It is important that an organization have a mechanism in place to alert the company’s Board of Directors and management about incidents of suspected employee misconduct and the need to conduct an internal investigation.  To comply with the Sarbanes-Oxley Act of 2002, many organizations have implemented a whistleblower hotline or an anonymous reporting mechanism; however, often the process implemented is ineffective in encouraging individuals to report instances of misconduct. For example, one organization’s “anonymous” reporting process specifically stated that an individual could either write a confidential and detailed memo to the Audit Committee Chairman or leave an in-depth complaint message on his cell phone. This organization did not receive a single complaint since the mechanism was implemented. An organization should evaluate its reporting method and confirm that it is designed effectively and communicated appropriately throughout the organization to promote its effective use. In addition, although not all complaints should be routed to the Board, the notification process for complaints received through hotlines should be structured so that the Board is aware of the number and types of complaints received and how these complaints were handled.

Once an issue has been identified and a decision has been made to conduct an internal investigation, the organization should make sure that it is managed appropriately and common pitfalls are avoided. An improperly managed investigation can lead investigators to calculate monetary loss inaccurately, fail to identify all the individuals involved in the perpetration of the scheme, inadvertently contaminate or destroy potential evidence, cause additional costs to be incurred due to violation of employee contracts and company policies and increase the possible reputational damage due to harsh public criticism from shareholders. In one such mismanaged internal investigation, an employee accused of misconduct was terminated before completion of the internal investigation and without being offered an opportunity to explain his actions as required by his employment contract.  As a result, in spite of the compelling evidence that this employee was negligent in his fiduciary duties and intended to use the company’s assets for his personal benefit, the company was held liable for breach of the employment contract, the ultimate findings against the employee were inadmissible in court and the company was required to pay severance costs to the individual.
An organization must be aware of—and make appropriate effort to avoid—certain potential missteps when conducting an internal investigation. The following are some of the most common mistakes made in internal investigations:

• improper selection of the investigative team
• inadequate triage of the potential evidence and target
• incorrect gathering, preservation and analysis of evidence
• limited scope of background checks
• inappropriately conducted interviews

The Board and Senior Management should establish policies and procedures to avoid these pitfalls when responding to allegations.

1. Improper Selection of the Investigative Team
After receiving a complaint, one of the first steps that an organization should take is to identify who is best suited to lead the investigation and who will be privy to the resulting information. During this process, one commonly overlooked factor is whether the investigative team is far enough removed from the situation to assure independence. The person(s) conducting the investigation should be qualified, properly trained in conducting investigations and independent of the allegations. When selecting the investigative team, the following should also be considered:

• The investigative team’s relationship with the suspect and/or the whistleblower. A long-standing or reporting relationship with either party can affect the objectivity of the team.
• The investigative team’s position within the organization. Are the individuals conducting the investigation “high” enough within the organization to obtain the required information?
• The role of the suspect’s supervisor in the investigative team. The suspect’s supervisor should not lead the investigation, as the supervisor may be too close to the allegation. Certain information uncovered during the investigation may indicate that the supervisor did not perform his/her duties completely and, therefore, failed to uncover the misconduct on a timely basis.

To ensure independence, the Board should also consider engaging external counsel, forensic accountants and other investigative consultants to conduct the internal investigation.

2. Inadequate Triage of the Potential Evidence and Target
Often, the target of the investigation is not isolated and restricted from accessing potential evidence on a timely basis. As a result, valuable information may be contaminated or lost due to the deletion or destruction of files. Triage of the situation should include placing the target on a leave of absence and restricting his/her access to the organization’s internal computer network and to its books and records during the course of the investigation. By doing so, the company will have protected the integrity of the potential evidence. As this is often a sensitive process, the organization should exercise caution and verify that these steps are taken in accordance with the company’s policies and procedures.

3. Incorrect Gathering, Preservation and Analysis of Evidence
Not surprisingly, some of the significant errors in an investigation occur during the collection and analysis of evidence. Prior to the commencement of the investigation, the investigative team should obtain and review the organization’s privacy policy to confirm that evidence collection is done in accordance with these policies. In addition, if all the documents and facts uncovered are not treated as if they will be subject to applicable rules of evidence, the evidence may be compromised and, therefore, inadmissible in future criminal or civil litigation.

Preservation Order
One of the first actions an organization should take is to determine which documents may be relevant during the investigation. Depending on the scope of the investigation, an organization may need to issue a document preservation order. If an organization neglects to issue a preservation order in a timely manner, a possibility exists that pertinent information and evidence may be destroyed.

Collection of Evidence
A crucial component of evidence gathering is ensuring that the chain of custody is documented. This documentation should include a description of how the information was obtained, when it was collected, who has handled it, where and how it was transported, and where it is stored and maintained. Improper documentation of the chain of custody during the collection process may result in information becoming inadmissible in court.

The individuals responsible for collecting electronic evidence should be aware of the following:

• Hard Drive Image: There are two ways an image of a hard drive can be created—a ghost image and a forensic image. A ghost image creates an exact copy of all files on the hard drive of the computer, excluding the free space. A forensic image, on the other hand, is an exact copy of the hard drive, including the free space. Deleted files, which sometimes can be retrieved using specialized tools and programs, are located in the free space of a hard drive. These files may hold valuable information that can assist in the investigation and may be missed if only a ghost image is obtained.
• Copying of Files: When copying selected files from a target’s hard drive, a common mistake can be to “click and drag” the files to another location. The use of this technique causes the metadata of the copied files to be altered. Metadata maintains and identifies the administrative properties of a file, such as the name of the person who created the file, creation and modification dates, number of revisions made to the file, and the most recent access date for the file. This is especially important because courts may deem evidence where the metadata was changed as inadmissible.
• Comprehensive Collection of Evidence: During the collection phase, some of the possible places from which electronic evidence can be gathered may inadvertently be overlooked. When retrieving electronic data, often only e-mail and documents from the hard drive of the target are collected. In reality, there are many other places where relevant data can be stored, such as flash drives, PDAs, backup files on network drives and servers, additional servers or other computers previously used by the target.

Analysis of Evidence Collected
A common mistake committed by investigators when conducting document review is the use of only a Windows search tool on the files of the target. This tool will not allow searches to be conducted on scanned PDF images and password-protected files. A scanned PDF is merely an image of a document. This file must undergo a process called Optical Character Recognition (OCR) for the file content to be searchable. The use of various computer forensic tools that can facilitate the review of evidence collected should also be considered.

Another common flaw when performing a document review is having an overly narrow focus when developing search terms or search parameters. For example, in one investigation which called for an e-mail review to identify collusion between two employees, the search was limited to e-mail communication between the two targeted employees. This search did not yield any results. After discussions with experienced investigators, the e-mail search was expanded to include all e-mail communication from the targets. This approach identified email that was sent by one of the targets to a third party and then routed from the third party to the second target. As a result of the expanded search, the company was able to prove the collusion between the two employees.

4. Limited Background Checks
Although a background check is often conducted on an alleged perpetrator, investigators often do not inquire about or know the exact parameters of the search. Inexperienced investigators may also limit a background check to an Internet search or to a compilation of raw data obtained from a search engine. A limited search may result in missing pertinent information about the target’s lifestyle or his/her criminal and civil litigation history and can be detrimental to the investigation.
An important consideration is whether a criminal background check is conducted on a local, state or federal level, as well as what specific jurisdictions are included in the search. A background check for civil court records should also be considered because these records can yield information about the criminal conduct of an individual. Criminal proceedings may not always be filed, and an individual who commits a criminal act may only be named as a party in a related civil suit.
In most cases, a background check requires the investigator to review large quantities of data obtained from various public records. This information should be analyzed in the context of the facts surrounding the fraud allegations being investigated so that the investigation stays focused on the allegations at hand.

5. Inappropriately Conducted Interviews
Interviews are one of the most valuable sources of information during an investigation, and interviewers must be experienced and skilled in eliciting information. Inexperienced investigators may act in a combative or unknowledgeable manner that ultimately may undermine the purpose of the interview.

At times, the target of the investigation is interviewed too early in the process. To the extent possible, the investigators should review applicable evidence and interview individuals who may have knowledge related to the allegation prior to interviewing the suspect. This will assist the investigators in asking pertinent questions when they interview the subject and allow them to refer to relevant and potentially incriminating documents during the interview.

It is recommended that two investigators be present during an interview so that one can act as a witness and be responsible for documenting the findings from the interview. The investigative team should also ensure that interview notes are documented in writing, are sufficiently detailed and capture the relevant content of the conversation.

In an era of increasing scrutiny of alleged corporate and employee misconduct, Directors should be aware of potential pitfalls when conducting an internal investigation. The investigative team should make certain that care is taken to avoid these missteps and develop a comprehensive and organized approach to the investigation.

To ensure that allegations are addressed appropriately and in a timely manner, the Board should develop an investigative policy and have a process in place to shorten the response time to a complaint and to mitigate problems encountered during the investigative process.

Tim Mohr is a principal in the New York office of BDO Consulting. He can be contacted at tmohr@bdo.com. Nidhi Rao is a director in the New York office of BDO Consulting. She can be contacted at nrao@bdo.com.

Since 2007, the private sector has shed 6.6 million jobs—half in manufacturing and construction. Governments added 185 thousand employees, hired teachers, and no change in those trends can be detected since the stimulus began.

During the economic boom, a huge structural international trade deficit emerged. Imports exceeded exports by about $700 billion annually from 2005 to 2008. By the end of the boom, nearly all was manufactured goods from China and oil.

The failure to pay for imported consumer goods and gasoline with exports creates a huge shortage of demand for U.S.-made products. Money spent on imports that does not return as payment for exports can’t be spent on U.S. made products. Inventories pile up and layoffs result.

Americans solved that problem, temporarily, by borrowing against homes, cars and credit cards to spend more than they earned. Banks got the cash from China and Middle East oil exporters, stuck with dollars from selling to Americans but not buying U.S. exports.

A bubble resulted in home construction, housing prices and stocks that inevitably burst. Viola, the Great Recession.

To lift the economy, President Obama must resurrect manufacturing, which requires exporting more and importing less, and shift idle construction workers from housing, which is in oversupply, to rebuilding schools, roads, hospitals, and factories.

Of the $789 billion stimulus, only about $100 billion is infrastructure. About $280 billion is tax cuts for individuals and businesses who are too scared to spend. The remaining, $400 billion mostly rewards Democratic Party constituencies—for example, huge increases in the Department of Education budget and grants to state and local governments are not laying off teachers and policemen as President Obama often asserts.

Cap and trade will only make matters worse—economically and environmentally. It will raise the cost of manufacturing in the United States and send jobs to China, where CO2 emissions are unregulated and higher.

Proposed changes in health care would increase the cost of insurance to businesses instead of lowering prices for drugs, doctor’s visits and malpractice insurance, as true reform would accomplish. That may reward yet other Democratic Party constituencies but it will further disadvantage Americans competing in global markets.

Real alternatives are available to failed Bush-era policies. Recalibrate trade policy to promote exports, balance trade with China and develop domestic oil and gas. Abandon cap and trade until China and India sign on to the same disciplines, require drug companies and doctors to charge no more than they are paid in Canada, and find honest work for malpractice lawyers.

All would require Mr. Obama to think outside the box and abandon the conventional wisdom of the left.Just as President Bush’s blind adherence to conservative ideology threw America into crisis, Obama must unshackle his policies from liberal group think to succeed.

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and the former Chief Economist at the U.S. International Trade Commission.

Bankruptcy for CIT Group Inc. is more likely after denial for additional relief from the Federal Reserve, Treasury, and FDIC. Linda Shen at Bloomberg reported that regulators were not convinced that the bank posed any systemic risk and resisted adding more taxpayer risk in addition to $2.33 billion already given to the bank. CIT needs $2 billion in rescue funds from its debt owners and has given them 24 hours to put up the money. Lacking sufficient cash, CIT will probably file for bankruptcy.

Treasury Secretary, Timothy Geithner, did comment directly on the CIT situation, but said “greater confidence in stability” is returning to the financial system. Other government officials cited the lack of a viable business plan for rejecting additional funds.

A stress test by the Federal Reserve concluded CIT would need as much as $4 billion in funding to withstand the worst economic conditions. The FDIC worried additional funds would put taxpayer money at risk due to the company’s declining credit quality. The agency’s main purpose is to protect depositors and not bank holding companies and their investors.

If CIT files for bankruptcy it maybe the first for a company that received TARP funds to keep lenders afloat. Credit default swaps for CIT were at 47% today, in addition to 5% a year. A CDS for CIT would require $500,000 a year, and $4.7 million up front, to insure $10 million of CIT debt.

Subsidized manufactures from China and petroleum imports comprise more than 90 percent of the deficit and both will rise as consumer spending and oil prices rebound later in 2009. At 2.5 percent of GDP, the trade deficit subtracts more from demand for U.S.-made goods and services than President Obama’s stimulus package adds. Moreover, the lift from the Obama stimulus is temporary, whereas the drag from the trade deficit is permanent.

Money spent on Chinese coffee markers and Middle East oil cannot be spent on U.S. made products, unless offset by comparable exports. The resulting shortfall in demand for U.S.-made goods and services is a significant cause of the recession and why the economy needs huge stimulus spending and budget deficits to keep going. The trade deficit could push unemployment above 10 percent for many years.

 

So far, the Obama Administration has failed to challenge Beijing’s morevirulent mercantilist practices—its large official purchases of U.S.dollars that suppress the exchange rate for the yuan, subsidize Chineseexports and artificially elevate Chinese savings and suppress U.S.savings.

If President Obama continues to ignore the trade deficit, his policies to fight the recession will result in a moderate recovery in 2010 but the economy will later collapse into a deeper recession when the stimulus money is all spent.

So far, the Obama Administration has failed to challenge Beijing’s more virulent mercantilist practices—its large official purchases of U.S. dollars that suppress the exchange rate for the yuan, subsidize Chinese exports and artificially elevate Chinese savings and suppress U.S. savings. The China-U.S. savings imbalance is hardly entirely a natural phenomenon rooted in consumer behavior.

Cap and trade legislation moving through Congress would make the situation worse by encouraging more manufacturing to move to China, where CO2 emissions would continue unregulated. President Obama’s energy policies will finish what Chinese and Japanese mercantilism began—the wholesale destruction of U.S. manufacturing and the middle-class wages it supported.

In 2009 the trade deficit is slicing $400 billion to $600 billion off GDP, and longer term, it reduces potential annual GDP growth to 3 percent from 4 percent. Manufacturers are particularly hard hit by these subsidized imports. Through recession and recovery, 5.4 million manufacturing jobs have been lost since 2000. Following the pattern of past economic expansions, the manufacturing sector should have regained about 2.7 million of those jobs, especially given the very strong productivity growth accomplished in recent years. Thanks to the record trade deficits accumulated over the last 10 years, the U.S. economy is about $1.5 trillion smaller. This comes to about $10000 per worker.

Although, President Obama promised to take such steps to curb the trade deficit during the campaign, those steps have been opposed by Wall Street, which is heavily represented among White House and Treasury political appointees. Politics and patronage seem to be getting in the way of sound economic and prudent budget policies.

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and the former Chief Economist at the U.S. International Trade Commission.

CEOs are much more optimistic about the economy’s future than six months ago in several key areas, according to a survey of 100 CEOs by the Conference Board Measure. The measure moved to 55 this quarter from 30 last quarter but the measure still shows the economy is weak.

When assessing current economic conditions, their own industries and profits more CEOs were more optimistic in the second quarter. A majority of business leaders expect economic conditions to improve in the next six months. However, CEOs disagree about the main cause of profit growth whether it is cost reductions, increased demand, technology, or price increases.

CEO confidence had been steadily deteriorating since the first quarter of 2007. CEO confidence had plummeted to all time lows by the fourth quarter of 2008. The current survey shows the first overall uptick in all categories since the end of 2006.

According to State Street, the SEC investigated the manager’s disclosures and management of certain fixed-income investments made through 2007. State Street has received a Wells notice—an SEC letter that says the recipient may see enforcement action, and allows the recipient to provide reasons against enforcement.

State Street was already sued by investors for its poor investment on faulty mortgage-backed securities; the manager set aside $618 million in 2007 to settle the legal claims relating to these losses.

Regulation has not kept up with innovations in banking, mortgages and the bundling of loans into securities for sale to investors. Consequent abuses resulted in tragic losses—subprime mortgages that failed and investors burned by shoddy mortgage-backed bonds. Ultimately, many banks and several other financial institutions failed too.

Banks skirted capital requirements—the amounts of shareholder capital banks must hold to backstop failed loans—by moving mortgage-backed securities offshore into so-called Structured Investment Vehicles (SIVs). Banks insured those securities against losses by purchasing SWAPs from other financial institutions; this should have insulated bank balance sheets against too many defaults but did not.

Unfortunately, financial crisis often occur because regulators fail to see the great threats until after the fact. 

Unfortunately, when too many mortgages failed, it seemed that every bank’s SIV failed simultaneously, and the biggest of the insurers, AIG, could not honor its SWAPs. Panic and system-wide failure followed.

Nonbanks got into the banking business. For example, individuals can obtain attractive interest rates through money market accounts at brokerages, and those firms can use the cash to purchase short-term corporate bonds. Big investment banks securitized loans and engaged in activities that looked a lot like commercial banking too.

President Obama proposes to make the Federal Reserve the systemic regulator. Assisted by a council of other federal regulators, it would have authority, for example, to head off an overhang of too many risky mortgages, securities and SIVs.

Also, he proposes granting federal regulators resolution authority to accomplish the orderly reorganization or sale of large bank holding companies and nonbanks whose outright failure would threaten financial market stability. Right now, the Federal Reserve props up those with loans.

Unfortunately, financial crisis often occur because regulators fail to see the great threats until after the fact. For example, the Savings and Loan Crisis of the late 1980s and early 1990s, was caused primarily by the repeal of Regulation Q, which regulated the rates banks paid on deposits—consequently, banks got stuck competing for deposits while they were carrying too many low-rate, legacy mortgages on their books.

More recently, regulators knew lots of subprime mortgages were written and banks were parking mortgage-backed securities in SIVs, but no one realized how much of a risk those practices posed to home values and bank balance sheets, until lots of homeowners defaulted.

Currently, the federal government is trying to work out Citigroup and AIG. However, just as those firms are too big to fail, they are proving too big for regulators to effectively restructure. Selling assets and reorienting such large businesses in trouble, instead of letting them fail, is a Herculean task, but sadly, federal regulators do not have the attributes of Greek gods.

New rules cannot give regulators perfect foresight or make them omnipotent.

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and the former Chief Economist at the U.S. International Trade Commission.

In it’s bi-annual report, the OECD predicted a 2.8 percent contraction of U.S. output this year, followed by growth of 0.9 percent in 2010.

The OECD advised the U.S. to work to continue removing toxic mortgage-based assets from banks’ balance sheets in order to promote investment. “Restoration of trust in financial intermediaries and markets is vital for a sustained and strong economic recovery to occur,” said the report.

Housing markets, while still weak, may soon reach a turning point, according to the OECD, which noted that the supply of unsold homes was declining in relation to demand.

On the economic front, new and existing home sales should show improvement but from very low levels. The recent back-up in mortgage rates, although unwelcome, really should not be enough to prevent pent-up demand and still very good affordability from triggering a housing rebound. Durable goods orders numbers for May and consumer spending numbers for April should reinforce signs of an economy beginning to lay the foundation for a recovery.

The Fed statement on Wednesday will be watched closely for policy changes. However, nothing in the economic environment justifies a change from the Fed’s current position of close to zero percent short-term interest rates, while the Fed’s latest foray into quantitative easing by buying long-term Treasuries has been so counter productive that they are unlikely to step it up. For now, the Fed will cross its fingers.

Meanwhile markets will continue to be vulnerable to geopolitical shocks. If the Iranian regime manages to squash the dissent of those who object to a rigged election, it may give Israel both a reason and an excuse to attack Iran’s nuclear facilities. Meanwhile, the North Korean screwball, presumably envious of the attention which the Iranian mob is attracting, is ratcheting up his own WMD activities.

On a cheerier note, we are now approaching the second quarter earnings season, and analysts appear to be revising their estimates upwards for the first time in a long-time. As of right now, this is shaping up to be a relatively mild liftoff from a severe recession. However, if that occurs, it could be quite good for profits as labor costs are held in check even while revenues improve. For investors, despite plenty to worry about, this probably still justifies being over-weight equities as we enter the second half of the year.

David Kelly is a chief market strategist at JPMorgan Funds. 

The former CEO of the bailed-out Royal Bank of Scotland Group (RBS), Sir Fred Goodwin, has agreed to forgo about half his pension, which led to public outrage earlier this year, reports The Wall Street Journal.

Goodwin was awarded a annual pension of £703,000, which included credit for ten additional years of work. His normal pension would have been £579,000. Under the new agreement, his pension is approximately £342,500 per year.

Goodwin’s original pension created such ire in Britain that he has avoided being seen publicly, especially after his Edinburgh home was vandalized. Many see him as the cause of RBS’s near-collapse as well as a symbol for the banker excess and greed that led to the financial crisis. Currently, the U.K. government owns 70 percent of RBS.

The Labor Department reported the economy only lost 345,000 jobs in May, down from 504,000 in April and 2.1 million the prior three months.  

Clearly, the economy must stop shedding jobs for the recession to end but a slowing pace indicates the bottom is near.

The consensus among forecasters is the economy will contract less than 2 percent in the second quarter, squeeze out less than one percent growth in the third quarter, and expand at about a 2.5 percent annual pace after that.

That is a very modest pace after such steep decline and much less than the 3.5 or 4 percent necessary to power rising living standards for most workers.

Why are prospects so limited? What does it mean for the stock market?

Stock prices will surge, because U.S. companies have slashed payrollsso much that even moderate growth will deliver big profits. Many willexploit opportunities in Asia through investments. Materials and energywill benefit from the upward pressure on commodity prices stimulated byAsian growth. High tech will emerge a winner as businesses seek morefrom fewer workers and less energy.

Through the Clinton and Bush years, U.S. markets were opened wide to the foreign manufactures—the inauguration of the World Trade Organization in 1995 and China’s admission in 2001 were seminal events. As automotive technology advanced, the horsepower and weight of cars increased, and Americans paid more for imported oil.

Lacking new exports to pay for imported TVs and gasoline, Americans borrowed from abroad and consumed more than they produced. The annual trade deficit jumped from $91 billion in 1995 to about $700 billion from 2004 to 2008, and the external debt now stands at nearly $7 trillion.

Banks loaned Americans cash against homes, cars and credit cards, and bundled those loans into securities for sale to the People’s Bank of China, Middle East royals and other investors. When payments became too burdensome, the bubble collapsed, the housing and car markets tanked, banks and GM needed bailouts, and Washington printed money as the creditor of last resort.

Now the federal government is borrowing even more from China and others to finance $789 billion in stimulus spending, but that can only jump start growth. Consumers need new good paying jobs, or must again borrow profligately, if they are to power a robust recovery.

Since December 1997, six million jobs have been destroyed—many in the high paying manufacturing, construction and financial services industries—and not enough equally rewarding jobs are likely to emerge in the months ahead.

The President talks about new industries, but jobs in alternative energy, health care and education will require huge government subsidies and taxes that limit private sector growth. Those jobs will not pay like working in an auto plant, putting up steel framing or marketing securities on Wall Street.

In 2010 and 2011, the economy will grow modestly, unemployment will stay above 9 or 10 percent, and the good wages necessary to power rising living standards and robust growth will not be forthcoming, especially in the face of rising state and local taxes, and the President’s planned levies on energy and health insurance.

Stock prices will surge, because U.S. companies have slashed payrolls so much that even moderate growth will deliver big profits. Many will exploit opportunities in Asia through investments. Materials and energy will benefit from the upward pressure on commodity prices stimulated by Asian growth. High tech will emerge a winner as businesses seek more from fewer workers and less energy.

The Great Recession caused stock prices to fall twice. The first slide began in October 2007 in anticipation of the slump that began two months later, and another slide started about a year later on doubts about the banks.

In 2009, a surge in bank profitability was just about guaranteed by generous low cost Fed lending and a steep yield curve, FDIC guarantees on bank bonds, and stress tests for banks that reassured investors.  And from its early March low to the May 7 release of stress tests, the S&P index jumped 36 percent.

Stock prices have continued strong, but not gained a lot, as I predicted on the Kudlow
Report when the stress tests were reported.

Soon the stock market will soon smell economic recovery, as analysts drill down into the prospective profits of companies they cover.

That is how the stock market anticipates an economic expansion.

Those who get in now will be popping champagne in New Year, lots of it.

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and the former Chief Economist at the U.S. International Trade Commission.

On the growth side, the most important numbers are probably the housing starts numbers due out Tuesday and unemployment claims on Thursday. Overall housing starts should bounce higher from an abysmally low April reading, although gains in the single family category, should they materialize, would be far more important than in the multifamily area.

Initial unemployment claims almost fell below 600,000 last week, and should fall below that threshold over the next few weeks, although this week an increase rather than decline is more likely.

Financial markets cannot be expected to fall in sympathy with theIranian people whose hopes for democratic change have been squashed bya crude and thuggish dictatorship. -David Kelly

On the inflation front both PPI and CPI will reflect recent gains in gasoline prices. However, with wage growth clearly decelerating, core inflation should grow more slowly, dampening largely unfounded fears of a resurgence of inflation.

The President will announce a set of regulatory reform proposals on Wednesday, although since these have already been widely leaked they should not impact markets too much.

Hovering over all of this will be the “results” of the Iranian election. Financial markets cannot be expected to fall in sympathy with the Iranian people whose hopes for democratic change have been squashed by a crude and thuggish dictatorship. But they may well be negatively impacted by the much increased risk of an Israeli attack on Iranian nuclear facilities, and the unpredictable response of the Iranian Regime to such an attack. While it is impossible to time markets, these events will have to be watched very closely because of their potential impact both on oil supplies and over geopolitical risks.

David Kelly is a chief market strategist at JPMorgan Funds.

Political analysts will watch election results from Lebanon and Iran, to see if President Obama’s Cairo speech and other conciliatory gestures by the US have any impact on the distant streets of the Middle East. And financial analysts will be weighing the impressive rallies in equities and high-yield bonds and considering when any pullback might materialize and how much they want to bet on their ability to time the market.

On the economy, new data should show rises in both exports and imports in April and increases in both import and export prices in May, as global trade and commodity prices adjust from excessively depressed positions. Weekly jobless claims may continue their painfully slow move back down to the 600,000 level while consumer sentiment may stall a little as a tide of rising unemployment impacts the public’s consciousness more than more positive, but less tangible, surveys of manufacturing orders.

At this stage, it looks as if second quarter growth is running in arange of -2% to +2%. While this would clearly be much better than thelast two quarters, it is still a wide range and equity markets wouldobviously be much happier if the economy eventually manages to post apositive number for second quarter GDP.

However, the most important report of the week will be the May retail sales report, due out on Thursday. Some improvement in abysmally low vehicle sales and higher gasoline prices should lead to gains for May, in contrast to disappointing declines reported for April. But the April numbers themselves will have to be watched closely as an upward revision to these readings has a greater potential to boost estimates of second-quarter GDP growth than any other indicator. At this stage, it looks as if second quarter growth is running in a range of -2% to +2%. While this would clearly be much better than the last two quarters, it is still a wide range and equity markets would obviously be much happier if the economy eventually manages to post a positive number for second quarter GDP.

On the Lebanese and particularly the Iranian elections, oil prices could be expected to rise if hard liners appear to be coming out on top while the risk premium embedded in oil prices, (and in stock prices also, for that matter) could fall if moderates are seen to be gaining.

On short-term tactics, it is hard to come up with good advice on the timing of a pullback. Perhaps the best than can be said is that, if prospects for an economic rebound continue to strengthen, it is a dangerous and unnecessary game to try to time entry and exit points from the market.

If an improving economy feeds a strong bull market in stocks, even one with occasional backtracking, most investors getting in and out of the market will tend to under-perform those who remain fully invested. A growing realization of this may, in turn, feed such a bull market as investors try to take full advantage twin rebounds in the economy and market, which like most infants are both growing and vulnerable.

David Kelly is a chief market strategist at JPMorgan Funds.

The Labor Department reported the economy only lost 345,000 jobs in May, down from 504,000 in April and 2.1 million the prior three months.  

Clearly, the economy must stop shedding jobs for the recession to end but a slowing pace indicates the bottom is near.

The consensus among forecasters is the economy will contract less than 2 percent in the second quarter, squeeze out less than one percent growth in the third quarter, and expand at about a 2.5 percent annual pace after that.

That is a very modest pace after such steep decline and much less than the 3.5 or 4 percent necessary to power rising living standards for most workers.

Why are prospects so limited? What does it mean for the stock market?

Stock prices will surge, because U.S. companies have slashed payrollsso much that even moderate growth will deliver big profits. Many willexploit opportunities in Asia through investments. Materials and energywill benefit from the upward pressure on commodity prices stimulated byAsian growth. High tech will emerge a winner as businesses seek morefrom fewer workers and less energy.

Through the Clinton and Bush years, U.S. markets were opened wide to the foreign manufactures—the inauguration of the World Trade Organization in 1995 and China’s admission in 2001 were seminal events. As automotive technology advanced, the horsepower and weight of cars increased, and Americans paid more for imported oil.

Lacking new exports to pay for imported TVs and gasoline, Americans borrowed from abroad and consumed more than they produced. The annual trade deficit jumped from $91 billion in 1995 to about $700 billion from 2004 to 2008, and the external debt now stands at nearly $7 trillion.

Banks loaned Americans cash against homes, cars and credit cards, and bundled those loans into securities for sale to the People’s Bank of China, Middle East royals and other investors. When payments became too burdensome, the bubble collapsed, the housing and car markets tanked, banks and GM needed bailouts, and Washington printed money as the creditor of last resort.

Now the federal government is borrowing even more from China and others to finance $789 billion in stimulus spending, but that can only jump start growth. Consumers need new good paying jobs, or must again borrow profligately, if they are to power a robust recovery.

Since December 1997, six million jobs have been destroyed—many in the high paying manufacturing, construction and financial services industries—and not enough equally rewarding jobs are likely to emerge in the months ahead.

The President talks about new industries, but jobs in alternative energy, health care and education will require huge government subsidies and taxes that limit private sector growth. Those jobs will not pay like working in an auto plant, putting up steel framing or marketing securities on Wall Street.

In 2010 and 2011, the economy will grow modestly, unemployment will stay above 9 or 10 percent, and the good wages necessary to power rising living standards and robust growth will not be forthcoming, especially in the face of rising state and local taxes, and the President’s planned levies on energy and health insurance.

Stock prices will surge, because U.S. companies have slashed payrolls so much that even moderate growth will deliver big profits. Many will exploit opportunities in Asia through investments. Materials and energy will benefit from the upward pressure on commodity prices stimulated by Asian growth. High tech will emerge a winner as businesses seek more from fewer workers and less energy.

The Great Recession caused stock prices to fall twice. The first slide began in October 2007 in anticipation of the slump that began two months later, and another slide started about a year later on doubts about the banks.

In 2009, a surge in bank profitability was just about guaranteed by generous low cost Fed lending and a steep yield curve, FDIC guarantees on bank bonds, and stress tests for banks that reassured investors.  And from its early March low to the May 7 release of stress tests, the S&P index jumped 36 percent.

Stock prices have continued strong, but not gained a lot, as I predicted on the Kudlow
Report when the stress tests were reported.

Soon the stock market will soon smell economic recovery, as analysts drill down into the prospective profits of companies they cover.

That is how the stock market anticipates an economic expansion.

Those who get in now will be popping champagne in New Year, lots of it.

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and the former Chief Economist at the U.S. International Trade Commission.

Political analysts will watch election results from Lebanon and Iran, to see if President Obama’s Cairo speech and other conciliatory gestures by the US have any impact on the distant streets of the Middle East. And financial analysts will be weighing the impressive rallies in equities and high-yield bonds and considering when any pullback might materialize and how much they want to bet on their ability to time the market.

On the economy, new data should show rises in both exports and imports in April and increases in both import and export prices in May, as global trade and commodity prices adjust from excessively depressed positions. Weekly jobless claims may continue their painfully slow move back down to the 600,000 level while consumer sentiment may stall a little as a tide of rising unemployment impacts the public’s consciousness more than more positive, but less tangible, surveys of manufacturing orders.

At this stage, it looks as if second quarter growth is running in arange of -2% to +2%. While this would clearly be much better than thelast two quarters, it is still a wide range and equity markets wouldobviously be much happier if the economy eventually manages to post apositive number for second quarter GDP.

However, the most important report of the week will be the May retail sales report, due out on Thursday. Some improvement in abysmally low vehicle sales and higher gasoline prices should lead to gains for May, in contrast to disappointing declines reported for April. But the April numbers themselves will have to be watched closely as an upward revision to these readings has a greater potential to boost estimates of second-quarter GDP growth than any other indicator. At this stage, it looks as if second quarter growth is running in a range of -2% to +2%. While this would clearly be much better than the last two quarters, it is still a wide range and equity markets would obviously be much happier if the economy eventually manages to post a positive number for second quarter GDP.

On the Lebanese and particularly the Iranian elections, oil prices could be expected to rise if hard liners appear to be coming out on top while the risk premium embedded in oil prices, (and in stock prices also, for that matter) could fall if moderates are seen to be gaining.

On short-term tactics, it is hard to come up with good advice on the timing of a pullback. Perhaps the best than can be said is that, if prospects for an economic rebound continue to strengthen, it is a dangerous and unnecessary game to try to time entry and exit points from the market.

If an improving economy feeds a strong bull market in stocks, even one with occasional backtracking, most investors getting in and out of the market will tend to under-perform those who remain fully invested. A growing realization of this may, in turn, feed such a bull market as investors try to take full advantage twin rebounds in the economy and market, which like most infants are both growing and vulnerable.

David Kelly is a chief market strategist at JPMorgan Funds.

The U.S. Securities and Exchange Commission sued him in 2005, alleging he lied to investors in a third-quarter 2001 securities filing and during a November 27, 2001 conference call.

The case was “a matter of credibility and accountability,” Alan Lieberman, an SEC lawyer, said after the verdict. “This jury held Conaway accountable for his own conduct.”

Conaway “dodged inconvenient information,” Lieberman told jurors in closing arguments last week. “He knew when to deny and blame others and say ‘Nobody ever told me.’”

Kmart filed for bankruptcy protection on January 22, 2002 after fourth-quarter sales fell. Conaway was fired two months later.

The SEC alleged that Conaway hid the fact that the company was short of cash and had a program to delay payments to vendors. The government alleged that Kmart began delaying payments to vendors to ease a cash crunch caused by an “extroadinary” $850 million inventory purchase by Kmart’s COO, without the knowledge of other top Kmart managers in the summer of 2001.

The U.S. Securities and Exchange Commission sued him in 2005, alleging he lied to investors in a third-quarter 2001 securities filing and during a November 27, 2001 conference call.

The case was “a matter of credibility and accountability,” Alan Lieberman, an SEC lawyer, said after the verdict. “This jury held Conaway accountable for his own conduct.”

Conaway “dodged inconvenient information,” Lieberman told jurors in closing arguments last week. “He knew when to deny and blame others and say ‘Nobody ever told me.’”

Kmart filed for bankruptcy protection on January 22, 2002 after fourth-quarter sales fell. Conaway was fired two months later.

The SEC alleged that Conaway hid the fact that the company was short of cash and had a program to delay payments to vendors. The government alleged that Kmart began delaying payments to vendors to ease a cash crunch caused by an “extroadinary” $850 million inventory purchase by Kmart’s COO, without the knowledge of other top Kmart managers in the summer of 2001.

GM, which is expected to file for bankruptcy in the next week, has faced the threat of government supervision since accepting more than $20 billion in taxpayer assistance in the past six months. A June 1 deadline was imposed, by which time GM needs to restructure its debt to prove its continued viability.

Attempts by GM to reorganize its bond debt for investors failed, demonstrating that a Chapter 11 filing may be imminent.

Obama has claimed the government is not interested in directly running the country’s automotive companies, saying “I don’t think that we should micromanage, but I think that like any investor, the American taxpayer has a right to scrutinize what’s being proposed and make sure that their money is not just being thrown down the drain.”