A blowout jobs number, blowout ISM Services and strong Factory Orders caught investors by surprise and those who were short had a very bad day.

Market Statistics

The Nonfarm Payrolls for January exploded well past consensus estimates to show the addition of +243,000 jobs. Most analysts believed the number would decline sharply from the +203,000 added in December to something in the 100-125K range for January. The explosion of hiring in a month known for seasonal layoffs really caught investors and analysts off guard.

The private sector created +257,000 jobs and the government workforce was cut by -14,000 jobs. Goods producing firms added +81,000 and service firms added +162,000. The diffusion index increased from 62.4 to 64.1 indicating nearly two thirds of private businesses were hiring. The unemployment rate declined to 8.3% from 8.5%. That is the lowest level since February 2009.

However, all was not rosy in the reports. The labor force participation rate declined to 63.7% and that is the lowest level since the recession. The drop in the participation rate was blamed on the conversion to the 2010 census data that showed high population levels than in prior surveys. This was the first month using the new census data. The companion Household Employment Survey also switched to the new census data and that showed an increase in population over prior estimates of 1.51 million people and increased the labor force by 258,000, employment by 216,000 and unemployment by 42,000.

The January benchmark revisions to prior months added +266,000 jobs for all of 2011. Gains were strongest in early 2011 and in the last quarter.

Forecasters and analysts were perplexed by the huge gains when the ADP and Challenger reports were predicting smaller numbers. Job gains were broad based across all industries so one sector did not produce outsized gains to skew the numbers. Construction did see a larger than expected increase and analysts believe it was due to the warmer weather allowing builders to get a head start on spring construction.

Now analysts are forced to reconsider the factors which had been weighing on hiring for the last year. That was slowing global growth, the European debt crisis, weak economics in the USA, weak home prices and restricted credit availability that prevented business expansion. Suddenly those factors appear to have weakened.

Obviously one month does not make a trend and the switch to the most current census data could have produced an accounting anomaly although those reviewing the data claim that is not the case. Over the last six months one million jobs have been created. If the current pace holds we could add another million over the next four months and three million for all of 2012. That would nearly double the number of jobs created in all of 2011. Again, one month does not make a trend but in the chart below there is a definite uptick since the low of 53,000 new jobs in May. Maybe there is hope for the economy and the market.

Nonfarm Payroll Chart

The ISM Services for January was also a significant surprise. The headline number spiked to 56.8 from 52.6. To put this in perspective the headline number has averaged 52.8 for the last six months with the high for that period 53.3 in August. This was a major improvement and well over analyst estimates for a rise to 53.0. This was the highest level since March.

All the major components posted decent gains. New orders rose from 53.2 to 59.4 and the largest increase since April 2009. Backorders rose from 45.5 to 49.5 and very close to moving into expansion territory for the first time since September. Employment rose a whopping +8 points to 57.4 from 49.4 and the largest gain since records were started in July 1997.

New export orders rose from 51.0 to 56.5 and that suggests the economic downturn in Europe is not impacting U.S. companies as bad as previously expected.

The sharp increase in new jobs and the sudden uptick in the ISM Services suggests the economy may be growing well above the current +2% GDP forecasts for Q1. The vehicle sales for January were also much stronger than expected at a rate of 14.1 million compared to 13.5 million in December. This suggests increased hiring in the parts supply chain and stronger consumer confidence than what was reported. You have to be pretty sure about your job before you commit to spend tens of thousands of dollars on a new car or truck.

ISM Services Chart

Lastly the Factory Orders for December rose +1.1% compared to Moody's estimate of 0.6% and consensus estimates of +1.5%. Orders in November rose by +2.2% so this was a slight decline but December is not normally a big month for orders. To have two strong months back to back was a real positive after the prior three months averaged -0.1%. New orders for durable goods rose +3%. Core capital goods orders rose by +3.1% from the prior month and +10% year over year.

The combination of these three reports, Jobs, ISM and Factory Orders, suggests the first quarter is off to a roaring start. Those predicting gloom and doom just a couple weeks ago are being forced to rethink their outlooks.

After a flurry of big reports we have a very weak economic calendar in the days ahead. There is literally nothing on the calendar that should have any market moving potential. The Jobless Claims and Consumer Sentiment are the only reports of any interest and those are light. The Wholesale Trade and International Trade reports are lagging data for December and will likely be ignored as will home prices. Anyone who does not know home prices are weak should not be in charge of investing their own money.

Economic Calendar

Not on the economic calendar but still a factor is the Greek debt disaster. Thursday's "imminent" deal on the debt swap is still imminent. Apparently the private sector debt owners don't want to agree to a deal until the EU and Greece agree on the final terms of the second 130 billion euro bailout. If that deal fails the debt swap talks are meaningless. The 130 billion deal is now thought to be at 150 billion but various EU members are holding up approval until they get more assurances of further austerity and further accountability from Greece. If the big deal is not done soon there won't be enough time to keep Greece from defaulting on 14.5 billion in debt payments on March 20th. The deal has to be approved, the details worked out, pass a final vote and then have funds distributed by March 20th. Officials claim the deal must be finalized this week for all of that to happen by March 20th.

Unions in Greece have rejected any further pay cuts or layoffs and the EU wants another 150,000 workers to be fired. The key point here is when Greece runs out of money all the public workers will be out of a job or at least working for free. The unions are quickly running out of bargaining power.

The Greek Finance Minister said Friday that many tough economic issues had been solved but other crucial issues remain. He also said something to the effect of "If these issues cannot be resolved and Greece elects to withdraw from the euro…" The fact he is even talking about that in public suggests there is a long way to go before everything is resolved favorably. I reported last weekend about an article in the Financial Times quoting Greek officials saying a withdrawal plan had been prepared and would be announced in early March. That news did not get much play in the press but those comments from the FM seem to indicate there is an alternative plan if they can't get the concessions they want from the EU. I believe Germany knows this is going to happen and that is why they don't want to give Greece any more money. The four remaining AAA credits, Germany, Finland, the Netherlands and Luxembourg are against loaning any more money without very strict rules. Why string an addict along for additional months or even years when the future outcome is already known. If they can't go cold turkey and kick the habit today then giving them a monthly fix is just postponing the pain.

There was a meeting scheduled for Saturday with the Troika officials and Greece will propose the terms of the potential debt swap agreement along with its terms for the second bailout. Representatives for the private banks and insurers taking the 70% haircut will also be back in Athens on Saturday to work out any final details. There are rumors Prime Minister Papademos might resign this weekend if he can't get the three parties in his coalition to go along with the stringent terms. "There is no other option" is the message. Accept the terms or subject Greece to a messy default and withdrawal from the euro. All three major coalition parties have rejected the terms. Greece is in its fifth year of recession and will post a budget deficit in 2012 of 9.1% of GDP.

Greece has NOT gone away as a market influence. We are reaching the point where something significant is about to happen. If by some chance Europe decides to open the purse strings again and goes through with the second bailout it would be VERY positive for our markets. If Greece announces it is going to default and withdraw from the euro it would be very negative on a short term basis. I believe a default is already priced in but there would definitely be a severe knee jerk reaction that could be dramatic. Greece is smaller than Houston in economic activity. Its GDP was only $330 billion in 2010. The impact of a Greek default would be harder on Greece than anyone else. Just be aware that we are approaching a critical point in this story where the outcome can produce a significant move in the U.S. markets. Hopefully the EU will buckle and commit to loan the money and by doing so kick the can well down the road where Greece won't be a problem for many months.

Also helping the markets last week was the vote by 25 out of 27 EU members for a stronger fiscal discipline plan. That took some of the focus off Greece. On Thursday Bernanke testified before the House Budget Committee and gave an optimistic outlook for the economy despite the "frustratingly slow pace of the recovery." He did not rule out QE3 but he did distance himself from any new stimulus in the short term. After Friday's economic reports we can kiss that potential QE3 goodbye and probably the plan to keep rates low until late 2014. If the economics in February mirror those in January we will be looking at a quick change of stance by the Fed.

Evidence of this could be seen in the ten and thirty year bond yields after the reports. The 10-year yield spiked +6.79% to a yield of 1.94% from a low of 1.80% Tuesday. The 30-year yield is very close to breaking to a new three month high.

30-Year Bond Yield Chart

Ten Year Note Yield Chart

Crude prices rallied on the jobs news because more people working will increase oil demand. Iran also played into the mix after Supreme Leader Ali Khamenei warned again about halting oil shipments to Europe and causing ten times the trouble for the U.S. and its allies if there was an attack on Iran for any reason. Khamenei also admitted to helping third parties attack Israel and said "From now on, in any place, if any nation or any group confronts the Zionist regime, we will endorse and we will help. We have no fear expressing this."

Israel is moving closer to a unilateral attack and comments like those by Khamenei will only hasten the decision. In the U.S. the threat level surrounding potential Israeli targets like synagogues, restaurants, etc, has been increased. Police forces have stepped up patrols and surveillance after a security document from Israel predicted attacks against soft targets in the USA.

In another speech Khamenei warned "Of a great event" where Zionists and the Great Satan (USA) would be defeated. Of course that plays into the master plan to keep followers in line and tease them with future victory. Who doesn't want to win?

The increasing openness by Iran in expressing hostility and threats is seen as accelerating decisions about preemptive strikes against Iran and the resulting loss of oil shipments. Several articles last week predicted Israel would attack within three months because Iran would reach a point in about six months where attacks would be less effective. Apparently Iran is rapidly moving installations and people in anticipation of an attack. Iran also launched new military exercises in the south to participate in winter war games against a "hypothetical enemy." U.S. forces are just over the border from the games in Afghanistan. Plans for new naval exercises in the Strait of Hormuz have been in the works for weeks.

Iran's oil minister Rostam Qassemi said Saturday Iran would "definitely" cut off oil supplies to "hostile" European countries, without specifying which ones they were. Brent crude rallied to a six month high on Friday in response to the escalating threats.

Brent Oil Chart

WTI Oil Chart

Gold lost $31 after the jobs report. Gold had been rising on the falling dollar and expectations for a weaker economy in 2012. Commodities in general had been in rally mode for several weeks and Goldman and JP Morgan warned on Friday they had come too far, too fast. While Goldman still expects higher prices by year end they felt the sector was due for a pullback.

The number of open contracts on 24 commodities rose by 9.3% in January and the most since January 2006. Speculators are the most bullish since November according to CFTC data. Hedge funds and other large speculators are holding 742,902 net long contracts across 18 U.S. futures products. That is up from 454,512 in December. Open interest across the 24 commodity group rose to 10.43 million contracts on Jan 31st, up from 9.54 million on Dec-30th.

However, this is also a seasonal event. Commodity funds normally liquidate positions in Q4 and then reenter new positions in January.

Gold Chart

Silver Chart

I believe we just heard the starter's gun for a strong rally in equities. With the majority of the investing public heavily invested in bonds there is going to be a flood of money coming back into equities once bonds begin to collapse. Given the dramatic economics and the dramatic sell off in bonds on Friday I believe we have seen a top in bonds. When that 30-year yield breaks to a new three month high the race will be on to dump bonds and buy stocks.

I am sure quite a few investors will believe the payroll report was a fluke and they will remain in bonds until the next few reports confirm. If they don't confirm then there is no harm and the existing strategies remain in place. If they do confirm an accelerating recovery then get out of the way. The herd will stampede and stocks will move higher, possibly much higher.

Of course the key here is that the future economic reports must confirm the improvement. However, if you are a fund manager with millions or even billions under management are you going to wait several weeks before you start reallocating your portfolio? Probably not. Odds are good you will start moving some money in order to be ready for the change in strategy.

Obviously Friday was a giant short squeeze. The difference was the new closing highs well over resistance and a strong reason why investing conditions may have changed. Investors and analysts have been waiting for three years for this moment.

On the NYSE there were 295 new 52-week highs and many of those were all time highs. On the Nasdaq there were 263 new highs. There were only 5 new lows on the NYSE and 14 on the Nasdaq. Advancers were nearly 4:1 over decliners but that is expected in a major short squeeze.

Monday is going to be the key. Asia should open higher on our news. Europe should also open higher but it depends on the events in Greece over the weekend. If Greece was to somehow be magically resolved over the weekend we would be in blast off mode.

I believe the change in sentiment has been underway for several days. For evidence I will use the Russell Microcap Index ($RUMIC). This is an index of 1000 stocks with an average market cap of $310 million. These stocks are traded on the major exchanges and not the OTC bulletin board. These are the smallest stocks in the Russell universe. You would recognize very few of these names. They are very illiquid and fund managers would not be throwing money at these stocks unless they were confident of the market direction. There is an ETF for it called the IWC. The RUMIC has been moving up steadily since the beginning of the year but look at the acceleration that started on Wednesday. That was when the auto sales came in at 14.1 million and the highest pace since mid-2008. The ISM Manufacturing rose for the third consecutive month to a 7-month high and construction spending rose +1.5% and the fastest rate in four months.

Russell Microcap Index Chart

Also fueling the sudden change in market sentiment is some good news from around the world. Germany's employment rate hit a record low and the economy grew faster than expected in Q4. The consumer confidence in the UK rose to seven month highs. Russia reported a Q4 GDP of 4.3% which was better than expected. Japan's industrial production spiked by +4% which was much more than expected.

China's services PMI fell to 52.9 from 56 and the second lowest on record. Wu Qing, a finance researcher with the State Council Development Center, warned of deflation ahead if China did not immediately increase stimulus and remove restrictive monetary policy. Qing warned China needed to cut rates ASAP. Zhang Chenghui, an economic researcher with The Economic Times, also warned the PBOC must cut rates "many times" in 2012 to avoid a hard landing. Reuters conducted a poll that showed economists expect the PBOC to cut the reserve rate four times in 2012 by half a point in each cut. The point to this paragraph is that China is under extreme pressure to cut rates and provide other stimulus for the economy. The odds are very good this will happen soon.

Don't forget the sharp decline in yields on sovereign debt in Europe after the nearly 500 billion euros in LTRO loans from the ECB. That program changed the outlook for Europe almost overnight. Now they are getting ready to do it again in February and the expectations are for as much as one trillion euros. This is QE at its finest despite the fact they "sterilize" it by taking liquidity out elsewhere. You give 900 banks 1.5 trillion euros for three years at 1% interest and you could float the Costa Concordia on that much liquidity. This is the ECB acting like the Fed and the program is working.

The downside to this bullish scenario is the weak earnings. Only 44% of companies have beaten on revenue for Q4. Guidance has been lousy with numerous high profile companies guiding lower. Just one week ago nearly every analyst was predicting profits that would barely grow in Q1 and Q2. That has not changed. However, those earnings reports had failed to dampen investor spirits. Stocks getting crushed on earnings were rebounding 2-3 days later. Investors were buying the hope rather than the reality. Now they have increased hope thanks to the payroll report.

The Dow and Nasdaq broke out to multi-year highs. The S&P and the Russell indexes are lagging that breakout. Since the Dow is the milepost by which the market is measured the headlines in the weekend papers will be "Markets hit Three Year High." If they use the Nasdaq Composite that headline would read "Tech Stocks at 11-year high." Regardless of the reasons those headlines will be bullish for sentiment.

The S&P gained +1.5% to close at 1345 and exactly at strong resistance dating back to February 18th. The range from 1345 to 1370 should be very strong resistance but with the Dow and Nasdaq in blue sky territory that resistance should weaken. If Europe and Asia trade up Sunday night we could see the S&P launch right to the top of that range at the open.

Of course the S&P is the most overbought on the RSI as it has been since Feb-2011. The beauty about rallies is they can remain in overbought territory for a long time.

Support is now well back at 1325 and I am sure a dip to that level would be instantly bought assuming of course there were no catastrophic headlines from Europe.

S&P Chart

The Dow closed well over the high close for 2011 at 12,810 to breakout to a new three year high. One market technician suggested using the 3% rule on breakouts. Be cautious until the index has moved +3% over the prior resistance level before committing large amounts of money. Breakouts that only exceed the prior levels by only a handful of points tend to backtrack.

The next material resistance is 14,000-14,100 and the highs from 2007. Just typing those numbers causes me to pause. I would have thought a return to those levels would be due to a strong recovery in the range of 4.5% GDP, low unemployment and strong profits for corporations. Obviously we are not there yet but even 13,000 should have been a result of those conditions. You never know what the future may bring.

The Dow's gains over the last month was produced by ten stocks that accounted for 58% of the gain.

Support is 12,700.

Dow Chart

The Dow Jones Total Stock Market Index, formerly Wilshire 5000, is only 200 points below strong resistance at 14,350 and a breakout there would confirm the broad market rally. This is not a narrow breadth index where a few stocks can account for the majority of the gains. This is the broadest index and a true representation of the entire market.

Wilshire 5000 - Dow Total Stock Market Index Chart

The Nasdaq has been the favorite of retail investors in 2012 and Friday was no different. There was a strong 1.6% gain with 263 stocks making new 52-week highs. Apple, Microsoft, Intuitive Surgical, Panera, Gilead Sciences, Peet Coffee, F5 Networks, Medivation and Fiserv were some of the companies making new highs. Google and Amazon were obviously missing from that list thanks to their earnings disappointments.

The Nasdaq vaulted over resistance by about 30 points so that was a pretty solid confirmation. Support is well back at 2800.

The Nasdaq 100 ($NFX) continued its breakout to new 11-year highs and it is now +125 points over prior resistance.

Nasdaq Chart

Nasdaq 100 Chart

The Russell 2000 continued its breakout over resistance at 800 and has now stretched those gains to 31 points with a huge +2.24% gain on Friday. The index ran into uptrend resistance at 830 and would be due for a decent dip but that depends on how much cash investors are planning on moving from bonds to stocks.

Support is well back at 800-805.

Russell 2000 Chart

The Dow Transports are inching higher but with far less conviction because of the high fuel prices. With oil still hovering around $100 that is a weight on profits.

Dow Transports Chart

As I stated earlier I think the jobs numbers, if they are to be believed, suggest the U.S. is growing faster than estimates from just a couple weeks ago. Charles Biderman from TrimTabs.com is highly skeptical of the payroll numbers produced by the BLS because they don't relate to real data collected in real time in the form of tax collections. The government could produce a real time number based on the number of employees being paid every week and the tax deposits by the employer. The government has steadfastly refused to change over the years for various reasons.

The Nonfarm Payroll numbers have been politicized in the past with various administrations changing the way they are calculated in order to paint a better picture of their economic success. Clinton was the last person to change the calculation but at least the new rules were clear. Since 99.9% of the public has no clue why or how the numbers are derived the only piece of the puzzle they see is the headline number. A strong number improves consumer sentiment and happy consumers buy more goods and spend more money.

Charles Biderman produced a short video explaining his position on what he says was a drop of -2.9 million jobs that miraculously turned into a gain of 446,000 new jobs over the last two months. See Video

Biderman's claims should be ignored by the market because most investors don't care. The will see the +243,000 new jobs headline and immediately form the opinion that the economy is accelerating. In theory this should produce more market gains as fund managers and investors begin to shift money out of bonds and back into equities.

The fly in the market soup is still Greece. As of late Saturday the battle is still raging between Greek politicians and the troika (EU, IMF, ECB). The demands by the troika are reportedly chiseled in stone and they are not giving an inch in the negotiations. Headlines were being updated continuously with claims and counter claims over who was to blame for the delays and lack of an agreement. The meeting of all Greek party chiefs was postponed until Sunday. The troika is requiring leaders of all the political parties to sign off on the new austerity measures. Several are dead set against it. Greece is supposed to present its final proposal to the troika on Monday and the EU Finance Ministers are expected to vote on Wednesday. These dates are subject to revision at any time.

The outcome in Greece should be known over the next three days. I know, we have been expecting the outcome every three days for the last three months. This time may be different. That outcome will play against the background of a potentially accelerating recovery in the USA and stronger economic numbers in Europe and possible economic stimulus in Asia.

The market appears to be setting up for what could be a strong continued rally "IF" all the parts in Europe and Asia come together as expected. The trend remains our friend and I would not bet against it next week. I was cautious over the last couple weeks but that caution is ebbing. I still believe Greece will eventually default but I have hopes the meetings this weekend end in an agreement that allows the EU to kick the can far enough down the road that Greece is not a daily headline for all of February.

Jim Brown

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