Unemployed in an Abnormal Business Cycle

Fear. You can almost smell it. So far, there’s just a whiff of it…a faint odor…a little trace in the air…like the smell in a subway car after a bum has left.

Yesterday, the Dow fell 213 points. Oil dropped to $76. Gold lost $9.

What caused it? What sets off a crash? Yesterday was hardly a crash. But our Crash Alert flag still flies. Because this is a market in danger. It is a market looking for a reason to crash.

You never know for sure when or why markets crash. At a certain point, markets become like drunks who want to play a game of Russian roulette. First, they have to find the revolver. Then, they find the trigger.

It looked to us as though investors were flexing their trigger fingers yesterday. Some blamed China’s recent move towards tighter credit (or what they thought would be a move to tighter credit)…others blamed news from the US:

“Jobless claims in US unexpectedly rise,” said the Bloomberg report. Here is how the Associated Press described it:

“A surprising jump in first-time claims for unemployment aid sent a painful reminder Thursday that jobs remain scarce six months into the economic recovery.

“The surge in last week’s claims deflated hopes among some analysts that the economy would produce a net gain in jobs in January and help fuel the recovery.

“A Labor Department analyst said much of the increase was due to holiday-season-related administrative backlogs at the state agencies that process the claims. Still, economists noted that that would mean claims in previous weeks had been artificially low. Those earlier declines had sparked optimism that layoffs were tapering and that employers would add a modest number of jobs in January.

“The January employment report will be issued Feb. 5. But the surveys used to compile that report were done last week, so economists are paying close attention to the jobless claims figures from that week.

“‘The trend in the data is still discouraging,’ Diane Swonk, chief economist for Mesirow Financial, wrote in a note to clients. ‘Hopes for a positive employment number in January…are rapidly dimming.’”

Anyone who was ‘disappointed’ by the jobless numbers hasn’t been paying attention. Consumer and business credit are falling. That means businesses are not expanding. They’re contracting. And that means they need fewer employees.

People without jobs can’t shop like they used to…and they can’t pay their bills. One out of 4 mortgaged houses is underwater. One in 10 is in foreclosure. Many more will probably go into foreclosure as the depression continues and default becomes more socially acceptable. Previous generations regarded default and foreclosure as a disgrace. Lenders priced this aversion into their lending rates. But now, default is just a shrewd financial move. When the financial costs of defaulting are lower than the costs of paying…that’s what borrowers will do. Just like Wall Street.

As the depression continues, attitudes will change… Voters will probably want real change in Washington; that’s what the Massachusetts election may be telling us.

But back to our story…

This morning, we see another itchy trigger finger. Stocks are falling in Asia. This time it’s blamed on Obama’s pledge to punish the banks with higher taxes.

But the real cause of the wobbles on Wall Street is the economy. Trillions’ worth of fiscal and monetary stimulus aren’t stimulating at all. They’re just shifting control of the economy to the feds…and shifting the debt bubble in their direction, too.

Does that make a nation more prosperous? Of course not.

The stock market has been ignoring the fundamentals. It’s priced dozens of big companies over 50 times last year’s earnings. Overall, stock prices are closer to a top than a bottom. And yet, a depression brings a bottom, not a new top.

We say this with caution. A few years ago, we might have said it with reckless confidence, but we were smarter back then. Now, we even place our breakfast order with caution. You just never know…

No one ever knows exactly what Mr. Market will do. If he wants higher stock prices, he’ll get them – no matter what the fundamentals tell us.

But we have to stick with the fundamentals anyway. That’s all we’ve got. And they tell us to watch out. In a ‘normal’ recession, businesses would be re-hiring by this time in the cycle. They’re not doing so. Why? Because it’s not a ‘normal’ recession. It’s something quite different. Something we haven’t seen in the last 50 years. Something we never wanted to see again. But here it is – a depression. That’s what those higher unemployment figures tell us. People who own and run businesses aren’t hiring. They know the jig is up. The insiders who own businesses are selling 24 shares for every one they buy.

Unemployment is over 10%…and it seems likely to stay there for a long time. Consumer and business credit are declining – for the first time in half a century. And those trends too seem likely to continue. There are still beaucoup mistakes to correct and a long way down to go.

So relax. Buckle your seat belts. Sell your stocks. And enjoy the show.

The Daily Reckoning