This Economy Is Getting Uglier

This week things got a lot uglier with Thursday's employment report along with other news in the financial world that we'll discuss in a moment.

For our part, our positions on the "short" side of the market performed well with unrealized gains of +2.0% in our interest rate position, +1.2% and +3.3% in our two inverse index positions and 0% in our currency position.

We continue in the "Red Flag" mode as we expect lower prices ahead and those expections were bolstered by this week's news and market activity.

Chart courtesy of StockCharts.com

In the chart above, you can see the SPX breaking its 50 day moving average and coming within 1% of its 200 day moving average. MACD remains on a "sell" signal" and the significant support at 880 and the 200 day moving average will make or break the "green shoots" rally. A break below 880 will be significant and set up a very likely retest of lower lows.

We will increase our inverse exposure if the likelihood of further declines increases through the summer. At the present, we are still 60% in cash and that could decline to 20-40% as we move further to the inverse side of the ledger if this new trend in fact takes hold.

The View from 35,000 Feet

The big news this week was Thursday's employment report which was truly a disaster.

467,000 jobs were lost in June compared to an estimated 350,000 and the news threw a huge wet blanket on the notion that recovery is just around the corner.

One of my favorite economists is David Rosenberg, former chief economist for Merrill Lynch, who wrote,

At no time in the 1990 or 2001 recession did we ever come close to seeing such a detonating job figure, not even at the depths of those drawdowns, and yet we have a whole industry of "green shoots" advocates today telling us that the recovery has already arrived.

He goes on to say,

In almost every industry, job losses were deeper in June than they were in May and the diffusion index fell to 28.6 from 31 which means that nearly 3/4 of the corporate sector is in the process of shedding jobs.

Furthermore, he reported that 2 million workers were pushed into part time work and that the average workweek reached a record low of 33 hours. If work week hours had remained the same as they were in May, this month's job losses would have been a shocking 800,000 decline.

And Nobel Prize winning economist Paul Krugram wrote that "we're going to need a bigger stimulus," because even with the Obama stimulus, "we're still 8.5 million jobs in the hole."

These guys are a lot smarter than I am, but more and more, it's looking to me like deflation is just ahead. And after reading that unemployment is climbing past 9.5%, the highest since 1983, I can only wonder how the consumer will be able to power any kind of recovery in our consumer based economy.

In the financial world, things look no better. US consumers are down about $15 Trillion in household wealth since 2007 and prime mortgage delinquencies doubled in the 1st Quarter as even good borrowers are unable to make payments due to job losses. The Case/Shiller housing index declined -18% year over year, and if you want a real shock, just go to zillow.com and plug in your home address and take a look at what your house is estimated to be worth today.

And very likely there won't be any improvement here as interest rate resets on variable mortgages peak in 2011 and commercial real estate is "the next shoe to fall."

Add it all up, and it's no surprise that bank regulators shuttered 7 banks this week, the highest weekly total since 1972, and most of those failures were attributed to sour construction and commercial loans.

Finally, India, Russia and China are ganging up on the U.S. dollar and suggesting more loudly and more frequently that the dollar should be replaced as the world's reserve currency.

The Week Ahead

This is a relatively light week for economic reports but the big news will be the start of earnings season with Alcoa (AA) on Wednesday. Overall earnings are expected to decline -35% so it could be an exciting few weeks, punctuated by this week's G-8 Summit in Italy.

So, never a dull moment as we work our way through the longest recession since the Great Depression.

Tuesday: June ISM Services Sector

Wednesday: May Consumer Credit

Thursday: Weekly Jobless Claims, May Inventories

Friday: Michigan Consumer Sentiment

Sector Spotlight

Weekly Leaders: Inverse ETFs, Taiwan,

Weekly Laggards: Silver, U.S. Oil and Gas Exploration, Financial.

Disclosure: TLT, RWM, DXD, YCS

Comments

[Roger Knights:]

"A break below 880 will be significant and set up a very likely retest of lower lows."

Even a break below 890 would be significant, because it would break the neckline of the head-and-shoulder top.

Jul 05 07:06 AM

[cameroni:]

For sure. You are right John. Deflation is ahead. It is here now. And a really serious deflation coupled with massive job losses, large reduction in consumption will call for massive stimulus and monetization off the charts. Particularly if that deflation is global in nature. And here of course I want to challenge the ideas of some who contend that an export driven economy like China can possibly pull the globe out of it's death spiral when buying is grinding to a halt almost everywhere.

Stimulus is clearly needed to offset declines in economic activity. But the act of stimulus is only inflationary and more inflationary over time as fiats are devalued to re-energize flagging economies.

More and more, it's looking to me like hyperinflation is the real threat in the future. Given all the facts we are well familiar with now there cannot conceivably be any other outcome.

"On July 5th 2009 John Nyaradi wrote:

"These guys are a lot smarter than I am, but more and more, it's looking to me like deflation is just ahead. And after reading that unemployment is climbing past 9.5%, the highest since 1983, I can only wonder how the consumer will be able to power any kind of recovery in our consumer based economy".

Jul 05 07:13 AM

[coldcall:]

Ya i dont see inflation problems just yet. Surely we need to see a real turnaround in the economy before inflation starts to be a danger?

Jul 05 08:15 AM

[User 143167:]

If China's economy goes up by 14%, you will have a stagflation.

Yes, I know you guys think that call is crazy. But look out, China has HUGE room to leverage up its system. They just did not do that. As now they are in the panic mode, everything could happen.

Count the M2 in China, it is 52trillion RMB!, equivalent to $7.5trillion. What is the M2 in America? $8trillion, no bigger margin there. And you think the RMB is way undervalued? Wow, those money will blow the world if they throw them out. Watch out!

Jul 05 10:14 AM

[derryl:]

An interesting note about foreclosures: I read a SA article yesterday showing that the bulk of foreclosures are not in subprimes or even resets but in prime loans where no money was put down on the purchase. With no skin in their underwater mortgages people are doing the rational thing and walking away.

Jul 05 12:34 PM

[T.Stamps:]

How can we expext any kind of real growth and optimism when
our leaders believe in socialism/fascism.

Jul 05 02:07 PM

[darrenlobo:]

I have to respectfully disagree with those who think we can't have recession & inflation. It happened here in the '70s. I also saw it when I lived in Venezuela in the '90s. Over there inflation went to just over 100% per year with negative growth. Sadly, we're repeating the same mistakes. See "Venezuela: From Showcase to Basket Case" www.cato.org/pub_displ...

Jul 05 04:33 PM

[bigmoney:]

what inflation? Helicopter Ben was lampooned throwing cash out of helicopters, presumably getting cash into the hands of eager consumers. However, just trucking cash over to bloated banks who just give their execs even fatter bonus's isn't inflationary.

Jul 05 10:36 PM

[WorseThanYo...:]

> And after reading that unemployment is climbing past 9.5%, the highest since 1983, I can only wonder how the consumer will be able to power any kind of recovery in our consumer based economy.

The problem here is that 1983 unemployment doesn't match 2009 unemployment. G.W. Bush changed the definition of "unemployed". You are now only "unemployed" if you are receiving unemployment benefits. Those run out, so you are no longer counted. The actual unemployment rate is probably between 16% and 21%, and that does not include the underemployed.

Jul 05 11:19 PM