The fourth quarter started out miserably with a -200 point drop on Thursday and a continued decline on Friday. The damage was not as bad on Friday as you may have expected but the trend is still down.

Market Statistics

The markets continued Thursday's closing decline when they opened for business on Friday. The incentive for Friday's decline was a worse than expected jobs report. The economy lost -263,000 jobs in September according to the Non-Farm Payroll report. Expectations had been for a loss of -150,000 to -188,000 jobs. The private sector job losses came in a -210,000 and surprisingly the government sector lost 55,000 jobs. The previously reported job losses in July of -276K were revised to -304K while the -216K loss in August was revised higher to -201K. The economy has now lost jobs for 21 consecutive months.

The really bad news came from the Household Employment Survey where the unemployment rate increased to 9.8%. Over 571,000 workers left the job market as discouraged workers. Household employment fell by -785,000 for September and that was the biggest drop since March. The average workweek shrank to 33.0 hours and that is the wrong direction if you are expecting the economy to improve. You want an expanding workweek to reduce the slack in the workplace and require new hiring. The pre-recession workweek was 33.8 hours. Returning to that level would be the equivalent of hiring 3 million workers.

Non-Farm Payroll Chart

The quoted unemployment rate of 9.8% is very misleading. If you have not actively searched for a job over the last four weeks or your benefits have expired you are not counted as unemployed. You have fallen into that discouraged worker category or another term is marginally attached workers. 571,000 additional workers fell into that category in September. If you factor all of these workers into the unemployment rate you get what the government calls the U6 unemployment and that rose to 13.2% in September. That was up from 12.8% in August.

There are roughly 154,577,000 people in the U.S. workforce according to the BLS. Also, according to the BLS there are currently about 15 million people unemployed. If you add in those who are underemployed the number rises to about 17.5 million. Underemployed means you took a part time job to pay the bills while you looked for a new job in your chosen field. Some estimates suggest the underemployed could be as much as 9 million of the 17.5 total.

Unemployed and Under Employed Worker Chart

Another factor to consider is the estimated 150,000 new workers who enter the job market every month. Not only do we have to create jobs to put the unemployed back to work but also we have to create 150,000 more jobs per month for new workers entering the system. Over the next five years the total workforce will grow to 163 million according to the BLS. That is an additional 8.32 million workers who will need jobs in addition to the 17.5 million currently unemployed/underemployed and disadvantaged. To get back to 5% unemployment by 2014 would require the creation of 15 million jobs. That means we will have to create an average of 250,000 jobs per month starting in 2010. The year 1999 was the most recent year where we hit that average at 264K per month thanks to Y2K. In 2003, the year after the last recession only a total of 87,000 jobs were created. Employers are always very careful after a recession to not over hire and give extra hours to existing employees first. Real job growth normally does not come until 24-36 months after a recession. 2.54 million jobs were created in 2005 and 2.14 million in 2006 thanks in part to the boom in the housing market. It took 48 months to recover the 2.7 million jobs lost in the 2001 recession. It could take a lot longer to recover the 7.2 million lost so far in the 2008 recession.

In 2010 an employer will have the option of hiring experienced workers at a higher rate or inexperienced workers at an entry-level rate. This will push the average income per worker to a lower level for years to come because of the millions of workers applying for new positions. For unskilled positions employers are now averaging over 100 applications. There is definitely no need to offer high wages to new employees. Most currently unemployed would just be happy to have a full time job. This is going to depress the economy for the next 12-18 months because unemployed, underemployed and underpaid workers make lousy consumers. Most analysts believe the unemployment rate will remain around 10% possibly into 2011.

With the negative economic numbers we saw last week the odds of a double dip recession are growing or at least that is what the professional analysts are saying. The ISM Index fell slightly to 52.6 from 52.9 but analysts were expecting a jump to 54.7. Definitely a negative surprise there. The production index fell sharply from 61.9 to 55.7 and new orders fell from 64.9 to 60.8.

National ISM Chart

Also released on Friday were the Factory Orders for August. Orders fell -0.8% after four consecutive months of gains. Durable goods orders fell -2.6%. The overall numbers would have been much worse were it not for a spike of +5.4% in petroleum and coal products. Most of the increase in orders for petroleum products came from in increase in the price of the commodity not in the quantity ordered.

Factory Orders Chart

A double dip recession "W" looks just like a "V" until the economy starts to slide into the second dip. We have not seen that slide yet and the disappointing economic reports simply tell us that recovery is still in its tenuous stage until it finds better traction. It is still too early to call it a V bottom but also too early to be calling it a W.

The economic calendar for next week is one of the lightest of the year. The two reports I highlighted are really non-events. The ISM Non-Manufacturing has already been overshadowed by the ISM Manufacturing last week. I am really stretching to call Consumer Credit a significant report but with the credit lines being cut every day it could hold some surprises. I added some earnings to the calendar to fill it out because the beginning of earnings season is going to be a pivotal event. I did not add the Treasury auctions to the calendar since the $79 billion total was one of the smallest weeks in recent months.

Economic Calendar

Analysts were expecting Q3 earnings to be relatively decent since the comparison to Q3-2008 would have been easy. Unfortunately the closer we get to the actual earnings the worse the numbers get. Over just the last week the Thomson estimates for Q3 earnings growth have worsened to -24.8%. On July 1st the consensus estimate was for a -20.9% growth rate. For comparison Q2 ended with a -27.3% growth rate. Since earnings were already negative in Q3-08 you would have thought that with our budding recovery many companies would have rebounded back into positive results. Apparently it is too early to make that call on the entire S&P but there are some leaders who are rebounding out of the recession.

The list below is the top 15 earnings improvements according to Thomson Reuters. I left off WFMI because going from a penny to 17-cents put them at +1700% improvement and off the chart numerically. I also ignored those going from seriously negative to less seriously negative like AIG. I listed the earnings date for those who have already set a date.

Thomson Top 15 Earners Table

The FDIC closed three more banks on Friday bringing the total to 98 for 2009. The Jennings State Bank in Spring Grove Minnesota, the Warren Bank in Michigan and Southern Colorado National were added to the list of failures for 2009. In other news Starwood Capital Group appears to have won the FDIC auction for $5 billion in assets seized when they shut down Corus last month.

In stock news Apple (AAPL) was upgraded to a BUY at UBS with a price target of $265. That is $95 over their last target and $80 over the $185 where Apple was trading today. The upgrade came on claims by analysts that exclusive relationships with carriers will expire in 2010. Apple signed exclusive deals with carriers in the various markets when the iPhone was first introduced. There is no reason in today's markets for exclusivity and opening up the iPhone to all carriers will give Apple added market penetration. UBS said Apple's market share could rise from 4% in currently exclusive markets to 10% when those contracts end. UBS said expiring contracts in Asian markets could add an additional 20.3 million Iphone shipments in 2010. UBS said consumers did not appear to be moving to the $99 iPhone 3G and Apple would retain strong margins. UBS expects total iPhone shipments would hit 36 million in 2010 and 40.5 million in 2011. Apple is expected to earn $6.98 in 2010 and $8.53 in 2011.

Apple Chart

First Solar (FSLR) had coverage initiated by Montgomery Scott with a buy rating. First Solar was also named to replace Wyeth in the S&P-500. Wyeth is being removed due to the acquisition by Pfizer.

First Solar Chart

Intel (INTC) was upgraded by Oppenheimer to outperform after global chip sales rose to $19.1 billion in the latest Semiconductor Association report. That was a +5% jump from the prior month but still down -16.1% from the same period in 2008. SEMI said this was the sixth consecutive month of growth in chip sales powered by consumer spending. Oppenheimer said chip sales could grow +10% in 2010. Intel CEO Paul Otellini said last week that PC sales could be flat to slightly higher for full year 2009. Not bad for the deepest recession since the 1930s. Sales of netbook PCs now account for 17% of all notebook sales. That is a huge new market niche that is exploding.

Intel Chart

The financial sector closed September with only a minor gain as worries over the true health of the sector continue to mount. The credit crunch is still the hot topic for consumers and for small businesses. GE may be able to borrow billions on their good credit but small businesses are still out of luck. Meredith Whitney wrote an opinion column for the WSJ on Friday and her outlook has not changed. According to Whitney "In the U.S., small businesses employ 50% of the country's workforce and contribute 38% of the input to GDP. Without access to credit, small businesses can't grow, can't hire and too often end up going out of business." Whitney believes banks should be given incentives to implement small business loans on a greater scale. She also said she expects another $1.5 trillion to be cut from credit card credit lines. With commercial real estate in implosion mode banks are loading up on cash for the second leg of the credit crunch expected to hit in 2010.

Banking Index Chart

I am going to try and get through this paragraph without being political but it may be tough. I have been reading about the various methods lawmakers are contemplating to fund the health care reform. Since President Obama promised not to raise taxes on families making less than $250K and individuals less than $200K, lawmakers are being creative with their ideas. Being considered are taxes on makers of medical devices like shoulders, hips, stents, etc. Taxes on providers like WellPoint, United Health and Aetna. Taxes on drugs like Lipitor, Crestor, etc. Taxes on procedures like Lasix, colonoscopy, etc. Plus taxes on businesses that do not provide health benefits. While these may technically not be a tax on individuals making less than $200K we all know who will end up paying the bill. Medical companies will pass these costs on to the consumer and while not a tax the medical bills will increase dramatically.

Paul Volker, the Presidents tax czar is now exploring the addition of a value added tax or VAT to fund health care. This is like a national sales tax. He is also recommending that money market funds be closed but that is another story. John Podesta, also an Obama adviser was also talking VAT last week as a way for the government to raise additional revenue to pay for new spending programs. Let's hope rational minds prevail before these things end up being turned into laws or those small businesses Whitney was talking about will be out of business. FYI, the Tax Policy Center said Friday that 47% of U.S. households or 71 million people will not pay any income tax in 2009 and quite a few of those households will receive checks from the government for various kinds of assistance.

Somebody needs to put a tax on Alan Greenspan's public speaking. On Friday Greenspan said the Fed balance sheet is a serious inflation risk. Greenspan warned that the Fed must remove its stimulus from the market at exactly the precise time or the damage could be severe. I guess he is trying to make up for his mistakes of not acting in a timely manner. He went on to say that the economy is "undergoing a disinflationary process" and said the Fed faces no urgent need at the moment to unwind its monetary stimulus. He warned, "It is critically important the Fed's doubling of its balance sheet be reversed. If you allow it to sit and fester it would create a serious problem." Since so many people are now looking back and pointing fingers at Greenspan's key mistakes including the housing bust he is apparently trying to shift the focus back onto the Fed.

When Greenspan Was King (Feb 15th 1999)

Bernie Madoff will not be sleeping well this weekend. The court appointed trustee attempting to track down the missing billions has sued the Madoff sons, brother and niece for $198.8 million. The trustee accused the family of "enabling the fraud" saying the family was derelict in their duties. As a result "they either failed to detect or failed to stop the fraud." According to the trustee if the family had been doing their jobs the fraud may never have occurred or continued for so long. The trustee claims that Madoff Securities was operated as if it were the family piggybank. The relatives took large amounts out of the company to buy homes, cars and boats. What the trustee fails to admit is that the family worked in the legitimate business in the same building and Bernie seldom let anyone onto the floor where the scam was being operated. The sons were quick to deny the trustee's claims reminding everyone they called regulators the same day Bernie confessed his scheme to them. He was arrested the very next day. Since Bernie has nothing to lose by claiming that he alone knew about the scheme the trustee is going to have a tough fight in proving otherwise. If the supposedly wealthy dad gave his family money for down payments to buy homes that should not have raised any red flags. I have done that several times and I don't have his wealth. Retrieving $200 million from people solely on the premise that they "should have known" because dad gave them money is going to be a tough sell. I hope he finds the missing $18 billion but I would bet the money went to pay earlier returns. That is how a ponzi scheme works.

The markets gave back only about 2% for the week, which is remarkable given the big declines on Thursday. The Nasdaq closed -93 points off its high of 2140 (-4.34%) but because of Monday's gains only gave up -2% for the week. The problem for the Nasdaq was the serious drop in the semiconductor index. I reported on Tuesday night that the index was still holding over support at 320 but that was crushed in trading once October arrived. The SOX declined to close the week at 306 for a -4.5% drop. The next support level is probably 295 followed by 285. We would target 250 if those levels broke. There is no fundamental reason for chips to be this weak with sales improving and chip makers predicting strong PC sales. The only reason for chips and the Nasdaq to be so weak is their gains over the last six months. These were the go to stocks that fund managers expected to lead out of the recession. They logged big gains and now they are taking profits. How long this continues depends on how severe the profit taking gets. Mild selling will have some who don't need to sell simply tightening stops and planning on riding out the storm. If the selling becomes frantic then odds are better that the selling will increase as everyone becomes worried their year-end bonuses are in jeopardy.

So far the Nasdaq is within normal trends for profit taking. Uptrend support at 2050 is still intact. A break there targets 1950 and that would still maintain the longer-term uptrend but begin to worry the bulls.

Nasdaq Chart

The Dow is on the verge of testing 9410 (Fib retracement) followed by 9300 and 9100 if sellers appear in volume. The Dow rallied 14.98% in Q3 and the biggest quarter since 1998. Conventional wisdom suggests that after such a big quarter we should see the markets rest in Q4. Of course that assumes there was nothing special about Q3 and it was a run of the mill bull market. Since that is not the case and it was a rebound after the worst recession since the 1930s there is ample precedent for a continued move higher. Maybe not immediately but eventually.

Bianco Research put together a list of the Dow's greatest quarters since 1904. The average gain the following month was +1.33%, the following quarter +3.46% and the next year +9.95%. However only six of the 23 quarters occurred in the third quarter. If you average all the record Q3 quarters the average gain was +27.25%. The average October following the record was a loss of -0.14%, average Q4 following was +1.21% and year 12.64%. While this is in interesting exercise in market trivia I don't believe it has any impact on our market direction today.

Table courtesy Bianco Research

Dow Chart

The S&P dipped to 1019 on Friday and the 50-day moving average. The initial support at 1035 has broken and uptrend support is around 1000. The lows from August were 978 and should be considered critical support. The break of 1035 suggests we will test at least 1000 before a successful rebound can occur. There needs to be enough fear coupled with enough support to convince the bulls that a real correction has occurred. Of course a real 10% correction would take us to 964 but I am betting against that option. We could see an intraday penetration below 978 but I think there will be too many buyers in cash on the sidelines trying to get in just above that level. I have seen it too many times were some number is defined as a critical level and buyers target a few points above it for an entry and the number is never touched.

SPX Chart

The Russell fell below 600 on Thursday and under 585 on Friday. The Russell came to rest exactly on the 50-day average at 580 with absolutely no signs of a bounce. I could easily see a dip to 558 and a full 10% correction. Small caps are suddenly out of favor but once the profit taking ends they will probably lead us out of the decline.

Russell Chart

Volume has been strong for the last three days and obviously decidedly negative. The 200-point drop on the Dow at Thursday's close was probably traders scrambling to exit before Friday's jobs report as well as end of quarter window undressing. Friday's rebound from the opening lows came on the back of several upgrades to big cap stocks. It was also short covering head of the weekend.

The good news from the Jobs report is a Fed that definitely will not be raising rates any time soon. They will wait until the economy starts adding jobs before starting to remove stimulus. Next week's economics should be ignored with the focus moving to earnings.

The quarterly gain discussion above is not relative because this is a recession rebound market. As long as analysts continue to expect economic improvements the markets should have a bullish bias. That does not mean we won't see a decent decline over the next couple weeks before a Q4 rally appears. If you have been reading my commentaries you know I expect an October low sometime before option expiration on the 16th. Fund managers will finish restructuring their portfolios by then and start adding to positions for the next move higher. At least that is what I am expecting. Louis Navellier has always said "Just when you think you are smart, the market will show you just how dumb you really are." I hope this is not one of those occasions.

I dropped out of dip buying mode when the S&P fell under 1035. Now I am targeting S&P-1000 for my next long trade. If we do move under 1000 then 975 would be my target with 964 as the full 10% dip.

Jim Brown