A larger than expected loss of jobs in July and a sharp downward revision for June sent the Dow down for a triple digit loss early Friday. Short covering at the close erased that loss.

Market Statistics

The big news on Friday was of course the July Non-Farm Payrolls. The headline number showed a loss of -131,000 jobs in July. However, there were 143,000 census terminations in July plus a loss of 77,000 government jobs. Net of the census workers there was a gain of 71,000 private jobs. This is far less than the 150,000 analysts expected. The June job losses were revised lower by -94,000 to a headline loss of -221,000.

The higher than expected job losses sent the markets into a spin on worries the economy is falling back into a recession. The construction sector lost jobs again as builders cut back on payrolls now that the tax credit stimulus has ended. State and local governments are also cutting back on headcounts because the stimulus funds have run out. In theory the private sector was supposed to have recovered before the government funding ran out. Obviously that has not happened. Even the post office is laying off people.

Uncertainty about the economic recovery is keeping employers from committing to hiring new workers. If the economy were to fall back into recession then employers would be on the hook for termination payments, unemployment payments and the expense for bringing on new employees in the first place.

Unemployment remained at 9.5% but only because another 181,000 workers became discouraged and gave up looking for jobs. When the employment picture finally improves in 2011 that will rise to more than 10% as those discouraged workers come back into the job market. The wider U6 level of unemployment that includes those discouraged workers and under employed workers who took a part time job to pay the rent (8.5 million), has risen to 19.8 million workers. Only 58% of the employment population is actually working. That is the lowest level since 1983.

Analysts claim it will take average monthly new jobs of at least 250,000 to maintain a growing economy. The workforce population, those of employment age, swells by 150,000 per month through graduations, legal immigration, etc. We have to have enough new jobs created to accommodate those new workers as well as whittle away at the nearly 20 million that are currently unemployed.

This is why a negative payroll report is so depressing for the market. When the number of unemployed workers rises it creates stress on the social services net including unemployment compensation and it causes stress in the financial sector because loan delinquencies grow. Unemployed workers are not spenders and that retards economic growth. On the positive side 155 million people are employed and a little more than half are paying taxes.

There are no estimates for August but the impact from census terminations should be over and it is possible we could see a positive number on the August report on September 3rd.

Payroll Chart

The Weekly Leading Index rose for the second consecutive week but the small gain was no reason to cheer. The index rose from 121.0 to 121.8. Not a big move and it could be erased next week then the payroll report is factored into the index.

Weekly Leading Index Chart (Moody's)

The economic calendar for next week only has one major event and that is the FOMC meeting on Tuesday. After Friday's jobs report the Fed is expected to announce some kind of quantitative easing program after the meeting. They currently have about $200 billion in expiring mortgage backed securities and instead of just keeping the money they are expected to put it back to work in the market by either buying mortgages or treasuries. In theory that would keep rates low but they are already historically low so I don't understand how that would help. Analysts were calling this potential move a baby step compared with what they need to do.

The two-year note yield fell to another all time historic low on Friday of less than 0.5% and the ten-year yield fell to a fifteen month low at 2.82%. Goldman expects that yield to fall below 2.5%. This is the problem that confronts the Fed on Tuesday. What can they do to stimulate the economy without pushing short-term rates to zero? The market is going to be holding its breath until the Fed announcement on Tuesday afternoon to see how the Fed sees the current economy and what they are going to do about it. The potential for a negative news event is very high.

I added a highlight to the weekly Jobless Claims after they came in at a 479,000 last week and the highest level since April 10th. Rising jobless claims are an early warning indicator of weakening economic conditions. That is especially true in August since manufacturers should be staffing up to make and ship products for the year end shopping season.

I also highlighted Consumer Sentiment because analysts were expecting an improvement but the jobs data could cause another decline instead. The cutoff for the survey may have been too early for this release but the next installment should show another dramatic decline. Nothing kills sentiment like a falling market and a loss of jobs.

Economic Calendar

Goldman Sachs (GS) was the first big name bank to dramatically lower their economic estimates for the coming quarters. Goldman said GDP growth in early 2011 is likely to fall to +1.5% with a gradual pickup by the end of the year. Goldman says GDP is likely to average +1.9% for 2011 compared to their prior forecast of +2.5%. Goldman expects the GDP for the rest of 2010 to average 1.5% compared to estimates of 3% last quarter. Goldman said the decline in estimates was due to congressional resistance to extending fiscal stimulus. They also expect the Core PCE Inflation to decline from its current +1.6% rate to +0.5% by Q4-2011.

Analysts from Goldman and Morgan Stanley are seeing conflicting views of the economic future. Jan Hatzius from Goldman believes the economy is poised for a sharp decline for the rest of 2010 while Richard Berner of Morgan Stanley had been projecting a +3.8% GDP for Q2. Despite the shock of only a +2.4% GDP in Q2 Berner still believes the economy will improve over the next five months. Hatzius believes the extra capacity in the economy will make it hard for companies to raise prices and set the stage for deflation. Demand is not sufficient to absorb the current economic production. Both believe unemployment will remain very high for the next couple years and remain a drag on the economy.

The FDIC closed the 109th bank of the year on Friday when it shutdown the Ravenswood Bank in Chicago. That was the 13th bank to be closed in Illinois this year. The closure will cost the FDIC $68.1 million. The number of banks on the FDIC problem list jumped to 775 at the end of the first quarter. To put that in perspective there were 140 bank closures in 2009.

In stock news Hewlett Packard CEO Mark Hurd resigned Friday after allegations surfaced regarding sexual harassment. Hurd was forced to resign after the company discovered he had a secret relationship with a woman who worked with HP on marketing matters and that he falsified expenses and other financial reports to conceal the relationship and help get her paid for work she did not do. Reportedly it was not a sexual relationship but the falsified expenses were as high as $20,000 per incident for travel and lodging. Hurd reportedly had a "systematic pattern" of submitting falsified financial reports to hide the relationship.

The woman reportedly produced more than a dozen private events hosted by HP for CEOs. Reportedly Hurd and the woman spent time alone after these events. High profile attorney Gloria Allred said she is representing the woman whose name was not disclosed. One news article claimed that Hurd tried to pressure the woman for sex and threatened to cancel her contract with Hewlett Packard if she declined. Reportedly Hurd paid the woman a large sum to buy her silence and to not file any charges against him and Hewlett Packard. Hurd is married with two children.

Hurd was seen as a white knight that rescued HP from the recession by ruthless cost cutting. He transformed HP from a computer and printer maker to look more like IBM and the largest technology company by revenue. Shares fell -$5 (-10%) after the close on Friday as the news broke. Despite his indiscretions and outright fraud in falsifying documents he will receive a $12.2 million severance package plus 350,000 shares of stock worth $16 million and options to buy another 775,000 shares.

Interesting that Hewlett tried to slip this news into the market after the close on a Friday afternoon when most traders have already left for the weekend. Nice try but the news was too juicy.

Hewlett Packard Chart

Research in Motion (RIMM) shook off three days of declines with a minor +1.22 gain as the Middle East ban of BlackBerry phones began to take effect. Saudi Arabia said Blackberry service would be halted at midnight on Friday. Service providers sent emails to all Blackberry subscribers in the country notifying them of the shutdown.

The UAE, India and Indonesia are also threatening to shutdown service if they are not allowed access to the encrypted data sent over the devices. Corporate users have an increased level of encryption and governments can't spy on users. Individual users have a lower level of encryption and RIMM has given various governments access to those messages. Governments like Saudi Arabia, the UAE and Iran claim the secure messages allow terrorists to communicate without fear of getting caught. In reality it also allows users to criticize, mock and object to government actions without fear of reprisals.

In countries without the freedom of speech the ability of the government to scan emails is dangerous to competing views. The Saudi government said the devices allowed users to visit websites that were not approved by the government. That is shorthand for sites that protest the government and allow freedom of speech. RIMM shares had lost $6 prior to Friday's rebound.

GM is planning an IPO possibly later this year and will give the government an opportunity to unload its 61% ownership stake. However, the UAW has to approve any IPO plans because it owns 18% of GM as part of the restructuring agreement. When President Obama was touring a plant this week he was asked why every taxpayer should not get shares since the people actually funded the bailout through their taxes. By giving taxpayers stock that would allow them to profit from the bailout. The president would not answer the question and claimed SEC registration rules as the reason he should be quiet. In reality any IPO question has to be approved by the union because of existing agreements. If it does not benefit the union I doubt it will be approved. Allowing shares to be dealt out to millions of taxpayers would probably not be approved.

Another government owned entity, AIG, said it was preparing a plan to issue shares to eliminate the government's 80% ownership of AIG. The company still owes $102 billion to the Federal Reserve and the government. CEO Robert Benmosche said the plan would lead to "significant dilution" of existing shareholders. AIG is trading at $41 today because it did a 1:20 reverse split back in July 2009 when it was trading for 50-cents per share. That raised it to $10 and over the threshold where funds were able to buy again. That split reduced the tradable shares outstanding to 135 million. If it sells another five billion shares to pay off the government and the price declines to $5 then it can do another 1:20 reverse split and still be trading for a reasonable price again. Unfortunately that is really "significant dilution" for any original shareholder.

AIG currently has a market cap of $6 billion based on its outstanding shares.

AIG Chart

New IPO offerings did not do well on Friday. The Dutch chipmaker NXP Semiconductors (NXPI) priced at $14 and below the expected offering price of $16-$18 and then opened at $12.99. Market makers managed to bring it back to close flat at $14 but the IPO was less than successful.

Drug maker NuPathe (PATH) priced five million shares at $10 each after cutting the range from $14 to $16. The stock opened at $10 and declined to trade at $9.61 and end its first day in negative territory.

Demand Media filed for an IPO on Friday and it is expected to be a successful offering. Revenues were $114 million for the first six months. The company specializes in creating search engine friendly content. This is expected to be the first billion-dollar company to IPO since Google went public. They are planning to raise $125 million in the IPO. The domain has grown to be in the top 150 sites as ranked by Alexa in 2010.

The heat wave in Russia means a new bull market in the U.S. for grains. Wheat climbed +7% to another new high on the news that Russia had banned grain exports. Russia has seen over 2,000 wildfires caused by the heat and many crops have been destroyed. The shortage of grain in Russia plus the growing demand from China, India and Canada means U.S. grain prices are going up. That means farmers in the U.S. will be pouring on the fertilizer and names like Potash (POT), Mosaic (MOS), Monsanto (MON), Bunge (BG), Intrepid Potash (IPI) and Dupont (DD) should see volumes rocket higher. All of these moved higher on Thursday but Bunge is the only one that held its gains in Friday's market. Mosaic and Potash both reported strong earnings and good guidance so the stage was already set for a continued climb.

Russia Wildfire Map

Internet diamond seller Blue Nile (NILE) was downgraded on Friday after posting earnings of 19-cents compared to estimates of 23-cents. They also issued guidance that was well below analyst estimates. The recession has killed the jewelry market and rival Zale's has closed hundreds of stores as sales crashed. Nile traded at a new 52-week low on the news. Downgrades were the order of the day.

Berkshire Hathaway reported a 40% drop in profits on Friday but most of the decline was attributed to a $1.4 billion paper loss in a group of derivative contracts. Buffett does not like derivatives contracts and calls them financial weapons of mass destruction but he was coaxed into selling some naked puts on four international stock exchanges back in 2007. Buffett sold puts on the S&P, FTSE, Euro Stoxx 50 and the Nikkei and received $4.9 billion in premiums. The contracts expire between 2019 and 2028. The notional value of the contracts is said to be between $65-$100 billion. If the global economy tanks over he next decade Berkshire could be wiped out because of this bet.

Berkshire has to mark to market the value of the contracts every quarter so they can be included in the liabilities section of their earnings. Buffett told investors back in 2007 that the values of these contracts would vary greatly and cause significant volatility in Berkshire's earnings. That has definitely been the case. Berkshire has taken non-cash charges of more than a billion dollars a quarter and then recorded billion dollar gains as the markets move up and down. For a person that is known for conservative investing this kind of bet is out of character. You wonder if today he regrets writing the puts because of the earnings volatility they have caused. The odds are good he will not live to see them expire worthless because of his advanced age. At 81 the odds of him making it to 2028 are slim.

Berkshire Hathaway Chart

Corporations are taking advantage of the extremely low interest rates. Last week was the third busiest week for corporate bond offerings. IBM, MET, AFL, HSBC, HES, PDE and C sold a total of $33.6 billion in corporate bonds. Since most of these companies already have a boatload of cash they are planning ahead by taking advantage of the cheap interest. S&P companies are rumored to be setting on $1.8 trillion in cash and investments as they wait for the economy to shift into a higher gear.

Google (GOOG) said it has catalogued 129,864,880 books and will continue to add to that total as they find older books that were never included in the current ISBN and older SBN numbering systems. Google wants to scan and catalog every book ever written if it still exists in print today. This somewhat ambitious goal is an obsession with Google as it attempts to catalog all the information in the world in one place. It also puts Google at the front of the pack when it releases its own e-reader. Nobody will be able to compete with Google's book inventory. There is also expected to be a web-based component to their e-reader. This is one Google project that could really add some dollars to the bottom line but the start up costs are going to be horrendous.

Google says they have 600 million raw records but that does not represent 600 million books. For instance a hardcover book and the paperback version is counted twice. Books with different forwards are counted twice. Books of the same title and author but published by two different publishers are counted twice. After eliminating duplicates that leaves 129,864,880 unique books and growing.

Crude Oil Chart

Friday's jobs report finally gave oil traders an excuse to sell but support at $80 held. Crude oil had been in rally mode on worries that the Iran problem was heating up and on the attack of the Japanese tanker in the Straits of Hormuz last week. The tanker was examined by several groups of experts and they found explosive residue to confirm the attack. An Al-Qaeda linked group called the Brigades of Abdullah Azzam has now claimed the attack.

They said a suicide bomber named Ayyub al-Taishan piloted a boat filled with explosives into the tanker and triggered the explosion. They showed pictures of the bomber holding up a picture of the tanker prior to the attack. There was minimal damage to the tanker and not even enough to determine it was a bomb until nearly a week later. Note to B.A.A: Nice choice on boat size. Keep it up until you run out of bombers. Actually finding out it was a terrorist attack ratcheted down the tensions because Iran attacking the tankers would be a much larger worry.

The falling dollar is getting very close to major support. We could see a technical rebound at any time and that could pressure oil and gold. Gold prices rallied last week on the weakening economics but the rally could be slowed by a rebound in the dollar. The action by the Fed on Tuesday is sure to have a dramatic impact on the currency issues.

Dollar Index Chart - Daily

For the markets it was an interesting week. The Monday short squeeze powered the S&P to 1127 and the 100-day average and that is where the gains ended. For the entire week the S&P struggled to move over that 1127 mark and several times it was successful for a few minutes if only for fractions of a point. It was as close to a dead stop as I have ever seen for a major index.

It is not that there was heavy selling pressure but there was enough persistent pressure to prevent any further gains. Volume was terrible. Thursday's volume was only 6.4 billion shares and the average for the entire week was only 7.06 billion per day. Monday's +220 Dow gain was on volume of only 7.5 billion shares. Volume should only get lighter after the FOMC meeting until after Labor Day. That means we are going to have more triple digit swings on minimal news events.

The S&P rallied above the 200-day, now at 1115 but can't seem to get over the 100-day average. Actually I am amazed that it held up so well on Friday after stalling at resistance all week. The closing spike was simply short covering after a week of failing to fall. Shorts loaded up every day when there were no gains in anticipation of a negative jobs report. When the S&P declined to 1110 at the open and held there for nearly four hours without any further signs of weakness the shorts had to cover and take profits going into the close. There is too much event risk to hold a marginal position over the weekend.

The S&P is painting a confusing picture. The overhead resistance at 1127 appears to be rock solid but the bulls showed enough interest to keep it pegged at that resistance for a week. Normally when resistance is firm for a couple days the bulls get restless and start taking profits. However, Keene pointed out that the ISEE call/put ratio hit 182 on Wednesday and anything over 150 is overly bullish. I am amazed that sentiment can be that high in August when August and September are historically the two worst months of the year. It is even more puzzling when the economics are weakening.

Since the markets can remain irrational far longer than traders can remain liquid, we just have to wait for the pattern to play out. This pattern will likely change dramatically by next Wednesday and the aftermath of the FOMC meeting. The markets are pricing in a new move by the Fed but they better be careful what they wish for.

The rising trend since July 2nd is in conflict with the converging overhead resistance and the S&P is being forced into a progressively smaller range. The odds are about 100% that there will be a break over resistance or a break of the July uptrend this week. There is nowhere for the S&P to go. Something has to give.

S&P-500 Chart - 15 min

S&P-500 Chart - Daily

The Dow is holding over its June highs and is actually in bullish territory. However it will be handicapped on Monday with Hewlett Packard down -10% in after hours trading. This will poison sentiment at the open if the decline in HPQ holds. CEO Mark Hurd was very well liked by the street and the market cap of HPQ had nearly doubled under his reign.

The Dow is not a trading indicator for me and I would rather use the S&P or the Russell for trade signals. The weighting of individual stocks in the Dow produces too much volatility. However, if the Dow moves over 10,700 it would be bullish and the other indexes would probably follow. Support is now 10,500.

Dow Chart - Daily

The Nasdaq was the most predictable of the indexes last week. I warned that 2300 was major resistance and that is exactly where the index stalled. Secondary resistance at 2320 was never tested. We got the same end of day spike but the Nasdaq gained the least of the major big cap indexes for the entire week at +1.5%. The chip sector remains a drag but the support at the 200-day is still holding on the SOX.

Tech sentiment is weaker than the broader market and that means a move higher could really ignite some short covering. The same converging resistance exists at 2300-2320 and it would be a tough act to power through that in August but a move over 2320 would be a buyable event.

Nasdaq Chart - Daily

The Russell is acting exactly as expected. The short covering rally early in the week failed to reach the July high and failed to hold over the 660 level. Friday's opening decline did NOT rebound as high as the big cap indexes and the Russell was the only major index to actually lose ground for the week. The banking index and housing index also lost ground but they are sector specific.

Small cap sentiment is deteriorating and the 200-day average was tested as support on Friday. Resistance at 670 and the 100-day at 667 were not tested all week. This is a clear clue that fund managers are easing away from small caps and potentially from the market in general. The small caps are a leading indicator for broader market moves.

If the 200-day support at 641 is broken next week then the bears are in control and I would expect further broad market weakness.

Russell Chart - Daily

Contrary to the other indexes the Transportation Index is attempting a breakout. The difference is subtle but we have a strong peg at resistance and the Friday decline was minimal. There is strong support at the 100-day average while the Nasdaq and Russell are well under their 100-day, which is resistance for them.

The transports are a leading indicator for the economy just like copper is seen as a leading indicator. Copper is used in everything as a conductor and rising copper prices are seen as a bullish economic signal of increased demand.

Every consumable item is shipped on a truck and while we don't really get truck volumes in a timely manner to plot consumption we can use earnings reports and guidance as a predictor of economic activity. The earnings from the transport sector were strong and several companies raised guidance. If you were looking at the market through a knothole and only saw the transport chart and their earnings reports you would probably be bullish. Unfortunately the market is made up of tens of thousands of factoids and the transports are only one indicator.

I would watch the transports for a break over 4500 or a break below the 100-day at 4375. A break over 4500 could be a leading indicator of a pending rally but a break below 4375 would probably mean the broader market has already begun to break down and it would be a confirming indicator rather than a leading indicator.

Dow Transports Chart - Daily

Another confirming indicator of the underlying bullishness in the market is the Dow Total Market Index. This is the largest index with 5000 stocks so extreme moves by individual stocks have very little impact. The $DWC is an identical chart to the Dow Transports. Resistance at the 100-day is solid but the index did not pull away from contact as did the Nasdaq and Russell. The DWC is borderline bullish. If the DWC moves over 11,750 it would trigger some buy programs and stimulate short covering. While this index is not as widely followed it bears watching for "real" market sentiment this week.

Dow Total Market Index Chart

In summary I believe the markets are pricing in a new quantitive-easing move by the Fed next week. As such there is a risk the Fed might not move or move in a way that the markets are not expecting. With rates already so low the normal types of Fed moves would not be effective. That means the Fed may have to resort to something drastic to get the market's attention. Drastic is not always a positive market event. If the Fed does something drastic then the market will wonder, "what does the Fed know that we don't know" and the results are normally less than desirable.

I continue to have a bearish bias but I have to admit the positive Transport and DWC charts are showing the possibility of an upside move. That conflicts with the weakening conditions on the Nasdaq and Russell so anything is possible. Add in a -10% drop on Dow component HPQ on Monday and the week could get off to a fast start.

I believe that after the FOMC meeting there is nothing left to move the markets. Earnings are basically over and the major economic reports don't show up again for four weeks. This leaves a void in the news with only the remaining earnings reports from weaker companies to stimulate interest in trading. With only three weeks left in the summer the volume is going to be very thin as traders try to cram in as much vacation time as they can. This makes for a quiet but dangerous market. As Art Cashin always says, "Ships can sink in a calm sea."

Jim Brown