This last week was very much up and down for all markets.  For the week the FTSE December futures managed to gain 41 points, The S&P500 lost 8.1 points and the DJIA  lost 23.7 points.  Monday provided the biggest swing with the DJIA regaining the 10,000 level again, finishing below 10,000 on Wednesday, above on Thursday and below again on Friday.

Most of the swings up and down can be related to the earnings being released. On Thursday initial unemployed came in higher than expected, but this was overlooked by the market.  On Friday the FED took over another 7 banks, raising the total bank failures for 2009 to 106.  More to come.

New home starts came in better than expected. Should we be suprised with the government handing out tax breaks for first home owners. That brings us to the amount of fraud involved in these first home owner tax breaks.  Many thousands have been found to be under 18, the youngest was just 4 years old.  The IRS is making a special check on those that have claimed the break.  There are going to be a lot of unhappy claimants.

Next year there are Congresional elections in the US. (November 2010) Things are starting to become unstuck for the Democrats.  Record unemployment, house prices still falling to mention just two.  Obama said today that his administration will not rest until everybody looking for work can find a job. This is what you might call a hollow promise, it will take years years before unemployment gets anywhere near pre crash levels, even then at 5% unemployment there are people looking for jobs. We can expect to see more “stimulus” in the next year.

The UK seemed surprised this week to discover GDP contracted when the market was expecting an expansion, making it the longest recession on record.

Meanwhile oil continues on the up and up and the US dollar on the down and down.  Gold is well established over the $1,000 per ounce.  So far October has not been a down month, and with only a week to go, it looks like this October will go against the odds.

It looks as though the markets were being held up high for the expiry of the October options. Talking of market highs it is interesting to note that the high for the December index options for Wednesday, Thursday and Friday were 5243.5, 5245 and 5245 respectively. A clear triple top. Is this significant? Probably, the market is way ahead of its self and reality has to kick in sooner or later.  The FTSE having surged through the last resistance point I mentioned last week has now created a new one at 5245.  There is also a long standing resistance level at 5300.

Much of the rally can be laid at the door of the DJIA. It managed to close above the 10,000 level for 2 days. It could be a short lived celebration.  In the last week oil has gone from around the $70/bl to $78.50/bl and the US dollar has lost ground against virtually all currencies. There is talk in Australia that the Ozzie dollar will be at parity with the US dollar and even go past parity in the not too distant future.

So what caused such irrational exuberance to drive the DJIA over 10,000?  Part is that 79% of the companies that have reported their earnings so far have come in “above expectation”. Discounting the banks, this has been due to “cost cutting” (read laying off workers). This is something that cannot be repeated over and over again. The favoured “Big Banks” (those too big to fail) are having a field day, borrowing money from the FED and lending it back again.  Also most of their huge profits have come from “trading”. Another reason we have seen such a big rally.  The smaller banks are doing it tough. Another failed last week bringing the total for the year to 99. The really bad news for banks is only just starting.  A big proportion of a banks lending portfolio is in commercial loans, and these are turning sour at an increasing rate.

The news is no better on the housing front, US foreclosures jumped to an all time high of 937,840 in the third quarter, that is a 23% increase from the same quarter last year. Interestingly the proportion of sub prime mortgages in forclosure is decreasing but the proportion of prime loans being forclosed is increasing. Then we have the ARM’s (Adjustable Rate Mortgages) that are resetting to (much) higher rates. 46% of option ARM’s are currently 30 days past due, despite the fact that just 12% have reset to higher payments.  There is no light at the end of the housing tunnel yet.

Again on Friday the Michigan Sentiment reading was announced.  The market was expection a result of 73-74 but it came in at 69.4  The market might think all is well, but try telling that to the person who has lost their job, or taking less money for working harder, just to keep their job.  Then you have all the new workers straight from school or college that are looking but can’t find a job.

Not withsatnding the comments from last week the FTSE rose again through the 5000 level to finish the week at 5128, a rise of 162 points for the week. So the support level mentioned last week of 4925 was respected. The resistance level of 5175 looks like it will be tested again.

It has been a week of mixed signals. Gold has reached new record highs, the US dollar is sinking against most currencies. Alcoa made a profit for the last quarter after shedding thousands of jobs plus a rise in the price of aluminum. Then Australia raised the base interest rate by 25 basis points which gave a boost to the US markets.  It is all illogical.

Banks in the US can borrow short term money from the FED at almost zero interest, and then lend it back to the FED (by buying 30 year bonds) at 4% interst.  How long can this shell game go on?  Governments around the world increased liquidity to ease the credit crisis, but did the banks lend it out again? No, instead they invested it where they could for a quick profit, hence a 50% increase in stock markets since March.  This is way ahead of the health of the companies these shares represent.

The US government has spent billions trying to prop up the housing market.  First they had to bail out Fanny Mae and Freddie Mac, then they have the First Home owners grant of $8,000 (about to expire in November), and to top it off the FHA (Federal Housing Administration) which insures mortgages with low down payments, is already in a loss position of $54 billion and rising.

The world is loosing faith in the “strong US dollar ” mantra that gets repeated regularly by the treasury. More talks are going on about creating a new reserve currency made up by a “basket of currencies”.  If this happens you can wave good bye to the current US dollar.

In John Mauldins letter this week he quotes from a study by Peter Bernholz at the University of Switzerland.  Bernholz analysed the 12 largest episodes of hyperinflation, all of which were caused by financing huge public deficits through money creation. His conclusion: the tipping point for hyperinflation occurs when the government’s deficit exceed 40% of its expenditures.  The US is at this point now.  The only thing keeping the US going is that the US dollar is the “reserve currency” of choice.  But this can change quite quickly, then what?

There is a good reason for calling it Red October as historically it is a month when the markets go down, sometimes by large amounts.  In my last post I was saying the the rally had got to a ridiculous stage, now I believe we are seeing the start of the long awaited correction.  I have two charts for you this week.  The first is a daily chart which shows the market has reached a support level of 4925

The next support level is 4500, then the July lows of 4075. If the market breaks through these levels then we are looking at retesting the March lows of around 3500.  But lets look at the longer period. Here is a Monthly chart.

In this chart the market has broken the support level of 5000.  The next week will tell if the market bounces again above 5000, or heads lower. My pick is lower, but I’m sure you guessed that. Why am I so bearish? One reason is that John Mauldin is bearish, I have been reading his weekly eletter for nearly 8 years and over that time he has been the most accurate in his outlook.  This week is a “must read” I have a link under “Recommended” for you to subscribe to his letter.

Another 3 banks in the US failed on Friday, bringing the total to 98 for the year. Next weekend will see triple figures.  The FDIC is running out of money and bringing forward fees the banks have to pay.  The next problem for banks is that commercial loans are failing at an alarming rate.  Home foreclosures are still at or near record levels.  There is fear about what will happen to home sales when the first homeowners grant of $8,000 ends in November.

On Thursday the initial unemployed number came in higher than expected at 551,000. Over half a million people have lost their jobs in only one week.  On Friday the non-farm payrolls also came in higher than expected with 263,000 jobs disappearing, and the “official” unemployment rate climbing to 9.8%  Everybody might be saying the recession is over but in reality it will not be over until jobs are created, not lost, and unemployment starts falling.

This rally is getting to the ridiculous stage. There was a net loss for the week when I last wrote, but that has been overtaken for the markets to reach new highs for the year.  We have the expiry of the September futures and options tomorrow and we could see the start of a correction next week, but don’t hold your breath.

So what is causing this irrational exuberance in the face of the highest unemployment rate since 1982, falling house prices, record foreclosures etc,etc?

Everyone is talking up the market.  Bernanke came out this week and said that the recession is “very likely” over, so of course the market went up.  The US dollar is tanking, gold is soaring, CPI is increasing, wages reducing, yet all is well!  It is the old story, you can fool some of the people some of the time, but you can’t fool all the people all the time.  Lets look below the “robust figures”.

This week retail sales surprised to the up side, increasing 2.7%.  But how much of this was due to the FED’s various stimulus packages?  One commentator says 100% of the increase is due to the FED.  The two biggest factors have been the “cash for clunkers” and the “first home owners grant”.  I was reading an article this morning where a couple received their $8,000 grant and went out and bought a new leather couch, table and chairs, a new bed for their new apartment.  Would they have even bought the place without the grant, if they did it is unlikely they would have spent that extra $8,000.

The cash for clunkers has ended, the first home owners grant is due to finish in November, but already there are calls for it to be extended for another six months. Forty percent of home sales are going to first home owners. The big question is how many people would have bought a new car or house without the FED giving them money to do it?  It will be interesting to see the vehicle sales figures now the cash for clunkers has ended.

From Bloomberg this week Joseph Stiglitz, the Nobel Prize winning economist, said that the US had failed to fix the underlying problems of its banking system, and that the problems at the banks are worse than they were in the 2007 before the crisis. This comment is reinforced by three more banks failing this week bringing the total to 92 for the year.

I am a bear in my outlook, but I am not alone.  This rally is caused but all this cash from various stimulus packages and bailouts being parked in the market. Plus smoke and mirrors to lure the small investor back into the market.  It is working though, I just hope they are nimble enough when the market turns again.

Well it has happened, a week when the markets went down overall.  Though the US markets had an up day on Friday before the long weekend.  It is hard to see what caused such enthusiasm. On Thursday the initial unemployed came in highter than expected, but little notice was taken of this, the market has become used to people losing their jobs. Over half a million people were laid off in the week.  The market was waiting for the non-farm payrolls on Friday.  This number came in better than expected with only 216,000 lost when the market was expecting 240,000. But that is still nearly a quarter of a million jobs that are no longer available.

With the figures coming in consistently around the quarter million mark each month it is not so surprising that the unemployment rate in the US is now 9.7% (those that they count) and closer to 16% in real terms.  Considering that when the stimulus plans were floated, the recovery time was based on an unemployment rate of just 8%.  It is estimated that the countable unemployment rate will be over 10% by the end of the year and will not “top out” until over 11%. It could be that the recovery will take longer than first estimated.

All this means that although there may be a statistical recovery with some positive GDP numbers, there is no real recovery.  What we need for that is an expanding economy with  jobs created each month leading to more people in work etc.  So much was said over the last decade as to how the “consumer consuming” was 70% of GDP.  It is going to take a lot to get that consumption going again.

Last Tuesday was the biggest down day for several weeks, bought on by renewed nervousness about banks, and their profits, or lack of them.  With good reason, anothe 5 banks failed during the week bringing the total for the year to 89. At this rate of failures it will only be another few weeks before we are into triple figures for bank failures.  If banks are continuing to fail at this rate when the economy is meant to be “recovering” it would tend to suggest that all is not what it is cracked up to be.

The next couple of weeks will be interesting.  Was this week’s loss just a pause in the rally or the turning point?  Time will tell.

I am calling it a Lazarus rally because each time it should end it rises up again. But sooner or later it will eventually run out of steam and the next big down leg will start.  We are coming up on the anniversary of last years crash which could cause a bit of nervousness in the market.

It is two weeks since my last post and in that time the market has risen to a close on Friday of 4918 points, some 240 points higher than what I thought would be the top. It seems determined to make the psychological resistance of 5,000. However both the S&P500 and the DJIA had a down day on Friday.  This was too small to signal a change in sentiment at this stage, we would need to see some follow through this coming week.  Another factor is that Monday is the last trading day for the month.  Mutual funds and hedge funds like to be able to report positive figures for the month.  Will rationality return to the market?

John Mauldin’s e-letter this week is about Uncomfortable choices.  The US has now got its self into the position where some uncomfortable choices will have to be made.  The past decisions of taking the easy way out have now led to the situation where they have “painted themselves into a corner” and steps will have to be taken that will ruin the “recovery”.

Richard Russell of Dow Theory fame wrote this week about how the US national debt is now over $11 trillion dollars with an interest bill of $340 billion which is at an interest rate of about 3.04%.  The Obama administration admits that they will add $9 trillion to the national debt over the next 10 years, bringing the total to 20 trillion dollars.  If interest rates remained at today’s low level it would still mean an interest bill of 618 billion dollars in a year, around 1.7 billion dollars every single day.  He says, and I agree, that no nation can hold up in the face of these kind of expenses. Either the dollar will collapse or interest rates will go through the roof.

The choices that will have to be taken at some stage will cause pain and anger, and changes of government.  It is the politicians need to hold onto power by keeping the voters happy that will delay any action to the last possible minute.  Just think of the problems California is having.

I have given up predicting when the rally will end, but one thing is clear: just as an individual can not indefinitely live beyond their means, neither can a country.  Sooner or later the punch bowl will be removed. John Mauldin is predicting another recession and he reminds us that in a recession the market drops by 40%. He did say his past history is of calling recessions early, but they still come. So make sure you can exit quickly if you go/are long.

The rally which has gone on since the middle of July has got well ahead of the “recovery” such as it is.  I am sure it has sucked in many small investors, who having lost money in the crash last September-October, have re-entered the market, not wanting to miss the boat.  Now I fear they are about to lose again, as the market heads lower.  The reasons I make this comment are many, and I will try to cover the main ones below.  But first the chart.

The FTSE hit resistance with a double top at 4778 and 4776 on Thursday and Friday (September Futures).  This combined with the news out of the US this week could signal that this rally has come to an end and the market could be heading for another test of the March lows. This last leg of the rally has been all about “signs of recovery” (green shoots), and much tinkering with the statistics to give a rosy view.  Historically markets have often dropped in September and October including the 1929, 1989, 2001, 2008 crashes – and so the market is usually either quiet or slightly down or strongly down on these anniversaries. Given what I write below the markets have no justification to rise further.

HOUSING: Much was made about the rise in home sales, but a look at the actual numbers is not pretty. The market is divided between sales of foreclosed homes (damaged 26%, move-in ready 23%) short sales 14% (price lowered to achieve a quick sale) and only 36% for a non-distressed sale.  Foreclosures are increasing! Last Month (July) saw a record number of 360,149 properties that received a default of auction notice or were seized.  Next year will be the peak for Adjustable Rate Mortgages resets to higher interest rates so we cannot expect an improvment in the real housing market for at least another year, if then.

BANKS: Another 5 banks hit the wall, bringing the total to 77 for the year.  I read a while back that before this is all over as many as 1,000 banks could hit the wall.  With the increase in foreclosures above it is continuing to affect bank profits and will do for some time. One way some banks are making a profit is borrowing from the FED at near to zero interest, then buying treasuries from the FED with that money and earning 3.75%. Just another way of supporting the banks and making it seem like there is a strong demand for Treasuries.

Unemployment: Perhaps the biggest con of all. As mentioned last week it is a puzzle as to how unemployment can drop (percentage wise) when non-farm payrolls was minus 247,000 jobs for July. I find there is an official class called U-6. This counts all those not counted in the official figure. Those who have given up looking for work, or are employed part-time but want full time employment.  There are 2.3 million in the U-6 class. The loss of jobs since this recession started (8 million) has wiped out all the jobs created since the 2001 recession.  With the population increase in the US there needs to be 150,000 jobs created each month just to keep unemployment stable. So it does not take a genius to see that there is a long long way to go to recover the 8 million jobs lost plus the 150,000 per month needed to cover the increase in population.

CONSUMER CONFIDENCE: On Friday the University of Michigan released its consumer confidence figure.  It came in at 63.2 when the market was expecting 69-70.  Notice is taken of this figure because it is produced outside of the government, and is not subject to “seasonal adjustments”. Consumers are battered and bruised. Many have lost their houses or jobs, or both. Or they are in fear of loosing their houses or jobs, or both.  The mood is not good, they are saving frantically, paying down debt. Even with the “cash for clunkers” in full swing, retail sales were down.  Consumers are not spending which will have consequences further down the track.

So you can see from the above there was no good reason for the market to rally to the hights it has achieved.  The insiders have started to sell shares and there is a good reason for this. However I remind myself that the market can remain irrational longer than I can remain solvent if I insist on arguing with it.

It has been over a week since my last post and the market has continued up thanks to a boost on Friday.  I happened to be watching the market on Friday when the US reports were released.  In seconds the FTSE went from minus 30 (it had been at minus 56 a little while earlier) to plus 20, finishing the day at plus 48, for an intraday movement of over 100.  Volatility is not dead yet, but was this move justified?

The cause was better than expected non-farm payrolls number, only 247,000 jobs disappeared (-325,000 expected), and even more surprisingly the unemployment number dropped from 9.5% to 9.4%.  How can this be when the day before initial unemployed came in at 550,000, and the average time it takes to find a new job has blown out to over half a year.  So how can the unemployment percentage drop?  It depends on who you count as unemployed.  When a persons unemployment benefit runs out they are no longer counted as unemployed, just what category they now fall into does not matter to the bean counters.

There are moves afoot to extend unemployment benefits in the worst hit states by another 13 weeks.  Mean while the government is hemorrhaging money. Cash for clunkers is the latest, boosting car sales, mainly for Ford. But again only by giving away taxpayers money to people that don’t really need it.  As soon as you drive a new car out of the show room it has lost 25% of its value.

Banks are failing at a steady rate, but it no longer affects the market. What does it matter if a bank fails, the FED steps in and business continues as normal.  In the old days when a bank failed the depositors lost their money, no longer though, so it does not matter if the bank “fails”.  With this weeks failure of three banks the total for the year is now 72.

The market has got well ahead if its self. It will correct but from what level, that is the question.

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