Friday was a day for surprises with job growth in May coming in much lower than expected and Hungary became the new Greece.

Market Statistics

The estimates for the Friday payroll report were being revised higher right up until the numbers were released. Goldman Sachs revised their estimates to 600,000 late in the week. President Obama was bragging in a televised speech about the strong jobs growth expected in May. Obviously they were all drinking the same Kool-Aid.

The May jobs report showed a gain of 431,000 new jobs. If you have been reading these pages over the last couple weeks you know that the Census Bureau was expecting to hire 400,000 temporary workers in May. They did not quite get all 400,000 hired but came close at 390,000. That means actual hiring across the U.S. amounted to ONLY 41,000 real jobs. All the rest was temporary census.

The actual estimates for hiring in the private sector ran from 50,000 to 200,000 jobs. Nobody expected less than 50K and almost everyone expected more than 100K. To say the private jobs number was disappointing would be an understatement after adding 231,000 private jobs in April and 208,000 in March. March was revised lower from 230,000.

The unemployment rate fell to 9.7% from 9.9% but it was a technical drop not an actual drop. After the March payrolls surged so sharply quite a few people who were considered discouraged workers and not looking for a job suddenly thought maybe they could actually be hired and rushed into the job market in April. This increase in job seekers boosted the available workforce and pushed the unemployment rate to 9.9%. In May those same workers became discouraged again and the labor force contracted by 322,000 as they quit looking for work. This pushed the labor force participation rate back down to 65% and technical unemployment back to 9.7%. Unemployed workers fell to 14.97 million after removing those discouraged workers.

The average duration of unemployment increased to 34.4 weeks and a new record. A record 46% of unemployed workers have been out of work for more than six months. The number of newly unemployed workers (less than five weeks) increased by 2.75 million to 18.7% of all unemployed workers. The U6 unemployment rate, which includes those working part time for financial reasons while looking for a new full time job is now 16.6%. That is the real unemployment number not the often quoted official rate of 9.7%.

I never cease to be amazed that so much attention is given to precisely measure the monthly change in a 143 million worker labor force. Since the monthly numbers are just estimates to be corrected much later this is a monthly exercise in futility.

In a couple months when the census workers are terminated we could see jobs decline rather than advance for several months. The state of the economy is not strong and anyone paying attention to the weekly new jobless claims around 450,000 per week should realize that fact. Moody's does not expect the U.S. to return to full employment until 2013.

In the chart below the blue represents private hiring in May with the red census hiring.

Remember, when listening to a politician claiming strong jobs growth if they do NOT mention the census hiring they are trying to deceive you.

May Payroll Chart

If the jobs numbers were not enough to shake up investors we also found out that Hungary may be the new Greece. The new Hungarian government, which was sworn in less than a week ago, said it was going to announce a new austerity plan to tackle the countries current economic problems. The new administration said it was also going to publish the figures about the "true" state of the 2010 budget. The new administration said it inherited a much weaker nation than their predecessors had revealed and had found that the economic numbers had been falsified. I guess the "blame it on the prior administration" excuse must be developing into a global trend since others have had so much success with the excuse recently.

The new prime minister's spokesman said, "Hungary had only a slim chance of avoiding a Greek-style debt crisis although the administration would act quickly to avoid the Greek path." The Hungarian currency plunged over 2% against the euro and hit a new one-year low. The stock of the largest bank fell 11.1%.

The new center-right government won the April elections by a landslide and capturing a two-thirds majority and ousted the incumbent socialists. The campaign platform was to boost growth via tax cuts and various economic stimulus measures. This was contrary to the new socialist programs and tax hikes proposed by the incumbents.

Hungary borrowed money from the IMF and EU in 2008 to avoid a default. As a condition of the loan Hungary was supposed to freeze its deficit at 3.8% of GDP. The new administration claims the corrected numbers show the 2010 deficit to be 4.5% to 4.8% but some analysts are expecting it to be more than 5%.

The sudden arrival of Hungary as a potential debt crisis equal to Greece is not such a big deal other than it again is a warning that European countries are not stable. Greece in April, Spain in May and Hungary in June. Who will pop up to attract headlines in July?

It is not that European countries are spending themselves into a crisis but they are deflating themselves into a crisis. Most of Europe is still in a recession and the more austerity measures are implemented the closer they will get to a deflationary environment. You can't cut spending drastically and raise taxes even more drastically and expect growth. With the EU forcing a new round of austerity measures on the weaker countries the more the Eurozone will decline. The common currency countries don't have the option of inflation to bail themselves out. They are stuck using the common currency so recession and deflation are the only answer.

I have written before about EU banks not wanting to lend to each other because of the potential balance sheet problems of owning too much country debt. On Friday the European Central Bank or ECB reported overnight deposits from member banks reached a record 320.4 billion euros. This is by far the most since the euro was created in 1999 and has exceeded 300 billion on four of the last five days. Those deposits earn 0.25%. Member banks are parking cash at the ECB on worries that the 750 billion euro rescue package may not be enough. The ECB said member banks will have to write off more loans this year than in 2009. Clearly the banking crisis is back in the EU.

I don't want to apply too much weight to the jobs report or the Hungarian problem. After all Hungary is number 50 on the country GDP ranking list. They are not significant in terms of global risk. I believe they were just convenient excuses. Remember my mantra of late, "when the market wants to go down it will always find an excuse." The market is in a bearish trend. It has not been able to post two consecutive daily gains of any substance since late April. Every little news headline is turning into the excuse of the day. We are in a bear market until really bad news is ignored.

That bad news is likely to get worse before it gets better. We have evidence from multiple economic reports that the U.S. is weakening. As that evidence grows the market will continue to weaken. The economic weakness may not be material and we may not actually dip back into a recession but that is what investors fear. If the June jobs report shows a loss of non-census jobs we could accelerate to the downside. Once the economics begin to improve the market will improve also, even if Europe is still in the tank.

One report I never focus on in my writing is the Economic Cycle Research Institute (ECRI) Weekly Leading Index every Friday. The index is supposed to predict future economic growth by factoring in the weekly changes in other economic reports. The index is a leading indicator of things to come by accumulating changes in dozens of other reports. The weekly index normally moves at a snails pace and saying the ECRI WLI gained 0.3 from 124.5 to 124.8 is not worth a weekly mention. That is the equivalent of reporting weekly on the six inches of continental drift every year. However, the change in the WLI over the last six weeks has been dramatic. The index has fallen from a cycle high of 134.7 on April 30th to 124.1 on Friday and the lowest level since July 2009. This is an earthquake in the index and in the forecast prediction of economic growth. This shows how the economy has suddenly changed direction. There is a rising number of analysts who think our GDP for Q3 will be negative. Some as much as -2% negative.

Weekly Leading Index Chart

When you really look at all the events of the past week it is a wonder that we did not close a lot lower. We had the Gaza peace armada and the blow up over IDF soldiers killing nine people. North Korea warned that war could erupt soon. "The present situation of the Korean peninsula is so grave that a war may break out at any moment" according to Ri Jang Gon, deputy ambassador.

There was a strong rumor that Societe Generale (SocGen) was facing a huge derivatives loss. The euro plunged -1.6% on the news although the rumor was denied by "unofficial" people at SocGen. The company's stock fell -7.6% despite a statement by the company. When asked by CNBC about the rumor a SocGen spokesman said, "If we had something to say, would have already communicated."

Euro Chart

The economic calendar for next week is very light with the only material event the Fed Beige Book on Wednesday. There was a call by Kansas City Fed President Thomas Hoenig to raise the interest rate to 1% by the end of the summer so the Beige Book will be key input for the June 22nd FOMC meeting. Dallas Fed President Richard Fisher, St Louis Fed James Bullard and Philly Fed's Charles Plosser have also expressed reservations about the extended period language. Jeffrey Lacker said he was "marginally comfortable" with the phrase and Atlanta Fed President Dennis Lockhart said he backed language promising rates near zero. "Waiting too long is probably less risky than moving too soon." We will hear a lot more of this talk before the June FOMC.

Economic Calendar

The president caught more flack over the oil spill as he cancelled his trip to Australia and Indonesia for the second time in order to make a third visit to the gulf. The president has gone from a "good working relationship with BP" to outright hostility. He is becoming increasingly hostile as the oil spreads as it did to the Florida shores on Friday. His disapproval rating on the spill has risen to 44% but BP's rating is much higher at 68%.

The president struck out at BP and blasted them over possibly paying their normal annual dividend. Analysts have been theorizing that BP might cancel the dividend this year in order to save cash for the cleanup effort. BP pays out an annual dividend of $10.5 billion. BP said it did not need to cancel the dividend but that was a board decision. They have more than $5 billion in cash and extensive credit lines.

Obama criticized BP for spending "lavishly" on TV ads to burnish their corporate image and considering paying the dividend. "What I don't want to hear when they are spending lavishly on advertising and shareholders is that they are nickel and diming fisherman and small businesses here in the gulf." I would agree with the sentiment but it is amazing how fast the president distanced himself from BP when his poll numbers started dropping. By attacking BP in his daily comments he is hoping to rise again in the opinion polls. It is amazing how attacking large corporations in banking, medical and energy can boost poll numbers.

BP is getting its fair share of negative press and deservedly so. All the methods attempted up to this point have failed. They have been less than truthful in their commentary and hired temporary workers for the last beach Obama visited to give the impression they were working hard on the cleanup.

Last week they successfully cut off the pipe at the top of the well and set another pipe and containment unit right on top of it in what should have captured 90% of the flows. Instead the gas and oil is simply blowing out under the seal and they are capturing only 6,000 bpd of a much-increased flow from the well. The well is now open directly to the sea and flowing at 100% of capacity. Scientists believe the well is gushing between 12,000 and 19,000 bpd into the gulf. Evidently the LMRP unit was not engineered correctly to capture all that capacity or the seal was damaged in the process. BP continues to claim that it will take a couple days to know if the device is going to work but a quick look at the real time video clearly shows a stronger leak in process.

The efforts by BP have been such big failures that there is a contest in progress to design a new logo for the company. This is not a BP sanctioned event. See Logos Here

Sample Logo Submission

The press keeps claiming the spill is the largest environmental disaster in history. put together this graphic showing that much more oil is spilled every year by tankers and rig accidents than the current BP spill.

Historical Oil Spill Events

Crude prices fell -$3.10 or -4.1% to $71.51 and wiped out the gains made since last Friday. Pushing crude down was the rekindled fear about an economic decline in Europe and a sharp rise in the dollar to a new 52-week high. Worries over the lack of jobs also took the speculation out of the crude market. Oil had rallied on hopes BP was finally going to fix the leak with the LMRP effort. Those hopes were dashed.

Crude Oil Chart

Dollar Index Chart

Natural gas stocks bucked the down market after gas prices rallied +2.3% to a new three month high at $4.97. President Obama was praising the benefits of nat gas earlier in the week and new EPA rules made it apparent many coal-fired plants would have to be closed or converted to nat gas.

EOG Resources was the exception to the rule with a decline of nearly $7 after a gas well blew out in Clearfield County Pennsylvania. The well spewed gas and gas liquids for several hours but it was finally capped at noon on Friday. There were no injuries. The well was being drilled in the Marcellus Shale. The blowout came during the fracturing process and 1.5 million gallons of fracture fluid was ejected from the well. EOG Resources was formerly known as Enron Oil and Gas. EOG operates 117 wells in the Marcellus Shale.

Natural Gas Futures Chart

Friday was also afflicted with a major downgrade of the financial sector. Richard Bove cut the price target and earnings estimates for Goldman Sachs and Morgan Stanley. He cut Goldman's target to $182 from $200 and earnings per share to $17.17 from $18.72. Bove said the quarter had been very bad for trading in both equities and bonds in the investment banking arena. He said it was going to be a bad quarter for Goldman.

He followed the Goldman downgrade with lowered earnings targets for Morgan Stanley (MS) and said this environment will ultimately impact JP Morgan (JPM), Citigroup (C) and Bank of America (BAC). He said the Goldman downgrade was unrelated to the SEC charges and everything to do with the fears in Europe, the fears in the financial market and the widening of the spreads. Bove had previously warned the new financial reforms would knock 10-12% off bank stocks but it would only be temporary once the industry adjusts. Despite the downgrade and the -3.2% decline in the Dow, Goldman only lost -1.2% to $142.

The biggest Dow losers were CAT, BA and AXP with -5% declines but the rest of the Dow stocks still took a serious hit. Consumer stocks VZ, PG and MCD faired the best with -1.5% declines. Mohamed A El-Erian, CEO of Pimco, said he expects more volatility ahead. "The disappointing jobs report is further evidence that drivers of self-sustaining private consumption growth are facing structural problems that result in slow income growth, reduced credit availability and lower ability to monetize wealth." Eduardo Castro-Wright, vice chairman and U.S. chief at Wal-Mart told shareholders that competition in the industry is "stiffer than ever." WMT shares declined with the market even though the company said it was going to buy back $15 billion of its shares.

Dow Component Chart

iSuppli reported the results of a first quarter survey of PC vendors and they had good news. In the first quarter global PC shipments jumped 22.7% from a year ago to 81.5 million units. This is the highest year over year growth since iSuppli began keeping records in 2003. However, analysts pointed out that Q1-2009 was a very bad quarter for PC sales. The following table is the top seven hardware makers ranked by market share in Q1.

Hewlett Packard - 19.6% share, up +22% year over year
Acer - 13.3% share, units up 47.1%
Dell - 13.1% share, units up 21.8%
Lenovo - 8.6% share, units up 58.5%
Toshiba - 5.6% share, units up 31.2%
Asus - 5.4% share, units up 136.2%
Apple - 3.4% share, units up 32.4%

Apple may be on the bottom of that list but it is far from the bottom in overall sales. Next week is the Apple Developers Conference and Steve Jobs is expected to announce an upgrade for the iPhone. Apple has provided updates or new devices every June since the iPhone was first announced in 2007. We know from the lost prototype saga that there is a new phone in the works with a front facing video camera that would allow for video conferencing assuming there was enough bandwidth. The bandwidth challenge with AT&T is expected to be eventually handled with the addition of Verizon to the iPhone options. Unfortunately that is not expected to be announced next week.

Despite the belief that a new iPhone will be announced this year there has been no slacking of demand. Analysts expect sales of 8 million units when the quarter ends on June 30th. Analysts claim the feature rich iPhone makes the device very "sticky" with users and none want to change to another device as is common with other smart phones other than the Blackberry. Apple shares are stubbornly holding in the $260 range thanks to the lure of a new product announcement and Apple's $42 billion in cash. Price targets range from a median of $320 to as high as $350. The new iAd business where developers can insert ads in their applications will bring another revenue stream into the Apple business.

Apple Chart

The Dow lost 110 points in the last hour to close down -323 points and close under 10,000 at 9928. The last two weeks of volatility gains since the May 25th dip to 9774 were completely erased. The Dow has been alternating between gains and losses with multiple triple digit moves over the last three weeks. The 10K level had formed as decent support but that support collapsed at the close on Friday.

This was the lowest close since February 8th at 9908. It is also a huge warning sign that we are about to test another level, possibly in the 9500 range. The Dow failed multiple times to break back above the 200-day average and four month closing low is a negative indicator.

The Friday decline came on nearly 11 billion shares of volume after the lowest volume week since early April. We averaged right at 9 billion shares all week until Friday's clash. There was lower volume on the advances and higher volume on the declines. This is a textbook market decline with multiple failures at high profile resistance, slowing volume as those resistance levels were tested and higher volume as support failed.

Dow Chart

The S&P ended at a new three month closing low at 1065. That is of course strong support and it was ahead of a weekend with tons of geopolitical risk. The resistance at the 200-day at 1106 was tested multiple times and failed every time. The support at 1065 has also been tested but the outcome looks bleak today. The trend is negative and the 1050-1065 range is the last hope before a dip to a significantly lower level.

Last Sunday I warned that the 200-day average should be our line in the sand for bullish trades on a breakout. That did not occur and today a move below 1065 should be the signal for additional bearish trades. Between those levels is simply high volatility noise.

SPX Chart

The Nasdaq was holding above the 200-day until the -83 point drop on Friday. The Nasdaq is still slightly more bullish than the Dow/SPX but only barely. The key levels to watch are 2200 followed by 2125 and the February support. If the Dow and SPX crater below their Friday closes the Nasdaq will probably try to catch up once Apple makes their announcement. Apple typically spikes on the announcement then rapidly declines. That could be the anchor for the Nasdaq that drags it lower.

Nasdaq Chart

The Russell has been the hero for several weeks with a firm resolve not to trade under the 200-day average. That was the support at the close on Friday. With the Dow and SPX firmly under the 200-day and threatening to go lower the odds of a break under the 200-day on the Russell are good. The next support is 625 from February, Sept and Oct. (black line) If that support breaks I believe we will see a drop under 600 to something in the 585 range. The Russell dropped -5% on Friday and besides banking and oil it was the biggest loser of the week. That suggests fund managers are finally turning some small caps lose in fear of a steeper market decline. A rebound on Monday would be nice but it would take a move over 670 to make me bullish.

Russell 2000 Chart

In summary, I am not positive on the market for next week. There are plenty of excuses left should the market want to go lower and there are new ones appearing every day. There is no overriding reason to be long the market and there are limited events on the calendar that could be strongly positive. There are far more events in the near future that could provide a negative push. Sentiment is increasingly negative and the path of least resistance is still down. I remain cautious until proven wrong.

Last Sunday I experienced a cardiac event that kept me in the hospital all week. I have never had any heart problems in my 62 years of existence so it came as a shock. It appears I will become better acquainted with my new cardiologist over the coming months. Fortunately there is nothing serious and I should have a couple decades of life still ahead. I appreciate the well wishes from everyone and I plan to be writing for years to come. I love the markets and the macro impacts of fundamentals, technicals, earnings and economics but I would like for the geopolitical events to quickly fade away. Unfortunately we don't get to choose what impacts our markets so I will continue to report on them until they do become mute.

Jim Brown