The battle to tighten budget deficits has now reached a new level. Public employees are pushing back by taking their employers—the cities—to court.

In San Jose, California, the public unions are taking the city to court to contest the city’s attempt to force the public employees to either contribute more of their paycheck toward their pension or accept a reduced retirement pension plan (source: Reuters, May 8, 2012).

There are eight similar lawsuits nationwide!

I have discussed most of these troubled cities in these pages before the court dates were set. You know what I’m going to say now; this is just the beginning.

The San Jose Police Officers’ Association is ready to fight for years if it has to, to protect what it feels it’s entitled to for its service.

The City of San Jose attempted to explain to the police officers and the other city unions that, since the recession hit in 2008, the pension fund has lost money on its investments, which has widened the budget deficit. On top of this, with home prices falling and fewer people working, tax revenues to the city have declined, further exacerbating budget deficits.

And with interest rates near zero, it is proving very difficult for pension fund to generate any interest income to help fill the budget deficit hole.

The City of San Jose has to make cuts somewhere to make up the budget deficit. It has chosen to increase pension contribution rates instead of cutting basic services. Of course, if the battle in court continues, the city may have no choice but to cut essential services for the citizens of San Jose, because the cost of the case was not planned in the budget deficit.

I’ve talked about the plight of Detroit. Its budget deficit is enormous as the city’s home prices continue to languish. Just recently, the city outlined a severe plan to address the budget deficit. The City of Detroit is planning to cut 25% of its 10,000 workers—or 2,500 employees (source: Detroit Free Press, April 24, 2012).

The cuts are across the board, from public safety like police officers to healthcare workers. A citywide hiring freeze has also been put in place. The city doesn’t want to cut the fire department so it is asking the federal government for a grant to help retain 100 firefighters, because the city cannot afford to with its budget deficit.

San Jose and Detroit join the long list of municipalities that are cutting essential services to their citizens and are pushing the public unions to the point where disputes are now being handled in court.

The pushback will continue until the budget deficits get pushed from municipalities to the bankrupt states and eventually to the federal government. Where will the next round of bailout money come from?

And can you believe that economists thought earlier this year that the Fed would not delivery QE3? The audacity of thinking more money printing was not coming!

Michael’s Personal Notes:

A sign of things to come…

Outplacement firm Challenger, Gray & Christmas released a report last week illustrating that, for the month of April 2012, planned firings at corporations in America rose 11% from a year ago. From the month of March, planned firings were up 7.1%.

The report also expressed the opinion of its authors that, at the current level of demand for goods and services, companies in the U.S. don’t require additional workers to meet output; very bad news for May’s upcoming job numbers report.

Sure, this means the U.S. economy is weak. Without sufficient demand from the consumer, which is 70% of GDP, companies will not hire new workers, which is going to stall jobs growth. This is a bad sign that May’s job numbers could be worse than April’s.

This is further confirmed by the fact that the biggest sector of the economy that cut the most jobs thus far in 2012 has been the consumer products companies. If consumers are not spending, then the companies that make and sell consumer products will not lead jobs growth, but instead lead in layoffs.

The report also highlighted that layoffs at the government level—led by education—continued to increase, which is something I’ve been talking about in these pages.

As municipalities continue to cut the expenses to meet their budget deficits, jobs growth will be nonexistent at the state and municipal levels. And the monthly job numbers will continue to display the effect of this reality.

Challenger always prefaces its report by saying that a corporation’s intention to lay off will change if the economy improves, which will lead to improved job numbers. Given all of the economic headwinds I’ve detailed in these pages recently, like weak U.S. durable goods orders, weak job numbers and weak retail sales, the economy will most likely not improve.

Many are saying that April’s job numbers report was not the start of a downtrend in job numbers. I beg to differ.

Where the Market Stands; Where it’s Headed:

I believe the stock market has been putting in a huge top for months…what technical analysts call the right shoulder of a “head and shoulder” pattern.

The bear market knows that worldwide economic growth is declining rapidly…that Recession Part II is not far behind. It just doesn’t want investors to know, so they keep putting money into the stock market so the bear can take it away again!

What He Said:

“A low savings rate was eventually blamed for the length of the Great Depression. Consumers just didn’t have enough money to spend their way of the Depression. With today’s savings rate being so low, a recession could have a profoundly negative effect on overextended consumers.” Michael Lombardi in PROFIT CONFIDENTIAL, March 26, 2006. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.

The Congressional Budget Office (CBO) releases a report every year on the “health” of the largest benefit programs in U.S.

In 2011, the CBO analyzed the budget deficit for Medicare and concluded that the program would run out of money by 2024. In 2012, the CBO maintained that 2024 projection.

The study noted that the U.S. government is doing everything it can to keep health costs in line, which is the reason why the 2024 doomsday timeline was not moved up. The report warns that medication, doctors’ pay and new medical equipment continue to rise in cost, which could worsen the budget deficit and so move up the doomsday timeline.

The news is much worse when it comes to Social Security. In 2011, the CBO stated that Social Security would run out of money by 2038. In 2012—from the report released last week—the CBO now says money for Social Security will run dry by 2035 – three years earlier thanks to a deteriorating budget deficit!

The major reason why the budget deficit for Social Security worsened was that the payouts were 3.6% higher than projected due to the fact that pensioners are compensated each year for the change in the rate of inflation, as reported by the Consumer Price Index (CPI). Since the payout was larger and taxes did not increase, the budget deficit widened.

What could disrupt this projection completely is the budget deficit for the disability program within Social Security. In 2011, the CBO said it was set to be emptied by 2018. In the CBO’s report released last week, the disability program is now set to run out of money by 2016!

The main culprit behind this rise in the budget deficit for the disability program was many more disabled people losing their jobs and, therefore, with this economic slowdown, having no choice but to apply for benefits.

Medicare and Social Security are supported by both employers and employees through taxes. Of course, with the economic slowdown, government revenues have decreased, since fewer people work, worsening the budget deficit.

The government has to spend more money in order to maintain support for Medicare and Social Security, which will ensure that the budget deficits of $1.3 trillion for the U.S. government for the current year will not only be maintained, but will continue to worsen.

Watch out for that stock market rally, dear reader, it is assuming that the economic slowdown will let up and the budget deficits will not worsen—neither event of which I see happening anytime soon.

Michael’s Personal Notes:

What the CBO is not taking into account in its deteriorating projections for the budget deficits in Medicare and Social Security in this country is the worsening of state and municipal pension and Medicaid budget deficits.

The CBO estimates are based on the Federal program and the Federal government’s responsibility to Medicare and Social Security. However, if the states can’t pay for Medicare and Social Security, who is going to take responsibility for these budget deficits?

I have written often in these pages about the crumbling budget deficits at the municipal and state levels.

The CBO is saying that Medicare will run out of money by 2024 and Social Security will run out by 2035, but the Federal government has cut state funding, as both the state and municipalities struggle under this supposed economic recovery.

If the Federal government needs to pay for Medicare and Social Security, it will need to print money, but what recourse do states have if their revenues are not enough to cover these costs?

Let’s take the state of Illinois as an example. This week, it was reported that its backlog of unpaid bills has reached $9.0 billion, with most of its budget deficit related to pensions (source: Bloomberg, April 23, 2012).

There has been a small economic recovery, which has increased Illinois’ tax revenue by 3.9% or $7.0 billion from corporations and individuals in the past nine months. However, this increase in revenue was not enough to offset the losses from the Federal government cutting its financial support to Illinois, further deepening the budget deficit.

With the unemployment rate still persistently high within the economic recovery, tax revenues have not returned to levels seen in 2007, further degrading budget deficits at the state and municipal levels.

The largest revenue generator for municipalities is real estate taxes. The housing market continues to languish and, with home prices not rising, tax revenues drop, which leads to a further decline in budget deficits.

The only recourse left is to raise taxes. With this supposed economic recovery, I wish them luck. Illinois has proposed a three-percent increase in pension contributions from current employees, while the inflation-adjustment increases in pension payments are set to be cut.

California is proposing raising taxes on high-income earners and a small increase in the state’s sales tax. Although the governor is stating that these hikes are to fund education and public safety, The Wall Street Journal is reporting that the revenue from the tax hikes is really being used to fill the large budget deficit in the teachers’ pension fund.

California cut its Medicaid payment rate by 10%, but the California Medical Association sued the state and won. The court agreed with the Medical Association stating that the 10% cut would result in inadequate care to patients, and would actually harm patients who are entitled to a basic level of care.

California is cutting money to Medicaid and raising taxes to fund pensions. However, as the economic recovery has no traction, the budget deficits will continue to worsen to the point where California, and many other states, will visit the White House and ask them for money to fund their pensions and Medicaid. Where will Washington get the money if needs to bailout the states? It will print more money.

Where the Market Stands; Where it’s Headed:

The Dow Jones Industrial Average has travelled 1,000 points, 8.3% higher, in the first four months of this year. There is rising optimism in the air about the economy turning the corner, advisors are turning bullish on stocks again, investors are starting to see the stock market as a “good place to put money” again—the exact three things the bear wants to happen.

Since March of 2009, we have been in bear market rally supported by ever-expanding government debt, artificially low interest rates, and an unprecedented increase in the money supply. Take these factors away and we see no structural improvements to the economy. Debt and money printing cannot support a stock market rally forever. The building blocks are in place for the final blow-off to the top for this bear market rally. The risk may not be worth the reward for the majority of my readers.

What He Said:

“The U.S. lowered interest rates in 2004 to their lowest level in 46 years. And what did Americans do with their access to easy money? They borrowed and borrowed some more, investing the borrowed money into real estate. Looking ahead, perhaps the Fed’s actions (of bringing interest rates so low as to entice consumers to borrow more than they can afford) will one day be regarded as one of the most costly errors committed by it or any other banking system in the last 75 years.” Michael Lombardi in PROFIT CONFIDENTIAL, July 21, 2005. Long before anyone was thinking of a banking crisis, Michael was warning that the coming real estate bust would wreak havoc with the banking system.

I think we’re going to get more of the same over the coming quarters—choppy economic news and choppy stock market trading. The key I think is to keep listening to what corporations say about their businesses. Corporate earnings continue to pour in and it’s very clear that not all businesses or industries are performing the same. The lack of broad-based, cohesive economic growth is the result of a global economy that’s still trying to balance itself out after the subprime mortgage-induced financial crisis. That bubble and its collapse continue to be far-reaching, for the world and the stock market.

There are two very significant investment risks out there and it’s my feeling that they will continue to create major headwinds for the stock market, this year and next. There is significant geopolitical risk with Iran and North Korea. These countries’ actions are naturally unpredictable. More predictable is the sovereign debt crisis in Europe and the zero economic growth it has created. Germany is the economic engine of Europe and that country is likely to outperform, but with sovereign debt in many of those countries running well over 100% of gross domestic product (GDP), the future to me seems inevitable. (See What We Can’t Forget About in the Stock Market Today.) Regardless of what happens to these countries or the euro currency, the end game is the same—little to no economic growth.

So, here is a scenario that I think has potential to transpire over the next couple of years. Europe’s sovereign debt problems will get worse, as politicians borrow more money to bail out member countries. Austerity packages will become more severe in order to aid on the government spending side and, therefore, the eurozone will be stuck with a long period of stagnating economic growth. While economic growth in the U.S. is on the cusp of accelerating, zero economic growth in Europe and declining rates of economic growth in the BRIC countries will reduce the earnings power of U.S. large-cap companies. Accordingly, it’s stagnation for the stock market as well. And this scenario doesn’t include the potential for another war.

This fundamental macro outlook is why I think the stock market is generally in the process of topping out. It may happen this year or next, but I just can’t see how corporate earnings are going to be able to accelerate in a world of very slow economic growth. That’s why I’m advocating a very conservative investment stance for stock market portfolios, with some exposure to commodities, as the Federal Reserve continues to increase the money supply.

The one thing the stock market has going for it today is that it’s not overvalued. The stock market isn’t in a bubble given the current earnings outlook. This reduces the chances of a big hit. Still, my gut tells me it’s time to become extra cautious, even though we should get more good news for a while.

The plight of municipalities here in the U.S. and their struggles under the weight of enormous pension budget deficits are reaching the critical phase.

In fact, many municipalities are contemplating bankruptcy, forcing me to conclude that jobs growth in the U.S. will remain under pressure because of the layoffs that would inevitably come from trying to balance local and state budget deficits.

In 2009, the U.S. government provided a stimulus fund to offset lost tax revenue for state and local governments. That money has been used up and, with pension budget deficits too large and deteriorating, states are telling municipalities that they have no money to help them with their budget deficits.

As most homeowners are aware, municipalities get a large portion of their tax revenues from property taxes. With more homes empty since the credit crisis and with property values significantly lower since 2007, municipalities are taking in less tax revenue, making their budget deficits even worse. With no help from the state, the only way to meet the budget deficits is to lay people off, and that trend has not stopped.

According to Reuters, the last three years of job losses at the state and local government level has been the worst since the Labor Department first began keeping records in 1955.

In a recent report, the Economic Policy Institute noted that, in the three previous recoveries from recession, public-sector employment jobs growth was significant. The Institute estimates that, if this recovery were like the previous three, we would have experienced jobs growth of 1.2 million in the public sector by now. Instead, since the beginning of 2009, 482,000 municipal jobs have disappeared, while 150,000 state jobs have been eliminated.

Moody’s estimates that states could cut a further 15,000 jobs in the remainder of 2012, while municipalities may lose between 150,000 and 175,000 jobs in 2012, providing significant headwinds to jobs growth. These jobs cuts are all a consequence of trying to close those enormous budget deficits.

Moody’s may be proven right, as the State of Florida just announced that it will have to cut 4,000 state jobs in order to meet its budget deficit.

As I’ve been suggesting, and as these numbers now prove, dear reader, public-sector job losses are going to make strong jobs growth very difficult in 2012 in this country. I didn’t mention the other avenue municipalities have for meeting their budget deficits: raising taxes.

In this economic environment, how well will higher taxes sit with people when municipalities explain it is to meet their budget deficits?

If this country doesn’t find economic growth and jobs growth soon, these budget deficit pressures are going to build to the point where more and more municipalities will declare bankruptcy and states will in turn run to the Federal government for help. (Also see: Serious Financial Trouble at U.S. Municipal Level Mount.)

Watch that stock market rally, dear reader.

Michael’s Personal Notes:

While one has to give China credit in its quest for accumulating gold bullion, the country is taking its approach to another level.

China is home to very large gold mining companies that produce 390 tons of gold bullion every year, which China is keeping for itself—not allowing the gold mining companies to export this gold bullion.

Zijin Mining Group is the largest of China’s gold mining companies. It has just offered to pay a 46% premium for Norton Gold Fields, one of Australia’s gold mining companies.

Zijin also owns a 60% stake—controlling rights—to Altynken, a major gold mining company based in Kazakhstan. And Zijin has said that it is setting aside 5.5 billion yuan ($880 billion) of cash that it has on hand for acquisitions overseas.

China’s Mining Federation is studying different ways it can make capital more available to its gold mining companies, so that acquisitions overseas will be that much easier.

In response to the Federation’s plan, one exchange has created a 10-billion yuan ($1.6-billion) venture capital fund that gold mining companies can access specifically for mergers and acquisitions overseas—to make the money available to Chinese gold mining companies and to help with logistics, to make the process easier.

There is no question that Chinese gold mining companies face opposition to buyouts overseas, as many countries want the commodities—and especially gold bullion—to remain within the control of the country itself.

However, offering premiums of 46% from what a gold mining company is currently worth can simply be too good an offer to resist. China is less concerned about price, and more concerned about securing gold bullion to back its currency.

The People’s Bank of China—equivalent to the Federal Reserve here in the U.S.—has been busy attempting to acquire gold bullion wherever it can find it. China has banned all exports of gold bullion and ordered its gold mining companies to sell all of their gold bullion to the People’s Bank of China.

It seems as though the country is also helping to fund its gold mining companies with capital, which is enabling them to buy gold mining companies overseas, mine the gold bullion, and return it back home where it can sell it to the People’s Bank of China.

As the saying goes, there is more than one way to skin a cat. It looks like China, in its desire to increase its reserve of gold bullion, which is just of fraction of what Europe and the U.S. holds, is using its gold mining companies to help with the confiscation of gold bullion worldwide.

So if you are thinking about selling your gold bullion, dear reader, there is a smart willing buyer who will be more than happy to take it off your hands. (Also see: China’s Appetite for Gold Far From Subsiding.)

Where the Market Stands; Where it’s Headed:

There is no doubt; the stock market rally that started in May of 2009 is losing steam each passing day. The Dow Jones Industrial Average fails to stay above 13,000, while more cracks in the economy appear each passing day.

No, we did not reach that speculative phase we would traditionally see at the end of rally. But even if it does happen, the five-percent upside potential left in the market may not be worth the risk for the majority of my readers.

What He Said:

“Prepare for the worst economic period ahead that we have seen in years, my dear reader, as that is what I see coming. I have written over the past three years how, in the late 1920s, real estate prices fell first before the stock market and how I felt the same would happen this time. Home prices in the U.S. peaked in 2005 and started falling in 2006. The stock market is following suit here in 2008. Is a depression coming? No. How about a severe deflationary recession? Yes!” Michael Lombardi in PROFIT CONFIDENTIAL, January 21, 2008. Michael started talking about and predicting the economic catastrophe we began experiencing in 2008 long before anyone else.