As we warned last week and over the past couple of months, the poor quality of the economic expansion finally has caught up to the economic statistics.

Last Friday’s dismal report showing a jump in the unemployment rate to 9.1%

left all of the cheerleaders from Warren Buffet to the

Secretary of Labor scrambling for explanations.

 

Given the lack of earnings or merger news, the stock market recorded its fifth straight weekly decline. As the charts illustrate, both the Dow Jones Industrial Average and the NASDAQ Composite dropped around 2.3% last week in response to the now obvious slowdown.

The Markets & Economy

We have been highlighting for months here in these weekly updates the lack of a true and self-sustaining economic recovery. With housing in the doldrums and unemployment remaining high, the concern should always have been about growth policies. Instead all we hear from Washington DC is talk about raising taxes, increasing regulation, whether it is on the financial service industry, energy or even with the Obama Administration’s attempt to prevent Boeing from opening a plant in South Carolina over the issue of it being “not as union friendly,” as they say in Washington.

As a result of all of these policies and attempts to orchestrate the economy from Washington, we have had a subpar recovery and one, which has been artificially supported by a zero percent interest rate policy. In addition, the Fed has also included several rounds of printing money to the extent whereby most of the bonds being sold by the Treasury Department are being purchased by the Federal Reserve.

In the private world this would be called a “Ponzi scheme,” and those perpetrating it would go to jail. When the government does it for some reason, there are few if any questions that the public hears about.

The important fact to remember though is that in real terms, the economy is not growing. This is why unemployment is officially at 9.1%, but in reality is much worse than that.

Look at the chart below that compares the unemployment rate with the record low employment participation rate.  This is something we have commented upon many times previously. One would think that in normal times this participation rate would not be falling - if opportunity for jobs existed. Worse still, one would also expect that if people are truly dropping out of the work force then the “official” unemployment rate would be dropping simply due to the arithmetic of the unemployment rate calculation.

The graph here shows that we have the worst situation imaginable. While people are dropping out of the labor force in record numbers, the unemployment rate is still rising.

Beyond that, the employment numbers are cooked beyond being taken seriously. Last month’s figures included an estimated 206 thousand jobs (see chart next page) from the so-called birth/death adjustment. Suffice to say this is an estimate by government bureaucrats that these jobs were created, but not able to be counted.

If that sounds both crazy and counter intuitive to you, since people are known to be dropping out of the labor force in droves, then join the crowd.

This problem is, of course, that those who are not working pay no taxes and receive benefits such as the 45 million Americans on food stamps and the several million Americans on unemployment for up to 99 weeks. This is 90 percent of the reason that the government is in deficit to the tune of 1.6 trillion dollars this year. When your taxable base goes away, you cannot make up the difference by taxing the so-called rich, who already pay virtually all of the income taxes in this country. There are neither enough rich people nor is there enough of their income to accomplish this.

Growth policies must start to be enacted or this slowdown could turn into a double dip.

What to Expect This Week

The economic data is slim pickings this week and so the impression left from last week will likely linger.

The good news is that after five weeks of decline (although cumulatively it amounts to only about 4.5 percent), the market has priced in quite a bit of slowdown - although the bank stocks look particularly dicey this morning. On top of this there is now the likelihood of a rebound in Japan from the slowdown which occurred there following the earthquake. This has also been a serious factor depressing the global manufacturing economy the past two months.

Finally, our look at the Economic Cycle Research Institute (see chart below) showed another marginal decline but the coincident indicators have stabilized.

All in all, it appears the slowdown is real and our government continues on in its clueless fashion. Look for the global economy to keep things from falling into a double dip, which will be good for stocks but do nothing for employment gains domestically.

  and

SYMBOL:  SWN                     SYMBOL:  BRCD

Last Friday there were takeover rumors in two of our holdings: Brocade Communications and Southwestern Energy.  Shares in both companies bucked the negative trend of the market last week.  While we never believe a deal for one of our holdings is imminent until the deal is announced, rumors have been persistent in both of these names for the better part of a year.

Last week a Wall Street analyst put out a report that Dell is likely to buy Brocade for as much as $10 per share.  Dell, Hewlett Packard and IBM have been rumored buyers of Brocade before and it appears there is some legitimacy to these rumors.  Dell has to diversify away from the PC market, and Brocade will allow them to become a much bigger player in the server and storage markets.

Friday the trading in Southwestern Energy was very active, as rumors that Chevron was looking to acquire the Company.  This would make sense, as large oil companies, like Chevron, need to enter the natural gas market.  Southwestern has some of the best assets in the natural gas industry.  We believe that a bidding war for Southwestern is likely, as domestic and international oil companies need to get exposure to the natural gas market.

Both of these companies are trading at 52-week highs and we still are a buyer at these levels.  We suspect that we will receive a nice premium if either of these deals is announced in the near-term future. 

  Southwestern Three-Month Chart       

  

Brocade Three-Month Chart

 

 

 

 

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www.mcintyreinvestments.net