The world is in a very tough spot right now and the word of the day is social unrest. On top of the news from the Middle East we got some, in my opinion, pretty bad jobs numbers on Friday. Of course if it was a good report it is because of the ‘economic recovery’ and when the report is bad it is because of snow, rain, wind, Earth or whatever else they want to say instead of the truth, the economy stinks.

There was not one good piece in the jobs report, not one. Sure, an unemployment rate of 9% was the headline given to us, but doesn’t this strike you as being odd since the BLS just added in some 300K under reported job losses from last year? On top of that we had, unadjusted, horrible initial claims reports for January and even the adjusted reports stunk. Even though the economy did add jobs governments are laying people off which is a problem as this will likely continue on into the future. Overall, there is still some 5 people for every open job right now, think about that and then think about how long it will take for unemployment to actually come down, especially with new workers coming into the work force through population growth.

We are not going anywhere in the near future and for proof of this look at Bernanke’s speech the other day when he basically guaranteed QE3. As an aside, I love how he said QE2 worked because asset prices, stocks, and bond yields were going up. Umm, wasn’t QE2 supposed to create negative real interest rates? And since when do we use the stock market as a barometer for economic growth? In fact, QE2 did work if you thought it would benefit stocks, but it has failed miserably for the other areas it was supposed to help, i.e. jobs, economic growth and negative real interest rates.

However, QE2 did have a successful side effect that only a few people have realized, it has overthrown a couple of governments and probably will topple a few more in short order. Remember how I said you can get inflation without money velocity? It is kind of happening and just imagine what will happen when banks actually lend again. Now, Ben says food prices are from emerging market demand which is true, but it is also because of bad harvests, which will continue, and the fact that commodities are valued in USD’s which have been sliding down in recent weeks.

This means food prices have risen for the poorest countries in the world to levels that are just unsustainable. When food prices rise in America we can weather the storm for a while, but in some countries food at lower prices consume 50%+ of the average families budget so they do not have the luxury of riding out the storm or cutting back they simply go without. They can only do this for a little while before something gives and we have witnessed what happens when that something gives way. I also believe we have only seen the beginning of the problem as no one has figured out that this year’s wheat harvest is likely to be very, very, bad and we will see much higher prices in a few months. The weather is whacky and I have a strong suspicion that the Midwest will not produce what we are used too this year. If that happens things could get very interesting and perhaps, just maybe, we will stop paying farmers to grow food in order to turn it into fuel, use sugar instead which we pay farmers to not grow… get the picture yet?

Things are getting interesting and I am trying to stick around to see how it all ends. In the meantime I believe that one must be long commodities, silver and softies for sure, and stocks until QE is over, which is likely to be never. I say that with a caveat as I believe if QE3 does happen stocks might get very choppy and at some point people will figure out that ZIRP + interest on excess reserves + QE = Really Bad News and is bad monetary policy. Then again, only a few have figured it out so far so maybe I am too optimistic.

Here we are in a New Year and as is tradition we see countless forecasts for what will transpire this year. My personal feeling is that they are all worthless since no one knows what the Fed is going to do and there is no denying that the Fed and the Fed alone has total control over the markets. Without the Fed we would not have seen positive returns in 2010, IMHO, and we only got those returns because the central bank flooded the market with extraordinary liquidity, again. The irony is that everyone knows something isn’t quite right, but they seemingly cannot put their finger on what is not normal.

As the weekly headlines come and go they are almost humorous now and completely contradict previous headlines. It is this that is contributing to that unsettling feeling most people have but cannot identify right now. Any given day you read about the recovery, often from a heavily seasonally adjusted figure, which signals a recovery in the economy, even though the unseasonal adjusted figure shows the data is not so hot, and everyone is bullish again. The next week we get a data point that is horrible and the world is coming to an end. Perhaps this is what many economists mean when they say this is a ‘muddle through economy.’ Regardless, things are better there is little question about that, but I would say we have stabilized ourselves in a less bad environment versus a real economic recovery.

I had previously said stocks would move higher and they did, but that is only because of the liquidity the Fed bestowed upon us and not because of truly better data points. We have seen unprecedented stimulus over the past 3 years from the federal government and the Federal Reserve which explains pretty much any positive data point. When you examine the real economy, i.e. Walmart, it is a different story. Frankly, when Walmart which has the largest customer base in the US is struggling when so many are preaching the resilient consumer something isn’t right. I know the high end retailers are doing OK and that proves my point which I made about a year ago that the recovery, thanks to the bailouts, and I use that term loosely, was lopsided to only the wealthy and not to Joe Six Pack.

This is also reflected in the unemployment figures and pretty much anywhere else you want to look. The rich are doing just fine thank you very much, but if you are in the middle class or poor the SNAP program is this way. While this is not fair it simply is what it is and is not going to change anytime soon, sorry. Perhaps that is what scares me the most right now, the inequality of wealth in America, don’t get me wrong I am a capitalist through and through, but it doesn’t take a rocket scientist to read history and what happens when the wealth gap gets this wide. On top of the middle class and poor becoming poorer we are now seeing what I thought was going to happen, inflation without an increase in money velocity.

Those who thought it was impossible for a country to experience inflation without money being in the hands of the people, well, you were wrong. When the central bank plays games, untested games, like QE it hurts the currency which drives up currency sensitive items, food and energy. When prices rise and wages stay the same it will more than likely exacerbate the underlying problems we are suffering from and may lead to civil unrest. We have food prices at the highest level ever and oil about to burst through $100/barrel, where is the outrage from the media on this, and people already feel poor, not a good combination. Again, all of that without an increase in money velocity, go figure.

Now, there are other reasons for the rise in commodities, but they are irrelevant in my opinion since Joe Blow could care less about why prices are rising he just cares about being able to feed his family. What is frustrating to Joe is that he is being told how great things are when he feels poor, is probably going to lose his house, can barely afford food, gas or his power bill. Joe is wondering what planet the commentators on CNBC are from when it is plain as day that things are not right in the real world. What Joe doesn’t understand is that the ivory tower announcers and the Fed are looking at the core CPI which says everything is hunky dory. The question is, do you think Joe cares that deflation is occurring in LED TV’s as much as Ben Bernanke does? Of course not because Joe looks at food and energy, but all economists look at is core CPI which excludes food and energy. That is where the disconnect is coming from, partly.

The public is slowly starting to not believe what they are being told anymore and that is a good thing. Remember how we were told that retail sales were going to be fantastic? They did not look so hot today, except for some high end retailers I might add. What I am getting at is simple, the real economy is catching up with the market. The really sick part is that when the economy does improve the Fed will have to kill the liquidity which will crush stocks. Those that preach stocks are a win-win because the Fed will pump money when the data is bad which is good for stocks or when the economy improves stocks should go higher are wrong, pure and simple.

This is the largest liquidity driven rally in the history of mankind or what TVland would call a bubble. Stocks are expensive and only going higher because of the Fed. However, when the Fed stops feeding free money to the banks it will end, badly. You can disagree with me all you want, that is what makes a market, but you know it is true. This is not a win-win situation for stocks. How can it be when just 6 months ago when liquidity was drying up the market tanked? We only saw a rebound when Ben spoke at Jackson Hole and said he would print and then he followed through, that is not the sign of a healthy market.

What we have is still a whole lot of uncertainty going on in the whole world. Nothing is certain except that central banks will merely print us into oblivion. Europe is a mess, we have some countries wishing to slow down fund flows to them, Korea’s on the brink of war, again, China is not buying UST’s like they once did, the US is awash in debt, which will not be solved by the Republicans, rising prices for food and oil about to go ballistic again. All that stuff is off the top of my head and I know I left a ton of stuff out, but this is enough, hopefully, to make one stop and think.

I said before that stocks will move higher and I continue that thought until one of two things happen, either the data really does improve or until QE2 ends in 2Q11. Both items are basically indications that the punch bowl or liquidity will dry up. I also believe stocks will underperform commodities, specifically silver and copper, in 2011 simply because the Fed will never stop the printing presses, they cannot. We are in a very odd period of time and, frankly, these are scary times with so many unknowns out there and a public slowly waking up to the fact that things are not as they seem, but that is a good thing, IMHO.

2011 will be a rollercoaster year with the schizophrenia kicking into high gear as far as the media is concerned, the world will be growing or coming to an end every other day, which should add more volatility to stocks. I also think we will see some things come to the forefront of discussion this year. How it ends is anyone’s guess and I will not even venture agues at the results. What I do know is that it probably will not be good. Here are my issues I think will be front page news this year:

-          Food prices continue to rise to scary levels

-          Treasuries begin to see a steep selloff

-          The US’s national debt will be a hot issue with China downgrading us, rightfully so, to junk level

-          The US is put on negative ratings watch by Fitch, but who cares about Fitch… right?

-          The tax cut extensions will prove to be a horrible idea, they really were to begin with

-          The Social Security tax break everyone gets moves up the date of depletion of the trust fund to, “officially,” the 2020 decade

-          Oil breaks through $100 probably eclipsing 2008 record price

-          The dollar will rally hard before it falls

-          Food shortages around the world will be a major problem

-          The Fed looses massive amounts of money on their treasury holdings

-          China openly sells US treasuries

I have previously laid out my thoughts as to what will eventually happen with the whole inflation-deflation debate, but the issue is still raging full speed ahead. It is interesting that it is hard to find 2 experts that actually agree on what will happen or is happening, deflation or inflation. I think it is obvious that we have disinflationary forces here as producers cannot pass along higher prices or they will lose business. In fact, only food, a basic necessity, has any real pricing power right now.

While I am comfortable claiming we have disinflation right now I do not think it will last for a very long period of time. I believe we will see more easing by the Fed via asset purchases, but that will not create immediate inflation. However, over a longer period of time we will see that inflation pick up and not because of money velocity, but because of straight out dollar devaluation. Let me explain.

We did not experience inflation in the 1930’s because no one spent large sums of money on a regular basis. People actually were starving even as food prices declined, sad really. The thing is that since we were on the gold standard, or a form thereof, it was impossible to have true inflation even though FDR was spending like a madman. The Fed was also not in the practice of buying assets because, well, they followed the rules. Because of the gold standard and there were no asset purchases, government bonds or otherwise, inflation remained tame, deflationary in fact. This is a very 30,000 foot view of the situation, but I think you get the gist of what I am saying.

Now we do not have the gold standard, I am not preaching for a gold standard either, just pointing out the obvious, and we have a completely fiat money supply. The Fed has used its “emergency powers” to do what it would not do in the 1930’s, buy assets. It is clear that the asset purchases are doing nothing for the economy other than keeping rates low on loans, which no one wants or are really willing to make unless you have a perfect credit score. It is not even kicking up much inflation, at all, which is because there is simply zero money velocity. Since there is no money velocity the typical economist will say that inflation is impossible and it can never happen, never say never.

What the heads buried in the sand do not realize, because they are using the Depression as their road map (they always do this at the wrong time I might add), is that the dollar is floating now with nothing backing it. That in itself is not bad, as a matter of general opinion, as long as the printing press is used sparingly and every country prints money at relatively the same pace. The problem is that now, after the crisis supposedly ended, countries are printing money at a slower pace or they stopped printing altogether. Many are certainly not doing asset purchases.

Forgetting the fact that QE will do nothing to ease the pain of the economy being bad, sorry, but it will do nothing whatsoever, what it will do is wreak havoc on the dollar. Since the currency is floating more printing and asset purchases will diminish the value of the currency. This has been Ben’s and Obama’s plan all along since Obama wanted to double exports within 5 years, something that can never be accomplished. We are seeing the impact of what more printing will do to the dollar now, unless you think 1.5 cent moves in the Euro/USD pair is normal, as investors move to a currency that is somewhat more sound, not that the Euro is sound, but perception is half the game.

The citizens, us, will not feel the devaluation right off the bat because we consume 87% of what we produce domestically. However, imported products will cost more and we do import a lot of goods, obviously. As domestic supplies are sucked up by foreign countries, as our dollar is worth less thanks to Ben, we will have to import more from elsewhere. This is how our next bout of inflation will begin, dollar devaluation without an increase of money velocity. If you think about it it will make sense, capital flows to the land with the cheapest goods and a weak dollar means China, Europe or whoever, will find more value, cheaper products, from America.

That actually sounds good, more purchases of American goods means higher production as we have to replace what others are buying, but that may not be the case. Why? Simple, prices domestically will be rising and our government, always trying to do the right thing will institute some sort of protectionist legislation to stop prices from rising as incomes are stagnant. It would be a form of capital controls of sorts, but in reverse. Can’t you see it now? Prices are rising and people are not able to get those big screen TV’s or something less important, food, so the government tries to stop it through making new laws. It sounds counterintuitive, but it would happen, look at what Congress wants to do to China in order to get the yuan to appreciate in value? Actually, if we do more QE Congress will not want that to happen because China will literally own us if or when the dollar is devaluated.

While all of this is happening the treasury market, after an initial huge ramp up in prices, this is what the Fed will be buying, will be in freefall as no one will want to be repaid, without a substantial risk premium, in devalued dollars. This will lead the Fed into more massive buying because even at this stage Americans will not even want to buy our own debt. Also, China will have no need to hold their massive treasury holds so they will be selling like mad. All of this is happening without money velocity picking up. Even if you think I am wrong about the previous paragraph think of it this way, if our production did pick up because of foreign country buying sprees that means we will have the money to buy things, but it will only increase the inflation rate… damned if it does, damned if it doesn’t.

It has nothing to do with actual money velocity anymore, we even have mild inflation with dwindling velocity now, and has everything to do with confidence in the system. More QE will be bad news for global confidence in the USD, it is on shaky ground as is. If we look at today’s market action it proves how the market will react, lower dollar, higher commodity prices and equities stuck because it is good news on one hand and bad news on the other hand. Longer term high inflation is bad news for stocks, in my opinion, and bullish for commodities, obviously. Stocks are horrible inflation hedging instruments, look at the last 10 years for proof, while silver (by far my favorite investment right now), gold and other metals should do very well. Of course, precious metals are not really an inflation hedge, but a currency hedge instead. Since we are looking at a currency issue rather than straight out inflation it makes bullion of any flavor very attractive.

Could anything change my mind about what I think will happen? Sure. If no QE happens it will be great news, but the likelihood of no QE ever happening again are about as long of a shot as you can get. While I am using QE for my defense of my position in this article I believe we can safely assume that budget deficits will not get better so even if no QE happens our spending will accomplish the same thing. I say that knowing that if the deficit does not resolve itself the Fed, to save the US, will still have to do QE eventually on a massive scale no matter what, to keep rates low so the interest doesn’t bust us. However, the Fed cannot suck in all that paper and treasuries will fail eventually.

Outside of no QE I think there is not much that can change my mind about what I think will happen. It is pretty much in stone and will happen either as I laid it out or in a somewhat similar fashion. In the near-term I am still bullish on treasuries, now that we sold off, and on silver, gold too, but I am more partial to silver right now. I am not crazy about stocks and would be very hesitant about committing major capital to any position right now, the market is trading odd to say the least. At this point bullion is your best play, silver looks very promising and a recent Scientific American article points out that there is only 19 years left of easily mined silver, a no brainer to me, buy it.

People always wait to buy metals to “see how it does” and while they are waiting the price goes nuts and then they buy it and wonder why they lost money. Don’t be one of those people, but buy it smart, some every month. Because even if you think the bulk of my argument is wrong, or all of it, we have disinflation and higher bullion prices, what do you think will happen when we do have inflation? Not to mention silver is not only a precious metal, but an industrial metal. So, if you think the world is going to end, buy silver. If you think we are in a real recovery, buy silver.

It is official, we live in Bizzaro World for sure. In this new normal there is no such thing as efficient markets, price discovery or any rational reason for the erratic movements in the markets from day-to-day. Just a couple days ago Europe was falling apart causing the markets to selloff hard, but today all is good again and the markets are up a couple hundred points. Bad news is now good news while horrible news is temporary, literally.

As for valuations of equities, who knows anymore, but one thing is for sure, price to earnings ratios are under attack, for the second time in a decade. I have read several stories talking about why P/E ratios are so passé and you need to measure a stock via the PEG or some other nonsense. We had this argument in 2000 and the traditional fundamental investors won that argument and I assume we will win it again. The P/E ratios are under attack because, drum roll please, earnings estimates are coming down. So much for the $90+ earnings estimates for the S&P 500 which, if those earnings per share were met, priced the forward P/E ratios, which is an absurd notion to begin with, at an attractive 12 or so right now. However, lower estimates means a higher forward P/E of say 16 or so, that is less attractive.

Fundamental analysis or value investing is about finding cheap stocks and those are getting tougher to find in today’s market. Not only that, but investors are leaving stocks, how many weeks or net outflows have we had? The outflow from equities is, I am afraid to tell you, permanent. Why? The Baby Boomers, it is that simple. They are retiring and making a fundamental, permanent, shift in their portfolios which involve less risk. That means fewer stocks for this group of investors which are the wealthiest generation, dare I say, in the history of America. I always wondered what would happen when the Boomers all started to retire, I always thought that systematic withdrawals would simply lead to wild swings in the market, never did I believe that they would just pack up and leave the market. Well, they are leaving the market after investing through 2 major crashes, plus worthless property now, in the markets they simply want much less risk. I do not blame them.

The big question is, with all this money leaving equities who is buying and why are we still at the current levels? It makes little sense, if you ditch the permabull thought process for a minute and use logic. More sellers than buyers means lower equity prices, that is always the way it worked until now. Today we have more sellers than buyers, based on net fund flows, and the averages are holding their own. We certainly have a ton of volatility, which makes the VIX seem really cheap at this level, but no real movement in the markets, either way. It simply makes no sense whatsoever and I am positioned neutral in the market right now so I have no vested interest in anything that might happen.

If we look at today’s data, for example, it was not good, mixed with the Beige Book it was horrible, we had a huge trade deficit, certainly smaller than last months, but wow, and we had 451,000 initial jobless claims. In what world were that data is good? Obviously in today’s world it is for some reason, but the facts remain that we are losing 1.85M jobs a month, through firings, almost 3 years into this mess. That is unreal. As Rosenberg points out these are the numbers we saw right after Lehman collapsed, so how is this good news? I can hear some people saying, well it is getting better or it could have been worse. Sure, but you have been saying that for a year now and it is the same, bad. At some point you have to realize that it is not going to get better anytime soon and the faster you realize it the sooner you can exit your positions, hopefully at a profit. The retail investor already figured all of this out, hence the wholesale selling of their funds.

That is what it comes down to, who is going to be able to get out before it is too late? I still find it hilarious that market pundits still preach the bull market is here and the sky is the limit for equities. These are the same people who never saw the tech bubble or the housing bubble, both times saying ‘this time is different,’ but now they claim they can see bubbles and everything is now a bubble, gold, bubble, treasuries, bubble, stocks, undervalued. Have you ever noticed that stocks are ALWAYS undervalued? Sorry, but we played this game before and the only one that loses are the investors while the pundits are still on TV making huge money while, clearly, being subpar at their chosen profession.

The bottom line is that computers are running the markets now. This explains the huge outflows from funds and the sideways movements of the markets as computers get the advantage of liquidity rebates and sub-penny pricing. In this environment I cannot explain bad news sending stocks higher other than computers taking over. I have nothing against them, I think they are a problem, but at the same time what kind of advantage does the ordinary investor have competing against algorithms that react in milliseconds. Yes, one can make money, but this action really screws up price discovery and creates a false sense of confidence because we could have another flash crash when the computers decide to back away, again. This is also, in my opinion, another reason why investors are moving away from stocks and heading to bonds, precious metals and dividend yielding stocks.

Based on what I have seen I am not interested in trading right now. I have a select few investments, precious metals and that is it. I had some nice trades, leveraged treasuries and more gold from the beginning of August, but have moved out of those positions. I see no value in this market and think it is merely a matter of time before we see a major move lower, but who knows when that will be. When we have that move lower I believe that will be the time to buy and only then might we see the retail investor come back to stocks. However, they will not be chasing growth stocks rather stocks that pay dividends. I do believe that when the selling subsides we will see a crackdown on HFT, but it will have been too late, as always. Boring is back and that is a good thing, but until we get true price discovery there is little sense to chase this market and those that do will get hurt.

The 2Q10 GDP report came out and it was an eye opener for many people as it showed that the recession, depression, was deeper than most believed and things are surely not as rosy as we are being told. Aside from the inventory rebuild there is not much else going on, final sales are dead as a door nail and some firms, like Samsung, are reporting good earnings, but warning of weaker times ahead. I take the Samsung warning pretty seriously as they are a large or the largest supplier of electronics which had shown signs of strength recently. So when they say things may not be rosy in the near future I suspect that will apply to more than just TV sales.

What made the news cycle this week was a report by Fed President Bullard about the threat of a Japanese style deflation here in America. I am kind of shocked that people were caught so of guard by this news, about 10 economic data points already indicated this to be if not already occurring a very real near-term threat. I suspect we are in for some really tough times ahead and worse yet I suspect we will see the Fed start moving towards quantitative easing, again. As I have said, repeatedly, this will not do anything to boost economic demand as we must wait for the deleveraging cycle to be completed by the consumer before demand will return. Zero Hedge just wrote a piece about this tonight which illustrates exactly what I have been saying for a month now, but no one is listening. Here is what they said:

“In other words, all those who say QE2.0 will do nothing to stimulate the economy are correct, as all such a greenlighted action would encourage is the warehousing of yet more cash by banks. And since banks have no incremental incentives to lend it out, it doesn’t matter if the Fed’s liabilities are $2.5 trillion or $2.5 quadrillion. Instead of stimulating inflation, which is the end goal, all such an action would do is to create further doubts about the stability of the dollar, which in turn, as Ambrose Evans-Pritchard discussed, is a sure way to go to hyperinflation without first passing either Go, or inflation.”

They also indicate my thoughts exactly, we bypass money velocity inflation and go straight to dollar devaluation, i.e. currency crisis, hyperinflation. The irony is that you would only feel this pain on imported goods and we do consume 87% of what we produce domestically so it may take some time before any real currency devaluation hits home. Regardless, Bullard indicated along with prior reports by Ben Bernanke himself that QE is on the table. The question is what kind of QE, treasury purchases or other asset purchases? Also, how much, I bet $3-5T in total purchases, but who knows.

What we do know, compliments of David Rosenberg, is that Ben Bernanke said IF we hit a Japanese style deflation that the target rate on the 30 year treasury would be 2.5%. Rosenberg says that if we hit that rate, down from the current 4% yield, one would receive about a 30% rate of return. I think he is right and if one followed his recommendations of treasuries and gold, along with high yield stocks, you would have avoided much volatility this year and had nice returns. I am happy to say I bought 2’s and 5’s when the yield was 1.10% and well over 2% so I am happy. I suspect the rally in treasuries will continue and if QE happens, wow.

The trade of the century, although risky, would be to leverage a long position into the 20+ year treasury market, UBT (2X bull) or TMF (3X bull). IF Rosenberg and I are right and this happens, QE, deflation or a major selloff in equities, those positions would do very well. However, they are risky, they are leveraged ETF’s, but if you time it right I believe that you could do very well. I also believe that the bull market in bonds is in full force again, very similarly to the summer of 2008 I might add which adds a bit of mystery to the rally in treasuries. The mystery is, what is going on and is the bond market telling you that something really bad is coming?

A look at the chart above looks like there is something going on in the bond market. We broke above the 123/4 mark on the 30 year futures and now that is support. I believe it goes higher because of, at least, of deflationary pressures and, at worst, because of QE. However, while I am short-term bullish on treasuries I hate them long-term since it will be impossible for the U.S. to meet its long-term debt obligations which means they will default somehow in the future, in my opinion. I also believe, as stated earlier, that QE will wreck our currency maybe not now, but at some point in the near future which makes gold very attractive as well. If QE is announced treasuries will go nuts and so will gold. If one is levered into treasuries you could do well, if you want the risk.

What QE means for stocks, I do not know. I would think QE would be bad for stocks as it signals things are not good and the economy is weak, but we are living in bizzaro world where good news is fantastic and bad news is even better.

The market has had a spectacular run lately, both up and down, which has been fantastic if you are a trader, but not if you are a long-term investor. Odds are that if you are a long-term investor you should be in bonds or cash anyhow at this stage of the game as the data clearly shows that equities are about to, or should be at least, take a rather large decline. The bulls have no data to stand on, zero, and the bears have all the evidence in the world including the Federal Reserve telling us that there is little to be excited about and what meager recovery we do have will take years to play out. How that could be interpreted as bullish is beyond me, but I am sure someone will read it that way. As for those waiting for quantitative easing part 2, keep waiting because it is not going to happen unless something different happens, like higher rates or a much stronger dollar.

What data am I pointing to? Pick a data series. The ECRI has been my favorite lately since it has never thrown off a head fake in the -10 range, we are at -9.8 now. Unemployment is also a favorite of mine, where is it getting better? Initial claims are stuck at 450,000+ per week, last week was a gift of seasonal adjustment, that will work itself out in the next couple of weeks. The employment reports are terrible and even the JOLT report was bad. I will say employment has stabilized kind of like how the Titanic stabilized when it finally hit the bottom of the ocean, but I fear there is a ravine close by and we are sitting very close to that edge, look for downside surprises in the employment reports. Housing is DOA and that is certainly not going to change, as I write this the Home Builder Confidence came in at a disheartening 14, need I remind you above 50 is considered positive? Tomorrow we are facing more housing data that is more than likely going to be worse than expected. Face it, there is little data in the bull’s camp except the data can’t get much worse or can it?

On the earnings front, well, we certainly had some great numbers last week, but what about this week? IBM missed on the revenue component and guided down by a couple of cents, no big deal, but big enough to emphasis a slowing in the second half. Texas Instruments met expectations, revenues were mildly light, but considering it is usually easy to beat estimates by a penny or two they couldn’t. Zions Bank, the fabled regional banks that were going to go gang busters this quarter, came in way below estimates, ($.84) vs. est. ($.54) and were light on the revenue side as well. Worse, on the top they said credit was improving, but they are setting aside more for credit losses and their charge offs increased between 1Q and 2Q10, how that is an improvement is beyond me, and we are talking about banks that get to carry loans at make believe values. Even Tupperware missed when people are spending less and eating leftovers! As I write many of these companies are trading lower off between 3 and 6%, not good news for the S&P futures.

Of course, we have a whole slew of earnings this week, a couple hundred companies, so why make big deal over these few firms. Oh, wait, they are IBM, Texas Instruments and Zions Bank, pretty big and respected companies that are leaders in their respective fields. Could earnings improve? Yes. Will they? I honestly do not know because, frankly and like it or not, earnings have been a mixed bag this quarter, but I also think earnings do not matter right now. The macro data is overwhelmingly bad and considering CEO’s do not want to repeat 2009 with negative warnings it is unlikely they will give negative guidance. I do not blame the CEO’s since they were punished relentlessly by the likes of Cramer in 2009 for not being positive enough and even today you only see CEO’s that give the most optimistic forecasts given air time on the TV. It is also or should be widely known that CEO’s are terrible at giving accurate forecasts, look at 2000 earnings releases and see what kind of guidance CEO’s gave back then. Clearly they did not see the slowdown coming when people like myself saw it a mile away, the same may hold true today.

So, is it too late to get short this market? Maybe, it depends on what happens tomorrow. My forecast is for the S&P 500 to initially drop to the 960-980 area where it will rebound, I obviously have no idea when it will happen or how long it will take. After it rebounds I believe it will drop to 860 so there is plenty of time to get short, depending how you plan on shorting it. If you are using options you have to be careful and trade them. If you are using leveraged ETF’s I think there is a lot of danger in holding them, but unleveraged ETF’s, like SH (I own SH), is safer to hold. I believe the best time to get short was 100 points ago, obviously, but last week was a great opportunity as well. Tomorrow, Tuesday, everyone is going to be looking to get short so you will pay a premium to jump on the bandwagon and will be assuming more risk than reward in the short-term.

What is interesting is that the rally, the whippy 7% gain, was a 61.8% retracement from the lowest closing low, 101ish on the SPY. It goes to show that the rally in itself was nothing more than a technical bounce and was rejected when it tried to go higher. That, to me, confirms that there is much more room on the downside than there is on the upside right now. Yes, stocks can move higher depending if ‘something’ happens like a stress test that was designed to not fail actually impresses people, but I actually believe that is irrelevant at this point. Europe is not the cause of our problems, we are as the data is all U.S. data that shows we are if not in another recession/depression certainly going to slow down significantly. I am short so I do not have to worry about working in new positions, I hope you were short as well. (I own various SPY put options, SDS, SH, TZA, BGZ, TYP)

Alcoa is infamous for having lousy numbers and missing its estimates, even Cramer came out today saying who cares about Alcoa, they have lousy numbers. Last quarter they had lousy numbers, but everyone else had great numbers, so what does this mean? To me, it means that Alcoa is the contrarian play since they beat their numbers and raised guidance. Although one analyst says he was not happy with the results as he thought they would guide higher and attributed last quarter’s beat to the airline and auto industries higher demand, basically he said the rest of the year would be weak. I have not looked through the company’s numbers because I do not own Alcoa and I do not want to own Alcoa, so why bother.

Alcoa had good earnings, at least good headline earnings, and CSX had good earnings, which is no surprise since the rail reports have been looking better, but I think we are in for some serious outlook shocks moving forward. All the initial signs are there as the economy is cooling off, frankly it was never that hot to begin with, as retail sales are not stellar, consumer credit is contracting and unemployment remains incredibly high. For some reason the unemployment aspect has become a new normal that most people are immune to, 454,000 initial claims last week was not good and a 466,000 4 week average is not good, in fact it is disturbing that more people are not concerned about this. Not to mention, unemployment benefits for some 3M people are about or have already ran out, not good at all for future earnings outlook, in my opinion, or maybe this fits into a V shaped recovery story somewhere along the way, I get confused nowadays.

One surprise last week was the news that Wells Fargo was closing down 638 stores that catered to non-prime, a.k.a. sub-prime, borrowers, I thought they got out of that business 2 years ago? The firm is expected to has a $.02 charge because of this closure which leads me to believe there may be more losses which led to the closure of the division, not a stretch, I know. Also considering that their pick-a-pay mortgage portfolio still looks terrible I think there is more to the story, but, frankly, with the suspension of mark-to-market accounting what does a bad loan really mean anymore? I will say even with the accounting gimmickry that a bad loan still impairs the balance sheet even if it ‘looks’ good in the reporting and over time a loss will catch up to the bank it is just a matter of how long. I also suspect that there is probably no more perfect quarters for the trading desks f Goldman and JP Morgan, my heart bleeds for them. What I am trying to say is that we might be shocked to find that financials do not perform as well as expectations and their outlook gets more cautious.

There is also technology which has been on fire for the past year, there is no denying that. Earnings have been fantastic and growth has been abundant for pretty much anyone in the technology arena, but will it continue? I fear, no. One of the dirty little secrets is the fact that for the bulk of the last years Asia has been the driving force of growth and these firms have had the benefits of a declining dollar which meant a lot of positive FX results. This is true for Google to Intel who all had several hundred million in earning kickers thanks to a depreciating dollar, but that trend stopped at the end of 1Q10 when Europe started to really catch on fire. I am sure 2Q earnings are going to be good, but guidance might not be as robust as many believe and there is now greater possibility for misses on the top or bottom line as well.

There is also Europe to contend with, I know, everyone says Europe is no big deal and the impact in the U.S. will be minimal. Well, the same people also said the sub-prime crisis was contained in 2007 as well, how did that work out for you? The fact of the matter is that 30% of the S&P 500 earnings are coming from Europe and they are going to stop spending as much, that is just a fact. This slow down will have an impact on earnings moving forward, how much? I do not know, no one knows which is why guidance will probably be more cautious this quarter. You may be saying, well Asia is growing like a weed and I will agree with you, but only somewhat.

I will say that the population in Asia will probably be more liberal with their wallets than businesses will be. China has a lot to contend with right now between property bubbles blowing up, banks worrying about capital requirements, loans becoming harder to come by, profit margins being squeezed by employees wanting higher pay, but their top importer, the EU, has a falling currency and the U.S. consumer is also not buying as much either. They probably are not going to be buying as much as they would be or had in the past. A good barometer of this is the Baltic Dry Index which has plummeted over the past few weeks. China is the reason why the BDI expands and contracts, for the most part, and it shows that China is importing less because they are uncertain or at the very least done stockpiling for now. I believe that means Chinese companies are not doing much capex right now, I could be wrong, but I just don’t see it happening.

The other thing I know people will rip me apart on is the $1.7T, or there about, in cash U.S. companies has on its balance sheets. Many believe all that money will be spent or used to hire, well, what planet are you living on? How long has that money been there for? 6 – 9 months maybe a year now? This is like the cash on the sideline argument, it doesn’t hold water. I agree that eventually that money will go to work somewhere, but not now there is simply too much uncertainty out there. These companies will not go out and hire people, why would they do that, they just fired them? They don’t hire people just to give people jobs, that what governments do. The bottom line is there is no end demand right now, all the evidence shows that as the consumer is deleveraging and so are companies.

That money is sitting on the balance sheet right now because firms are worried about what is going to happen. Most firms paid down debt and are preparing to hunker down for a bad business environment for a long period of time which is why they are not raising dividends to much higher levels or buying new equipment. There is simply no reason to invest right now when the current employee level and technology can met their needs which is the problem with deflationary depressions. Over time this may change, but given what we see right now and the sharp drop in the leading indicators, drop in retail sales, etc. companies are just going to hold that cash until they absolutely have to spend it. I hope I am wrong, but it doesn’t look that way.

I believe that we have plenty of reasons to be worried this earnings season. There has been tremendous technical damage done to the S&P and unless we get stellar earnings and good guidance I do not see the markets going higher. The headwinds are just too strong right now and there is little sign that things are getting better, the opposite is true. I believe we are heading for an immense P/E multiple compression and that is a good thing for value investors, bad for those who own AAPL though. Speaking of which, AAPL is also another reason to be weary of the market right now, it is the only alpha holding out there, take that bad boy out and it will be like trying to get an elephant through an eye of a needle. Plus, if AAPL broke the trust they have with their users who can the people trust? Look for lower guidance.

How anyone is really surprised by the possibility of a further decline in economic activity is puzzling to me. Perhaps it is all the distortions in the data that is coming from the government supporting the economy. Maybe it is because their vested interest is to have you invest in their funds. Perhaps they just drank the Kool-Aid. No matter what it is almost a certainty, in terms of forecasting, that the economy will either stagnant here or decline.

The main indicator that has been telling us there were problems for some time now is the initial claims data and the lack of private payroll growth. Sure, we saw a bump up in payrolls with the 5%+ GDP print, thanks to inventory restocking, but 1Q10 GDP shows signs of significant weakness. What has held true is initial claims, first they got better with the big GDP print, but now they are soft with the constant downward revisions to 1Q10 GDP. The ECRI data also points to weakness in the economy as well which correlates with initial claims data. From my lens, employment is not a lagging indicator, I have been pounding the table on this for a year now, it is a leading indicator in a post credit collapse scenario.

Friday’s employment report is now being telegraphed by Bloomberg to be weak, -110K is the forecast, especially since the Census hiring is done and they are now laying off workers. All of this is not surprising if you track initial claims and use it as a leading indicator. To put the monthly initial claims data into perspective 1,850,000 are filing claims for the first time and that means there needs to be about 2M jobs created every month to offset the ones just lost and we also have to contend with population growth as well. To be blunt, full employment is a figment of one’s imagination at this point for at least the next 5-8 years. Unemployment will be our greatest problem for a long, long time and there is little the government can do since end demand is the issue.

There is simply no way the Fed can raise rates for the foreseeable future either since one of their mandates is full employment. Yes, I know they said they would raise rates before employment recovered, but they won’t for political reasons. Obviously, that might change depending on what happens in the future, but for right now there simply is no reason to raise interest rates, at all, from their perspective. Worse is the fact that the Senate did not extend unemployment insurance last week which means a million plus people will lose benefits very soon. After their drunken spending binge to bailout the banks after they created this it is beyond me how they would let a million people just wither and die. There are 6 people for every job opening out there so it is not like these people are actively NOT trying to find work, so enough with that whole theatrical display of utter idiocy. Keep in mind I am a deficit hawk, but there is a difference between government wasting money and government helping those who cannot find work.

The loss of those benefits will have a huge impact on the economy as a whole since that money will not be spent. Retail sales will continue to slide and foreclosures will continue to rise, how many of those million plus people are barely hanging on? I am not sure how so many people can claim that the unemployed are simply freeloaders looking to live the highlife on such a meager government stipend which is what you hear often on other blogs or by the ultra rightwing. Considering that there are so many people looking for work the competition for a job, any job, is extremely high which reduces the odds of a person actually getting a new job anytime soon. Not to mention that unemployment benefits are usually around $300 – $500 a week I find it hard to believe that anyone is living the highlife on such a low amount, but that is the case. I am sure that there are abuses, but this is one of those give me a break moments and I am definitely right of center.

The other reason many believe a double dip is out of the question is that companies have extraordinary amount f cash on their balance sheets. Well, all I have to say is how long has that cash been on their balance sheet and it has not gone to work yet? This is like the temporary employment is a bullish indicator, if it is not happened yet the odds of it happening anytime soon are dwindling. The cash on the balance sheet is also part of the deleveraging cycle as companies pay down debt and hoard cash. Perhaps the main reason that companies have so much cash on hand is they think that business is going to get very tough in the near future. After all, many of our best companies have roots going back beyond the Depression and they know the value of having cash on hand to make it through the storms. Of course, they could spend it all tomorrow, but I ask again, what are they waiting for and why hasn’t it happened yet?

The bottom line is that it is really shocking to see so many smart people caught off guard about a potential double dip recession. All of the signs have been around for a longtime that the thought should have entered their mind at some point in time in recent months. There is a chance that we could avoid it, but I do not see how. I should point out the fact that I never bought the idea that we actually made it out of the first one, other than a statistical recovery that is. Time will tell on this one, but if Friday’s report is worse than expectations we will be well on our way to S&P 900.

Look, things in the U.S. are certainly better, even though I am bearish on the economy, but they are just a “less worse” type of better rather than a true recovery or whatever you want to call it. Someone once commented that I would not know a V shaped recovery if it sat on my face, or something to that, as the recession in the early 1980’s saw a lag in initial claims of some 6 months before the recovery in employment happened. Boy, I hope that person is reading this because that comment was made in august or September of last year, almost a full year ago, and initial claims barely broke the 500K mark as we speak, is that the ”V” we are looking for? The fact is in a post credit collapse employment is a leading indicator, I said it a year ago and I am saying it now and the only difference is the unemployment rate is HIGHER today than a year ago.

What changed over the last 12 months?

Nothing. Wait, I take that back, a lot. The U.S. is now $3T more in debt, we performed a “stress test,” which we are telling the ECB to do, more on that in a minute, and the Fed expanded its balance sheet by how much? What did we get for all of that? A 5.2% GDP print based on inventory a rebuild that was probably premature, if we take away the stimulus would firms have rebuilt their inventories so much? I think not. Unemployment is slightly better thanks to temporary jobs and government hiring, not exactly what I would call “robust” at all. The bottom line is all my criticism of the stimulus was right, it failed.

The banks are better you say, right? Are they? If you think that, well, I just don’t know what to tell you. Did the banks get rid of the “toxic assets?” Did they write all their bad debts off? Did real estate values increase? How about commercial real estate, is that sector flying strong again? No. Are banks loaning money again? Sure, if you have a credit score of 850 or better and don’t need the money they will gladly make a loan to you. However, if you need to refinance your home you better hope you qualify for a government program or you are out of luck. The “stress test” was a joke and meant nothing because we are at the outer limits of the stress test, remember, 10% unemployment, etc., etc.? What saved the banks was one thing and one thing only, the repeal of mark-to-market account, period, end of story.

If we brought back mark-to-market accounting today we would have a handful of big institutions left, I guarantee it. Just look at Wells Fargo’s balance sheet with the “Pick-A-Pay Loans” they inherited, worse, they bought, from Wachovia, the LTV’s, except for Texas, God Bless Texas, are all horrible. I am not saying WFC would fail, I am just saying they would have to realize pretty significant losses is all. It is no coincidence that right after, literally right after, the repeal of mark-to-market accounting rules by the FASB, by Congressional pressure I might add, bank earnings went through the roof. What replaced mark-to-market accounting? Mark-to-model accounting, do you know who made that model famous? Enron, need I say more?

Europe

Now, Timmy Geithner is over in Europe telling the Europeans to do a “stress test” to let the world know all is well. Sorry Tim, I do not think this will work since it is technically not the banks in question, but rather the sovereign debt that they are holding. Why not do a stress test on governments instead, maybe that will solve the problem. This is a banking problem, again, that was brought on by huge deficit spending and countries inability to service their debt loads, this is big, huge actually. While this will impact banks it is not really banks that caused it, but politicians who decided to bribe the people with their own money.

It is likely that one of the PIGS, or whatever we are calling them now, will default given the issues they have and the inability of politicians to say no to spending. It is just odd, it always has been, that the people demand all this gravy from the government in the form of give a ways, tax credits or straight cash in some form. Don’t these people realize that they are only getting back their own money? Actually, if governments spent less and had lower debts that means they would have lower overall taxes which means the people would have more money on their own… they would be better off! However, the people insist on being bribed with their own money and politicians are only too happy to oblige.

The point is that this bigger than the banks as we are talking about the solvency of countries now. Bailouts are much more difficult to do for countries and the implications of a default by any country has widespread ripples that most people have no idea can or would occur. Even if Hungary or Greece defaults it is a huge deal and will impact governments and banks all over the world. I have been saying this for months now, Greece is a big deal and all those people saying it is not are, well, disqualified to render their opinions anymore as the markets have spoken and they have sided with me.

Run a stress test, it doesn’t matter because it really doesn’t matter Tim. The problem is with government spending this time and I do not think mark-to-model accounting can fix this problem.

The real problem

The real problem is I do not know where the sovereign debt problems will end, I know it will get worse. I know that more European countries will succumb to this very same issue as most European countries are socialist by their very nature and their debt levels are very high. As the weaker countries fall they will drag the stronger countries down with them, it is just how it works. I made a call that the Euro will fall to 1.18, we are about there. Do I think it will go lower? Yes, to parity in the near future. I think 1.16 is the next level, but the ECB will have to intervene and China has to intervene as a weak Euro is a major problem, it is, another story for another time. The currency will not survive without a mechanism to eject the weak states, period.

After the carnage in Europe is done, I do not have a timetable for that, it could be tomorrow or 10 years from now, but more than likely it will be sooner rather than later, the debt problems will spread, to the U.S. We have $13T in debt and an economy that is not recovering, I am not happy about that, but those are the facts. We are spending $4.9B a day, 3 times the amount George Bush, not exactly the face of fiscal conservatism I might add, was spending. We are in major trouble and what are our politicians doing? Trying to figure out how to get stimulus 3 out the door, that’s what.

I have been saying for months that our debt to GDP level is almost at parity, but it takes the Drudge Report for people to start listening? OK, at least people are listening now. The problem is we have no politicians willing to take the steps to fix out problems. Go ahead, elect the Republicans, look what they did from 2000-2006, they really helped to speed the process up, in my opinion. Of course, out current President and Congress has surely kicked what the Republicans did into hyper drive as they added 30% to our debt load in less than 2 years, that is $3T, an astounding figure. Neither of these parties really want to fix the problems, in my opinion, because they have a vested interest in perpetuating the problems so they can stay in power, it is just how it works.

What this means is we are all in very big trouble. I am not talking about, oh, gee, go buy an ounce of gold and protect yourself from inflation, I am talking about the Weimar Republic, hyperinflation, type of trouble. I see no way out besides inflation and in a big way. As Paul Krugman points out, there is a big difference between Greece and the U.S., we can print our own money. We also know Ben Bernanke has no problem with hitting that print money either. I am also confident that the Fed is, basically, completely incompetent.

If we cannot go to the market to finance our debt, which we have trillions of dollars of that most of it matures in under 10 years, the Fed will monetize it. That is how we will deal with our sovereign debt crisis, we will print our way out of it and it will be the very worst thing we can do. Instead of cutting our government, spending or doing anything else that is logical, because politicians want to get reelected, they will choose to inflate their way out. Will gold protect you? Yes, but so will food and any other useful commodity including toilet paper. It disturbs me to no end that we are where we are and that the President is listening to the likes of Mr. Krugman who thinks deficits don’t matter, they do, and that since we can print money it is OK, printing money is not OK.

In the meantime I am still short the market. We will have a bounce I am sure and I almost took a nice broad long position today, but I passed. While I am sure we will have that bounce I did not think the risk reward was worth it. My target is still 900 on the S&P 500.

A few things have been out there that just blew me away over the past couple of days. The first was when I saw a video of Jim Cramer advocating for the Treasury to issue $2T in 30 year paper to solve our debt issues. The second is that some talking heads believe that we will get a 700K print for the NFP, non-farm payroll (employment report), on Friday. It leads me to believe that most people in the world have just lost their mind or at least lost touch with reality. There is some logic to the aforementioned items, but reality just does not work like that and when one throws out an idea make sure it is feasible first or make sure it is a clean number, as in the 700K NFP on Friday.

First, Jim Cramer, the man I love to hate, but I respect the hedge fund manager as a take no prisoner SOB who got the job done, but this “I am going to make you mad money” thing, well, I think not. He has been giving out some decent advice lately, too little too late, but nevertheless, he has advocated high dividend stocks for sometime which is a good strategy as I see deflation. However, he said yesterday that the Treasury should issue $2T in 30 year paper while rates are low because we have too much short-term debt, he is right, and we will eventually have funding issues, he is right again. The issue I have is that the U.S. has $13T in total debt with much more coming so $2T does nothing to “solve our debt problems” and the bond market would reject $2T in 30 year paper. I mean come on, the market would demand a higher yield than 4.23% for that size paper. This is also the same guy who said, no more than 8 months ago, that Treasury should issue a 5% 30 year Retirement Bond as well, yeah right.

If one has been paying attention to the bond auctions they would notice that there is a reason Treasury is issuing shorter maturities, no one wants long-term paper from the U.S. government. Investors would just assume buy 10 year TIPS instead which offer some protection from the inevitable inflation risk that exists. Why would Treasury want to steepen the yield curve even more than it already is? If Geithner has half a brain he will try to move our maturities out to the 10 year mark and if Treasury swamped the 30 year they would move the yield up on the 10 year. It is just a bad idea and it impresses no one, period. I am surprised that Cramer would even say such a thing as he did run a ton of money, but, well, I guess I am not surprised.

The other hot issue of the day is the employment report due out at 8:30 AM EST Friday morning, it is THE report on the first Friday of each month. This month we are due for some really interesting data I suspect, especially given the smooth work last month in the Birth/Death model, I know I talk about that a lot, but it is important that you look at that figure and understand it. I see some estimates that we will see a print of 700K on Friday and, frankly, I would not be surprised, it won’t be real, but I would not be surprised at all.

The NY Post ran a story on how some Census workers were hired for a few hours, paid, fired and rehired which will boost the NFP figure on Friday. Are those accusations true? I don’t know, but it would not surprise me if they were. All I know is that it would be awfully tough to pull off a huge private sector growth figure with 460K+ weekly initial claims and with many blue chip companies announcing more layoffs, H-P is laying off 9K, seriously. There are still almost 6 people available for every open position which is not good news or bullish for new hiring. I am not saying it is getting worse, but I am saying it is not getting better.

There are specific area’s to watch and the first one is the actual unemployment rate, I think we will see it uptick to 10.2%, remember we now have an oil spill which impacted a very large area. Another area is the BLS Birth/Death model, obviously, which may add another hefty 200K to this month’s report. I also believe you must subtract all government jobs out of the report since they are temporary and we need private sector jobs to pay for government jobs to begin with. The U-6 report is also very important as it will show the under employed, which is a huge, and growing, problem in America that everyone turns a blind eye towards. Finally, temporary jobs are no longer a bullish indicator. Perhaps a year ago they were, but if they are not converting to fulltime employment by now they never will, sorry, but subtract them out.

The other painful part of the report is the time it takes to find a job, this is the heart breaking, in my opinion, part. The vast majority of unemployed are taking far longer than 6 months to find work, in many cases more than a year, this is the worst since the DOL has ever recorded, it started keeping records in 1948. Basically, those are Depression era numbers there are just no other times in our history where it took so long to find work and I can assure you people are not voluntarily staying unemployed to collect that whopping $400 a week unemployment benefit check. This is a major problem and it is not getting better, sadly, and you need to look beyond whatever the headline number is to see what the real situation is like. I am sure Joe Biden and President Obama will be patting themselves on their backs on Friday, but I can assure you that whatever the number is it will be the equivalent of Enron accounting.