The markets shook off a major decline at the close as shorts raced to cover on rumors there would be an aid package for Greece announced over the weekend.

Market Statistics

The Dow declined -168 points intraday to touch 9835 before the rebound began. The markets and especially commodity stocks were crushed this week as the dollar rallied to new 6-month highs on fears that the Eurozone was going to collapse. Daily comments that no bailout was imminent by the ECB or the IMF failed to convince analysts as news of additional problems continued to suggest something would have to be done.

Late Friday there was a rumor the IMF might announce an aid package for Greece over the weekend and the reaction in the market was immediate. Even if the rumor was untrue those with heavy short positions could not afford to hold over the weekend. Should a deal be announced the markets would have exploded higher at the open on Monday and shorts would have been hurt very badly.

Once the rebound began on Friday it was a race to the exits as stops were hit and shorts watched in disbelief as the markets returned to positive territory.

The markets started off mixed after the Non-Farm payrolls came in weaker than expected with a loss of 20,000 jobs instead of the gain of +5,000 jobs analysts expected. The loss of jobs was not the only problem. With this report the Labor Department revised the job numbers for each month all the way back to January 2009. The net revision showed there were -637,000 more jobs lost than previously reported.

In the table below I have listed the revised job numbers on the first line and the numbers prior to the revision on the bottom line starting with Jan-2009 in the left column. Every month saw revisions to the downside except for November, which was revised higher to show a gain of 64,000 jobs. Note that December 2009 was revised sharply lower to a loss of 150,000 jobs.

The BLS announced in October they were going to revise jobs lower in February by -850,000 due to a major glitch in the birth-death model for new businesses. The B/D model always assumed that in the long run jobs are created not destroyed. The severe contraction from the credit crisis killed thousands of small businesses, which account for 65% of new jobs created.

The BLS also announced it will post another revision in February 2011 by an expected one million more jobs lost. By prorating and backdating these losses over two years they are trying to avoid the headline risk of admitting they under estimated jobs lost over the last few years by as much as two million jobs. (See Bloomberg slide show on revision)

Job Loss Revision Table (thousands)

The unemployment rate dropped to 9.7% from 10.0% in December, but only because 843,000 workers dropped off active job seeker rolls and into the discouraged worker category. That means they have given up actively looking for work. This reduction in the active workforce makes the unemployment calculation show a lower unemployment rate simply because there are fewer workers actively looking. These people did not get a job they just gave up looking. This is a bogus method for quoting unemployment.

The Labor Dept unemployment rate of 9.7% equates to 14,837,000 unemployed workers. However, the U6 unemployment, which includes those in the discouraged category and those who are working a part time job because they can't find full time work is now 16.5% or 25,238,195 people. This is why the economy is struggling to recover.

Analysts pointed to some technical factors such as rising hours in the average workweek to 33.3 and a +0.3% gain in average hourly earnings as signs of a rebounding job market. However, the number of people employed for more than six months increased to 41.2% of those unemployed. The longer a person is unemployed the harder it is to get a job.

There were some positive signs. The household survey showed total household employment rose by 784,000 in January. This was a huge increase and assuming it does not get revised lower in future months it is very positive for the economic outlook.

The establishment employment report had some challenges. There was a reported gain of +42,000 workers in the retail sector. Since retailers don't hire in January but terminate people in January analysts expect this is the result of a seasonal adjustment. The Labor Department adjusts the numbers on a seasonal basis to account for such things as holiday hiring and firings. Since far fewer people were hired for the holidays the normal seasonal adjustment over compensated on the termination side and gave a false impression of a gain of 42,000 in January.

The government hired 33,000 workers in January of which 9,000 were census hires although I never heard anyone in the press mention anything about census hiring. I did hear a lot of comments from politicians bragging about the drop in the unemployment rate to 9.7%. Never let a good data point go to waste.

Here is my conclusion. The government hired 9,000 census workers and over compensated in the seasonal retail adjustment to show 42,000 fictitious jobs in retail. That totals 51,000 jobs and the headline number showed a loss of 20,000 jobs. If you remove the census jobs as only temporary it appears to me that the economy really lost 71,000 jobs in January. The next four months will show strong gains as the government adds another million temporary census workers and then a million worker loss when those workers are terminated in July/August.

This suggests politicians will be fighting for the microphone for the next four months to brag about jobs gains and then be nowhere to be found when all those workers are sent home. Anyone brave enough to face questioners in July/August will say, "Those losses don't count, they were only temporary census workers." Funny, they counted on the way up, why not on the way down. Mark my words and I will bring you some specific quotes when it happens.

There are 129.5 million people employed in the U.S. today. That is exactly how many were employed in 1999 even though the working age population has increased by +29 million in the last 11 years. Regardless of how the government slices and dices the reports this means there are millions of additional workers competing for the same number of jobs and that is a major drag on wages and the economy. In 2009 the Fed had a zero interest rate policy, added over $2 trillion to their balance sheet in stimulus and the Federal government added over $1.4 trillion in stimulus of their own. Employment still fell by -4.8 million in 2009. The National Federation of Independent Business says 71% of small businesses do not plan to hire in 2010 due to extremely tight credit and lack of consumer spending.

Revised Non-Farm Payroll Chart

The Consumer Credit report for December was released on Friday and it showed consumer balances actually declined in December by another $1.7 billion. If consumers can't be counted on to bump spending during the holidays the odds are good they won't spend over the coming months. The $17.5 billion drop in November was revised even lower to a drop of $21.8 billion. The drop in November was mostly due to a drop in credit lines by lenders and the flushing of marginal customers ahead of the changes in the new CARD rules. Also impacting consumer balances are newly unemployed workers using their severance pay to pay down balances to lower payments while they search for a new job.

This is not an economically friendly report. Without consumers increasing their balances the economic recovery will continue to progress slowly. This report gives us a glimpse into the bigger problem rather than the entire picture but we can certainly put the pieces together ourselves. Until employment firms and we are adding 250,000 jobs per month the consumer is not going to be spending money. It is a classic chicken and egg story. Employers can't hire until consumer spending returns and spending won't return until workers are rehired.

Consumer Credit Chart

The economic calendar for next week is so lackluster there was nothing to highlight except for the Bernanke testimony on Wednesday. He is testifying to the House Financial Services committee on how he plans to end the Fed's current stimulus programs. This is another opportunity for 15 minutes of face time by every politician on the panel. Bernanke is not likely to give them anything meaningful since the Fed has already announced a timeline for ending most of the programs. They are not likely to get anything other than the "considerable period" language on interest rates. It is a dog and pony show to emphasize the importance of the politicians rather than a meat and potatoes session with Bernanke spelling out his plans.

This lull in economic reporting will end the following week with the next round of regional Fed surveys, FOMC minutes and the Consumer and Producer Prices Indexes.

Economic Calendar

I briefly scanned the earnings scheduled for next week and there were a few high profile names like Disney, Biogen and Agilent Technology but it is mostly a small cap week. It is also energy week with dozens of energy stocks reporting. The results for those in the energy sector have been mixed but most are reporting big declines from the comparison quarter due to the decline in activity in the sector.

Video game makers Electronic Arts and Activision will both report and ERTS has already warned. ATVI sales are expected to be flat despite the success of Call of Duty II. Further negativity out of either of these companies could depress market sentiment.

The big news will not be energy, earnings or economics but global debt issues. The failing economies of the Eurozone "PIGS" ("P"ortugal, "I"taly, "G"reece and "S"pain) are continuing to push the Euro lower on worries that the Eurozone coalition will fall apart.

On Wednesday Portugal had a failed bond auction, which could be the first of many to come. Granted Portugal with a GDP of $243 billion is smaller than Massachusetts, GDP of $312 billion, but it is a preview of things to come. Portugal tried to sell 500 million in bonds but received bids on only 300 million.

If any of the PIGS I mentioned earlier tried to sell a large amount of debt today the odds are good the auction would fail or be at an interest rate they could not pay. Dubai, Greece, Poland and Spain have already been forced to pay much higher interest on debt they sold recently.

The advent of the Euro and strict economic policies required in order to join the Eurozone gave lesser countries access to relatively cheap debt because the Euro was thought to be a sound currency. Essentially the Euro concept worked too well and allowed those without sound financial policies to hide under the Eurozone cloak and fuel their deficits with cheap debt denominated in Euros.

The problems in Greece are starting to be seen in other Eurozone countries now that investors have decided to look under the cloak. What they are finding is some serious sovereign risk for hundreds of billions in Euro debt.

Over the last couple years investors and consumers have begun to think that governments will always rush in and rescue or bailout any failing entity. Fast forward to today and governments in Europe have run out of ammunition and can no longer rescue themselves from the massive spending on stimulus. This is a two edged sword. They can't afford to withdraw the stimulus because their economies are still not self-sustaining. They can't afford to continue the stimulus because they are broke and can no longer sell debt. Lastly the remedy to the problem is to slash spending and raise taxes but to do that would be economic suicide.

Slashing spending in the Eurozone countries means slower growth or worse a return to recession. That slows down the global rebound because the Eurozone would no longer be consuming.

Too big to fail does not apply to countries. Greece as a member of the Eurozone is considered to be Europe's responsibility. Unfortunately there is no mechanism in place for the Eurozone countries to bail out another country. Membership in the zone meant you had to adhere to the strict financial rules that supposedly kept everyone out of trouble.

If anybody in the Eurozone is going to bail out Greece it would have to be Germany and that concept is not going to fly. Citizens of Germany will not want to bail out Greece. If they did then the rest of the PIGS would land on their doorstep looking for their own bailout. Citizens of Greece would not like the idea of having Germany tell them how to run their country. Germany's economic minister reminded reporters on Friday that the same rules that required less than 3% debt to GDP also banned bailouts of or by EU member countries.

The other option is a bailout by the IMF. The IMF is in business to bailout countries from unsound financial practices but may not be inclined to spend the tens of billions necessary to rescue Greece and then the rest of the PIGS from insolvency.

Greece promised this week to slash its debt to GDP from 12.9% to 3% by 2012. Unfortunately nobody believes them and it is theoretically impossible. Many analysts believe their debt is actually 15% but the government is hiding the debt. It was recently discovered that Greece falsified their economic statistics in 2009 and hid 40 billion in debt to make the deficit look smaller. With that kind of track record it will make borrowing new money rather difficult. The prime minister said this week the planned austerity cuts would be so drastic that they "would draw blood from us all."

Blood is what they are likely to get next week. Greek unions estimate that the announced budget cuts will lead to jobs losses of more than 100,000 and increase the unemployment rate by +5%. One of the major unions with membership of more than 300,000 has called a public strike for Monday. The government deployed 10,000 riot police in Athens in December for a far smaller strike. Another union with 500,000 workers has also called for a strike for February but has not yet announced a date. These strikes will likely turn hostile.

Greece and the Greek islands have a landmass about the size of Alabama with a population of roughly 10 million. Because of their history they have a deep distrust of government in any form. Greek citizens have developed tax evasion into an art because of the dislike of government in any form.

The problem was illustrated by reactions in Portugal to a new austerity plan proposed to keep Portugal from going the same way as Greece. Portugal is also watching deficits rise uncontrollably. Portugal's opposition parties defeated a government austerity plan Friday and passed their own bill allowing the country's autonomous regions to rack up even more debt. That raised new questions about European countries' ability to control their swollen budget deficits, which are undermining faith in the region's euro currency.

Greece owes 290 billion Euros in debt and most of it is to European banks that are already struggling to stay afloat after the financial crisis. That is twice the amount owed by Lehman Brothers when it went under. Greece will need to borrow another 54 billion euros to cover its budget gap in 2010. Investors are worried that any serious budget cuts by Greece would plunge them back into recession and eventually cause a devaluation of the Euro by default.

It is not going to be earnings driving our market next week but more in the continuing saga of the Greek debt crisis. The entire world appears to be rushing to short the Euro and buy dollars and that is killing stocks and commodities.

The Euro broke support at 138 on Thursday as the crisis intensified and some analysts are now claiming it could return to 125 and the level seen at the bottom of the financial crisis. The dollar has broken out to new six-month highs as it again becomes the safe haven currency for the world.

Euro Currency Chart

Dollar Index

Commodities were crushed on the spike in the dollar as well as the worries about the potential for another recession in Europe as a result of austerity programs. China started the commodity decline when they started putting on the brakes to lending in order to keep growth and inflation under control.

Copper has sold off nearly 20% since its high at 350 in early January. Worries that the global rebound was not as strong as had been expected have been weighing on the metal. I am thinking about starting a position in copper this weekend in the newsletter.

Gold Chart

Copper Chart

Crude oil was under additional pressure from a rumor that the London based hedge fund BlueGold Capital was in trouble and was dumping positions. That rumor hit the wires at 11:00 causing crude to fall from $72.91 to $69.50 in 30 min. The hedge fund immediately responded to the news and told Reuters there was absolutely no truth to the rumor and trading had been no different than any other day in the last six months. BlueGold has been known for making big bets in the oil market.

BlueGold was started in 2008 and saw 210% returns in the first year. In 2009 they reported gains of 60+% but so far in 2010 they are down 11% suggesting they were betting the wrong way on the January spike. In 2006 Amaranth Advisors folded after losing $6 billion betting on natural gas futures. That high profile failure shows what can happen to hedge funds that bet the farm on the wrong commodity or in the wrong direction. Whenever these rumors appear the market reaction is instantaneous because nobody wants to be caught in traffic if a billion dollar fund has to liquidate positions.

Crude Oil Chart

The rebound on Friday may have pushed the indexes back into the green but the internals were still negative. Decliners (3409) still beat advancers (3105) but the volume was positive. Advancing volume was 7.2 billion shares compared to declining volume at 4.9 billion. It was a huge volume day overall with 12.3 billion shares total. This brought the total for Thr/Fri to 23.5 billion shares and a huge increase from early in the week.

We have seen a really interesting trend pop up. Look at the graphic below for the last three weeks. The volume on Thr/Fri has been huge compared to the rest of the week. Massive down volume and completely lopsided A/D numbers. This Friday was the ONLY high volume day that saw a reversal of the closing on the lows trend. Look at the volume for Thursday. That was the most heavily lopsided day and qualifies as a 90% reversal signal. Whenever you have a 90% day there is almost always a reversal. Friday's short covering spike may have come on an IMF bailout rumor but the markets were primed for a rebound after that 90% down day.

Internals Table

On Friday it appeared as though traders were remembering back to late 2008 when nobody wanted to hold a position over the weekend. There was too much news and too much uncertainty and gap opens were going in both directions. Shorts were afraid a bailout announcement would appear and the markets would gap up a couple hundred points.

Now we have to decide if the storm has passed or are we spending the weekend in the eye of the storm with more volatility again next week. I think it is entirely up to news out of Europe. A default by Greece would be very bad and although the markets are pricing in that potential we are not there yet.

The bigger problem is the Greek contagion spreading through southern Europe. Investors holding debt on a dozen different countries are scrambling to dump it, insure it or find some way to protect themselves. This is going to keep pressure on the Euro to the downside, the dollar to the upside and pressure foreign banks that may be holding some form of Euro debt. I don't think the storm is over but the final chapter may not be written for many months. This is just the opening plot setup and now we have to wait through endless news reports repeating the same tired story until something happens to either solve the problem or end it with a default.

The markets may have rebounded but they did not do it from any material level. There was no touch of a critical support point where bulls could point and say the sell off is done. The rebound appeared to be completely rumor related and appeared to be powered by a big futures trade. At exactly 3:PM a massive load of S&P futures hit the tape and over 250,000 contracts traded in less than 15 minutes to push the S&P futures from 1047 to 1061. Any time a monster move begins exactly on the hour it is suspicious. The indexes traded sideways until they started to decline again at 3:45 and five minutes later another volume spike of 132,000 contracts hit the tape in only a 5 min period. That is five times the average volume for a 5 min period.

I thought maybe a fund was covering and I spent an hour reviewing the time and sales data from 2:45 until the close and while there were blocks of 100-500 contracts blowing through there were no real signs of a large fund covering. The graphic below is filtered time and sales for 3:01:45-3:02:45 and these were all the electronic trades for 100 contracts or more. In this same period there if it was were literally thousands of small lots from 1-20 contracts, which indicate small speculative investors either having their stops hit or racing to buy the bounce. I looked very hard and there were only 61 trades from 2:45 to 4:00 with 400 contracts or more. Granted those are large trades but given the speed the maket was moving you would have expected more fund related.

S&P Futures Time & Sales

After researching every potential angle I keep coming back to rumor generated short covering as the reason for the bounce. Every day trader worth his salt has had a short bias for the last couple days because the market technicals were decidedly bearish. When the rumor broke the squeeze began. Most futures traders are momentum traders and once momentum changed they switch from short to long in a single click of the mouse and that helps power the rebound.

The Dow hit 9835 on the dip and -167 points down. The rebound brought it back over 10,000 with only a -55 point loss for the week. Neither the closing level of 10012 or the intraday low of 9835 are particularly important. There is no relative strength at either location other than the round number sentiment at Dow 10K.

Dow 9650 is the 10% correction level if that is where we are going. Resistance is 10,300 and the Friday close is right in the middle. You could make a case for either direction but I still believe the path of least resistance is down UNLESS somebody bails out Greece. We are still too early in the news cycle on Greece for it to just go away.

Dow Chart

The S&P, like the Dow above, declined to a level that was not specific support and then rebounded to close at a point that had no relevance. There was no reason for it to close at 1066 other than once back to positive territory the clock expired on those traders buying the dip. For the S&P to reach a 10% correction level it would have to drop to 1035, which also happens to be decent support. I still believe we will test that level. Resistance is well above at 1100.

S&P-500 Chart

The Nasdaq has fallen the hardest of the big cap indexes and came within 12 points of a 10% correction at 2088. The rebound could have been driven in part from the touch of 2100 but I am not convinced. Resistance is 2140 and that is exactly where it stopped at the close. If tech bulls were powering the recovery then why did all the indexes exhibit the exact same characteristics? We have seen many times where the Nasdaq was strongly positive and the other indexes remained down. Friday's rebound was lock step with the rest of the stock universe. The NDX actually closed positive for the week but the position on the chart was exactly the same as the Composite. Resistance on the NDX is 1745 and that is exactly where it closed.

Nasdaq Chart

The Russell did reach that mythical 10% correction level when it passed 584 on the intraday dip. The Russell closed at 649 on Jan-14th and a 10% correction from there would be 584. The Russell fell to 580 intraday on Friday. Unfortunately unlike its bigger brothers it did not recover to the prior intraday resistance of 595 suggesting the touch of 585 had no magical recuperative powers. I tried looking at the Russell from all angles on various charts and could not find any reason to believe it won't retest 575 before this correction is over, possibly even 555.

Russell 2000 Chart

I believe we are in the eye of the storm. If nothing happens over the weekend I think the negativity will return again on Monday. There are a couple events next week including the Monday strike that could accelerate the situation and make it worse.

I know it is ridiculous to think our equity markets are being held hostage by Greek debt but it is not just Greece. It is the entire Euro coalition and the potential for it to fracture. How that would impact global economics is unknown but a Euro plunge to 125 or lower would be a disaster for those holding Euro denominated debt.

In late news Saturday evening the G7 meeting in Canada produced a statement that should rile the markets on Monday. The G7 agreed to tax banks for the government bailouts of the global financial system. Any kind of massive global tax on banks to repay bailout funds is not going to be met with cheers by the market.

Secondly the G7 was assured by ECB president Jean-Claude Trichet that Greece would meet tough new targets to reduce its deficit by 2012. Obviously basic math is a challenge for Trichet. French Finance Minister Christine Lagarde said the EU would monitor the debt reduction plan and said Greece would not receive money from the IMF. Since the short covering on Friday was on expectations for an IMF bailout announcement this weekend it appears traders could reverse course next week since according to the G7 members, there won't be a bailout.

Our markets may be held hostage until "PIGS" fly or at least find a bailout partner.

Jim Brown

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