobs report on the dollar and the bind the Fed has worked into. Perhaps the Fed is pleased to be in this condition of having their hands tied to keeping interest rates near zero, the thinking being that as the dollar is continuously devalued effective labor rates in the US compared to overseas will cause jobs to return to US shores.

There are all kinds of problems with this kind of thinking. Remember what happened when interest rates were kept artificially low in the 2003-2007 period? It fed the horrible real estate and securitized mortgage bubbles, which inevitably led to the 2007-2009 bear market as credit collapsed amid banking exposure to highly leveraged mortgage securities for properties that were collapsing in value.

Do you think that a return to extended periods of low interest rates (which will further collapse the dollar) will do anything more than create another investment bubble somewhere else?

It is folly to fall into the simplistic trap of thinking that we can create a large new labor market by collapsing the dollar. Today’s investors want a real return on their money, with little consideration on whether that investment creates jobs or not.

Where do you think capital is going to move if the dollar continues to drastically decline in value? Do you really think that investors are going to plunk down money to invest in plants and equipment when their dollar investment is going to lose great value, simply based on the currency exchange rate? That dollar can go other places, you know.

Do you really think that large financial institutions are going to be motivated to borrow money at near zero percent and then loan it out for buildings and equipment at anywhere near reasonable rates when they can take those dollars and simply place them in other investments where they can make a greater return?

Banks have made so much money by borrowing at zero interest and then leveraging it in the stock market and similar investments that there is little to no incentive for them to go back to their original charter of being a lender. They are in the business of making money and they can make more if they invest it in the next bubble (rising stocks and securities) rather than risk that money on a mortgage for a piece of risky valued property and/or equipment.

In reality, a continual decline in the dollar just makes it more expensive for the American consumer to get by. Much of what we purchase in the US is manufactured outside of our country. As the dollar is devalued, these things will become more expensive – hence, inflation … perhaps terrible inflation.

While the intent may be to create a disincentive for consumers to purchase imported goods and motivate them to purchase US manufactured goods so that more jobs can be created to produce US manufactured goods, it is just not that simple.

Capital will flee the US on a permanently devalued dollar, removing the very thing needed to create US manufacturing capacity. Thus, jobs will suffer rather than increase because of the persistent belief that a lower dollar benefits jobs, exports, and contributes to an affinity for US produced goods. It won’t happen.

The Fed’s persistence in driving the dollar lower on the supposed belief that it is good for the US economy will do nothing than what it has done in the past. It will create another bubble that the quick and informed financial wizards can profit from – to the demise of our economy and the purchasing power of the average US citizen.

But isn’t this what the Fed is all about?

Even the most uninformed among us can surely see that this action is benefiting the banks the most, with very little of our government bailout/stimulus going to the benefit of the consumer, either by way of jobs or tax benefits.

The message you hear is that a near zero interest rate benefits the consumer by keeping lending rates low. In actuality, a near zero interest rate closes down the lending machine and diverts the needed capital into a bubble opportunity for the speculative financial captains of our US economy.

It’s all about them, not about you.

Check it out here:

While there is still evidence from a technical basis that the short-term cycle has potential for further advance, the risk of a bearish pattern setting up for the longer term remains. Check out the potential development of the current bearish head and shoulders pattern:

As you can see, the market needs to advance a lot to best the October highs. While this remains a possibility, there is a clear risk that this rally could fall short and develop a lower high with the next decline testing the neckline of this pattern (the black dashed line).

Should the neckline be violated on a coming decline (after this advance finishes up) then the traditional expectation is that a stronger intermediate term correction could develop, taking prices generally 40-60% down from the highs seen in October.

We continue to watch and maintain a cautiously bullish bias, acknowledging the risk that a larger correction may be underway as well.