• British GDP shrank 2.4% in the 1Q (more than the 1.9% shrinkage expected)
• The VIX – a widely used measure of market volatility is – fell 25 points. But it’s still 25% higher than average.
• US equity trading volume is also down – signaling a lack of demand… and a possible sagging in the recent bear market rally
• US Treasury yields have remained more or less unchanged over the month of June despite the boys at the Department of the Treasury flooding the market with an impressive $176 billion in new issuance
• Crude oil prices are up over $71 a barrel. Meanwhile, the IEA has lowered its forecast for oil consumption. (There is enough storage for 62 days of global consumption – 10 days above Opec’s stated goal.)
• June auto sales are will come in at about 10 million units annualized. This is less than 50% their peak and roughly back at levels last seen in the 1960s.

Rosenberg writes that “the crisis at the lower levels of government in the US is now so intense that as many as TEN states may not have a budget prepared for the fiscal year that is about to commence next month!”

Wow!

Notes faithful will be aware that we view the fiscal crisis in California as a precursor of what’s to come in America. The mechanics of this are very simple. The government spends too much money out of an empty pocket to appease and please. It relies on a just about half of the population (according to the IRS the top 50% of earners pay 97% of income taxes) to contribute the majority of the tax revenues. This upside down pyramid eventually topples (revenues shrink while spending increases), and the government is thrown into a “budget crisis” (which is really a spending crisis by a different name).

The US federal government isn’t far behind state governments (a) because it has a larger tax base to rely on and (b) because it can borrow seemingly infinite amounts of money on the international debt markets thanks to the dollar’s status as world’s reserve currency (foreign governments and banks need dollars to buy a wide range of commodities, which are priced in the US currency).

But one day (sooner rather than later in our humble opinion) foreign buyers of US debt wake up and realize that huge increase of dollar-denominated debt on the market is causing the value of the buck to decline… and they look for alternatives.

This is happening already. China and its fellow “Bric” nations, Brazil, Russia and India are already vocalizing their discontent with the dollar-pegged system. The problem is they don’t yet have an alternative mechanism to the dollar. But they’re working on it. And when they come up with an answer to their dilemma, $174 billion in Treasury bonds a month will no longer find a happy home. The feds will have no alternative but to raise yields to attract investors. Higher yields mean higher borrowing rates overall, which mean you can forget about a sustained recovery or a return to the golden years of US economic dominance.

According to Rosie, the situation in the ten problem US states “is so acute that state governments are now threatening to go after unused gift cards for sales revenues — affecting $7 billion of income for the retailing sector.”

U.S. stocks edged up on Tuesday after a surprising rise in December pending home sales and strong earnings from drugmaker Merck tempered worries about the economy and an otherwise gloomy quarterly results season.

But Nasdaq’s gains were limited as a poor revenue outlook from flash memory card maker SanDisk Corp , whose chips are used in products including cell phones and digital cameras, signaled slower consumer spending in the technology sector.

Still, investors saw a glimmer of hope in the housing market after pending sales of existing homes rose 6.3 percent, lifting an index of home builder stocks  nearly 6 percent.

Wall Street was also helped by news that the Federal Reserve extended, by six months, programs designed to funnel billions of U.S. dollars to markets worldwide to keep money flowing in the battered banking system.

“We have a lot of investors desperately looking for signs that fundamental improvement is on the horizon,” said Craig Peckham, equity trading strategist for Jefferies & Co in New York. “The Fed is extending liquidity programs and telling you in same breath that conditions remain quite strained.”

The Dow Jones industrial average added 43.32 points, or 0.55 percent, at 7,980.15. The Standard & Poor’s 500 Index  gained 3.91 points, or 0.47 percent, at 829.35. The Nasdaq Composite Index  rose 3.05 points, or 0.20 percent, at 1,497.48.

Cost cuts and favorable taxes helped Merck & Co and Schering-Plough Corp post quarterly results above Wall Street estimates. Merck was among the Dow’s biggest boosts, up 5.5 percent to $29.99, while Schering-Plough rose 5.3 percent to $18.40.

Pending sales of existing U.S. home rebounded in December, according to data based on contracts signed, a promising indication after months of negative data.

No. 1 U.S. home builder D.R. Horton was the top percentage gainer on the New York Stock Exchange, surging more than 18 percent to $7.23. It reported a smaller-than-expected quarterly loss on Tuesday.

Luxury home builder Toll Brothers gained 4.2 percent to $17.70, while No. 3 U.S. home builder, Pulte Homes , rose about 3.5 percent to $10.60, ahead of its expected results on Wednesday.

But the Nasdaq was hurt after SanDisk warned that revenue for the current quarter would fall short of expectations and said it may undertake an equity offering that could dilute shares by as much as 20 percent. The stock plunged nearly 23 percent to $8.71.

Losses still plagued banks amid a lack of definitive measures to steady the sector. The KBW index of banking shares fell nearly 6 percent as investors worried that the government may have to nationalize the sector, or parts of it.

Bank of America tumbled 9.5 percent to $5.44, while Citigroup shed nearly 5 percent to $3.47, after hitting a session low.

Stability in the housing market and financial sector is critical to the recovery of the U.S. economy, which slipped into recession in December 2007. Investors are bracing for the U.S. payrolls report for January that is due for release on Friday morning, which could pin unemployment at 7.5 percent, the highest rate since September 1992.

“It’s going to be tough to get anything really going before we get to that jobs report on Friday,” said Marc Pado, U.S. market strategist at Cantor Fitzgerald & Co in San Francisco. “It’s looming like a dark cloud.”

NEW YORK, Feb 3 (Reuters)