Markets Looking Past Rise in Jobless Claims and Moving Higher

April 2, 2009 – The futures are indicating higher openings for the broader markets this morning as the Street reacts to what looks to be a relatively productive G-20 meeting, and to hopes that recent economic data in the US supports the thesis that the US economy might have bottomed-out.

Initial jobless claims were forecast at 650,000, but the number came in at 669,000, and the ninth week in a row we are over the 600,000 level. The futures came off their highs on the number. It has been interesting to see the Street look past both of this week’s jobless reports which both came in worse than expected. The number is consistent with an economy where there isn’t the stabilization that has been hoped for. Continuing claims also moved higher to 5,728,000.

The dollar is softening against the euro this morning despite the fact that the European Central Bank is widely expected to cut rates today. The euro is trading up to $1.3414, or 1.25%. We fully expect the dollar to slide to new lows into 2010.

Meanwhile, gold is down $15.50, on further profit taking. Recent strength in stocks is being attributed to the reason that gold is softer. The idea is that gold loses some of its ‘safe haven’ status as other investment vehicles firm up. There is certainly some truth to this, but we think the key catalyst for the performance of gold will be dollar weakness. Pace the fact that gold had (and is still having) a bull market right alongside the Wall Street through October 2007 (and into March 2008), while the dollar consistently slid from June 2001 through March 2008. So we see any near-term weakness in gold as a buying opportunity.

Oil prices are up $2.23 as traders adjust for renewed hopes that the global economy may have seen its worst and that there is a bit more visibility to getting back on track. As with other areas of the economy, there appears to be a developing consensus that the oil markets are improving, and Goldman Sachs raised its 2009 target to $50 from $45, also influenced by OPEC cuts.

In terms of what we expect in today’s market, the Street appears to be taking the ‘half glass full’ approach, looking past dismal employment data so far this week and is focused on taking the stance that the worst is behind us. What is remarkable is that the rationale being used for looking past the employment data is that job numbers are ‘lagging indicators’, so should apparently be being discounted against future expectations to some extent. This is a totally bad argument.

Job losses are, in no world, a lagging indicator. Common sense would suggest that when an individual loses a job or is laid off, this results in a change in consumer behavior going forward. She spends less because the future is less certain. Less consumer spending impacts business revenue and profitability in the future. Lower earnings and free cash flow impact business decisions to invest, spend and hire. In turn, this results in a worse performing economy and greater headwinds.

So we totally reject that the employment data is less relevant because it is a lagging indicator. It is not a lagging indicator. It is a leading indicator. And the fact that the numbers so far this week have not only been expectedly bad, but worse than expected, while the national jobless rate is expected to further increase in March to 8.5%, tells us that the worst is not over. We would advise our readers to adjust and invest accordingly. Our recommendation is to use this strength in the markets which has been ‘talked up’ by myopic pundits as an opportunity to hedge against downside risk.

The tools we recommend considering are:

·         SPDR GOLD Shares (NYSE:GLD) – see our recent commentary on this.

·         Pro Shares Short Dow 30 (NYSE:DOG) – the principle here is simple, we think the DJIA is trading at the high end of its range and there is more risk to the downside than there is upside. So this is an ETD that effectively shorts the Dow. When stocks move lower, this instrument increases in value. We would be adding this as a hedge against the downside when the DJIA pushes over 7,800.

·         Out of the money covered calls – write covered calls on positions that are either profitable close to being profitable to bring in extra cash and lower cost averages with the goal of seeing the calls expire, and then do it again. We don’t see the markets moving away from us to the upside in the near-to mid-term. There is too much uncertainty out there. There is a risk that you will be called out of a position, but we think it is a calculated one, and this is why we suggest out-of-the-money calls, and we wouldn’t be writing them until the DJIA moves over 7,800.

·         Long puts – buy puts to lock in profitable positions. This is portfolio insurance. We insure our homes, cars, lives…why not insure your stocks. Buying a put on a stock you are long in provides you with the right to sell the stock at the strike price where you bought the put. So if the stock sells off in broader market weakness, you have the right to sell it at a higher price (the strike) and then you can buy it back at the lower level. The strategy offers unlimited upside (less the premium of the put) and limits your downside. More investors should use this.

Wit, Wisdom, Fools and Folly

Stewart Hoffman, Chief Economist at PNC Financial Services said on Bloomberg that he expects tomorrow morning’s nonfarm payrolls to show the unemployment rate hitting 8.5%. He said layoff announcements seem to have slowed down, and hopes the weekly declines tape off a bit. He added that it appears that the Q1 didn’t end as weak as it began.