I suppose it was back in the late fall and reiterated again in mid-winter that I believed the market would simply go up for no real reason until QE2 ended and then it would begin to decline as liquidity ended. It looks as though I was somewhat accurate in that prediction although you did not have to be a rocket scientist to figure that out unless you were a permabull with your blinders on and absolute faith in the government and the Fed in which case please move along.

The Fed knew the same thing I and many others did and that is why at the last meeting they emphasized that they would continue to reinvest maturing paper and interest from the existing portfolio, kind of a QE infinity if you will, but on a small scale. I do believe they will let QE2 go and not announce anything new until the fall when they see the economy really weaken. I think a couple months of sub 100K jobs reports, with a healthy BLS birth/death adjustment, along with softening other indicators such as the PMI and so forth the Fed will get the point and step in with $1T in QE since $600B did not work.

That is how it works as one QE is ineffective the next one gets bigger. The really unfortunate part is that Japan has done the same thing and it did not work but there is a big difference between the US and Japan, we are the reserve currency and they aren’t. In other words, Japan could print all they wanted because their citizens bought their own debt and the world settled trades in dollars. However, the US is limited in what they can really do in QE because as the value of the dollar sinks, and we really had a nice scare a week or so ago, the world will pick a new reserve currency on its own. You know how that story ends.

Ben knows this and he knows that his QE options are limited and he can probably only get away with 1 more so it will be big, it has to be. If that one does not work and spur growth, well, the Fed is done and completely out of bullets in a traditional sense. We would see some new things coming to the table like in 2008 with all the new facilities and such, but I have no idea what they will be or what they will look like since we do not know how things will play out.

What I do know is that we should get a nice bounce in the dollar here sending commodities lower for a bit. This will give Ben and Washington a little relief and you an opportunity to buy, buy, buy every commodity you like. I love silver, still, wheat, gold, palladium, soybeans and corn (unless the subsidy is pulled). If those go on sale buy them either directly or via the growers or agricultural ETF’s.

In the mean time enjoy watching Ben sweat it out as he will not have answers for the weakness in the economy or the weakness is ‘transitory’ which is the longest transitory period I have ever seen. Kind of like this recovery it is the longest start of a recovery ever as it gains steam and loses steam every other week. Good luck.

The past 2 weeks we have seen the markets do things that simply do not seem natural from freefall flash crashes to intraday 300 point turn around rallies. However, there is one thing that is pretty clear, I would not buy this pull back. As David Rosenberg points out and a few other non-perma bull market strategists, not that there are many left, point out is that these wild swings are not normal in a bull market.

Think back to the market of late 1999 to the early 2000 and you will remember such swings, but do you remember how it ended? If you bought on those dips you never made your money back, ever if you bought the NASDAQ and you would have barely broke even in the S&P 500 if you sold at the peak in 2007. I think it is safe to assume that this market action is a sign of a sick overbought market trying to lure you in to buy one more time before it robs you blind, don’t do it. To be clear, I believe the broad market will move lower, I think 900 to 950 is not an unreasonable target, but we could move much lower than that. Before you say it, no the fundamentals are not so strong that we could not see the lows of last March, more on that in a minute.

I am not saying do not buy great individual companies, not at all, I am bearish on the market, but I like some individual names. I am bullish in the biotech area as there are tons of patents expiring in the next few years and you will see big pharma buy many of these names, but I also like big pharma too. Look at the yields and the rock bottom P/E’s, they are dirt cheap and you should look at some of these names, but biotech is not a prisoner to the business cycle, as long as it is well funded and near approval for a drug. I also like consumer staples that pay dividends, boring names, but they pay you to hold them and no matter what the economy is doing you will always need toilet paper and a toothbrush, I hope at least. I also still like high quality bonds and can make a case for treasuries right now, but use your own discretion, I would stay away from high yield, I sold mine a couple months ago.

Why do I think boring and income is the best model right now? Well, the market is going to correct even more than it already has, kind of a simple explanation. Income strategies, which I have been on the record for supporting since last year, makes sense because we are living in disinflationary, possibly deflationary, times where real yields are much higher than what we think. I am a long-term inflationist, come on look at all the money being printed and Obama wants to double exports in 5 years, you cannot do that with a strong dollar, but right now deflation is the name of the game and income makes sense. Deflation also means stocks need to be trading at much lower multiples than most people think and that is why I think this correction will potentially be much deeper than most people believe. Time will tell who is right about that.

The Fundamentals!

What about the fundamentals? Are they better than a year ago? Sure. Do they support a 20 P/E multiple on the S&P 500? Nope. Do you really think the housing data since the homeowner tax credit implementation was actually real data? No way. How about unemployment, do you believe temporary jobs are going to lead America to the next level of prosperity? Well, all the amazing job growth has been only in the temporary job area, let’s not forget that the actual employment report numbers are tinkered with via the birth/death model which added 188K jobs to last month’s employment report. For those of you who don’t know, the birth/death model are estimates the BLS uses to predict how many new business are started based on how many business died and population growth, it is fantasyland stuff basically.

What about corporate earnings? They have been good, but I do not believe they are sustainable. First, the stimulus is running out, that is a very important thing to remember moving forward. Second, a cool 30% of the S&P 500’s earnings come from Europe and up until lately U.S. companies enjoyed, globally, a weaker dollar which is over since the new sovereign debt issues are driving the value of the dollar higher. In technology a large percentage of earnings came from Asia and I do not believe that will continue much longer because of what is happening in Europe, Greece was a big deal indeed.

You see, Europe represents 20% of the worlds GDP and, believe it or not, China’s top importer is not the U.S. it is the EU. So, if the EU is going to have lower growth because of austerity measures, which they will, it will automatically be a drag on world GDP, but it will specifically hurt China. If China begins to slow down that is very bad news since China is “the recovery story of the world” or some other tag line the media gave it. In other words, China will be buying less from the U.S., exporting less to the EU and the EU will be buying less from the U.S. Also, China will be running, more than likely, trade deficits not surpluses which means they do not need to buy our debt. Can you see the problem now?

Greece is/was a big deal not on its own, but because it was locked in with the other PIIGS which were locked into the EU as a whole. It is all very bad news and no matter what CNBC says we are all still coupled with each other. It is the interlocking of the global economy, especially in the debt markets, that is the problem and there is no escaping it. I am afraid that even when governments guarantee debts that may not be enough anymore because, as the price of gold is proving, people are losing faith in money. Our whole system is based on faith and when that faith is damaged that is when problems get out of control and I believe we are just about at that point. The rumor yesterday was a .50% rate cut, how is that good for the Euro? If anything that would have brought it closer to parity to the USD. Printing another trillion just won’t calm markets because it means nothing. At this point I cannot see much of anything from Europe that will calm the markets.

The only things they can do is let the PIIGS default on their debt and kick them out of the EU, not necessarily in that order. Anything else will just prolong the problem and the printing press is the cause of the problem, not the solution.

I was reading Zero Hedge yesterday, a post in regards to gold where Peter Schiff was part of the topic, and there were some interesting comments. One caught my attention as being somewhat ludicrous which is not unusual, but is was because the author is a contributor to the site. Unfortunately the comment was flagged as junk, I hate it when that happens because counterpoints are always good things to have and I do not mean to rip him apart, but rather correct years of misinformation he probably picked up from school or TV armchair economists.

One comment he made was:
“On gold to the moon: Peter you’ve been talking up your gold positions for years, but once calm is restored, you’re going to take a major haircut on gold.”
Another was:
“On the US economy “not growing”: Has he looked at the ISM, employment (not just payrolls but household survey), industrial production, and the leading indicators over the last ten months?”
And the other one was referencing that as soon as the trillions in bailouts the banks received hits the economy it will calm the economies or something to that effect. He also indicated that as long as confidence remains in the system everything will be fine, which is true, but how much will it take to keep that confidence or instill that confidence? Also, the more money we inject to create confidence the more confidence it actually erodes, it is a zero sum game in the end. Part of the comment was that the EU was trying to avoid a “deflationary death spiral” or something similar, this is why people should not flag things as junk because they are not junk, which is what really bothered me.

People are thoroughly confused by deflation and deflationary death spirals and what that means. Deflation is a problem, we have deflation now, but it is not a huge problem. However, a deflationary death spiral is what we had in the 1930’s and is what keeps Ben Bernanke up at night. We will not, I do not think, have that deflationary death spiral and I think we need to understand what that death spiral was, what caused it and why we will not have it. After that I want to address the rest of the comments he made above.

What we suffered fro in the 1930’s was horrible and something I hope we never see again. To understand more about what it was like in the Depression please Read The Depression: A Diary by Benjamin Roth and stay away from the academic stuff. However, during the depression dollars were scarce because fo the massive bank failures and deposits were frozen or simply lost when the bank closed down. On top of that the stock market wiped out millions of peoples savings which had a domino effect into the real estate market which is what caused the banking crisis, somewhat reversed from today’s crisis I might add.

What this did was literally wipe dollars out of existence, they just disappeared and were not transferred to anyone else. Today one persons loss is likely another’s gain through derivatives or other hedging instruments known as bailouts, but that was not the case in the 1930’s. Since these dollars were gone or frozen and the U.S. was on the gold standard we did not have a Helicopter Ben to get dollars into the system, at first the Fed tightened credit, who knows why, but they later tried to reverse that decision, but it was too little too late. What we had was complete demand destruction and people saving whatever dollars they had, which was strange because people would rather starve than spend their money.

In fact, while people were starving crops were on or at a record pace, prior to the dust bowl fiasco of course. It was a simple fact that the U.S. was tied to the gold standard and could not put more dollars into the system and people just did not want to spend what they had saved because who knew what tomorrow would bring. We also had no safety systems in place such as unemployment insurance, welfare or Social Security, until FDR was elected a few years into the Depression. By not having those safety nets in place it made things much, much worse and that is why we had such massive deflation.

This was not the run of the mill demand deflation, which is what we have now, this was the death spiral lack of dollars in circulation plus no demand deflation. So for people to draw a comparison to 1930’s deflation to todays is a bit ridiculous to say the least. We have those safety programs now so people will not starve instead of spending money, ironically our poor actually have cable TV, go figure, and we have other safety nets in place. This is why we will not see 1930’s deflation and this is also why we can hide the evidence of our current Depression, if we do not have to see the soup lines they are not there, right? Never mind the fact that 1 in 8 Americans receives some form of Food Stamp assistance, if that is not a Depression statistic I am not sure what is.

The banking system is still suffering from after shocks much like we saw in the 1930’s, closures did not stop for years after the crash of 1929 as real estate continued to decline in value, sound familiar? We are still suffering from similar bouts of bank closures today because of declining real estate prices and that is unlikely to change. Many of these banks were bailed out, funny how some “too big too fail” are now failing after they were bailed out. How can, as his comment claimed, the markets be calmed because of trillions in bailouts will build confidence when those banks who were bailed out are still failing? This is very similar to the 1930’s when many banks who received aid under the first Hoover plan still failed. The point being is that it will take a long time for the system to heal itself and with the government propping it up it will take much longer. The Depression lasted some 10 years, 7 with major government help, our current problem got help on day 1, how long will our recovery really take?
With the massive stimulus and government spending in the banking system it is nothing more than inflationary measures. The comment that “when the trillions making it into the economy will only build confidence,” is a bit absurd, in my opinion, as it points out that the issues were very bad for a very longtime. Also, when the trillions, a bigger and more accurate statement would had been if the trillions, make it into the economy it will create inflation, period. There is really no doubt that the measures taken by all the central banks were to stem the tide of the aforementioned deflationary spiral and it did work, but the central banks cannot stem the tide of the inflation that they created. After all, central banker’s primary mandate is to inflate the currency at about a 3% annual rate to begin with so they have no real mechanism to dis-inflate a currency anyhow. Sure, they can raise rates and do reverse repos, but serious, that will do little.

In fact, for all the money spent on bailouts and stimulus measures I would argue we have received a very poor return on our investment. We had a sharp mini-V of a +5% GDP print, but that appears to be it. We had spend far less in the past and had averaged far higher GDP prints, about a 7% print after major interventions, so, sure, you got a V, but it is one side of a W, sorry Charlie. People had been bragging about the ISM Survey’s for some time until the Ism survey’s failed to support their claims, but they fail to support my claims as well. In fact, they are neutral, but well below what we would call normal expansion averages. Not to mention, these are survey’s and should be calculated as survey’s, as in this is how people feel at this point in time, not as this is what will happen in the future.

My main point is that we do have growth and things are better, but no where near where the bulls think they are and we are not heading to where they think we are going. The comment also pointed to the leading economic indicators as a “bright spot.” Funny, Kudlow and company have not brought up the LEI for sometime now because, well, the number rolled over a couple months ago now and has been heading lower, funny what happens when Uncle Sam cuts off the money. So, I am not sure what LEI the commenter is looking at, but the one everyone else is looking at is pointing to the South, not the North, good luck if you think down is up and up is down because you got Vertigo my friend.

The global economy is about to end its amazing recovery, sorry folks. Europe is 20% of the global economy and they are instituting massive austerity measures right now and these are only the start, more is needed. If 20% of the world’s buyers have less money you will see economists start lowering forecasts very soon, trust me on that one. You know how the U.S. is pestering China to revalue its RMB? Well, it is pegged to the U.S. dollar, right? Do you know who China’s largest trading partner is? Hint, it is not the U.S., it is the EU. That means Chinas products are now more expensive in the EU than they were just 2 months ago. Wasn’t China credited for the global recovery? Isn’t China in the middle of a liquidity bubble? Won’t not selling products hurt their exports causing an artificial popping of their bubble which could cause more problems for the world than originally thought? I think so, but we are still pressuring them to revalue and spreading the falsehood that we are their largest trading partners, what baloney.

It is kind of funny to see people dismiss all this information and keep economic events locally when this is a global economy, I mean, there is a reason why when the U.S. market tanks foreign markets go down as well and why when we go into a recession so do other countries. Decoupling will happen, but not until the rest of Asia emerges like China did, but until that happens China is dependent upon the U.S. and the EU. However, let us mak sure we are clear, the EU is, for sure, China’s biggest trading partner and a falling Euro is a big problem for China as well. Keep an eye on that, I am.

On to the topic of the day, gold. Peter Schiff has been bullish on gold since, well, forever now and has taken much heat for it since it climbed from $250 to $1,240, yes, taking heat for something that quadrupled. The commenter stated that gold will take a haircut, a major one, when markets calm down, maybe he is right, but let’s take a look so far. Trillions have been spent on the banks, that has not calmed the markets and now you have governments in trouble, what is going to calm the markets even if small governments start defaulting? Even beyond that, look at 2003, 2004, 2005, 2006, 2006, 2007, 2008, 2009, 2010. During most of those years the markets were considered “calm” and in a “goldilocks” period upon a new wave of global liquidity never before seen, what happened to the price of gold? Oh, yeah, it quadrupled.

The one big down year gold had was in 2008, when it first hit $1,000 I might add, when everything was in liquidation because of a global margin call. If the Fed did not start dropping money from helicopters we would have had our 1930’s deflationary spiral on our hands, but that is not what happened. What happened was things were supported by the government and long before the markets shot back up 70% gold was on its way back up to it’s previous $1,000 high. So, Peter Schiff can hold on to his gold trade all he wants, it worked for him as he lost little during the collapse by holding it and it returned more than the S&P, from January 1, 2009 to December 31st, 2009, than the S&P 500 did without the volatility. Comments like the ones made by the person in question show that they do not look at the facts and simply do not like the asset class, or do not understand it, and end up looking silly at the end of the day.

Do I think gold will go down? Yes. Why wouldn’t it? Everything rises and falls, but I think it will be much high 10 years from now than today. We know that central banks inflate the currency, that is a fact. We know, especially right now, that sovereign default risk is real and confidence in currencies is really a fleeting thing, we have merely been lucky for 38 years since the gold standard was eliminated, we know that turmoil will always exist and we know gold, silver or other commodities are a finite resource that has much higher demand that supply could ever meet. In my opinion, only a fool would not want to own gold, just look at APMEX.com, all their smaller American Eagle coins are sold out for crying out loud, is that the confidence in the global system we are looking for? Is that the sign of a growing global economy? Nope.

Was it Greece? Was it a fat finger trade? Was it high frequency trading? Was it quant funds run amok? No one knows for sure, but it was ugly to say the least. I believe the selloff was very, very real and a matter of no one left to buy the dip. We fell within 1.5 points away from all trading being halted and we miraculously reversed course and rebounded some 700 points. Some think it was the Fed or the plunge protection team, I would say that is not farfetched either.

The one thing this was definitely not was a fat finger trade, like originally reported. When trades are entered for equity orders they only use numbers, not letters so the whole “B” versus “M” argument is a bit irrelevant and merely makes a good news story. I believe this whole thing was a perfect storm of a hugely overbought market, yes it is and was overbought, mixed with Greece contagion fears sprinkled with a bit of tight orders by HFT or quant funds and no one left to buy, anything. All liquidity was sucked out of the market and when that happens, well you saw what the results are.

I believe this is only the beginning and things will get much worse. It was also odd to see mining stocks remain in the green along with gold. If this was a trading error these stocks should have tanked as well, but they did not. This tells me that the selloff was more than a bad trade or order imbalance and any other ludicrous reason the media can come up with. It was selling, real live selling from people who know what it is like to lose 40-50% of their money and did not want to repeat that again. Watch fund flows to verify this, I bet we see more bond fund inflows in the very near future.

Even if you were short it was a tough market for you, especially option traders who saw the bid/ask spread widen to levels I have rarely seen before. I am long VIX August and September calls and it took an hour to get pricing back to normal and there was no premium being given for being in the money. It was amazing to see the selloff today as I jokingly went to my wife’s office and said the market is crashing, it was down only 280 at the time, and when I turned it to CNBC to show here it was down 400 and moving fast to the downside. It was breath taking and luckily I was hedged, but the talking heads on TV and perma bulls that you talk to probably told you that hedging was not important and the market now only moves up, it doesn’t, sorry to tell you.

I always find it odd that when the market tank there is talk of manipulation, but if the market goes up for 8 straight weeks that is normal, come on now. I do not believe anything about today was manipulated, except for the massive rebound that “just happened” all of a sudden. No one seems to be really looking for the cause of this, in a serious manner I mean, and are chalking the decline up to a fat finger event, etc. I am a bit more inquisitive though and while I do not have an answer, I have some theories.

I have heard rumors that the overnight repo market in Europe is frozen, I do not know if this is true yet, and if you notice the overnight LIBOR has been creeping up and is close to the 1 and 3 month rate, this might mean the rumor of the repo market is true. On top of that the risk of contagion is extremely real, I wrote about that a week ago in the “Greece Does Matter” post, and the next up is Portugal followed by Spain, Italy and France who owns tons of PIIGS debt, $781B to be exact. After that it is anyone’s guess to who is next, but it is more than likely going to be the UK. What is happening in Europe should be a lesson, in advance, for the US who, ever since Obama has come into office, seems to think the European way of doing things is better than our system, it is not.

The reason for the debt crisis is the massive debt these countries accumulated to give away free health care, massive pensions, paid vacations and other luxury things to their populations. Clearly following the European lead is not a wise move, but that will not stop our politicians who are immune to market downturns because, A) they are all wealthy and B) they are paid very well for what little work they do. We are the next Europe and we will suffer the same issues they have now if we do not get our act together. I am fairly certain that the funding crisis which is a rumor today will be public knowledge in a few days and is one of the main reasons for our selloff today.

If Europe cannot fund itself, other than through the printing press, today will seem like good times moving forward. This is bigger than Greece and it is 10 times bigger than Lehman, we are talking about countries now, not banks. Essentially, we decided to save the banks at our own peril and we are now seeing the results of this action. We should have let them fail, all of them, because we now run the risk of major countries failing. Was Goldman Sachs really worth it? I think not.

What really stood out today was gold, it went up and is on the verge of a tremendous break out. Are gold bugs really that creepy now or is it that we knew something in advance? For those of you wondering, it is the latter. Gold is now the new reserve currency, period. We may suffer from deflation when this funding crisis escalates, but that will quickly turn into inflation, very, very fast. When dollars come into high demand and they are not available we will see this deflation, but remember, we have Helicopter Ben at our disposal. He will literally get into his helicopter and drop dollars all over the country. This will seem like nothing as the dollar stays strong, but that will be very short lived.

After the dollars are dropped inflation will be swift and unlike anything we have seen before. You see, even though Ben flooded the banks with dollars over the last 3 years none of those dollars made it to us, the people who spend them. Instead the banks bought treasuries, also a good option for investors right now, and this time the dollars will bypass the banks and hit us directly, think Bush stimulus instead of green energy stimulus from Obama. Putting that money in our pockets will mean people will spend, that is what Americans do, don’t ask me why. There is where inflation begins and that is only the start. I am not sure what they will do after that, but I am confident it will involve more spending and giving us money, thanks china!

There is where the problems will really begin because there will be a global funding crisis at that point. This means that no one will buy our debt so we can buy iPods. Ben will have to print it, literally print it to get it into our hands. Inflation is a funny thing and very misunderstood, but I assure you that we will not enjoy it, we will at first though if we pay off our personal debts. In the end we will merely be left with tons of worthless paper and sky high prices. What happens next is a mystery to even me and I am a doom and gloom guy, but it is not going to end well. This is why you must own gold, in your possession, because it will get that bad. The worst case scenario is the value of said gold drops, but it will still be better than holding only USD’s. I think the biggest risk is not owning it versus owning it at this point.

Perhaps this was a one day event though, I doubt it, and everything will be fine. Tomorrow we will receive news that the government hired tons of people and private companies hired more temporary workers, we know the number will be good because Obama already scheduled an 11 AM press conference to go over the jobs report. However, those who continue to think temporary jobs and government jobs are a good thing will be very disappointed to learn it is not. I believe that we will open up much lower, working off unclosed sell orders, and we will rebound some tomorrow, who wants to be short into the weekend.

The real show might be next week, depending what happens over the weekend. I am not sure of the near-term outcome or what will happen, I am holding my shorts and VIX calls though, but we did get a glimpse of what will happen longer term today. I do not know about you, but I did not think it looked pretty. As far as believing some trader pushed the wrong button, come on we can do better with our excuses than that.

Apparently the markets, that wonderful forward looking discounting mechanism, did not see or have fear what is happening in Greece. It is safe to assume that this proves that the markets are not efficient and it fails to see potential problems. What is interesting is that Greece and Portugal were not or should not have been a surprise to the markets since we have all known about the issues with the PIIGS for months now. How anyone could have been surprised by this news today is beyond me. I guess the junk rating on Greece may have been a surprise, but come on, when the 2 year note was yielding 11% how in the world can it be anything other than junk?

The market has gone up for 8 weeks in a row and while the talking heads thought this perpetual “tortoise rally” was normal anyone who has even a little investment experience knew it was not. I still remember Dennis Kneale, last week, calling people who held cash “fraidy cats” because the market is back and it will be a bull market forever. The world does not work like that and the risk trade has been, frankly, out of whack. Money has been pouring in to everything from high yield to emerging markets in the expectation of a steady 1-2% a day. This was verified from mutual fund flow data reported last week which showed investors moved more money into equity funds, for the first time in a longtime, and, in my mind, confirmed we must be near a top, dumb money always moves in after fantastic rallies.

Whether or not this was a top remains to be seen, but it certainly looks like it from my lens. I have been wrong before and might be again, which I admit. However, even though I was wrong it doesn’t mean that the markets were right either. Earnings are better, I still see some misses in revenue though, but the underlying macroeconomic data has merely gone from very bad to just plain bad. When we cheer a 57% confidence reading that is a problem because that it is a horribly low number. The housing data is not verifiably strong when you have, like in October, a rush of people buying for the tax credit right before it expires. If the housing numbers stay “strong” for May then you may say housing is rebounding, but I highly doubt we will see such strong numbers at that time. Housing is a key indicator because it employs so many people and homes were the collateral that were the bad debt sitting on bank balance sheets.

Unemployment remains incredibly high, use the U-6 data not that foolish headline number, which is a severe problem. Given that weekly claims have stabilized at -450K is horrendous at best. That number shows that private employers are still shedding jobs and I am confident that the employment report next week will show “stellar” job creation in the government sector and in the temporary help area, those are not good areas to see growth in. I am a believer that the temporary help is just that, temporary and will not convert into fulltime employment, we would be seeing that conversion by now, but we are not. Housing problems plus high unemployment will keep the economy down for some time.

On top of the squishy soft economic data being heralded as a full blown recovery, don’t get me wrong less bad is a welcomed improvement, we have a sovereign debt crisis. People claim that Greece is only 2% of Europe’s GDP and dismiss their troubles. That is a bad idea because while they are right about Greece they conveniently forget that all the PIIGS account for some 13% of Europe’s GDP and they are all in trouble. Spanish and Italy’s bonds have been trading lower pushing their yields up over 4% and Portugal was officially downgraded, that is all really bad news. Each country, individually, is not a big deal, but combined we are talking about the potential to default on hundreds of billions of dollars worth of sovereign debt.

To put this into prospective, France owns some $781B of PIIGS debt, if they all default what will happen to France? They will be in trouble, of course. Then there is Germany, how much PIIGS and French debt do they have? I do not know, but I assume a lot. What will happen to Germany if they get stuck with declining value of all that paper? They will have to bailout their banks, I assume France would have to do the same for their banks as well. That, basically, puts the banking system in jeopardy again, in less than 2 years. What I am explaining, probably in a horrible way, is what contagion looks like and it doesn’t end there either. The U.K. has exposure to all these countries and they are already in horrible financial shape and the series discussed above makes the U.K. susceptible to the contagion.

U.S. banks have exposure to both European banks and sovereign debt which means out fragile banking system could face another challenge. Let us not forget that the U.S. is also heavily indebted, along with Japan, and people may start to question the safety of U.S. Treasury debt, as they should I might add. From my lens, in a worst case scenario, meaning this all happens, it would be a coin toss as to which country goes next, either Japan or the U.S. given their immense debt loads. This scenario is unlikely or has a low probability of happening, but it is possible and it could trigger a global currency crisis.

This explains why gold went up today in the face of a stronger dollar and a rush of selling from the market. Even silver held its own today in the face of dollar strength. This shows that gold is still a flight to quality, it is also in a bull market as well, and it is a trusted currency. In fact, gold’s rally today is why I think it is possible for a global currency crisis because if this was another credit crisis, like 2008, it would have sold off for liquidity, but it did not. I am not sure if I would be buying gold right now because I already own a position, but if I did not own any gold I would be a buyer.

All is not well in the global markets and people should stay nimble as to where to put their assets until things settle down. I would say this decline is extremely bearish and way overdue, the higher the market went the worse the selloff would be, which could make it worse. It was insane to think that volatility would not comeback and that people went from sheer panic a year ago to such utter complacency this year. The worst part about all of this is if this does trigger another crisis what can the Fed or the governments do to calm the markets or remedy the situation? Nothing, they already spent all their ammo and they even had to borrow some to boot. I am not saying this will trigger another crisis, but it certainly has all the ingredients for one, if you look at the big picture.

It was funny to see many of the pundits spin bad data on the weather. This equates to my daughter saying the dog ate her homework. It is hard to believe the snow is to blame for higher initial jobless claims when we are in the middle of winter. However, I will concede that retail sales will be pretty horrible because of the weather, but other pieces of data, well, not so much of that weak data can be blamed on some snow.

Housing starts stink because the housing market is in trouble and even massive government stimulus is not helping. My guess is this data will probably improve in March to April because of the last minute rush to buy homes, but I would not count on that being much of a bump. What is worse is that the President wants a permanent moratorium on foreclosures which is doing no one any good and, in fact, will hurt banks that would not be able to collect or sell an asset that is earning them anything. I am referring to Obama’s demand that before a foreclosure can happen it has to pass through the re-modification process. Capitalism is officially being suspended until further notice.

As far as jobless claims are concerned, they are going to get worse as far as I can see. I am basing this on antidotal evidence of firms continuing to announce layoffs and a jump in the mass layoff indicator a few days ago. It is crazy to think employment will improve when you have blue chip companies announcing layoffs and claims are heading back above 500K a week. This is not because of the weather it is because the economy stinks. David Rosenberg calls this a Houdini recovery and he is correct. Besides a statistical recovery and a rally in equities, which is odd considering the dismal news over the past 2 weeks, the average person is worse off than they were last year. Again, unless it has been snowing for 8 months it cannot be blamed on the weather.

Perhaps it is snowing in Greece as well, that will explain their financial problems. It is true that the weather hurts certain things, but it has a rather limited impact on employment. After all, snow removal companies would probably be hiring. The weather might hurt retail sales, but with more people using the internet, me included, to shop I would not buy the soon to be claim that the weather killed retail sales. This is all about uncertainty in the world and to deny that there is uncertainty is simply crazy.

We have problems all over the place from domestic issues to possible sovereign defaults. Let us not forget we will witness municipal bankruptcies in the near future as well, chapter 9 is the more likely bankruptcy procedure. Health care reform is back and will be passed, whether you like it or not, and believe me you should be careful what you wish for because this means higher premiums for everyone. Do you really think Anthem raised prices 39% because they wanted to? Nope, it is because, I as speculated months ago, they know they are out of business in 4 years. All of these things mixed with tight credit conditions means tons of uncertainty.

Why the markets are not down 200 points, I do not know. However, it appears that Goldman Sachs was a huge buyer or S&P 500 futures yesterday, according to Zero Hedge reports, which made this a futures driven rally, check out the trading between 3 and 6AM for more weird futures action. I do not want to spread conspiracy theories, but all I am saying is the markets are trading very odd right now. I am still very bearish, how could anyone be bullish with the horrible data we have seen as of late? This is not 1 week of bad data, but 2 months worth of bad data and the market ignores it, weird.

If you believe the recession is not over or we are due for a double dip then this employment report was certainly bullish for put options or leveraged bearish ETF’s. If you are a long only bull today’s report should make you move a bit more defensively. While the rate of firings has certainly been declining the real question is why are we losing this many jobs at this stage of the supposed recovery? I can hear it now, employment is a lagging indicator, sure, for an inventory led recession you would be correct, but not for a credit collapse, sorry.

More on the employment report in a second, I love government data, but there was a piece of a lesser reported report data released today as well. Credit contracted at a hefty $15B clip last month compared to the consensus estimated $5B, this is a problem for the V shapers. Contracting credit at this level means that consumers are still deleveraging and it indicates that they will be buying less iPods and Kindles in the near future. However, consumers shedding debt is a good thing because debt is wealth destruction and maybe the government will begin to figure out what the majority of Americans have already figured out, spending money you do not have is not a good idea.

Do we really have 10% unemployment? Not a chance, it is much higher. The BLS is constantly taking people out of the employment pool which lowers the unemployment rate, except on the U-6 report. Let’s not forget about the BLS’s birth/death model which is constantly giving us a major fudge factor for jobs. For example, in December this model added 59K jobs, meaning the BLS estimates that 59K people started their own companies. It gets better, if you go to the BLS website birth/death page it shows that during April of 2009 it estimates 226K people started their own business, when no credit was available. This fudge factor was so bad that the BLS will have to adjust the numbers at some point in time, like February 2010 when the BLS will add, officially, 800K to the unemployment rolls, because even they cannot hide how bad it was/is forever.

The length of time it takes people to find work is at record levels, the medium time frame is 20 weeks, but it takes about 40% of unemployed people 29+ weeks to find a job, if they find one. This is where it gets interesting because the longer it takes to find a job the more discouraged you get and the less you look. The less you look, the less “attached” you are to the labor forest and the BLS will just remove you if you stop looking for work, see no evil, hear no evil…

Basically, if the BLS left the “marginally attached” people in the employment report the official unemployment report would have grown to about 10.4%. Now, after spending $1.6T in stimulus and job creation bills this is just getting less encouraging and downright scary, unless you are delusional to reality. There was one bright spot in the report, well 2 bright spots, November was revised to positive 4K, which is completely unbelievable and inconsistent with all the data for the month of November, and temporary help increased for December. I want to say this again, at this stage f the recovery, how can we still be shedding jobs when every pundit has said that firms have cut to the bone or over fired? Clearly they were wrong.

While I do not believe the November employment report, simply because it does not match any of the interim data, let’s assume it is correct and we had +4K in job creation, so what? Sure, that might make some feel better for potential future job growth, but it was, in large part, due to temporary employment hiring for the holidays, so it is relatively meaningless. Even with all this infrastructure spending and stimulus we are still losing a construction job, which is not good. With productivity at a mythical 9% we are still losing manufacturing jobs, which is horrible. Temporary employment is just that, temporary and meaningless.

Everyone is making a big deal over this temporary employment hiring because it is a precursor to more hiring, supposedly. No, it is not, sorry. I would like to agree with everyone that large seasonal temporary hiring will lead to more hiring in the future, but it is not, period. Here is why, these temporary jobs were created exactly when most temporary jobs were created, October, November and December, this is for the holiday shopping season. I would expect these people to start being laid off in the middle of January after the shopping season is done.

My view on temporary help is pretty simple and I know many will disagree with me and that is fine, but temporary help is brought on to keep costs low and, in this case, to prepare for the inventory rebuild. After that is done the temporary help is let go and the company does not have to pay any severance or, while they are working for the firm, any benefits and they pay temporary workers a lot less than their fulltime counterparts. I do not believe it is leading up to fulltime employment or a precursor to more hiring in the future in this case. In the past that may have been true, but in this recession or depression we are going to have a very uneven recovery or a double dip and firms know this so temporary help is just as the name implies, temporary.

If CEO’s really believed in a V shaped recovery like most of the pundits why in the world are they net sellers of their stock? My point is pretty simple, if employment was going to improve and demand was going to pick up CEO’s, who know their companies and industries the best, would be buyers of their stocks, they are not. If they are not buying their own stock they surely are not going to hire these temporary workers, sorry.

To sum up today’s employment report, it was horrible. I was not expecting a report this bad and I am a bear. The absolute irony is that the market did shrug off this bad news so it is likely that we will see 11,500 or maybe 12,000 on the Dow and 1,200 on the S&P 500 before the big selloff comes, but don’t kid yourself, there is going to be a selloff. That is unless you think the markets are supposed to go straight up and break all resistance with absolutely zero volume? The unfortunate part is that by the time the correction comes there will be many more unsuspecting people sucked into the market only to suffer more losses. Regardless, let us hope we do not have more employment reports like this, if we do I do not know what to tell you because that would be a signal of a major fundamental problem with the economy.

What no one wants to talk about, ever, in terms of retirement planning is the sequence of returns and the impact on retirement planning. I am bringing this up now as we wrap up the worst 10 year period ever in the S&P 500 we have ever had. In fact, technically, this is the only official 10 year period of time the S&P 500 has ever been negative. I say officially because the 10 year period is subject to interpretation, but regardless we are looking at a period of time wrapped by 2 of the worst periods ever to invest in the equity markets. In other words this decade had the mother of dumbbell negative returns ever.

What the impact of this 10 year period has had on retirees will be felt for the next couple of decades. Essentially, many retirees or pre-retirees have been wiped out or will have to drastically alter their lifestyles in order to make their money last. While I could easily blast the likes of Scott Burns, Suze Orman and a million other drive by financial advisor writers for dispensing horrible advice that they likely did not even follow themselves, I will not. They simply told people what they believed to be true because they used flawed logic and ridiculous assumptions that normal financial advisors would have dismissed as idiocy, not that they are innocent either, but they were the targets of these writers inept ridicule for long enough.

The simple fact is this, everything has a cycle whether we are talking about the Earth, the moon or the markets they all of a cycle. When we look at market returns sometimes the cycle shows an unmanaged index does substantially better than managed money while at other times managed money does better than the unmanaged index. Over the past 15 years we saw the unmanaged index do better than managed money, but will that trend continue? Unlikely. That cycle has run its course from my point of view, sure there will be stand out sectors, but that is it. If you go back in time to the 1970’s it is fair to say that this theory of mine pans out and managed accounts did better than the unmanaged indexes, but you know me, let’s not let the facts get in the way of what they pawn off as the truth.

The beginning of this decade should have been the warning sign for those following the advice of the financial rags who themselves have never ran money or witnessed what it is really like to lose someone money. Instead they blast brokers for making money and tell you to buy an index fund because over the long-term “nothing outperforms the S&P 500,” how’s that working out for you? Simply put, they did not know their history and they over simplified a very complex thing, your retirement planning. Retirement planning is complicated and deeply personal and no one, I really mean this by the way, should ever take their retirement planning advice from the TV or newspaper.

With hindsight on my side, unfortunately, it is now clear that these people did not know what they were talking about. Not only that, but their intentions are now out for everyone to see. One person mentioned already, who always advocated Vanguard index funds, opened an RIA firm and will gladly manage your money for a small fee, even though he said brokers were crooks before, unless he is the broker I guess. The other person sells binders for $50 or $100 that you can buy at Staples for $10 or $20, but since they are branded with their logo or some other nonsense they are worth more, I am still trying to figure out why that is. Either way, to their legions of devoted followers their betrayal means nothing or they will continue to mindlessly follow them, which is astounding to me, even though they destroyed their wealth. Here is what I mean.

The sequence of returns is the timing of returns, either good or bad, and the impact on your portfolio. This is the most important aspect of investing and the biggest ‘Black Swan’ there is because it is out of your control. This is why asset allocation is so important when you are talking about your serious retirement money. I have a larger portion of play money that I speculate with, but you better believe that my real money, my retirement money, is not in some E-Trade account with my finger on the buy/sell button all day long. I have a plan with my real money and I do tinker with it occasionally, but only when I feel the need to be more conservative or more aggressive, but it is professionally managed, not by me, to keep my emotions out of the game. However, the sequence of returns is always ignored by most gurus I read or listen to and it will devastate you if you are not careful.

If you invest and instantly lose 10% for the first couple of years it takes you a very long time to regain those losses or exceptionally high returns for a few years. It is even worse if you are taking income from your portfolio which is the case for many retirees, unfortunately. I am going to concentrate on those taking income from their portfolios in this example, just 5% income I might add, because many Boomers retired either in 2000 or in the last few years, either way you will get the point. I am not even going to show you the double whammy of the dumbbell negative returns because that is so depressing it is not even funny. In fact, this will be and is such a serious problem I am not sure what can be done about it because literally millions of Boomers are in serious trouble now.

Here we see someone who decides to retire and rolls over his 401K and listens to a buy and hold indexing guru. They decide to invest into a generic fund and let it all ride thinking that 5% withdrawals should suit them just fine, since he is told the market averages 10% over the long-term, another farce I might add. Unfortunately for this investor he got suckered into a bad time to invest and the market fell 10% for the first 2 years he owned his fund, but no problem writes the financial guru, just hold on and everything will be fine, really? Well, you tell me if everything looks fine to you.

Exhibit 1-1

Keep in mind, I am not showing any other negative returns, not even a negative 1%, and I am showing +8% returns for every other year in this illustration. I am also showing a straight 5% withdrawal rate, not ever a little more for the grand kids, to pay the taxes or medical bills, just 5%. This person runs out of money in about 20 years with 2 negative years right off the bat and they did not even look that bad, 10% market declines are, well, normal right? That is just one illustration of the sequence of returns and how they can impact the investor, not imagine if I put in the 2008 50% decline in there, there would not be anything left. I also ran this with 6% withdrawals, but the only difference is it gets uglier faster.

There is nothing you or I can do about the sequence of returns, but I have never seen something so important ignored before. While we are wrapping up the worst decade on record for stocks don’t you think we should talk about this stuff a little bit, especially since Boomers are about to retire in droves, well they were at least. Frankly, those bond funds everyone is slamming right now, do you know why they are so popular, not that I agree with it I might add, but they are so popular because they have positive returns on the 5 and 10 year benchmarks. Look at equity portfolios, most funds look horrible, except some managed funds I might add, but in comparison investors are saying, well sure this fund only did 5%, but it is better than the -3% I did over 10 years, so buy it.

I may sound bitter, but this is serious stuff that people just take so lightly and it drives me nuts. CNBC is now all about entertainment, not about serious news anymore which is a shame. The personal financial gurus are all about selling their latest book rather than helping people do real things, but maybe it is the peoples fault when you have to have a segment called can I afford this. People, if you have no money in the bank, in debt up to your eyes, make $50K a year, then no you cannot afford a $700K house, it is common sense. However, even though they are getting calls like this it does not justify giving out poor advice, ignoring history, not understanding the sequence of returns, the basics of asset allocation, vilifying brokers, picking on products – yes folks a variable annuity turned out to be the best product in the world to buy in 2000, and simply recommending index funds because they are index funds – a monkey could do that.

It is always fun to make forward looking statements or predictions even though no one knows what is really going to happen. I decided to write this piece because Dennis Kneale was bragging about his wonderfully generic and completely mindless 2009 predictions he wrote last year which he claims was 90% accurate, even though it was the equivalent of a John Edwards show accurate list of junk.

Sorry, but predicting ‘corporate smashup,’ which I am not even sure if that is an actual technical term or not, but regardless, is as pretty generic as you can get as the government was passing out bailout money like mad. My other favorite prediction was that the Big 3 would get bailout funds as they were begging Congress for, drum roll please, a bailout, I mean seriously. The mindlessness went on of course, but that is Dennis for you, so I figured I would actually go out on a limb and make real predictions, and not use general ‘corporate smashup’ terminology.

I am not picking on Dennis, ok I am, but its fun! In all fairness to Dennis 2009 was a tough year for him as CNBC teased him with his own show only to take it away from him. He clearly is putting all that weight back on again, hey we all face the battle of the bulge at one point or another though. He got smacked by multiple guests for being an idiot because, well, he’s an idiot. The real irony is his 2010 prediction of Twitter going under is already in the can as they just inked 2 deals worth millions, wrong again Dennis and it is not even 2010 I guess VC money is a lot smarter than you, go figure.

Here we go, 2010 predictions:

1. Sovereign debt issues will escalate in Eastern Europe, meaning defaults because no one cares about that area. Dubai will not receive more exceptional help because they will be “made an example of” by its neighbors. Greece will be bailed out by the EU, go figure. However, emerging market debt will be OK.
2. Unemployment does not improve and will reach 11.2%, unfortunately. U-6 unemployment/underemployment will reach 20%+.
3. A third party will be formed in the US, but not in time for the midterm elections.
4. Democrats will lose the majority in the Senate and the super majority in the House, but not the majority.
5. Obama’s approval ratings will mirror Bush’s as he pushes cap and trade which is unnecessary and punitive to the American people. He will learn that there is a price for over exposure, seriously, we do not need to see him every day and he is no FDR. Unfortunately, if we give anyone any credit for the BS growth we are witnessing it is the, I can’t believe I am going to say this, the Fed.
6. Bank failures will reach over 300 for the full year.
7. We will see a spectacularly large bank failure next year, obviously not a too big to fail, but a large institution. I actually would place the FHA in this category, but it could also be a large regional about the size of a Key Bank, I refuse to give my prediction because of legal reasons and Key Bank is for comparative purposes only, but they are not in great shape.
8. We will see inflation and the Fed will be unable to raise interest rates due to the unemployment picture. For the first time we will have a recession, or whatever we are calling it by then, with rising prices.
9. Health care premiums will go sky high because the biggest sham of “reform” just got past by our elected officials who do not understand how the system actually works.
10. Some nut job attempts to shoot investment bankers because of high bonuses they will receive. I am not advocating it, I think it is stupid and it will be senseless, but there is a high probability that some nut job will do it.
11. High frequency trading, dark pools and other questionable practices will be regulated or severely restricted by Congress through legislation. Whether or not this is a good thing remains to be seen, but I would suspect it is.
12. The market suffers a sharp and severe correction as people realize that stocks do not go straight up and the markets actions have deviated from the realities of the economic conditions. When this happens is anyone’s guess, but it will happen.
13. We may see a 5% GDP print, but those numbers will be severely revised down and we will see the weakest ‘recovery’ ever in the history of recoveries from recessions. After we had spent some $2T+ fighting this economic downturn which will astound the public. The average recovery in terms of GDP growth is well above 6%, but the latest revision for 3Q09 GDP is 2.2% which is appalling. Remove government spending, just forget it because you don’t want to know.
14. The dollar will have some strength before the Fed realizes that it must double its balance sheet again and we will then see new lows in the DXY by year end.
15. Gold will reach new nominal highs.
16. The debt ceiling will be raised again to $16T before they eliminate the debt ceiling completely. I am kind of kidding here, but seriously why have a ceiling when as soon as they hit it they just raise it?
17. Emergency tax hikes will be enacted by summer bringing top marginal rates to 40%. Capital gains tax rates will increase to 25% and dividends will revert to ordinary income. I would not be surprised to see a VAT enacted as well, just because.
18. Google takes over the world because Android is really a secret mind control device that when Eric Schmidt gives the secret command, I hear the word is ‘snicker doodle,’ everyone with an android phone will do Google’s bidding.
19. Obama will finally fess up and admit that he was born in Kenya followed up with the following statement; “what are you going to do about it?”
20. Mark Haines finally snaps on the air and starts babbling incoherently to himself while swatting at invisible bugs… wait he already does that.

There you have, Ray’s long list of predications for 2010. Some will happen, most won’t, but they are fun to guess at. I also have a wish list that involves people joining that 11.2% projected unemployment rate because they deserve it, but since its Christmas I will refrain from printing such a negative list. However, I am sure you have guessed that one of those wishes, projections, is that Dennis’s contract will expire at CNBC and we never see him again, I can dream. However, as we have seen from other failures like Ron Insana no matter how bad you screw up that network will always take you back. Man, how do I get a job there? Merry Christmas, yeah I am not politically correct.

This seems to be a continuing theme for whoever is driving the markets to the moon, sell the dollar and buy equities. If you were watching today you would have noticed that oil, gold and stocks were trading down to relatively flat. Right about 12:00 the dollar started to decline which drove stocks and commodities higher.

This is a continuing trend within the markets and the primary reason why we have had such a dramatic rally. However, the reduction in buying power is not worth the trade off, in my opinion. If you are watching the news channels they attribute the markets turn on higher oil prices and virtually ignore the dollars plight, even though it is a weak dollar that moves oil. Why are they ignoring a declining dollar, I do not know, but they are.

There is really no reason for the market to be positive today as unemployment numbers were not very good, but, I guess, no revision in 2Q09 GDP was somewhat good news. Either way, we are seeing continuations of a very tired bull market were the likes of AIG, Citi, Fannie and Freddie are the market leaders. While the talking heads applaud this move I am reducing my equity position to 7%, down from 25%, most of which is international holdings.

Frankly, we are setting ourselves up for a most painful selloff which I am choosing to not participate in. I do not know when it is coming, but it will come and I am sure it will be brutal. The likes of Mark Haines seem to think that my view is very bullish for stocks, maybe it is, but I consider my view to be balanced with the data on hand. The data I see is horrible, frankly, and when AIG and Citi, both of which heavily owned by the government, are the market leaders then we have a serious speculation bubble building.

Examine the chart below, the data at hand and make your own call. I am sticking with the call I made 3 weeks ago, which we are barely 2% higher than now, of a market top. Of all the people I have spoken to, no one understands why we have not sold off yet and, perhaps, we will not. Until earnings catch up with valuations or valuations trade down to earnings I am very bearish on equities.