The market rallied last week, the result of a “better than expected” monthly jobs report. But things are not quite what they appear to be – in reality, the jobs outlook is somewhat bleaker. Here’s my outlook on the market’s prospects for 2010 – along with what you can do to ring out gains regardless of how far stocks fall…

Last week, the Bureau of Labor Statistics estimated that private sector payrolls grew by 67,000 in August (including the impact of fewer census workers, the headline number was a loss of 54,000 jobs).

The “birth/death” model, which never makes it into the press release, added 115,000 private sector jobs from new businesses that were assumed “born” in August. Subtracting this “birth/death” figure yields a loss of 48,000 private sector jobs — a reasonable adjustment since new small businesses aren’t exactly sprouting up rapidly these days.

State and local governments, whose budgets remain under severe stress, cut an estimated 10,000 positions. As money from the 2009 federal stimulus package dissipates, the stress on state and local budgets will worsen over the next few quarters. Many will have no choice but to cut jobs. This area of the labor market — state and local government jobs — is one of the few that has yet to adjust to post-credit bubble reality.

You know the labor market is unhealthy when many pundits are calling for the Federal Reserve to “spur” job growth. With the Fed’s Jackson Hole conference in the headlines lately, this is a relevant topic for financial markets.

If wheat and other raw food prices keep soaring, does anyone really expect the Fed to tighten policy? I doubt it. The Fed is actively trying to devalue savings and recapitalize the banking system at the expense of savers. It can print a years’ worth of honest labor in a millisecond, and might eventually seek to bypass the banking system if it remains lethargic in its role of transmitting easy credit. Considering the current state of government policy and central banking, should we really be surprised that the private sector economy seems to be malfunctioning?

We’ve probably reached the point where further Fed easing will cause more negative consequences than so-called “benefits.” For example, can the Fed really keep long-term Treasury yields pegged to low levels if existing Treasury holders want to sell? How much new money creation might it take to keep long-term Treasury yields pegged to a desired level? If it went down this path, the Fed might have to create several trillion new dollars to hold bond prices up (yields down). This new money creation, in turn, would heighten fear of future inflation. At this point, the Fed would lose the small bit of credibility it has left.

Some sort of government debt restructuring is likely in the coming years. There is good news about this scenario, at least for Americans: Japan is likely to reach this point — the total revulsion of government bonds that cannot possibly be repaid in honest money — far sooner than the U.S.

Such is the folly of central planning. It’s not a good idea to manipulate market prices far from their natural state. In this case, the Fed is trying to keep the Treasury’s cost of borrowing at artificially low levels. Eventually, holders of Treasury securities might realize that they’re artificially propped up, and all hit the Fed’s bid at the same time.

By the way, this scenario argues for gold having a place in your portfolio. Those who say they “don’t understand” gold (and there are far too many of them right now for gold to be in a bubble) are implicitly agreeing that the current fiscal and monetary regime is sane. It’s clearly insane, and will eventually have to change.

The idea of a U.S. dollar as a store of value is now based more on faith than on being compensated with a positive, real rate of interest. When faith in the dollar as a store of value diminishes, the only option the Fed will have is to tighten monetary policy and restore positive, real interest rates. Such a policy tightening would quickly end myriad carry trades and banking strategies depending entirely on a near-zero cost of funds.

Regards,
Dan Amoss, CFA
Penny Sleuth

September 8, 2010

Dan Amoss

Dan Amoss, CFA, is a student of the Austrian school of economics, a discipline that he uses to identify imbalances in specific sectors of the market. He tracks aggressive accounting and other red flags that the market typically misses. Amoss is a Maryland native, a graduate of Loyola University Maryland, and earned his CFA charter in 2005. In spring 2008, he recommended Lehman Brothers puts, advising readers to hold the position as the stock fell from $45 to $12. Amoss is managing editor of the Strategic Short Report.

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