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Good Morning: I will briefly dispense with yesterday’s muted market activity before tackling a recent Supreme Court decision that could vastly extend corporate influence in political campaigns. I think we can use the very logic offered in the majority opinion to hoist those five Justices by the own petard.

Compared to the harrowing decline and sizzling rally after the unemployment figures were released on Friday, Monday’s market action was almost boring. With no economic data scheduled for release, and with stock markets overseas mixed (Asia down; Europe up), U.S. stock index futures correctly foretold a mixed opening in New York yesterday. The averages hovered just over and under the unchanged mark until the final hour of trading. Some fresh worries about Greece , courtesy of a rumor that had Deutsche Bank refusing to lend to Greek banks in the Repo market, seemed to weigh on stocks late in the session. The sell off that ensued left the averages with losses ranging from – 0.7% (NASDAQ) to -1.1% (Russell 2000). Bonds were little changed, as was the dollar. Only commodities could buck the dullness, and the CRB index rode the strength of the grain markets to a gain of 1.1% on Monday.

Amendment I
“Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the Government for a redress of grievances.” (First Amendment to the Constitution of the United States)

This space is usually reserved for opinions that try to take the high road when discussing high finance, but today I ask for indulgence as I stroll down the low road of political finance. Let me say from the outset that I am a patriotic defender of our nation’s Constitution, as well as the first ten amendments to it that are more commonly known as “The Bill of Rights”. These documents are simple, elegant, and powerful. And, unlike almost every piece of legislation authored today, copies of them can comfortably fit in one’s pocket or purse. Embracing an enduring form of brevity, our Founding Fathers were green in a way that should make the modern lawmaker envious.

I am an ardent supporter of the rights bestowed by “We the People” to citizens of these United States by the First Amendment to the Constitution. I benefit from its protection every time I use this forum to convey my views and opinions. Because I have so much respect for our Constitution and the Bill of Rights, I am usually sympathetic to judges who hail from the “strict constructionist” wing of jurisprudence. As opposed to those judges who use modern interpretations of the Constitution to enable them to legislate from the bench, a strict constructionist tries to rule based on laws as they are written. Judges of this philosophical bent are usually fonder of precedent than are those who wish to give either older legislation or even the Constitution itself a face lift based on the “spirit” of said law. The make up of our sitting Supreme Court is said to contain more strict constructionists than not.

Corporate Campaign Spending Backed by U.S. High Court

Imagine, then, the shock with which lovers of either free speech or strict constructionism (or both) viewed this recent ruling by the Supreme Court in “Citizens United v. Federal Election Commission”. In a 5-4 decision, the Supreme Court ruled that corporations no longer are bound by decades of precedent that restricted their influence over elections to voluntary contributions made by individuals in said corporation to a Political Action Committee (or PAC). Now, says the Supreme Court, corporations will be able to spend whatever general corporate funds they deem necessary to take to the air waves and target an ad campaign for or against any issue about which they would like to persuade the voting populous. What were the folks on the High Court smoking?

The rationale, if one could call it that, seems to be one which very strictly interprets the First Amendment: “Congress shall make no law…abridging the freedom of speech…” From the majority opinion, penned by Justice Kennedy:

“The government may regulate corporate political speech through disclaimer and disclosure requirements, but it may not suppress that speech altogether,” Kennedy wrote.

Defenders of free speech were dumbstruck by the ruling, but I, for one, will not remain mute. After reading again our Constitution and its Amendments, I have one simple question: How can a corporation be granted the same rights under law that are expressly and only reserved for individual citizens?

The Constitution of the United States
The Bill of Rights

Corporations, though composed of individuals bearing rights, are not citizens. Ergo, their “speech” is not protected. From newspaper stands to members of the S&P 500, corporate entities do not have rights granted them by our Constitution. You don’t have to trust me on this issue; read for yourselves what our Founding Father proscribed for our democratic republic in the core documents that endure more than two centuries after their ratification in 1789. Rights are bestowed upon individuals, first and foremost, and the only entities conveyed any rights or roles in governing those individuals are the following: both houses of Congress (the legislative branch), the President (the executive branch), the Supreme Court (the judicial branch), and State governments. That’s it. Nowhere will you find the word “corporation”, nor will you find a reference to any entity even faintly resembling the eighteenth century equivalent of a Dow 30 constituent.

There are many other reasons why this ruling ranges from the puzzling (i.e. can money be considered speech?) to the dangerous (corporate PACs and lobbies already have undue political influence, so this ruling will only encourage citizens to believe — rightly or wrongly — that corporations “own” the political system). This ruling will be corrosive to the ties that bind us all. Many already suspect — again, rightly or wrongly — that the banks lobbied to have financial regulations stripped away in the decade prior to the financial crisis, only to come running for a taxpayer-funded bailout when the system their campaign donations helped design came apart at the seams in 2008. Giving corporations even more power and political influence will only cause this nascent mistrust to spread.

But rather than fight the corporations (though we, as shareholders, should at least try to stop them from spending our undistributed profits on politics), perhaps our best chance lies in using the strict constructionist argument against the Justices themselves. I hope someone like Charlie Rose can persuade Justice Kennedy or Chief Justice Roberts to be interviewed during their next break. If Mr. Rose can use the Socratic method to ask them about the Constitution, their adherence to strict constructionism, and just where in the document we can read about “corporate political speech”, then the silence that follows will be something to behold. If the Justices want to strictly interpret the Constitution, then they must – by their own logic — agree that only individuals are granted rights under it.

Unless these Justices can be shown the folly of their ways (and it’s an extreme long shot), then the only other avenue for reversing this ruling involves the drawn out process of passing a Constitutional Amendment. Despite the recent bluster you saw during the State of the Union address, don’t count on Congress for help. It would be easier to find a “man bites dog” story than to see our elected officials try to sew shut the pockets that finance their careers. Sadly, it just might be this newly legal form of corporate campaign finance that enables incumbents to survive during the fall elections. So unless voters decide to throw off their apathy and clamor for a Constitutional Amendment, perhaps throwing out the entrenched politicians on both sides of the aisle this autumn will suffice. Without action of some sort, there is a risk that a growing number of Americans will feel disenfranchised by corporate political influence. How such a group will some day seek to “redress their grievances” is anyone’s guess.

– Jack McHugh — on the lighter side of Constitutional matters, please read both the article below and the accompanying passage from our Constitution. I wonder if the Maestro ever received Congressional approval before he was knighted by Queen Elizabeth for his “contribution to global economic stability” in 2002? Not only was his Knighthood for “economic stability” a tad premature, it may have been — to a strict constructionist — unconstitutional.

Knighthood for Fed’s Greenspan

“No Title of Nobility shall be granted by the United States: And no Person holding any Office of Profit or Trust under them, shall, without the Consent of the Congress, accept of any present, Emolument, Office, or Title, of any kind whatever, from any King, Prince, or foreign State.” (Article I, Section 9, Paragraph 8 of the Constitution of the United States)

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).

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Public sector workers in Greece are preparing to strike this week. They oppose the plan to reduce their wages and pensions. These payments are more than half of the Greek budget. Greece’s estimated 2009 deficit was 12.7% of GDP. If the proposed austerity measures are enacted, the proposed 2010 budget deficit will be 8.7% of GDP.

The government of Greece must cut its deficit or the bond market vigilantes will crush the pricing of Greek debt, interest rates will climb much higher, and the country will find its ability to finance its operations significantly impaired. We have some thoughts on how this will play out. But first there is a lesson from Greek history which the unions have ignored.

The famous Greek philosopher and poet, Simonides of Ceos, was engaged by Scopas, a nobleman from Thessaly, to chant a lyric poem in honor of his host. Simonides performed admirably but also included a passage praising the famous twin young Greek gods, Castor and Pollux. After the performance, Scopas offered to pay Simonides only half the agreed sum and told Simonides that he needed to get the other half from the two gods he had praised.

Later during the banquet, Simonides received a message to come outside and meet two young men. When he exited the nobleman’s banquet he found no one waiting for him. Suddenly the roof of the banquet hall collapsed and killed the guests, including Scopas.

The story is famous because Simonides was the only survivor and was subsequently asked to identify the mangled corpses. Since he remembered where folks were seated at the banquet he could state who was whom and coined the phrase “here lies so and so” as he identified the victims’ remains for their relatives. Simonides’ phrase is a probable source of the modern-day epitaph we find on tombstones throughout the English-speaking world.

Thanks for this story goes to my son-in-law, Scott Newstok, whose literary expertise includes the study of epitaphs, as articulated in his new book Quoting Death in Early Modern England. Let me also add thanks to Cicero, who originally recorded the story.

Read the rest of this entry »

While yesterday’s US stock market close was poor, Asia and Europe didn’t follow today as debt in Greece, Spain, Portugal, etc… rallied, their CDS narrowed and stocks bounced. The Greek finance minister said January tax revenues came in above expectations and that spending was below target for the month and said “that means the deficit reduction for January is well within what we have promised.” The euro is rising in turn. Also helping is the story that Trichet is headed to the European Union leaders summit a day early in order to address Greece’s problems even as the Greek finance minister said “the worst possible signal which we could send out is one calling for outside help.” The Jan NFIB small biz optimism index rose to 89.3 from 88 and is at the highest since Sept ‘08 as most components were up. To compare historically though, the 30 yr average is 99.

The equity market correction over the past few weeks due to sovereign credit concerns on top of China policy tightening moves, mixed US economic data and a raised bar of earnings expectations has also gotten around to the credit markets over the past few weeks. Today, the investment grade CDS index is at 105 bps, up 4 from Friday and vs 84 bps two weeks ago. It was last at this level in late Nov in response to the news that Dubai was requesting a standstill agreement on their debt obligations. The KDP high yield index is rising to the highest level (in yield) since early Dec and is up about 60 bps in yield over the past three weeks.

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The Friday afternoon equity rally occurred on hope that the EU might figure out a way to bailout Greece and anticipation of another Manic Monday rally.

No Greece bailout has appeared, only the hollow G7 vow to continue applying whatever stimulus that still exists…Today – Only the hope of a Monday Mania rally remains for bulls. But the Nikkei is down 1%; so in Sunday night trading SPHs are down 0.20. 1050 on the S&P remains a key level.

There is little if anything for governments and central banks to do at this point. So solons are trying to euchre the markets with verbal intervention.

Bailing out PIGS is not the major issue. If the EU does a bailout, it will only be a temporary aid because socialism is collapsing on a global basis due to the enormous, unserviceable debt.

Countries accustomed to the undeserved goodies that socialism promised but delivered on borrowed money do not have the political will to cut the unaffordable spending. So in the near future, the market will force the requisite changes.

At some point the borrowed money train will halt and the goodies will disappear, just like in the USSR.

Reuters: Greece sticks to austerity plan: finance minister Greece will stick to its deficit-cutting plan and the first three months of the year will be crucial for regaining investors and EU confidence, the country’s finance minister said in an interview on Sunday.

http://www.reuters.com/article/idUSTRE6160KH20100207

Reuters: The euro zone’s top finance officials sought on Saturday to ease concerns about a deep budget crisis that has roiled financial markets and raised questions about the future of the single currency group. After a two-day meeting of finance ministers and central bankers from the G7 industrialized nations, European Central Bank President Jean-Claude Trichet said he was confident that Greece, which has been hit by the budget deficit crisis, would meet tough new belt-tightening targets.

http://www.reuters.com/article/idUSTRE6151OG20100206

Reuters: G7 focuses on Europe debt “We talked about Greece, Portugal and Spain and we told our partners we had to solve the problem ourselves without the help of the IMF,” Eurogroup chair Jean-Claude Juncker told Reuters on Saturday, the second day of a meeting of finance leaders from the Group
of Seven rich industrialized nations. Euro zone countries like Greece, Spain and Portugal are under increasing pressure to bring spending under control.

http://www.reuters.com/article/idUSTRE6144XX20100206?loomia_ow=t0:s0:a49:g43:r2:c0.500000:b30291690:z0

The Telegraph: Gordon Brown to attend crisis talks over Greece Gordon Brown will attend crisis talks in Brussels this week as the eurozone faces a crisis over the spiraling debt Greece and other countries have built up. The Prime Minister will preach a “tough love” message for Greece and along
with the other major leaders will urge the country to slash its spending over the next three years.

They will be presented with an agreed plan which will demand that the deficit has to be cut from 13 per cent to 2 per cent by 2013… http://www.telegraph.co.uk/finance/7183524/Gordon-Brown-to-attend-crisis-talks-over-Greece.html

Over the past year we have recounted numerous times that there has been no restructuring of the US economy or Europe for that matter. All that has been done is that sovereigns have absorbed trillions of dollars in private sector debt and crappy paper and issued trillions of dollars of debt to support more
stimuli and crappy paper absorption.

If we have entered a new crisis phase in which sovereign nations have to bailout out other sovereign by issuing more debt, the final crisis stage will occur when the market revolts against the debt of the nations that bailed out other sovereigns. This is checkmate.

The usual suspects trumpeted the better than expected House Survey in the January Employment Report. However, we found an anomaly in the survey that suggests a sloppy book-cooking gambit.

The Household Survey shows an increase of 541k jobs and a gain of 111k in the pool of available workers. This produced the decline to 9.7% in the politically sensitive unemployment rate…Part-time workers increased 252k, which is more than half of the 541k gain. http://www.bls.gov/news.release/empsit.t09.htm

Here’s what makes the Household Survey job gain very suspicious. The entire gain is attributed to one category, ‘Women, 20 years and over’, which increased 529k…’Men, 20+’ declined 1k!

HOUSEHOLD DATA

http://www.bls.gov/news.release/empsit.t01.htm

How is it possible that so many women were hired and men lost 1k jobs?!?! This is highly improbable! Moreover, NSA Women, 20+ only increased 7k. NSA Men, 20+ declined 914k! [Table below]. And the civilian noninstitutional population of ‘Women, 20 years and over’, declined by 36k!

‘Self-employed’ declined 128k; so women weren’t starting businesses. http://www.bls.gov/news.release/empsit.t08.htm

Teenage male jobs (16+) increased 18k. Teenage women jobs declined 5k…“White Women” accounted for 495k of the 529k gain. White men are +31k. http://www.bls.gov/news.release/empsit.t02.htm

The Household Survey increase in jobs is NOT supported by withheld taxes, which show a 7.2% decline for January. Tax data measure real money going into workers’ hands.

From our Wednesday, February 3, 2010 report: The US Treasury reports withheld taxes of $140.381B for Jan 2010; FYTD is $547.710B. For January 2009 withheld taxes are $151.285B; FYTD is $597.593B. Jan 2010 withheld taxes are down 7.2% y/y; FYTD is down 8.35%…January NFP should continue to
show job losses. But it could be crafted to show unrealistic strength like the ridiculous Q4 GDP of 5.7%, or seasonally adjusted employment surveys. http://fms.treas.gov/webservices/show/?ciURL=/dts/10012900.txt

The Household Survey’s highly improbable increase in only female employment suggests faulty methodology (malfeasance), some unqualified adjustment or a clumsy attempt to craft a better employment report for political expediency (fraud). The reasonable conclusion is the Household Survey job gain in January is bogus.

It’s a good time to review what constitutes a ‘job’ in the BLS’s Household Survey. The BLS: Household survey. The sample is selected to reflect the entire
civilian noninstitutional population. Based on responses to a series of questions on work and job search activities, each person 16 years and over in a sample household is classified as employed, unemployed, or not in the labor force.

People are classified as employed if they did any work at all as paid employees during the reference week; worked in their own business, profession, or on their own farm; or worked without pay at least 15 hours in a family business or farm. People are also counted as employed if they were temporarily absent from their jobs because of illness, bad weather, vacation, labor-management disputes, or personal reasons.

http://www.bls.gov/news.release/empsit.tn.htm

Please note the in the Household Survey people are counted as employed even if they received no income or had sustained absences from work. You can imagine what ‘personal reasons’ does to the data.

One last concern about the Household Survey in January Employment Report, from the lips of the BLS: Also, household survey data for January 2010 reflect updated population estimates…The change in population reflected in the new estimates results primarily from adjustments for net international
migration, updated vital statistics and other information, and some methodological changes in the estimation process.

http://www.bls.gov/news.release/empsit.nr0.htm

The BLS claims that the ‘population control’ adjustment reduced the Household Survey by 243k. This means that without the new adjustment 784k jobs would’ve appeared. If 529k job growth is dubious by tax data, January job growth of 784k would be side-splitting.

But if you take the BLS at its word on the new ‘population control’ adjustment, which is due to new Census Bureau data, then Household job growth is substantial small in previous months.

The BLS admits that December 2009 Household jobs have to be lowered by 243k…Ya think the BLS is doing this to confuse or frustrate people?

Carl Bialik in a WSJ blog gives another reason to question the Household Survey: My print column this week examines a quirk in U.S. Census Bureau data that may have led to research errors. A National Bureau of Economic Research working paper this week demonstrated that so-called microdata — a
subset of all Census responses, released to researchers who want to dig deeper into demographic trends — for several surveys contained flaws…

But other polling researchers expressed concern. “In at least some cases, the conclusions that have been drawn from the surveys that were incorrectly adjusted will have been wrong,” said Paul Lavrakas, a survey consultant and former chief research methodologist for Nielsen Media Research. “Thus, it is critical for surveys researchers that the U.S. Census Bureau generate and release data that is beyond reproach.”

Several researchers saw the revelations as a reminder that all survey data are flawed in one way or another, representing as they do an imperfect window into shifting public opinion and behavior. “All demographic and economic data are error-ridden,” said Gary V. Engelhardt, an economist at Syracuse
University. “… You can’t get around that, and that shouldn’t be surprising. And anyone who has thought an ounce about how the data they are using are collected shouldn’t be surprised that sometimes those
errors are large.”… http://blogs.wsj.com/numbersguy/census-bureaus-balancing-act-891/

SPX Fibonacci Fan levels

Chart courtesy of Fusion Analytics

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As seen above the S&P 500 Index tested and reversed off its lowest fibonacci fan trend line (orange lines) on Friday. This intraday reversal level of 1,044 came was starting to approach the support level of 1,037 we had called for several days ago and the reiterated on Thursday. However for the last two weeks it has rallied above but then fallen back below its downtrend line (red line).

While two weeks of stalling at resistance is not a major concern yet it does at very minimum raise a cautionary tone given the S&P 500 has had such a large, uninterrupted advance. Weekly momentum indicators are losing momentum and are close to flashing some sell signals, however until near term support is broken near 1,026 (blue line and arrows) it is hard to get too negative.

So to reiterate some yellow lights are flashing but the bottom line is the trend is up and remains intact and only a move below the 1,026 level would be viewed as a negative.

-Kevin Lane

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Kevin Lane is one of the founding partners of Fusion Analytics, and is the firm’s director of Quantitative Research. He is the main architect for developing their proprietary stock selection models and trading algorithms. Prior to joining Fusion Analytics, Mr. Lane enjoyed success as the Chief Market Strategist for several sell side institutional brokerage firms. In those capacities he oversaw the firms’ research departments. He produced a broad range of widely followed institutional research publications ranging from industry specific notes to quantitative/fundamental reports on individual stocks. His buy side clientele consisted of many of the nations top money managers and hedge fund managers. Mr. Lane is a member of the Market Technicians Association.

Not that anyone should have but if they did look to the G7 meeting for more clarity on the outlook for Greece and the possibility of a spread to other highly indebted countries and what the response would be, they didn’t get much. With respect to Greece, the French Finance Minister said “the European members of the G7 will make sure it is managed,” whatever that means. European debt and CDS in the PIIGS are wider and is weighing on their stock markets with Greece especially down 3+%. In terms of global stimulus and the exit, the Canadian Finance Minister summed up the goal but also the dilemma by saying “we need to continue to deliver the stimulus to which we are mutually committed and begin looking at exit strategies to move to a more sustainable fiscal track.” The WSJ reports Bernanke will lay out his strategy on exit. Unfortunately, the exit to their grand experiment has no precedent on such scale.

February 5, 2010
By John Mauldin

Unemployment Numbers: A Mixed Bag
A Bubble in Search of a Pin
And Speaking of Bubbles
Help in Europe, California, and Tampa, and Becoming our Parents

Should Greenspan and Bernanke have seen the bubble in housing and other assets and acted, or should we accept their defense that you can’t know whether there is a bubble until after the fact? We will look at research that suggests they should have known, and, at the least, policy makers should no longer be allowed to say, “How could I have known?”

Of course, the employment numbers came out this morning, and the results are mixed; but that is better than they have been for the past two years. We dig into the numbers to see what they are really saying. And finally, we examine why the markets are so volatile. Is it just Greece, or is there more? There’s a lot of very interesting, and important, material to cover.

But first, and quickly, as I wrote in Outside the Box a few weeks ago, I am starting to very selectively buy biotech stocks, and mostly, though not exclusively, companies associated with the regenerative genetic revolution that is coming our way. I am convinced that this is going to be a decade of the most amazing medical breakthroughs, which will literally change (and in many cases extend) our lives, as therapies to treat all sorts of diseases become available.

This is the last time I am going to mention it, but here is the link to that OTB, which analyzes why we may see a bubble in biotech stocks before the end of the decade. The OTB was written by my friend Pat Cox, who covers these stocks and other technological marvels in his newsletter, Breakthrough Technology Alert. I have been following Pat for some time now, have talked extensively with him, and think he is one of those guys who have a handle on what by all accounts is going to be an amazing decade of breakthroughs.

I have asked his publisher to offer my readers a very discounted subscription price for one more week. (Ignore the deadline of February 5.) And yes, the promotional piece is a little over the top, as it is for most subscription newsletters (I am lucky mine is free – I don’t have to do that). But I think his letter has a lot of substance. The link to the site is in the Outside the Box. Don’t procrastinate. Join me, because for once in my life, dear God, I want to be in at the beginning of a bubble. And now to our letter.

Unemployment Numbers: A Mixed Bag

January employment numbers are characteristically volatile, as the birth/death ratio numbers are typically the largest of the year. This month the birth/death model subtracted (rather than added) 427,000 jobs (yes, I wrote that correctly). This is a very large “adjustment” month, and the volatility gets smoothed over in the seasonal adjustments. It is part and parcel of the process, as making estimates about how many new businesses are formed or die is extraordinarily difficult at turning points in the economy.

As an acknowledgment of that, the employment level for March 2009 was revised down by 930,000 jobs, and by December it was a total of almost 1.4 million extra jobs lost. That means that the Bureau of Labor Statistics overestimated the number of new jobs significantly. December’s job loss was really 150,000, not the 85,000 originally reported. How would the markets have reacted to a number that large?

January saw a slightly larger than estimated loss of 22,000 jobs, which would have been 53,000 without new federal employees, 9,000 of whom were hired to perform the census. (By the way, federal employment is absolutely exploding!)

Now, the somewhat good news. I have been writing about how the household survey has been much weaker for almost two years than the establishment survey. For instance, the total number of unemployed rose by 589,000 in December, while the number of people not classified as looking for work rose by 843,000. No matter how you spin it, those were very ugly numbers.

This month the household survey showed the largest one-month turnaround that I could find. As The Liscio Report noted:

“Adjusting for the changes in the population controls, total household employment rose by 784,000 – and when further adjusted to match the payroll concept, employment was up 841,000. Moves of this magnitude (regardless of sign) are unusual, but not unknown – and frequently undone in subsequent months. The less volatile ratios were also up, with the participation rate up 0.1 point, and the employment/population ratio rose a nice 0.2 point, its first increase since last April. While it’s too early to say whether this strength in the household survey is a harbinger of an upturn that will soon show up in payrolls, it’s something to be filed under ‘tentatively encouraging.’”

The work-week hours rose slightly. Income growth was better than it has been. Temporary workers rose, which is typically a harbinger of an increase in full-time employment. The number of people working part-time for economic reasons plummeted by 849,000.

And finally, the unemployment rate fell 0.3% to 9.7%. This of course means that more people are dropping out of the labor pool, and it also means they will at some point come back.

On the negative side, a loss of 22,000 jobs is nowhere close to the 100,000 new jobs that are needed just to hold unemployment steady. 41% of those unemployed have been so for over 6 months.

And quoting David Rosenberg:

“While there will be many economists touting today’s report as some inflection point, and it could well be argued that we are entering some sort of healing phase in the jobs market just by mere virtue of inertia, the reality is that the level of employment today, at 129.5 million, is the exact same level it was in 1999. And, during this 11-year span of Japanese-like labour market stagnation, the working-age population has risen 29 million. Contemplate that for a moment; fully 29 million people competing for the same number of jobs that existed more than a decade ago. That sounds like pretty deflationary stuff from our standpoint.

“Not only that, but consideration must be taken that in 2009, we had a zero policy rate, a $2.2 trillion Fed balance sheet and an epic 10% deficit-to-GDP ratio. You could not have asked for more government stimulus. Yet employment tumbled nearly 5 million in 2009.”

Finally, a very sad chart, courtesy of David. Those in the 25-54 year-old male category have seen their total number of jobs fall back to the level it was in 1996. Fourteen years later, and the “breadwinners” who are supposedly in their prime have seen an almost 10% drop in employment.

As noted above, January employment numbers are very volatile, and are likely to be adjusted either up or down by a lot in coming months. But this report was not the disaster of December. It still shows a very weak economy that certainly does not need a large tax hike next year. I hope we start seeing some positive numbers soon, but I am not optimistic that we are going to see the 200,000-plus new jobs per month we need to really start denting the unemployment numbers, for some time. Not when the National Federation of Independent Business says 71% of small businesses do not plan to hire this year.

The Fed is taking away quantitative easing. Stimulus spending is exiting in the last half of the year. States and communities are having to either raise taxes or cut spending by $350 billion! I heard on the radio coming back from the gym (I think it was my friend Steve Liesman on CNBC) that there are now 55,000 fewer teachers than a few years ago.

And again from the NFIB, small businesses see very tight credit conditions, which makes it hard for them to expand (see chart below). The headlines this week from the Fed banking survey said that banks were prone to be less tight, but the NFIB writers went deep into the report. What they found is that very large banks are willing to be less tight in their lending standards. Smaller banks were in fact not as easy. Loan demand is falling. Consumer credit actually declined slightly in December, after plunging in November. If you can’t count on Americans to buy during Christmas, the world is in fact moving to the New Frugal.

All this is not the stuff that robust recoveries are made of. We drift back into Muddle Through the last half of the year, I think. And if Congress does not act to postpone or mitigate the enormous tax increases due in 2011, we slip back into recession. It will be a policy error of major magnitude to raise taxes with 10% unemployment and a weak economy.

A Bubble in Search of a Pin

We are going to once again return to the book highlighted the last few weeks, This Time Is Different, by Carmen M. Reinhart and Kenneth Rogoff. This is a book you should buy and read, especially the last 4-5 chapters, and try to get your Congressman to read it as well, so he or she can see what happens to countries that run up their debt. It makes no difference if it is small or large, the end result is the same.

Last week we looked at the role of confidence in allowing governments to borrow money. This week we ask whether Greenspan and Bernanke, along with the entire Fed, should have been able to determine whether a bubble was building in the US economy and lean against it, preventing the debacle we are now in. Reinhart and Rogoff gently come down on the side of those who think they should have, and that we need to implement changes in our institutions. Others, as we will see, are not so gentle. Let’s look at a few selected paragraphs I pulled off my Kindle (all emphasis mine).
Read the rest of this entry »

For the week ended Tuesday, the CFTC said the net spec short position in the Euro reached a record high dating back to its introduction in 1999.

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As noted in the January letter, a close below 1,080 in the S&P would be negative, and it did yesterday, closing at 1073.87. Before getting into the ‘technical’ aspects, let’s look at what has driven the decline since the S&P made a new recovery high on January 19.

In the December letter, I wrote, “My guess is that the U.S. economy will hit a soft patch by mid-year, for all the reasons cited above. However, the biggest surprises are likely to come from overseas.” On January 20, the China Banking Regulatory Commission announced that it expected banks to reduce their 2009 lending of $1.1 trillion by 22% in 2010. As discussed in the December letter, “One of the most widely accepted investment themes is that China will continue to grow far faster than every other country in the world for decades to come. While this is likely to be true, that doesn’t mean there won’t be a few speed bumps along the way. China, with $4 trillion in GDP, represents less than 10% of world GDP and derives 35% of its GDP from exports. After being prodded by the government, Chinese banks have increased lending by more than $1 trillion in 2009, or by more than 25% of GDP. In addition, the Chinese government launched a $585 billion economic stimulus package. Most of the stimulus and lending went into fueling a surge in their stock market, and commodities, property and land prices. Through October, the total floor space of housing sold rose 50% above year earlier levels. Some developers have warned that land prices in some cities have already risen so far that it will be hard to make money on future developments, without large price increases.” The January 20 announcement represents the first step of pulling back on the extraordinary stimulus China unleashed in 2009. I think their intent is not to step on the brakes, but to tap the brakes periodically to gradually slow credit growth and real estate speculation. In coming months, there will be more small increases in interest rates and reserve requirements.

Since Chinese demand has been perceived as the little engine that could ignite a global recovery and the primary driver behind the run up in commodity prices, this announcement started a selling wave in resource based stocks, and stock markets around the world. In the U.S., investors were given more reasons to sell, when President Obama unveiled his plan to overhaul the banking system, doubts on Chairman Bernanke’s reconfirmation surfaced, and some suggestions within President Obama’s State of the Union speech that weren’t entirely well received. However, there are rumblings from overseas that are more important.

On January 26, S&P changed its assessment of Japan’s debt rating from stable to negative, and warned it might lower its sovereign debt grating from AA. The real story is what is happening in Greece and how it may affect banks within the European Union. I also discussed this potential in the December letter. “Banks in Europe employed leverage of 40 to 1, versus the merely ridiculous 30 to 1 leverage of their U.S. counterparts. European banks have also been slower to acknowledge losses. As we all know, major banks in the U.S. were brought to their knees by sub-prime mortgage loans and the overall decline in home prices. Most of the European banks were affected by the same malady. Where they differ is their large loan exposure to Eastern Europe, Russia, Dubai, and Greece. This exposure is their version of sub-prime lending, and it has the potential to be as unsettling.” Over the last few weeks, the developments in Greece have certainly been unsettling, as concern over Greece’s ability to deal with its 12.7% budget deficit have caused Greek bond yields to soar. As I noted in the December letter, the Greek situation poses a thorny problem for the European Union and the banks within Europe. “On December 19, Ewald Nowotny, who is an ECB governing council member and head of the Austrian central bank, said the ECB would not bail out debt-stricken member states, such as Greece, which must repair its public finances on its own. Greece will have a fiscal deficit of 12.7% of its GDP in 2009, far above the European Union mandated ceiling of 3%. If push comes to shove, it will be interesting if the ECB allows one of the countries in the EU to default. If we have learned any lesson in the last two years it is that in a global economy any misstep is very quickly spread throughout the global financial system.”

As we can see, Greece is far from alone in exceeding the 3% deficit of GDP speed limit of countries in the European Union. The U.K is not in the EU, but their budgetary problems led S&P to place their sovereign debt on warning in May 2009. If the EU makes an exception for Greece, what will they do for the other countries that have the same problem? Although Greece represents less than 3% of total EU GDP, does letting them collapse risk another domino style credit crisis that could quickly spread to European banks and beyond? This could be the canary in the coal mine.

As discussed in recent months, there are many secular and cyclical reasons why a smooth transition form a statistically driven rebound in GDP to a self sustaining recovery in the economy is unlikely. And that is assuming, another phase of the financial crisis does not emerge. As I reviewed in the October letter, “The next potential challenge within the current period of instability will develop in the next six to nine months, as the U.S. economy will: A) smoothly transition into a self sustaining economic expansion, B) experience a modest dip, with GDP growth sagging to around 1% to 1.5% before reaccelerating, C) experience a more pronounced dip lasting up to two quarters with one quarter of GDP near 0% before rebounding, D) perform a flawless one and one-half gainer after the V-shape recovery stalls and go to hell in a hand basket. The correct answer to this question is important since the financial markets will obviously respond accordingly. Experts suggest that when confronted with a multiple choice question, and a distinct lack of certainty, go with C. If for no other reason, correct does begin with C. However, since forecasting and investing involves a high degree of probability, I would assign the following odds: A 5%, B 30%, C 45%, D 20%.” The problems in Greece and the issues they raise, and the fact that China will take additional steps to curb their 2009 lending binge, do not lower the probabilities of choice D.

Since last summer, I have continually noted the lack of selling by large institutional money managers as being the back bone of the stock market’s rally, since these managers believe a sustainable recovery is on the way. It doesn’t take much buying pressure to boost the stock market if there is very little selling pressure to overcome. In the last 8 days, there have been a number of reasons to sell, and they have, and in the process pushed the S&P below 1,080. This is clearly a short term negative. However, the more important level for the intermediate and long term is 1,030. Since the March 2009 bottom, the S&P has marched progressively higher with each ‘technically oversold’ low (July, November) being higher than the previous low. Based on a number of momentum indicators, the market has reached an oversold level, comparable to readings at the July and November lows. Any additional weakness will get the market even more oversold, and stretched, laying the foundation for a rally. The odds favor the S&P bottoming above 1,030, and sometime in the coming week. It is interesting that the three prior lows have been on September 2, October 2, and November 2. Closing below 1,080 should bring in more selling on Monday, which could set Tuesday, February 2 for a reversal day.

There are a lot of important data points being released next week, not least of which, is the jobs report for January next Friday. Recent events have shifted the focus away from the recovery story, and a batch of decent numbers next week could refocus large institutional investors on the earnings rebound they have been expecting. No matter what, the quality of the next rally is very important. Although the chances of a move above 1,150 have diminished as the result of this pullback, they have not been eliminated. Two pieces will have to fall into place for new highs. The overseas issues will have to settle down. China is not likely to make additional tightening steps in coming weeks, and the problems with Greece and the EU will also have to recede. And the economic data points in the U.S. must continue to support the recovery story. If so, large institutions will shift back to the buy side, after it becomes apparent the correction has run its course. A self sustaining recovery is far from a sure thing, but that doesn’t mean the illusion of one can’t be sustained for another 2 or 3 months.

If the S&P does close below 1,030, investors should sell into any ensuing rally. If the S&P bottoms above 1,030 and reverses higher, that new higher low will be important. Even if the top is in, and it might be, the next rally should retrace 33% to 50% of the decline from 1,150. A close above 1,105 will be good.

Jim Welsh