Stock Market -- Investor Confidence Measures

Confidence has improved since last autumn but remains on the subdued side. The market does
continue moderately overbought, but the idea that players are zealously bullish is nonsense.

Price / Earnings Ratio
The market is trading around 14.5 x 12 mos. net per share through 3/31. In an economic recovery
with rising earnings and low interest rates and inflation, the SP 500 should be trading up at 16.5x
or 1585.

Credit Quality Spreads
The ratio of top quality corporate yields to lesser light BBBs stands at .69. By past standards that
ratio should stand up toward .85 at this juncture of an economic expansion.

Comparison To Treasuries
The earnings / price yield % for the SP 500 measures the return on equity at market value. The
e/p yield is now running 6.8% compared to the 10 yr. Treas. in a range of 2.0 - 2.5%. The e/p
yield is at a substantial premium. Naturally, a near zero short rate is holding yields on longer
maturities down, but preference for quality and perceived low risk remains very high.

Market Volatility
I did a good job at laying out the unfolding of the recent powerful rally in the market, but, so
far, volatility has come a in fair bit lower than I had anticipated. The chart link ahead compares
the SPX with its 12 day ROC% and the VIX, or volatility premium inherent in index options.
$SPX The chart's top panel shows a sharp decline in short term price volatility and the bottom panel shows a hefty decline in the VIX or "fear" index. A VIX reading in a range of 10 - 15 reveals
a decent level of market confidence. Should the VIX drop down to 10 and stay there for a
goodly number of weeks, we would be entitled to say that investors have grown both smugly
confident and highly complacent. We are not there, yet.

Long Treasury Bond

Back toward the very end of 2011, I put on my "Dutch Uncle" hat to warn of the risks of a long
positions in the 30 yr Treasury for 2012 ( See 12/26, 12/23 posts). Back then, the situation for
the market had not turned negative, but it did so in Jan.

For about 45 years now, it has been my argument that the best determinant for turns and trend in
the Treasury bond market was a combination of the momentum of industrial production plus that
of sensitive materials prices. I use a 6 mo. annualized measure as well as a weekly trend measure.
Both turned up starting in January which signals a rising long T yield. As it has so far turned out,
the rise in yield although a sharp one, has been muted by trader expectations that China -- a very
heavy hitter in the industrial commodites business -- will continue to experience more moderate
production growth. This development has been a drag on the normal sharp seasonal rise in
sensitive materials prices which has become a trademark of China's very large industrial base.
In short, the damage to the Treasury bond could have been far worse.

I am not interested in this market now. I would look to buy the long T about 60 basis points up
in yield as a trade, and since the US is experiencing a more advanced, albeit moderate economic
recovery, I would like to see the yield at a more substantial premium to my very long term
3% inflation benchmark. The chart link gives you the picture.

Economic Indicators / Analysis

I use a very stripped down version of the coincident economic indicator to include real retail
sales, industrial output, civilian employment and the real wage. Measured yr/yr, this indicator
was a positve but modest 2.1% for Feb. '12. This compares to a much stronger 3.9% reading
for the 12 mos. ended Feb. '11. The indicator captures the substantial erosion of recovery
momentum over the past year. On a positive note, the momentum of the coincident indicator has
been improving since late 2011 on stronger sales, production and employment.

For the prior month, both  real retail sales and production came in with moderate readings -- 4.0%
for production and 3.6% for retail. These are solid enough after 30 months of economic recovery.
The yr/yr pace of increase in employment has moved up to 1.8% -- its best showing during the
recovery -- but 2% or a little stronger would be more representative of a nicely improving labor
market. The real wage declined yr/yr by 1.0% through Feb. and is still too weak to provide
solid support for consumer confidence. Under normal circumstances, where business properly
recognizes stronger labor productivity, the real wage should be advancing by 2% and the current
dollar measure by 5%. Imagine the outrage in the executive suites of corporations if directors
were handing out real wages that were headed down.

The US economy has ticked up here in early 2012, but a continuing negative real wage casts a
large cloud over the visibility of the economy going forward.

Stock Market -- Daily Chart

The SPX closed today at a new cyclical high of 1403. The advance underway since late Nov. '11
is running on the sort of steep trajectory that seldom lasts more than 3-4 months before it hits its
expiration date and fades to a lower plane. So, that would be late March at the outside. The present
fast updraft of a few days duration could carry the SPX up to the 1430 area over the next week or so.

The market is overbought on measures running out even beyond 60 days, but none of the overbought measures are as yet outrageous. SPX

As mentioned in the 3/13 post below, with cash reserves modest, a rising market might claim funds
from the bond (Treasury) and PM sectors (gold). Such has been in evidence this week.

Retail Sales -- Quick Note

Retail sales including for restaurants is classified as a coincident economic indicator, but
it really lies somewhere between a leading economic indicator and a coincident one. There is
decent retail sales data going back to shortly after WW 2, but most services stick with the
reformulated data from 1992. At any rate, retail tends to trend fairly steadily higher during
periods of economic expansion, and you should note when the retail trend shifts lower or starts
to sputter. These are usually solid warnings the economy is edging toward difficulty. The
trend of sales is solidly up for now: retail sales chart

Stock Market -- Fundamentals

Primary Fundamentals
These are measures I use to determine when we have an "easy money" bull market which features
high return for the assumption of low risk. The stock market entered the latest "easy money" era at
the end of 2008, and this reading remains in force today. All five indicators need to turn negative
before the era ends and that has yet to occur. The only period in modern history that rivals the
current one for duration is the early 1932 - early 1937 era when the conomy and the stock market
benefited from a super accomodative monetary policy to arrest a depression.

As with the '32 - '37 interval, the market has provided a high return, but accomodative monetary
actions did not shelter investors from periodic sharp corrections (2010 and 2011 in the current
epoch). The volatility then as now reflected low investor confidence levels as well as concerns
about the durability of monetary and fiscal ease. In this sense, the current bull has been very much
different from the post WW 2 markets.

The volatility may continue going forward as it has yet to be seen whether the market can advance
in the absence of overt QE policy. Moreover, as 2012 winds down, discussion could also build
around the idea of tightening fiscal policy for 2013 and beyond. Investors have to be prepared for
that.

I doubt my primary indicators will all turn negative in 2012 if only because the Fed is keeping
the "risk free" 91 day T - bill rate between 0.0 - 0.25%. So, the primary bull case will be there
through the year, but, the volatility may be there as well.

Secondary Measures
I watch liquidity available for stocks as well as the trend of the oil price very carefully. On my
reading, liquidity in support of further stock market strength is low now, and it may well be that
to send the market substantially higher, players may have to swap out of bonds especially but
also PMs and selected commodities to free up funds for stocks. Importantly, private sector
credit growth is recovering and if banks eventually begin competing more vigorously for funds,
there will be more liquidity available for stocks.

The price of oil has been kited up by threats from Israel, the US and the EU on one side and Iran
on the other regarding Iran's nuclear development programs with the prospect of conflict and a
possible oil supply shortage to worry over. So far, Iran has been the prime beneficiary. The
rise in the gasoline price is hurting Obama substantially and he may eventually either have to
tap the SPR or tell Israel to shut the hell up or both. Intentionally or not, Israel is now meddling
directly in US politics and They will pay for that down the road if I know my US.

Without further threats to or from Iran re: the oil supply, the current price range of $105 - 110 bl.
seems a bit too high.

Financial System Liquidity & Stock Market

Fed Bank Credit
The Fed's currency swap line fell again in the past week as EU liquidity jitters continue to
lighten. FBC is now about flat for the year and is up at only a 4% annual rate since mid-2011.
Unless there is a sudden worsening within the EU banking sector requiring more US$ infusion,
FBC is likely to flatten out or even drift a bit lower. So far since 2009, the stock market has
tended to grow uncomfortable without Fed QE at its back.

Banking System Liquidity
Measured yr/yr, my broad measure of credit driven liquidity stands +4.6%. Much of this increase
directly reflects Fed QE. The loan book for the banking system is also up 4.6% yr/yr and the
recovery in loan demand is rising with all major sectors now participating. Banks are flush
with liquidity and have been able to expand the loan book and Treasury holdings at the same time.
Thus, there has been little emphasis on competing for deposits or issuing holding company
commercial paper which tend to expand the broad liquidity pool. With the Fed not now providing
QE support, rises in bank lending and the broad deposit base to 6% yr/yr would leave me more
comfortable with the stock market, although system private sector lending is finally showing
some decent acceleration. Hard to tell yet whether the stock market is taking much notice.

Money Market Funds (Cash Reserves)
MMFs in aggregate increased by roughly $50 bil. in late 2011 and early this year but this build
has largely been drawn down in recent weeks. Further support for the stock market, should it
come, may reflect draws on the large Treasury and the small PM markets.