The Kelly Letter took advantage of the two-day rally last Thursday and Friday to open a hedge against another leg lower in the market. We had previously set a limit buy price on the hedge 13% lower than its Jan. 30 close. I explained to subscribers in a note sent Feb. 1 that the reason we went with a price so much lower was “to allow excitement over the passage of the stimulus bill to send the market up (and this ETF down), ahead of the letdown to follow.”

We got the excitement part right. Will we get the letdown part right, too?

Most people think not. There’s growing consensus that Wall Street is about to embark on a “monster rally” to S&P; 1000, which is 15% higher than Friday’s close.

Don’t cross off that letdown just yet, though.

The ignored employment report on Friday was the worst we’ve seen so far in this recession, which is saying a lot. Another 598,000 jobs disappeared in January and the unemployment rate ticked up from December’s 7.2% to 7.6%, putting it at its highest since October 1992. The labor market is reeling worse than any sector except housing. That will continue to pressure consumers, and consumer spending comprises the bulk of GDP.

Why will the pressure continue? Look at these unemployment forecasts:

  • RGE Monitor: 9.1% by end of 2009 and over 10% by 2010 with 3.6 million job losses in 2009

  • Goldman: 9% by end of 2009

  • JP Morgan: 8.2% by mid-2009

  • Merrill: 8.6% by 2010

  • Bloomberg Survey: 7.8% in 2009

  • Fed: unemployment rate likely to rise significantly into 2010

We already see the pace of job loss accelerating. For the week ending Jan. 31, initial jobless claims rose by 35,000 to 626,000 — their highest level since Oct. 1982. The four-week moving average rose from 543,250 to 582,250. Courtesy of Econoday, here’s what the trend looks like:

The fiscal stimulus contains a provision for unemployment insurance. That will help those without jobs to survive, but will do nothing to stem the accelerating rate of lay-offs or encourage new hiring.

Looking at the size of the drop-off in the chart above and recalling the many projections for deeper drops ahead, one does pause at the excitement over a Washington rescue.

Get your hedge on.

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