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    MARKET EDGES

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While the propensity for emotional over reactions in markets never cease to amaze me, this one was rather predictable – that’s why we sold down a lot of our invested exposure early in the week as the market was making its new 3 month-cycle highs at SP500 941.

Plenty of money managers and the manic media alike basically aren’t allowed to be bullish anymore – with the SP500 already down -1.4% for 2009 to date, the trigger fingers associated with chasing short term performance are already shaking.

I don’t think it’s the actual level of unemployment that’s freaking revisionist historians out in this country as much as it is the steepness of its acceleration. As always, in order to frame up yesterday’s news we must look back and consider where The New Reality fits within the context of economic history.

This 7.2% unemployment rate, of course, is last year’s number. Markets move on expectations of tomorrow, and this week’s -4.5% drop in the SP500 implies that the masses genuinely expect US unemployment to worsen – and I agree that it will – but NOT at an accelerating 6 month rate…

That’s why I am getting bullish for another “Trade” higher in both commodities and stocks. Everything that matters in my macro model occurs on the margin. If the unemployment rate starts to go up at a decelerating rate, the US stock market is going to continue to make higher lows.

Look at the chart below – is it steep? You bet your Madoff it is! This is the steepest 6 month sequential acceleration that the USA has seen in unemployment in 33 years. You have to go back to 1 to see this kind of 6 month delta and, on a 6-month basis, I don’t think it will re-accelerate from here.

On the contrary, I think there is a much higher probability than current expectations bake in that, come one month from now, we will not be looking back on peak pessimism for what it was – at the peak of a sequential acceleration. Yes, I think the unemployment rate will test 8%, but I do not think that we’ll be testing 9% or higher 6 months from now (7.2% +180 basis points of continued acceleration = 9%, which I believe is Goldman’s estimate).

Why?
1. US jobless claims have improved, materially, in the last 2 weeks
2. Obama’s “shovel ready” plan of 3M jobs has basic math implied that provides a cushion to my estimate
3. Unless either points 1 and 2 change, I won’t need to change my view.

I realize this is not consensus, but when I was calling for a 6-7% unemployment report by 2008 end at this time last year, at least as many people disagreed with my bear case. This is what makes a market. Lets strap the accountability pants on - put me in print at less than 9% unemployment 6 months from now.
KM

Keith R. McCullough
CEO / Chief Investment Officer