The Dow Jones Industrial Average was up 26.2 points, or 0.32% as of 11:00 a.m. today (Thursday), while the Standard & Poor’s 500 Index was up 4.58 points, or 0.52%.

The surge was prompted by an increase in U.S. wholesale prices, which allayed concern over deflation. Producer prices rose 0.3% in April after falling 1.2% in March. Food prices posted the biggest gain, soaring 1.5% – enough to offset a 0.1% fall in energy prices. Excluding food and fuel prices, so-called core-prices climbed 0.1%.

The rise in producer prices accompanied an increase in import prices, which climbed 1.6% in April, the government said yesterday. Producer prices and the cost of imports comprise two of the three major gauges of inflation. The third measure of inflation, consumer prices, is scheduled for release tomorrow.

The rise in U.S. equities was further supported by a solid earnings report from Wal-Mart Stores Inc., the world’s largest retailer. Wal-Mart posted a profit of $3 billion, or 77 cents a share, in the quarter ended April 30, up from 76 cents a year earlier, matching analysts’ forecasts, according to Thomson Reuters.

Net sales for the quarter fell 0.6% to $93.4 billion, but the company blamed that decline on the negative impact of a stronger dollar, which dented international sales. Wal-Mart’s international operating income fell 16.2% to $880 million on an 11.1% drop in sales to $21.3 billion.

However, international operating income at constant exchange rates was $1.13 billion in the three months ended April 30 on sales of $26.1 billion.

“In almost every country we grew the top line faster than the market despite the strong dollar and a recession that is even deeper in some countries than it is in the United States,” said chief executive Mike Duke.

Wal-Mart’s resilience offered a modicum of comfort to the retail sector after a report yesterday showed retail sales fell 0.4% in April, the eighth monthly decline in the last 10 months. Retail sales tumbled 1.3% in March.

Retail sales have been badly battered by a sharp rise in unemployment. And data from the Labor Department today furthered illustrated the frailty of the current labor market.

Initial claims for unemployment rose by 32,000 to 637,000 in the week ended May 9, from a revised 605,000 the week prior, the Labor Department said.

The economy has shed about 5.7 million jobs since the recession began in December 2007. Payrolls fell by 539,000 in April, as the jobless rate climbed to 8.9% – its highest level since 1983.

Source: Producer Prices and Wal-Mart Results Give the Market Edge Over Weak Jobs Data

Tuesday

Earnings Announcements: AMAT

Wednesday

Economic Reports: Retail Sales

I’ve mentioned it before, but until Americans feel confident about the future of the economy, they won’t spend money. A slowing decline could show some hope that things are bottoming out. Tied into this report, and worth noting, is the large number of clothing retailers that are reporting this week (Macy’s, Nordstrom’s, JC Penney, Abercrombie and Fitch, Kohl’s, and American Apparel), and Wal-Mart’s earnings are announced on Thursday.

Earnings Announcements: FRE

Thursday

Economic Calendar: PPI, Core PPI

It looks as if inflation has been kept under control for at least another month. Both the PPI and Core PPI readings that are announced on Thursday are expected to show only the slightest increases since last month. We know inflation will start creeping in soon; it’s just a matter of when.

Earnings Announcements: WMT

Friday

Economic Reports: CPI, Core CPI, Industrial Production, Michigan Sentiment

As mentioned above, inflation has been held in check, and the CPI and Core CPI announcements that come out on Friday are expected to show little to no change since last month.

The Industrial Production report (and Capacity Utilization) for April are expected to show more sobering numbers. The manufacturing sector is going nowhere fast. Until these readings turn positive, any economic rally will be short lived.

Finally, the preliminary Michigan Sentiment report for May is released on Friday. Expectations are for a very small drop since last month. With the market moving up over the last few months, and the Fed stating that they see and end to the economic downturn by the end of the year, I think this report will surprise to the positive side. Nothing major, just a slight improvement.

Source:  A Big Week for Retailers, Will Inflation Be Held In Check?

Total retail sales for March clocked in at $344.4 billion, a decrease of 1.1% from February and a 9.4% dive from March 2008. Overall, first quarter retail sales sank 8.8% compared to the same period a year ago, the U.S. Commerce Department said in a report.

The stats reverse the back-to-back monthly gains that kicked off 2009. Those gains surprised the market not only because they followed dismal holiday shopping numbers in November and December, but also because unemployment continued to get worse.

“The surprisingly sharp drop in retail spending shows how uncertain consumers are about the recovery,” Joel Naroff, president of Naroff Economic Advisers, wrote in a note to clients. “Consumer spending had been growing much more strongly in the first quarter than any of us could have expected, so a one-month cutback should not have been a surprise.”

Among the hardest hit sectors, gasoline station sales were down 34.1% from March 2008, and motor vehicle and parts dealers’ sales were down 23.5% from last year. Food and beverage stores held strong with only a 0.1% decline. Healthcare spending posted the best figures with a 2.2% annual gain.

“This was not a pretty report as demand for just about everything fell,” Naroff said. “There were large reductions in demand for furniture, electronics and appliances, building materials, sporting goods and clothing.”

Sinking demand for energy products played a large hand in keeping producer prices in check. The U.S. Department of Labor said that the Producer Price Index (PPI) for finished goods, a measure of inflation, fell 1.2% in March after inching forward 0.1% in February.

Prices for energy products fell 5.5% after rising 1.3% in February. Food prices fell 0.7% after falling 1.6% the month prior. Excluding food and energy, the PPI was a flat for the month.

While not a positive, flat inflation isn’t much of a threat when compared to the host of other economic issues the Obama Administration is addressing. In fact, the U.S. Federal Reserve said it expected inflation to be “subdued” in a March 18 statement.

But inflationary concerns will be on the horizon, when government measures to reboot the economy kick in – flooding the market with liquidity that can’t be absorbed by record low interest rates.

Source: Retail Sales and Inflation Slip in March

Speaking at a dinner at Columbia University, Soros actually compared the current situation to the breakup of the Soviet Union, and said that the whipsaw effects of the crisis are actually more severe than the Great Depression.

“We witnessed the collapse of the financial system,” Soros told his audience. “It was placed on life support, and it’s still on life support. There’s no sign that we are anywhere near a bottom.”

He said the bankruptcy of. Lehman Brothers Holdings Inc. (OTC: LEHMQ) in September marked a turning point in the functioning of the market system.

His comments echoed those made earlier at the same conference by former U.S. Federal Reserve Chairman Paul A. Volcker, who is now a top adviser to U.S. President Barack Obama. Volcker said that overseas industrial production was declining even more rapidly than it was in the United States, which is itself under severe strain.

“I don’t remember any time, maybe even in the Great Depression, when things went down quite so fast, quite so uniformly around the world,” Volcker said.

Market Matters

Nothing has been able to get this economy (and stock market) back on track. Congress passes – and President Barack Obama signs – a near-$900 billion stimulus package and the U.S. Federal Reserve revises (negatively) its economic outlook for the remainder of 2009. Major financial institutions get significant (bailout) assistance from the government and Bank of America Corp.’s (BAC) chief is subpoenaed for misleading investors over Merrill Lynch & Co. Inc.’s (MER) (excessive) bonuses.

Automakers beg Congress for (and receive) a bailout of their own and General Motors Corp. (GM) and Chrysler LLC come back for even more as part of their restructuring plans.  Investors try to look past the unscrupulous practices of Madoff and the U.S. Securities and Exchange Commission (SEC) brings suit against billionaire Alan Stanford’s global enterprises over an apparent $8 billion fraud through its high-yielding CDs (with Venezuelans particularly hard hit).

Stanford Financial manages assets of $50 billion in 140 countries, with the primary bank operations in question based in Antigua.  With the Dow Jones Industrial Average hitting a six-year low and falling below the perceived floor set in November, investors are left scratching their heads.

So much for the “challenging” times setting a tone for bipartisanship in Washington.  As the stimulus package passed with only token Republican support in the Senate, its party leader called it “a missed opportunity, one for which our children and grandchildren will pay a hefty price.“  He then revealed that not one House member even took the time to read the bill.  The Obama administration also announced a plan to help millions of homeowners avoid foreclosure, while attempting to stabilize the housing market (to the tune of another $275 billion).  As long as the Treasury’s checkbook is out, GM wants another $16 billion and Chrysler could live a few more days with an additional $2 billion.

Oil rose (briefly) late in the week as the U.S. Department of Energy revealed a surprising decline in crude inventories and a slight increase in the demand for gas now that prices at the pumps have fallen below $2 a gallon and stayed for a while.

After taking the Dow down more than 300 points following Presidents’ Day, nervous investors sold all the way to a new six-year low and the worst week for equities since October.

Financials continued to be hammered as talks of bank nationalization picked up steam.  Global stock markets followed suit with Japan’s Topix closing at a 20-year low.   With investors shunning equities of all shapes and sizes (and U.S. Treasuries offering little in the way of returns), gold became the safe-haven recipient and futures climbed above $1,000 an ounce.  For now, investors just talk of “values,” “opportunities,” “rallies,” and “rebounds,” but few seem willing to follow-through with any real buying.

Economically Speaking

With U.S. Federal Reserve Chairman Ben S. Bernanke and friends trying any and all tricks in their arsenal to jumpstart the economy, the central bank chief admitted that the efforts to date have resulted in very limited successes.  The Fed negatively revised its outlook for the remainder of the year and now projects that unemployment could reach 8.8% and the GDP may shrink by as much as 1.3% in 2009.  Meanwhile, our global trading partners are struggling with problems of their own.  Japan’s economy experienced its worst quarter in almost 35 years as its manufacturers suffered through substantially declining demand for their goods.

The domestic economic data confirmed that the Fed’s new (weaker) projections may be right on target.  Housing starts in January fell by almost 15% and activity now stands 56% below the pace of construction last year.  Industrial production tumbled more than expected last month, and automakers face even more shutdowns as part of their recently proposed restructuring plans.

The labor market remained incredibly weak as new jobless claims rose again in the most recent release and the number of workers receiving unemployment benefits for over a week stood around a record high 5 million people.  On the inflation front, the cries of deflation can be put on hold for the time being.  Both the producer price index (PPI – wholesale) and the consumer price index (CPI – retail) experienced their biggest gains since July 2008, as energy prices actually rose last month.

Still, consumer prices remained flat (no real increase) on an annual basis, the lowest level of price change since August 1955.

Weekly Economic Calendar

Source: Super-Investor George Soros the Latest to Predict the Worst is Yet to Come

A steep drop in commodities prices has dampened inflation expectations significantly in recent months. But despite declines in consumer and producer prices, the Fed’s monetary base – the amount of total amount of a currency that is either in the hands of the public or in the central bank’s reserves – has expanded by 80% in the past six months.

Meanwhile, the Fed’s balance sheet has ballooned to $1.8 trillion in assets from $959 billion over the past year.

However, Bernanke argued yesterday that that many banks are opting to keep their capital on the sidelines and that “a significant shrinking of the balance sheet can be accomplished relatively quickly.”

“Some observers have expressed the concern that, by expanding its balance sheet, the Federal Reserve will ultimately stoke inflation,” Bernanke told journalists at the National Press Club. “The Fed’s lending activities have indeed resulted in a large increase in the reserves held by banks and thus in the narrowest definition of the money supply, the monetary base. However, banks are choosing to leave the great bulk of their excess reserves idle, in most cases on deposit with the Fed. Consequently, the rates of growth of broader monetary aggregates, such as M1 and M2, have been much lower than that of the monetary base.”

Bernanke added: “At this point, with global economic activity weak and commodity prices at low levels, we see little risk of unacceptably high inflation in the near term; indeed, we expect inflation to be quite low for some time.”

Still, as credit markets and the economy begin to recover inflation could make a speedy recovery.  Should that happen, the Federal Reserve will have to act quickly, something Chairman Bernanke says he is prepared for.

”The Federal Reserve will have to moderate growth in the money supply and begin to raise the federal funds rate. To reduce policy accommodation, the Fed will have to unwind some of its credit-easing programs and allow its balance sheet to shrink,” he said. “A significant shrinking of the balance sheet can be accomplished relatively quickly, as a substantial portion of the assets that the Federal Reserve holds…are short-term in nature and can simply be allowed to run off as the various programs and facilities are scaled back or shut down.”

To increase transparency and give the market a better sense of the Fed’s expectations, the FOMC will publish long-term projections for the economy, particularly inflation.

The FOMC’s projection of inflation over the next five years, he said, “may be interpreted … as the rate of inflation that FOMC participants see as most consistent” with price stability and maximum employment.

By releasing longer-term projections The Fed seems to be edging closer to an “inflation target,” which is something already utilized by central banks in Europe, as well as an objective Bernanke himself lobbied for in the past.

The FOMC believes that the optimal inflation level over time between 1.7% 2%, according to the minutes from its Jan. 27-28 meeting.

The producer price index (PPI) rose 0.8% in January, after falling 1.9% in December the Labor Department said today. Core prices, which exclude food and energy, rose 0.4%. Consumer price data for January is scheduled for release Friday.

“It is doubtful that the price increases will be able to stick given the weakening economy and rising unemployment,” James O’Sullivan, a senior economist at UBS Securities LLC told Bloomberg News. While “inflation hasn’t collapsed yet, the big concern is still that inflation will fall too much.”

Source: Federal Reserve Chairman Bernanke Not Yet Worried About Inflation

Well, the big news this morning, is that the Jobs Jamboree was just awful, but “not as bad as some forecast” and therefore the dollar rallied. OK, I’m shaking my head in disgust too, but that’s what the headlines reported later in the day on Friday, as the reason for the dollar rally. But let’s get to the meat of the Jobs report… First of all, jobs lost in December were -525K, which was bang on the forecasts. But here’s the two things I found to be very scary in the report… First of all, November’s awful print of -533K was revised downward to -584K (recall, I questioned a month ago if it would reach -600K on the revision)… And here’s the really scary number… -67K Retail jobs were cut in December… That’s right, December! The month when retailers are supposed to be on fire!

I was very impressed with the network news on NBC with Brian Williams, Friday night, as they did report the numbers as awful, and highlighted the Retail jobs losses as I did above… But then I got to thinking… Who the heck watches network news any more? Oh well, they tried!

Oh… And for those of you keeping score at home… The Bureau of Labor Statistics (BLS) decided that they would ADD 72K jobs in their Birth / Death Model… Makes sense, eh? NOT! So, if they hadn’t put their hands in the cookie jar, the total job losses in December would have been within spittin’ distance of -600K! Any way… The Unemployment rate rose to 7.2% from 6.7%, that’s quite a hefty rise in one month, and is very reminiscent of moves made in previous recessions…

But the dollar rallied, so I’ll leave all that Jobs Jamboree stuff, and move on!

The euro is much weaker as we begin this week than it was last week, and besides the mental giants that marked up dollars after the jobs report, the euro was feeling the pressure from some statements from European Central Bank (ECB) President, Trichet… Yes, it sounded as though Trichet had turned dovish… But then there were denials that he said anything, but it was too late, the cow out of the barn!

The ECB DOES meet this week, on Thursday, and while I once thought that the ECB would skip cutting rates at this meeting, I now, with the Trichet comments even if he didn’t say them (you know me, where’s the smoke, there’s fire!), believe the ECB will cut rates this Thursday, and that is also weighing on the euro.

As we, (me, and you dear, long time reader) know all too well, the euro is the Big Dog on the currency porch… It’s the offset currency to the dollar, which is quite impressive given the fact that it has only been around for 10 years! Anyway… Back at the ranch, dollar strength shows up here with the euro first and foremost… But guess what happens when everyone finally begins to focus on fundamentals again? Well, Oooh! Oooh! Call on me, teacher! Call on me! Yes, you, in the back, what’s your answer? Well, teacher, My answer is that the dollar will come under pressure again, and with the euro being the offset currency to the dollar, this current weakness will be a thing of the past. Very Good, young man, please move to the front of the class!

So… After the dollar performance on the bad news of the Jobs Jamboree, I got to thinking that the Trading Theme that was all so evident… I know, I thought we had put the Trading Theme of second half of 2008, in the closet… But here it is again, all dusted off, and looking as though it might be here to stay… For those of you new to class or in need of a refresher course… The Trading Theme I’m talking about, is the one where the deeper, the darker, the more dangerous things get for the U.S. and the economy, the dollar is rewarded, as dollars are repatriated, and Carry Trades that used the dollar as the funding currency get unwound, thus propping up the dollar…

I’ve seen this before, as I’ve explained before… It was Japan in the late 90’s… Their economy was circling the bowl, and yen was being repatriated, pushing the yen to 88!

These Carry Trades also use Japanese yen as the funding currency… And that goes to explain why Japanese yen is trading so strong again… Last week, with the risk takers dipping their toes in the risk waters again, Japanese yen was weakening… But not now!

This is all bad news for the high yielders, which had really stretched their legs last week! The usual suspects of Aussie, kiwi, Brazil, South Africa, have all been sold again on this return to the Trading Theme which has risk takers pushed to the back corner of the room…

This is as good of a time as any to repeat my thoughts for 2009… ( I did this the last week of 2008) First of all, I believe, we’ll get an Obama bounce, thus pushing stocks back up, and giving everyone a false sense of euphoria… By late spring, this euphoria should all be fading, as people begin to realize that we’re just mortgaging the future with stimulus package after stimulus package… And all that “horded up cash” that investors have been holding on to, will begin to get spent… Then we’ll have a problem Houston, as the Corporations that have slowed production down during the recession, can’t produce enough to meet demand, and inflation begins to soar!

The dollar basks in the sun during the first part of the Obama bounce… But, when the bloom is off the rose, we should see a return to the fundamentals…

OK… This week, we’ve got some hefty data in the U.S. and of course the ECB rate meeting on Thursday. Here in the U.S. we’ll see this week… The Trade Deficit for November, Retail Sales for December, The TIC Flows, the stupid CPI and PPI reports will also print. Sprinkle in the Philly Fed (manufacturing), Business Inventories, and the Initial Jobless Claims, and we’ve got a data cupboard that chock-full-o-numbers!

None of these should be good for the economy, save for the stupid CPI report, which they will try to push off on us a report that inflation fell -.2% in December, and now stands year-on-year at 1.8%… HOGWASH! The boys and girls that print this report think that just because the price of Oil has collapsed, they can mark inflation down to the bone… That’s right, there’s no other inflation going on, not medical, not tuitions, not insurance, not food, not ball game tickets! HOGWASH!

After all that, there is no data scheduled for printing today! I hear that Big Ben Bernanke is going to speak on “The Crisis and the Policy Response” at the London School of Economics tomorrow. Oh boy! NOT!

OK, before I head to the Big Finish… I wanted to give you a piece of my friend, Bill Bonner’s, Daily Reckoning (www.dailyreckoning.com) from Friday, as he discussed the massive amounts of stimulus that have been put in place and the massive amounts yet to be put in place… Here’s Bill…

“When America’s economy was young and competitive it survived slumps and crashes without medical intervention. Now, every passing cold requires feeding tubes. And this latest bout of influenza has the doctors in a panic. They are casting aside warnings and giving the patient masses doses of the old quack treatments. They’ll increase the dosage – until they run out of supplies – and then switch to those new, experimental medicines that have recently been used in field trials by Dr. Gono in Zimbabwe.
Since they cannot leave well enough alone – the public won’t stand for it – they will keep giving bigger and bigger doses, of more and more dangerous medicines, until the patient dies.”

Currencies today 1/12/09: A$ .6845, kiwi .5790, C$ .8340, euro 1.34, sterling 1.4955, Swiss .8940, rand 10.02, krone 7.0550, SEK 8.0450, forint 208.20, zloty 3.02, koruna 19.83, yen 89.80, sing 1.49, HKD 7.7540, INR 48.84, China 6.8370, pesos 13.69, BRL 2.2940, dollar index 82.93, Oil $38.70 (Oil is collapsing once again!), Silver $11.11, and Gold… $844.50

Source:  A Jobs Disaster!

Such concerns may be warranted in the short-term. But in the long run, deflation won’t be the challenge we face.

Thanks to an overly aggressive central bank, and more than $1.5 trillion in U.S. Treasury Department bailout programs – as well as other factors related to the ongoing global financial crisis – inflation will be the problem that ultimately bedevils us.

As long as oil and commodity prices drop, the PPI and CPI indices, which include oil and commodity prices, also will fall. Such a decline, however, does not constitute deflation; it is simply a one-time price adjustment. This is particularly true if most of the commodity-price declines are simply a reversal of excessive increases that had occurred over the previous year. That’s essentially what we’ve been seeing here.

However, the deflation believers currently have an additional argument: With output in the United States plunging, and the stock market down around 50% from its October 2007 peak, there are very few pressures pushing prices upward. For instance:

• Manufacturers, facing sudden sales declines, cut prices in an attempt to clear inventories or engage in foreign sales drives, intensifying price competition in all markets.
• Nobody is pushing for wage increases – folks are all too pleased to keep their jobs, and their employers know this.
• So while the U.S. economy is declining sharply, prices will not increase significantly and may even decline.

But even this will not turn into deflation, unless the recession is exceptionally prolonged. Currently, output and employment are dropping very sharply, as is the stock market. This cannot continue for more than a few months – the latest being perhaps late spring of the New Year. As output declines, forces pushing it towards recovery will become stronger and equilibrium will appear.
Provided world trade remains open healthy – and doesn’t plunge by 60%, as it did during the horrid stretch from 1929 to 1932 – we will avoid a second Great Depression, so the bottom in output cannot be all that far down, and will be reached relatively quickly.

Since inflation was running at more than 5.0% when output began its steep descent, it is unlikely to have turned significantly negative by the time the economy reaches bottom. After all, the so-called “core” PPI rose at a rapid clip of 0.4% (equivalent to 5.0% per annum) even in October, while the Cleveland Fed’s “median” CPI, which smoothes out fluctuations, rose by 0.1% in October and 3.2% over the past year.

Once the bottom has been reached, the excess liquidity that has been created over the last few months through the various bailouts – such the Treasury Department’s $700 billion Troubled Assets Relief Program (TARP), which is fueling bank takeovers, and not expansionary lending, and the follow-on $800 billion credit-market stimulus unveiled late last month – will combine with the huge federal budget deficit to spur inflation. By that time, discounting will have become much less prevalent, as the most aggressive discounters will have gone out of business and inventory excesses will have been worked off. Costs will have increased, since many producers will be operating well below capacity.  And the excess money supply will push up inflation.

This time, there will be no surges of foreign competition restraining price increases – Chinese producers are currently suffering high inflation in both wages and prices, so their sales prices are increasing fast.

To estimate the inflation rate we might see, you can look at money supply growth over the past year. The St. Louis Fed’s M2 money stock, the broadest money supply growth now reported by the U.S. Federal Reserve, has increased by 10% over the past year, while the St. Louis Fed’s Money of Zero Maturity (MZM), the nearest we can get to the old M3, has increased by 7.4%.

Both those rates are far higher than the increase in nominal Gross Domestic Product (GDP). In fact, money supply has been increasing about 65% faster than GDP since 1995, which is when former U.S. Federal Reserve Chairman Alan Greenspan began to overly relax monetary policy. In the most recent two months, MZM has risen only modestly, at a 3.1% annual rate, but M2 has risen much more rapidly, at a 20.6% annual rate. (The difference between the two figures reflects quirks produced by the various bankruptcies and bailouts – for example Washington Mutual Inc. (OTC: WAMUQ), nominally a “thrift,” has been taken over by Bank of America Corp, (BAC), a bank).

In any case, it seems likely that inflation in the 7%-10% range lies in our future once output stabilizes. The deflationists here have a huge problem: Their view of falling prices is in incompatible with swiftly rising money supply, so only a sharp fallback in money supply, which we are not seeing, would make deflation plausible.

The Fed has been blamed so widely for not expanding money supply fast enough during the Great Depression, that it is showing every sign of making the opposite error now.

If inflation does return with renewed force, we need to invest accordingly. One way of doing so would to use Treasury Inflation Protected Securities (TIPS). TIPS yields have recently risen, as investors have focused on deflation. Indeed the 10-year TIPS currently yields 3.11%, only 0.08% lower than the 10-year conventional Treasury, so the market is saying inflation will average 0.08% over the next 10 years. That’s nonsense, and such a mis-pricing makes TIPS an attractive investment, even though conventional Treasuries are vulnerable.

Another investment that benefits from inflation is gold, which has declined in price, albeit less than oil, and is currently selling around $770 per ounce. If inflation is expected to take off, gold prices will rise sharply, and a gold price of $1,500 per ounce is by no means out of the question. The most efficient way to buy gold is through the SPDR Gold Shares ETF (GLD).

Source: Why Fed Policies and Treasury Department Bailouts Will Lead to Inflation Rather Than Deflation

Regardless of any formal announcement of whether or not the United States drops into an actual recession, the ongoing credit crisis guarantees a contraction of the American economy by virtually every measure we know. That period of darkness will be marked by a dramatic slowdown in economic activity, as well as by rising unemployment, additional declines in U.S. stock prices, and constant volatility. And it could last as long as 12-18 months.

But when the dawn does come, it will be one to remember. If U.S. President-elect Barack Obama gets it right – and I have every reason to believe that he will – then investors will be presented with the greatest investment opportunity of our generation. At that point, shares of American companies will be at such low levels that wholesale buying by individuals, mutual funds, pension funds, institutional money managers, and foreign-controlled sovereign wealth funds, will generate gains that will not only make us whole, they will make us rich once again.

A Market Mandela

Creating an analysis of the U.S. economy’s outlook for the New Year is akin to creating a mandala, a geometric work of art whose pattern, symbolically or metaphysically, represents a microcosm of the universe from the human perspective. In some Buddhist temples, mandalas are made of tiny colored beads, painstakingly created by several monks as a form of meditation. In celebration of the ever-changing nature of the universe, the mandala is then joyously shaken by its creators, until it is once again nothing more than chaos embodied in a box of colored beads.

Regardless of the big picture, analysis of a mandala – or the economy – always starts at the center and emanates outward. With the U.S. economy, that centerpiece is credit. The credit crisis has shaken the complex mandala that is our economy and transformed the United States economy into chaos. It’s complex because this economic-forecast mandala derived its form from thousands of individual pieces – in the case of the economy, from scores of data points, many of which are currently dark and foreboding.

The credit crisis we are experiencing results from the contraction – or worse, the cessation – of lending. Under normal circumstances, institutions and markets freely facilitate capital movement between lenders and borrowers. But that’s not happening, now.

Because of a lack of transparency into the balance sheets of borrowers holding such complex and illiquid securities as collateralized debt obligations, credit-default swaps, and non-performing loans, and because of increasing recessionary fears affecting businesses and households, lenders don’t want to increase their loan exposure. Banks are holding onto the cash and liquid securities they control, using them as a cushion against their own potential losses. The U.S. Treasury Department’s direct-to-bank capital injections do not alter these banking realities. In fact, as a Money Morning investigative story recently demonstrated, instead of using these taxpayer-provided infusions to increase their lending, these banks are using the money to finance takeover deals.

The Recipe for a Recession

The National Bureau of Economic Research (NBER) will ultimately determine whether or not the United States is technically in a recession. The business-cycle dating committee of this privately run, nonprofit economic research group is right now studying five factors in an attempt to determine if the United States has entered a recession and, if so, when that downturn started, MarketWatch.com reported. Those five factors are:

• Gross Domestic Product (GDP).
• Industrial production.
• Employment
• Income.
• Retail sales

Regardless of any formal announcement by the NBER of whether we’re in a recession, the credit crisis guarantees a general contraction of economic activity, by every measure.

“Any doubt that we’re officially in a recession can be put aside,” Anthony Karydakis, former chief U.S. economist for JPMorgan Asset Management – and now a professor at New York University’s Stern School of Business – recently wrote in Fortune magazine. “The rapid deterioration of labor markets points to a sharp decline in hours worked and output in the fourth quarter. This is likely to lead to a decline in personal consumption to the tune of 5.0% or so for that period. Since [consumer spending] makes up about 70% of the economy, the stage has already been set for real GDP to shrink at a more than 4.0% rate in the fourth quarter.”

Confirmation of that belief is evident by looking at each of the NBER’s five key indicators.

• Gross Domestic Product (GDP): The U.S. Commerce Department estimated that the U.S. economy, as measured by GDP, rose 0.9% in the first quarter. In the second quarter, GDP advanced an estimated 2.8%. For the third quarter, GDP declined an estimated 0.3%. My own econometric models suggest that GDP actually contracted at a 1.5% pace in the third quarter and will decline another 2.75% in the fourth quarter. For the year, that would mean the U.S. economy actually fell 0.55%. The U.S. economy last posted a full year’s negative GDP in 1991, when it declined 0.2%. Verdict: Recession.

• Industrial Production: This measure of output by the nation’s factories and mines dropped 2.8% in September, and a very steep 6.0% in the third quarter. Verdict: Recession.

• Employment: The U.S. Bureau of Labor Statistics announced Friday that October’s unemployment rate was 6.5%, a jump of 0.4%, which was double what most economists expected, and also its highest level in 14 years. The economy has now lost a total of 1.2 million jobs since the beginning of the year, with nearly half of those losses occurring in the last three months alone, pointing to an acceleration in the pace of erosion in labor markets. Karydakis, the Stern School professor, wrote in Fortune: “By way of comparison, during the 2001 recession and in the sluggish growth that followed in 2002-03, the unemployment rate reached a peak of only 6.3%, in June 2003. We’ve already exceeded that mark and, given that we are still in the early phase of the current recession, the unemployment rate should be expected to push toward the 7.5% range – and possibly higher – during the next three months to six months.” Verdict: Recession.

• Income: Personal income increased $24.5 billion, or 0.2%, and disposable personal income (DPI) increased $25.7 billion, or 0.2%, in September. Personal consumption expenditures (PCE) decreased $33.6 billion, or 0.3%. Excluding the rebate payments made to U.S. taxpayers under the Economic Stimulus Act of 2008, DPI increased $30.3 billion, or 0.3%, in September, and increased $44.0 billion, or 0.4%, in August. Verdict: Too close to call.

• Retail Sales: October retail sales are coming in well below already-diminished expectations, and some reports have been downright depressing – including The Neiman Marcus Group Inc. -26.8%; The Gap Inc. -16%; The Nordstrom Group -15.7%; J.C. Penny Co. Inc. -13%; Kohl’s Corp. -9%;  Ltd. Brands Inc. -9%; Target Corp. Inc. -4.8%; and Wal-Mart Stores Inc. +2.4%. In a report last week, Moody’s Investors Service projected that the retail sector’s woes will continue into 2009 as consumers cut back on buying apparel, footwear and accessories “in order to save money for essentials.” The credit rating firm said in a separate report that holiday spending “will prove even weaker than expected,” amid October’s financial-market swoon. Verdict: Recession.

If U.S. exports are taken out of the GDP calculations going back to January, it’s apparent that there has been very little domestic growth in the economy. And when revisions are finalized in the next few months, we’ll be looking back at the recession that we’re all but certain is upon us right now. Until the credit markets are freed up and borrowers are extended credit at reasonable rates, it’s unlikely that credit, the centerpiece of the economy, will be anything other than a major cog in the wheel.

There are some signs of a thaw, but not anytime soon. The U.S. Federal Reserve’s lowering of the Fed Funds target rate to 1.0%, and coordinated rate reductions by the Bank of England and the European Central Bank, as well as other major worldwide central banks, may start to ease the stranglehold gripping the worldwide credit markets.

The prospect of President-elect Obama’s choosing a different means of attacking the credit crisis will be closely watched and, by itself, may create an air of confidence that perceptions will change. But changed perceptions will not be enough.

The truth about our economic outlook is that it is predicated on demonstrably better transparency. If U.S. banks follow the lead of their European counterparts, which have recently been freed from fair-value, mark-to-market accounting, and which may retroactively mark assets to “internal models” back to July, then balance-sheet clarity will continue to be cloaked in darkness. Lack of confidence in the banking system will persist, especially among the banks themselves. The first order of attack needs to be the creation of a fundamental leadership position that leads to an open, transparent and accountable measure of balance sheet assets and liabilities. As long as failing banks are being propped up, this cycle of credit contraction will persist.

The outlook for the economy is inextricably tied to the price of oil. The run-up of benchmark crude this summer to the record $145 a barrel level, and its subsequent fall to half that level, has wreaked havoc throughout the economy. Similarly, the run-up in commodity prices, and their subsequent fall, also has caused a lot of damage. Together, the dramatic rise and fall in the price of oil and other commodities is a harbinger of greater volatility in the future.

Follow the Money

Follow the money. Capital rapidly inflated the tech-stock bubble. When that bubble burst, capital flowed into and flooded the hard-asset world of real estate. When that bubble burst fast, speculative money dove into oil and commodities. When the U.S. and world economies looked weak, those bubbles burst. The looming threat of inflation this past summer instantly gave way after the drop of oil, gold, metals and agricultural commodities. And now, deflation is seen as the looming threat on the horizon.

Which threat should we worry about?

The answer is – both. The prospect for near-term deflation seems all too real. As raw material prices fall and finished good prices fall due to a lack of purchasing power resulting from lack of credit and world-wide recessionary fears, the U.S. consumer has fundamentally changed his or her collective psychology. Is U.S. consumerism, which is responsible for 70% of GDP, in full retreat? If it is, as all measures project, then it’s likely that government stimulus efforts will overshoot their intended mark.

Just look at what the United States has done already as it battles this financial crisis. It has:

• Handed out more than $150 billion in stimulus rebate checks.
• Floated a $700 billion financial bailout rescue plan – almost $160 billion of which has already been placed.
• Bailed out American International Group Inc., to the tune of $125 billion.
• Covered JP Morgan Chase & Co.’s bet on taking over
  The Bear Stearns Cos. – to the tune of $29 billion.
• Looked to lend struggling automakers $25 billion.
• Agreed to guarantee depositors at all banks.
• Stepped in to buy commercial paper that no one else will buy.
• Guaranteed money-market-fund investors.
• And backstopped the Federal Deposit Insurance Corp. (FDIC), Fannie Mae and Freddie Mac.

And now we’re getting wind of another stimulus package and more help for everyone.

If, in six months to a year, the credit markets are facilitating borrowers again, the massive buildup of U.S. debt will result in a falling dollar and higher interest rates.

That spells inflation.

A massive re-inflation of the economy portends another flood of speculative money into oil and commodities. The cycles are increasingly condensed, more volatile and will be increasingly more disruptive.

Welcome to the brave new world of global finance and speculation.

The Federal Reserve’s balance sheet has ballooned from $900 billion to more than $1.8 trillion. That’s 13% of GDP. The Treasury Department has telegraphed its intention to float $550 billion of debt in the fourth quarter and estimates it will have to float another $368 billion in the first quarter of 2009. Our national debt will then be close to 49% of GDP.

If there is an easing of credit in the economy, and borrowers come to market with the pent-up demand that has not been met for the past year, the competition for funds will raise interest rates. Higher interest rates will counter any stimulus effect from government programs.

Who will buy U.S. Treasury debt if the world is less apprehensive about credit quality? Lenders will once again seek higher returns, potentially forcing the Treasury Department to increase its rates. The potential of this event may sink the dollar if investors perceive that the U.S. economy is stagnant and the world is awash in dollars. The yield curve – the spread between the Treasury’s two-year and the 10-year paper – has been steepening. A steepening yield curve, where short-term borrowing costs are low and long-term rates considerably higher, is good for banks that borrow short and lend long.

But if the perception of risk diminishes, and the perception of future inflation increases, the yield curve will invert and the threat of rising rates will cause a sell-off in the short end of the curve and a rush into longer-dated maturities. Any increase in short-term interest rates would be painful for struggling banks. An inverted yield curve would be devastating, and inevitably would lead to more bank failures.

Home on the Range …

At the core of the U.S. economy sits a desperately ailing piece of the mandala – the U.S. housing market. The once bright prospect of home ownership, which historically formed a beautiful economic picture, right now doesn’t exist. For most Americans, the family home constituted the bulk of their wealth. Or at least it did. And this family financial portrait will get worse before it gets better, since the real estate collapse is far from over. Goldman Sachs Group Inc., for instance, projects another 15% drop in housing prices.

I think that’s conservative. Mortgage rates are actually rising as Fannie and Freddie have to pay higher interest on their short-term notes and bonds. Thirty-year fixed-rate mortgage paper averaged 6.47% last week, up from its 52-week low of 5.36%. The 15-year fixed paper was trading at 6.18%, up from its 52-week low of 4.91% (based on Bankrate.com rate surveys). This trend is definitely not our friend. As housing prices continue to fall, and inventories stagnate and grow in many areas, homeowners are increasingly underwater and are increasingly entertaining foreclosure as a viable economic alternative to indentured servitude.

The Hope for Homeowners Plan, which looks to lower interest rates and reduce principal on mortgages, and which makes homeowners pay a share of the appreciation on their home to their lender when they sell it, was initiated in October and was expected to garner some 400,000 takers. As of last week, according to The Wall Street Journal, there had been only 42 takers. That’s not a misprint – 42 – I even checked with The Journal.

In the real estate realm, the proverbial “other shoe” hasn’t dropped yet, but certainly is dangling – and that’s commercial real estate. As homeowners writhe in agony and stop spending, retailers will go out of business, businesses of all stripes will suffer and commercial real estate will implode. The leverage left over from just the private equity foray into commercial real estate in the acquisitive 2006-2007 period is staggering. Refinancing will be impossible. Banks are stuck with hundreds of billions of dollars of leveraged loans that they took on as bridge and mezzanine financing from the private-equity shops alone, at the time believing they would  be able to securitize those loans and sell them off to investors.

There’s no chance of that, now.

One deal in particular illustrates this entire mess.  Private equity behemoth The Blackstone Group LP took Hilton Hotels Corp. private for $26 billion. Blackstone put up $6 billion of its own money as equity and borrowed the other $20 billion from Bear Stearns, Bank of America Corp., Deutsche Bank AG, Goldman Sachs, Morgan Stanley, Merrill Lynch & Co. Inc. and Lehman Brothers Holdings Inc.

Based on a current analysis of the deal at the multiple of seven times projected cash flow that the market currently puts on Starwood Hotels & Resorts Worldwide Inc. - Hilton’s nearest rival – if Blackstone values its property comparably, it will have to mark its Hilton holdings down 50%, because it paid 13 times projected cash flow. That wipes out all of Blackstone’s equity in the deal. What’s more, the $4 billion portion of the loan that Bear Stearns took on, courtesy of JP Morgan Chase casting off Bear’s orphaned liabilities, now sits on the Fed’s balance sheet – and isn’t likely to go anywhere anytime soon.

Until the real estate cycle completes its implosion and begins to stabilize, there’s nothing that will fundamentally alter the outlook for the economy. This is Ground Zero. President-elect Obama must resist creating only a political solution to the overwhelming economic problem of declining house prices and declining real estate prices in general. Any attempt to put a Band-Aid on this economic plague will only delay the day of reckoning. I regret deeply the conclusion that the lake must be drained before we can realistically climb out of it. But there just aren’t enough ferrymen to get us all to shore.

Always a Silver Lining – My Forecast

The outlook for the economy is not rosy – and that’s an understatement. But there is a silver lining. Even in the near term, the stock market will present innumerable wealth-creation opportunities.

• First, there are plenty of shorting opportunities out there now, and more will present themselves in the future.
• Second, in due course – in perhaps 12-18 months – we will be presented with the investment opportunity of our generation. If President-elect Obama gets it right, and I believe he’s got the potential to bring us all together and get the country through this (and if you’re reading this Mr. President-elect, I’d like to put in my vote for [New York Fed President] Timothy Geithner as next U.S. treasury secretary), American companies will be able to be purchased so cheaply that fortunes will be made. The recovery will not only make us whole, it will make our people and our nation rich again.

I have absolutely no doubt that the United States will lead the world back into balance. The sea change that has arrived is the result of the conservative experiment having lost its true moorings, pushing the economy into disaster. Not that a wholesale swinging of the pendulum to the other side would be good. In fact, it would be disastrous. We have the potential to end up with a new, fair, transparent and judiciously regulated environment where capital formation can again spread its wings and the U.S. economy can fly.

There are new hands reaching into the colorful box of beads that comprise the American landscape and economy. From any human perspective, the United States is more than a microcosm of the universe; it is the center of the world as we know it. It will take time to construct the new mandala. We all need to meditate on the process to ensure that the design we embrace will ultimately be inclusive, forward-looking and – like all great art – an inspiration to all who view it.

Source: U.S. Economic Outlook for 2009

Well… Nothing has changed since I left you last Wednesday. The awful economic data just keeps piling on, and the dollar gets bid up on safe haven purchases. We did see the Eurozone and Japan announce that they are in a recession… Chris was kind enough to leave me the following, so here’s some more Chris….

“The dollar weakened slightly after the US Industrial production numbers showed a rebound in October. The 1.3% monthly gain sounds great, but it followed September’s drop of 3.7% due to the Gulf Coast hurricanes. After adjusting for the effect of the hurricanes and a strike at Boeing, output dropped .7 percent during each of the past two months. The trend continues to be very weak, and the recession which currently grips the US is now expected to last through 2010.

The US was rescued from the last two recessions by US consumers, who continued to borrow and spend right through the previous slowdowns. But we can’t count on consumers to pull us out of this one. Plummeting home values, dwindling incomes and the near disappearance of credit have proved a potent mixture for the US consumers. The number of personal bankruptcy filings jumped nearly 8 percent in October from September. Filings totaled 108,595, surpassing 100,000 for the first time since the bankruptcy laws were changed in 2005. The number of filings were up nearly 34 percent from October 2007, and are expected to total over 1.2 million for the year.

Not only are bankruptcy filings up, but most filers have much more credit card debt than in years past. A recent study found that the typical family who filed for bankruptcy in 2007 was carrying about 21 percent more in secured debt, and about 44 percent more in unsecured debts like credit cards than those that filed in 2001. Don’t count on US consumers to rescue us this time, so who will? Pelosi and President elect Obama are already talking about increasing government spending to try and borrow and spend our way out, but any stimulus or massive government projects will only add to the overall debt and increase the deficits. We are already being crushed by our debt load, and increasing it won’t be a long term positive for the US. The dollar continues to be propped up by safe haven purchases and the global deleveraging, but this dollar strength can’t continue. Once we return to the underlying fundamentals, the dollar will fall.”

OK… Thanks once again, Chris!

The BIG NEWS today should come in the form of a testimony by Treasury Sec. Paulson, regarding his TARP… This should be interesting folks… You see there is a whispering campaign to withdraw the “blank check” that lawmakers gave to Paulson and Fed Chairman, Big Ben Bernanke, and any attempt to not fully disclose the details of what has been given out to date, or… Any more changing of horses in the middle of the stream, could cause a ruckus. It could also cause the safe haven boys and girls to go “all in” on their safe haven purchases, because, it will be just like last week, when Paulson did change his course for the $700 Billion bailout money, and the blanket of “unknown” was cast upon the markets, and the risk takers ran for the hills.

In other words… The Trading Theme that is in place that rewards the dollar when things look darker in the U.S. will be working overtime, buying dollars…

For the sake of honesty… And not that I’m cheerleading the currencies (I get real tired of this… Recently I’ve had some readers turn on me and accuse me of “knowing nothing” and being nothing more than a “cheerleader”) Come on! Can’t you see the forest from the trees? This is simply telling it like it is… WE have a HUGE deficit problem, and unless you are willing to begin paying taxes that amount to about 75% of your income to pay the deficit down, then we need to get the dollar weaker now, for that’s the only way we’re going to be able to pay down the interest alone on these debt obligations is with a cheaper dollar! So, yes, I push for that dollar to get weaker now, so that the tax obligations of my kids and grand kids aren’t oppressive!

OK, sorry but I had to get that off my chest… So, for the sake of honesty, let’s hope Paulson comes to the lawmakers with a cup of honest, and let the chips fall where they will. Oh! And yesterday, the Wall Street Journal reported that Paulson is unlikely to launch new bailout (the used “rescue” but we all know what it is!) programs, saving his unused horde of cash to hand over to the new Treasury Sec. and say, “here you go, spend it wisely, but just between you and me, this isn’t enough to help anything”

Judging from happened in the overnight stock markets, with the risk takers nowhere to be found, the consensus being the overnight markets don’t believe Paulson will deliver the goods, and stocks sold off in Asia and early Europe… I suspect that the U.S. market will take a cue from those overnight markets as well, at least until Paulson talks… And the Dow only has 273.58 points to give before falling below 8,000… UGH!

All those “Safe Haven buyers” must really be “scaredy cats” because as I look at the bond screens, I see that you will get 13 basis points for a 3-month T-Bill, and 80 basis points for a 6-month T-Bill… By the time the broker takes his fee or commission you are left with nothing! So, that’s the same as putting the money under your mattress or stuffing it in coffee cans and burying it in the back yard! And, if you want to talk long notes and bonds… Well, you’ll have to go to the 30-year bond before you can get yield that comes near to covering the inflation rate! Uh-Oh! Negative real earnings for the “safe haven buyers”…

How long can that continue? How long… Can this be going on? How long… Can this be going on? How long are these guys and girls going to accept negative real earnings? That’s the $64 question… But, I have to believe that once these “safe haven buyers” decide that they’ve had enough, the unwinding will go very quickly, and the whiplash we’ll receive from watching yields turn around will hurt!

And, with the unwinding of the “safe haven buys” one would think that the dollar gets put on it ear once again… That is unless there’s a new “hoola-hoop” for investors to move into… But since there’s no “hoola-hoop” to speak of, and probably won’t be, given the fact that the regulators will be scrutinizing “new instruments” to make sure they “don’t get fooled again”…

Did you see the news yesterday that Citgroup plans to cut 50,000 jobs? That’s just awful! And if true, will be the latest jolt to Wall Street! Chief Executive Vikram Pandit addressed employees in a town hall-style meeting Monday morning, giving them the bad news. These job cuts won’t take place overnight… And that they plan to be finished with them by the 3rd QTR of 2009.

The data cupboard today will give us a look at the Producer Price Index (PPI) (wholesale inflation), which is expected to fall from previous printings, as Oil prices have fallen faster than anyone and I mean anyone could have imagined. We’ll also see the TIC Flows (net security purchase by foreigners) for September… This data should see some improvement, but remain well below the figure needed to finance the current account deficit.

Yesterday, Capacity Utilization printed for October, and improved (on first glance, wait for the revision) on September’s revised downward figure of 75.5%… Capacity Utilization has long been a fave piece of economic data of mine due to the fact that it is one of the very few / rare pieces of data that is forward looking. Capacity Utilization weakness was one of the factors I used in calling the recession in the U.S. back in January. Capacity Utilization and the ISM Index (manufacturing)…

So, how about that stirring communiqué’ from the G-20 crowd! I was moved! The chills went down my spine, my eyes filled with tears of joy, it was something to behold! Oh? They didn’t do all that? I must have been dreaming, eh?

What a joke! These leaders from around the world met and didn’t come up with anything other than rhetorical direction only? Fire them all! Throw the bums out! This is ridiculous! It just shows me that they are probably more interested in pointing fingers than actually agreeing to work together to deal with this global problem.

So… Look for more of the Trading Theme today, folks. The deeper, darker, more dangerous clouds are moving back in over the U.S. economy.

Currencies today 11/18/08: A$ .6465, kiwi .55, C$ .8115, euro 1.2635, sterling 1.5040, Swiss .8345, ISK 182, rand 10.2850, krone 7.0180, SEK 8.0425, forint 214.40, zloty 3.0475, koruna 20.4280, yen 96.10, baht 35, sing 1.5270, HKD 7.75, INR 49.65, China 6.8280, pesos 13.22, BRL 2.3215, dollar index 87.07, Oil $54.80, Silver $9.35, and Gold… $736.75

Source: TARP Testimony Today