Analysts are mixed on what pushed the markets higher but whatever the reason it is the highs being tested not the lows.

Market Statistics

Friday was all about the Nonfarm Payroll report but there was still lingering background support from the Romney debate surprise and the Fed. The Nonfarm Payrolls shocked everyone. The number of new jobs created was right in line with estimates at +114,000 but the unemployment rate saw a sharp drop lower. The rate fell from 8.1% to 7.8% despite the number of new jobs being well under the 150,000 per month required to handle graduations and immigration. More than 456,000 people dropped out of the labor force and the labor force participation rate of 63.6% is now at 30 year lows.

The Nonfarm Payrolls for the prior two months were revised higher by +86,000 jobs. July rose from +141,000 to +181,000 and August from +96,000 to +142,000. That was not the reason for the sharp drop in the unemployment rate. The government added +45,000 jobs. Thank you China for paying their salaries.

There are two reports every jobs Friday. The employer report is produced from the data received from 140,000 employers. That is the report that showed a gain of +114,000 jobs in October. The second report is the Household Survey where the data is gathered each month from a survey 60,000 households. The unemployment rate comes from the Household Survey.

The Household Survey showed that 456,000 people dropped out of the labor force in September. That by itself would cause a dip in the unemployment rate because it changes the total people in the labor force by -0.3%. By itself that would have lowered the unemployment rate but there was good news as well. The survey showed that 873,000 people found new jobs. That lowered the number of unemployed persons to 12.1 million. The majority of those jobs, 582,000, were taken by people forced to accept part time work because full time was not available. Yes, people did find work but it was part time.

This is the third consecutive September where part time workers surged. This should not be a surprise to anyone. People normally look for part time work in the three months before the holidays to earn extra money to spend on gifts, parties, family get-togethers, travel, etc. Most of those people were probably drawing unemployment benefits that were about to expire or had already expired. Even if you are living with your parents and have no urgent need for day to day money you would still want to raise cash for the holidays. UPS, FedEx and Wal-Mart all hire more than 50,000 each for part time work in Q4.

The combination of 456,000 people dropping out of the labor force and the addition of 582,000 part time and 291,000 full time jobs caused the monster dip in the unemployment rate to 7.8%. It should be noted that the same survey showed a loss of -119,000 jobs in August and another 368,000 people left the labor force. In July the same survey showed a loss of -195,000 jobs and 150,000 left the labor force.

Here is the $64 million dollar question. Does anyone really think the Household Survey suddenly reversed to add nearly one million jobs in September when the economy was dropping back into recession according to almost every economic report?

The historical data from the St Louis Fed shows there have been very large spikes in the Household Survey in the past. However, this was the largest gain in the last five years and was out of character with the last six months. The blue lines are Household Survey and red lines are the Employer Survey.

FRED Payroll Chart

Quite a few people thought there was something fishy in the numbers. Former GE CEO Jack Welch blamed the sudden job gain on political dirty tricks in the accounting. Two Congressmen and John McCain also went public claiming the sudden surge a month before the election was suspect.

Even Moody's stressed that there was "considerable suspicion" surrounding these numbers and the high number of part time workers added.

That is the first time since January 2009 that unemployment has been under 8% and it almost NEVER moves more than a tenth of a point in any single month. To move three tenths in the month before the election was the equivalent of waving a red cape in front of a bull.

I have speculated in the past when the numbers suddenly changed for no reason that the process was flawed and should be changed. When you have several dozen people calling 100s of homes a day and asking the survey questions it would be very easy to swing the outcome. "Did anyone in your family find employment in September?" Response is no but the operator checks off yes instead. I am NOT saying it happened but it is possible. Calling 60,000 homes a month would average out to 2,727 calls per workday. If you had 20 callers that is roughly 135 calls per person per day. Assume just ten of the operators wanted their high dollar government job to continue for another four years without threat of a cutback, they could easily impact the totals by a large amount and nobody would ever know since it is a phone survey.

Moody's said in a note to investors that the unemployment rate is expected to rebound to 8% or HIGHER in the coming months. The next report is the Friday before the elections. That is going to be a highly scrutinized report with lawmakers already claiming foul.

Nonfarm Payrolls Chart

On a side note I also think it is strange that September produced so many jobs when the Jobless Claims did not subside. The first two weeks of September had jobless claims of 385,000 per week and that was four month highs. If employers are going to add new workers they would probably not be laying off current workers. They would first increase the number of hours for existing workers because that has the least liability. Taking on a new worker adds costs like insurance and benefits but adding a couple hours to existing workers schedules is cheap. In the past that is normally the trend. Analysts can project a future increase in hiring by watching the rise in hours. In the Nonfarm Payroll report the average hours worked has been flat at 34.5 for months and would seem to indicate no hiring plans.

Weekly Jobless Claims Chart

Executive search firm Korn Ferry (KFY) surveyed employers from Sept 28th to Oct 3rd and found that 58% of employers plan to hire workers sometime within the next 12 months. However, 69% are waiting for resolution of the fiscal cliff or the European financial crisis. The survey showed that actual hiring was stagnant. While 26% said they were currently hiring, 25% said they were in the process of laying people off. Nineteen percent said they were hiring more than a year ago and 19% said they were laying off more people than a year ago. Forty-nine percent said they were holding the line and delaying a decision until the economic outlook stabilized. This survey was yet another contradictory indicator to the surge in the Household Survey job numbers.

The Monster Employment Index for September was also reported on Friday. The headline number declined from 156 to 153. Hiring fell in 12 industries and rose in seven. One was unchanged. Hiring in all but one region declined and that one was flat.

Not to beat a dead horse but "hiring declined in all but one region." All the other reports discussed above showed hiring was either declining or weak except for the unexplained gains in the Household Survey.

The economic calendar for next week is heavily weighted to European events. Tuesday and Wednesday are particularly troublesome. On Tuesday the Troika issues its report on Greece and its progress on austerity and implementing the terms of the last two bailouts. It is expected to be ugly. Greece is expected to be way behind schedule and desperately in need of additional funds, possibly as much as 40 billion euros. There are still 41 billion euros left undistributed from the last bailout. The report will be released on the same day as the EU Finance Ministers meeting and Angela Merkel's visit to Greece.

The Merkel visit is going to be a lightning rod for Greek citizens. You can expect huge demonstrations and riots demanding no further austerity. The opposition parties and trade unions have vowed a "baptism of fire." The prime minister warned on Friday that Greece faced "Societal collapse like Weimar Germany without immediate financial aid."

The Eurozone Finance Ministers meet on Wednesday and Greece will be the topic.

There is a strong potential for major headlines from these events.

The Fed Beige Book, a report on Wednesday of economic activity in all the Federal Reserve regions, could be ignored if Europe is melting down at the time.

Economic Calendar

Spain is not specifically on the calendar for next week but it will be in the headlines. The prime minister is still dragging his feet on asking for a bailout in hopes of getting past the Oct 21st regional elections. If he asks for a bailout the Troika will immediately start telling Spain what new austerity measures they must take. EU coordinator Ollie Rehn said on Saturday that Spain's proposed budget for 2013 was seriously optimistic and the proposed deficit would be a lot higher if real economic growth expectations were used. That is not a good sign. With citizens already protesting against austerity the news of additional measures would be negative ahead of the regional elections.

Spain's Finance Minister, Luis de Guindos, spoke at the London School of Economics and said "Spain doesn't need a bailout at all" and he was completely serious. The audience began to murmur and finally broke out into audible laughter throughout the entire audience. Not to be perturbed by the audience reaction he said the current reform programs already announced along with the ECB bond-buying program would be enough to help Spain recover. He later said Spain would not ask for a full sovereign bailout and forced austerity overseen by the Troika but would be able to recover by accepting the enhanced credit line the ECB is offering in its bond buying program. Surely he is aware the OMT bond buying also has conditions attached.

He said Spain will actively support the eurozone banking union. I guess they will be glad to dump their insolvent banks into the union in hopes of getting the union to recapitalize those banks. Unfortunately, Merkel and friends have already said no undercapitalized banks would be allowed into the union. It makes you wonder if the finance minister listens to the news. The prime minister, Rajoy, will be attending the Club Med summit in Malta this weekend and Reuters is reporting that France and Italy, fearing contagion from Spain, will demand Rajoy immediately request a bailout. There will be headline risk from Spain for weeks to come.

ECB head, Mario Draghi, said on Friday the next move is up to Spain. He repeated nine times in a 54 minute press conference that the ECB would not start intervening in bond markets until governments like Spain request a bailout and agree to the conditions. He also ruled out the ECB from taking any further losses in Greek debt. The Greek PM has been asking bond holders to cancel their bonds because Greece can't pay and their debt load is more than was agreed to under the bailout terms. Greece asked the ECB to roll over any Greek debt it holds. Draghi pushed back against the request saying it would "qualify as monetary financing" which is prohibited under the ECB charter. Analysts believe the ECB could transfer the debt to the ESM and then the ESM take the write down. Germany, Holland and Finland would probably veto that.

There was another study out last week on the potential impact of the fiscal cliff. While most analysts believe there will be some compromise there will still be an impact. The study said a full cliff dive would cut GDP by -4 points in 2013 and even a compromise would cut -1.5 points from the already weak estimates of +1.3% growth. There is a very good chance we will see a recession in 2013.

Apple (AAPL) shares are already in recession. Apple shares closed below their 50-day average at $652 with a -$14 decline. This is the lowest close since August 17th. Pushing shares lower was news that thousands of workers at the Foxconn iPhone 5 assembly plant were on strike. Over 4,000 workers struck over strict quality control standards and demands they work through the week-long National Day holidays, which begin on Monday. Quality control inspectors have even been beaten up by the workers for demanding such strict quality compliance. Foxconn employs over one million workers and assembles most of Apple's products.

The strike in the assembly process has almost completely shut down the iPhone 5 production according to reports. With Apple trying to roll out the iPhone to more than 20 countries this is a serious problem. Production is already behind because of quality control problems at screen maker Sharp.

Shares of Apple are -$50 below their all time closing high of $702 on September 19th.

Apple Chart

Google (GOOG) rallied to a new high intraday at $774.38 but declined to end the day flat at $767.59. Google (Motorola) won a patent case against Microsoft in a German court. The court ruled that the Microsoft patent that allows applications to work on different handsets was not infringed. This will allow developers to avoid writing separate application code for each handset and save time and development costs. Motorola, now part of Google, has won several patent cases in recent months. The German courts are proving to be the battleground of choice because they respond quickly with a minimum of costs compared to other countries. Normally if you win in one country you can then press your win as a precedent in other countries.

Google Chart

First Solar (FSLR) junction modules have been out in the sun too long. Avian Securities downgraded FSLR from positive to negative and warning that a reliability issue for junction modules has resurfaced. Apparently there is an engineering problem in the modules that affects safety and reliability depending on what type of installation they are used for in the field. First Solar published a note confirming the problem but said a replacement order had already been implemented and it would not have a significant impact on earnings and was considered in the published guidance on August 1st. FSLR said there were 232,000 modules in the field that could develop a problem with a "loose cord plate." FSLR knows where they are and they are working proactively with users to repair or replace them under warranty.

In theory this would appear to be a nonevent and the -11% drop on Friday just a knee jerk reaction. However, it is best to wait until a new direction appears before jumping into FSLR shares. $20 is support but I am sure only a few FSLR shareholders actually heard the follow up news while the downgrade headline will resonate for several days.

FSLR Chart

Zynga (ZNGA) fell -12% to a new low after warning it now expects to post a loss for the quarter. The company said it would take a charge of up to $95 million against the OMGPop purchase. Zynga bought the company for $183 million. Analysts also said the conversion from web-based Facebook games to mobile is "more painful than expected." Zynga is trying to move away from Facebook games and concentrate on mobile and use as a game portal. An analyst at Sterne Agee who was previously bullish now sees "significant layoffs in the coming months" and said he was surprised at the lowered guidance. Zynga now expects 2012 bookings as low as $1.09 billion compared to prior estimates of $1.15 to $1.23 billion. Zynga's Farmville game had 80 million players at its peak and now it is closer to five million. Zynga has a lot more games now but they are struggling to find another breakout winner. You have to believe Facebook is thinking about an acquisition here in order to keep them generating games to keep Facebook popular. Zynga's market cap has declined from $7 billion to $1 billion since the IPO. That is pocket change for Facebook.

ZNGA Chart

Facebook shares declined -5% on the Zynga earnings warning. We are getting closer to the next three share lockup expiration on Facebook. On Oct 29th there are 234 million shares held by employees that will be available for sale. On Nov 14th another 777 million shares of stock and stock options will unlock. On Dec 14th another 156 million shares held by early investors will be available for sale. There are currently 675 million shares outstanding and available for sale. The lockups above will release another 1.167 billion shares and that does not include the shares held by Zuckerberg. He has said he has no plans to sell his shares for at least a year so Facebook has removed them from the lockup totals. Facebook earnings are Oct 23rd.

Facebook Chart

F5 Networks (FFIV) lost -4% after Barclays downgraded the company from overweight to neutral. The analyst said the outlook for corporate and federal government spending remains weak. He said the outlook remains strong for F5 thanks to solid fundamentals in the application delivery controller (ADC) market. They are gaining share from Cisco. "However, we believe further upside requires a pickup in the economic growth rate."

Competitor Adtran (ADTN) warned it was seeing revenue declines in the mid teen percentages due to "typical seasonality and the current telecom spending environment."

F5 Networks Chart

Chipolte Mexican Grill (CMG) should be making Einhorn a lot of money. The stock is accelerating to the downside after Einhorn trashed it last Tuesday. CMG lost -$13 on Friday to close right at a 52-week low. CMG has lost $70 in the last three weeks. The decline accelerated after Raymond James downgraded Panera (PNRA) from market perform to underperform. The analyst said Panera and food stocks in general are at risk long term from weakening fundamentals and food price inflation caused by the historic drought in the Midwest this year. That was one of the complaints Einhorn had against Chipolte, rising food costs for corn and corn products like tortillas. Panera lost -2%.

CMG Chart

Earnings begin next week but only a handful of companies report. Alcoa, Yum Brands, Costco, JP Morgan and Wells Fargo are the main reports. S&P is expecting Q3 earnings to decline by -1.9%. Earnings at oil and gas producers are expected to decline by -24% and the biggest drop in three years. Without the decline in the energy stocks S&P earnings would rise +2.5%.

India's stock market declined -15% in seconds and trading was halted for 15 minutes in a flash crash that shook investor confidence. The drop was later traced to 59 erroneous orders that briefly erased about $58 billion in value from the market. The orders were entered by Emkay Global Financial Services for a client. They were supposed to be for $126 million in trades. The index fell -900 points and circuit breakers were supposed to kick in at -570 points or 10% of the prior quarter's close or 5703.3 in this case. About 20 stocks fell more than 19% as a result of wrong quantities being entered on the orders.

For whatever reason investors are still pulling money out of the equity market. I suspect it is the fiscal cliff and the fact we are at market highs. The combination of the two are a compelling reason to take profits. In the week ended 9/26 investors withdrew $5.1 billion from stock mutual funds. The prior week they withdrew $4.8 billion according to the Investment Company Institute or ICI. The total outflows from stock mutual funds for 2012 is around -$93 billion. Bond funds saw inflows of $8.8 billion last week and $8.0 billion the prior week. Since 2009 investors have pulled $138 billion from stocks and put more than $1 trillion into bonds according to the WSJ. It is pretty amazing to me that the market continues to ignore fundamentals and move higher even with the strong outflow of funds. Don't fight the Fed.

Goldman Sachs sent a note to investors on Friday saying the S&P would decline to 1250 before year end and then rebound to 1575 by the end of 2013. The reason was the impending impact of the fiscal cliff battle once the election is over. Regardless of who wins the presidency the battle still has to be fought. President Obama has said repeatedly he will not cave in on the tax battle this time. He is not going to extend the Bush tax cuts and he wants to raise taxes on high income individuals. If the republicans retain control of the House this is a recipe for disaster.

If Romney wins he has pledged to kick the cliff well into next year to give him time to come up with a comprehensive solution on tax reform. The market wants Romney to win because of lower taxes and less regulation.

Morgan Stanley still expects the S&P to decline to 1167 by year end as a result of the fiscal cliff, a decline in earnings, trouble in Europe and continued economic slide in China. MS believes S&P earnings in 2013 will be $98 compared to consensus estimates of $115. They believe the economy will continue at stall speed with 1.3% GDP growth in 2013. MS believes fundamentals will eventually matter despite global QE in progress.

Marc Faber, Gloom, Doom and Boom Report, was interviewed on Thursday and within the next 6-9 months he expects to buy anything he wants 20% or more lower. Faber is normally a bear.

I wrote on Wednesday after the $4 drop in oil prices that the political release of crude from the Strategic Petroleum Reserve (SPR) was dead. With crude at $88 it would generate a political firestorm for the president to release reserves to combat high gasoline prices. Unfortunately I may have to rethink that claim. The cost of gasoline last week is the highest in history for this time of year.

The national average for gasoline is $3.79, assuming you don't live in California. The reason for the high prices is not a shortage of crude oil. There have been an unusual number of refinery outages and pipeline shutdowns over the last month and the combined effect is higher prices as supply and demand seek a balance.

Releasing oil from the SPR would have no direct impact on prices since there is no oil shortage. However, it would be politically expedient with prices expected to reach $4 per gallon by the election. The announcement would impact the price for a couple days and possibly break the back of the rally. I doubt it since damaged refineries would still exist and production would still be slowed.

Exxon had a fire at the 584,000 bpd Bayton Texas refinery on Wednesday. That is the largest in the USA. Exxon said there may be "some impacts to production" from the fire but the plant would reopen. A partial shutdown of the Colonial Pipeline, the largest refined product pipeline, also contributed to the higher prices, because it transports gasoline around the Gulf coast.

The California problem has nothing to do with crude supplies either. California brought this on themselves. They legislated that gasoline in California had to conform to a special blend because of strict air quality rules. A fire at the Chevron refinery in California last month that will keep the refinery at reduced production levels for another month is the primary reason for the gasoline shortage. There was also a power failure at an Exxon refinery in California that forced a restart of production and that means the processes running at the time of failure have to be cleaned out and restarted one at a time. They have been flaring gas all week in an effort to flush the systems. A Chevron pipeline in California was shutdown in September because of elevated levels of chloride in the oil.

With those two refineries offline there is a shortage of that special California blend of gasoline. Prices are approaching $6 a gallon at some stations although the official average is $4.49 for the state. Many stores are over $5 and the highest reported is $5.99. Prices have risen $1.15 in the last nine days with stations shutting down because they can't get gasoline. Exxon and Valero are rationing deliveries to customers. Valero halted spot sales on Friday to allocate remaining supplies to its own stations. Because of the special blend requirement they can't use gasoline from other refineries. There is a price to pay for limiting yourself to one specific blend and refusing to let refineries be built or expanded. This is why California always has the highest gasoline prices in the country. The California Oil Marketers Association has asked the state to expedite a waiver allowing refiners to sell winter grade fuels immediately rather than wait for the normal Oct 31st switchover date. That fuel is easier to make because it has less additives.

California Gas Prices

Price Locations

California Gas Lines

Despite the high prices for gasoline, demand is slipping back to the lowest levels of the year. Last week the country burned 8.633 mbpd of gasoline. That is down from 9.306 mbpd in the week of August 10th. The high prices will only accelerate that drop in demand.

Crude prices rebounded on Thursday from that $4 loss on Wednesday to $88. Prices rebounded to $92 and then dropped back to $89 on Friday. The $88 level is support but I expect volatility to continue for the next couple of weeks. $85 would be the next support level.

WTI Crude Oil Chart

The S&P rallied to 1471 intraday on Friday before retreating to close negative at 1460. The 1471 level was -3 points below the high back on Sept 14th, the day after QE3 was announced. In that intervening three weeks the S&P declined to 1430 before returning gradually to the highs. The question everyone wants answered is of course "Is this a double top?"

Personally I believe we would have a lot more confidence in a possible double top if the interval had been several weeks longer. So far the S&P has just consolidated its September gains with a minor bout of profit taking. We have seen nothing that would indicate there is a correction in our near future.

The return to the highs is bullish. It shows investors are willing to shake off continued bad global economics and daily earnings warnings. The strong performance by Romney in the Wednesday speech powered the markets higher on Thursday. The Nonfarm Payrolls provided the lift on Friday. Unless Spain suddenly asks for a bailout over the weekend the headlines from Europe on Monday are expected to be all negative. Actually they could be very negative with Merkel in Greece. That is a dangerous confrontation in the making after protestors stormed the Parliament last week.

I have not changed my expectations for a market decline in the second or third week of the month. At this point I have nothing in the way of charting to support that expectation. The Dow has returned to 13,600 and appears ready to breakout to a new high. The Nasdaq is less bullish but it is being dragged lower by Apple. The Russell 2000 is holding at support and trending perfectly sideways.

The Dow Transports actually rallied for three days after holding support at 4900. Had they broken support I believe it would have been lights out for the rest of the indexes.

Dow Transports Chart

With all the indexes giving slightly bullish signals you have to wonder if QE3 is going to cancel out the October election curse. Historically the market goes down in the October before a presidential election. Fund managers appear to be reversing their bearish stance they took in anticipation of the seasonal swing. Volume remains low at 5.6 billion shares on Friday despite the touch of the old highs. You would expect higher volume if the rally had legs. There are just enough bearish signals mixed in with the bullish moves to keep everyone wary.

If we were to breakout over 1475 next week it should trigger significant short covering as it would be a surprise to nearly everyone.

The tall wick on Friday's candle is typically bearish.

S&P Chart

The Dow came very close to breaking over strong resistance at 13,600 and one more good news story could do the trick. Likewise a story like "Mob attacks Merkel in Greece on Monday" could push the Dow well below current support at 13,400.

The dips are being bought despite the daily earnings warnings and headlines from Europe. The fundamentals don't matter and the "hated" rally could be on the verge of a new leg higher.

Dow Chart

The Nasdaq is the reality check for the markets. The index spiked well above resistance at 3135 on Thursday and then hit 3171 intraday on Friday before falling back to close on that 3135 level. That was a -36 point drop from the highs.

Obviously the $14 decline in Apple, 20% of the index, had a lot to do with the decline in the Nasdaq but there were other losers. Tech stocks are weak after Hewlett Packard warned again on declining sales.

The decline back to 3135 is not earthshaking. Real support is 3100 and we have been well above that level for nearly two weeks. We have a pattern of higher lows and higher highs despite the many warnings from the tech sector. Don't fight the Fed appears to be alive and well.

Nasdaq Chart

The small cap Russell 2000 has shown surprisingly low volatility. Given the time of the year we should be seeing increased volatility as fund managers restructure portfolios for their Oct-31st fiscal year end. This is very strange but somewhat bullish. However, note the long bearish wick on Friday's candle. The opening spike higher was immediately sold but they could not push the index to any material loss.

Russell 2000 Chart

They say the trend is your friend until it ends. Rarely does it give you any advance notice. You wake up one day with the market at or near its highs and the bottom falls out. The problem with anticipating that event is that the market can continue making those minor highs for weeks on end before the trend breaks.

Fund managers may be waiting for the first batch of earnings to make the final decision on which stocks to sell and which to hold for their year end. OR, they might have been making those decisions on every dip since June and now they are hoping for the daily dips to add to positions.

Nobody ever knows which way the market is going to move day to day. We have to bet on the current trend as though it won't end but protect ourselves with stop losses because eventually all trends do end. This one has been pretty choppy and that is why so many people don't trust it.

Analyst Ryan Detrick pointed out an interesting statistic on Friday. The Dow has been up for 11 of the last 12 months but stock funds have seen continuous outflows for the past 17 months. Eventually fund managers are going to run out of money OR retail investors are going to come running back. Typically they either come back on strong breakouts to new highs or they buy the dips after major corrections. Over the last 12 months $275 billion moved into bonds. Since bonds are yielding nothing and not likely to produce a return for the next two years that investment is dead money. Eventually investors are going to see the light and move back to equities. The pivotal event that will bring investors off the sidelines is the resolution of the fiscal cliff. That is still several months away so our irrational market may stay irrational a little while longer.

Enter passively, exit aggressively!

Jim Brown

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"Everybody has a plan until they are punched in the face."
Mike Tyson