About Me

Retired chief investment officer and former NYSE firm partner with 40 years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!

Wednesday, December 27, 2006

2007...Part 5 -- Gold & The US Dollar


The gold price ($628. oz.) is in a seasonally strong period
presently. This interval normally lasts through late Jan. /
early Feb. of the succeeding year. For the current rally in
gold to have any real "pop" short term, it needs to take out
overhead in the $640-650 oz. area. Sluggish oil and industrial
commodities prices probably have inhibited speculation so far.

My gold macro-model has gold fairly valued now at $520. I can
make a decent case for gold to go to $550 by yearend 2007, so
gold bugs and bulls will have to look elsewhere for a rationale
for the current price, much less a sharply higher one. Reasoning
from my model, gold made a blow-off top just above $730 this year
reflecting the culmination of a lengthy period of inflationary
monetary policy by the Fed that dates back to the late 1990s.
Since the end of 2004, monetary policy in terms of monetary
liquidity growth has been tight. My view is that the Fed will
keep policy firm for as long as it can next year, before easing
to pave the way for a stronger economy in 2008. So, that leaves
me suggesting that there could be large but temporary downside
price risk in gold after the seasonally strong period winds up
later this winter.

US Dollar

I have a simplistic view on the dollar: If folks in the US should
not hold dollars, neither should foreigners. You can put dollars
to work now at no or nominal risk and earn 5.25%. That translates
into a positive after tax return adjusted for inflation. Moreover,
the Fed has kept the printing press in the "slow go" mode now
for nearly two years. Domestically, the dollar is fine. This
contrasts sharply with mid-2004, when short rates were 1.00%,
inflation was accelerating and the Fed was only just entering into
tightening mode. From my perspective, it makes little economic
sense for foreigners to dump dollars now.

Looking at 2007, it may well be that dollar fundamentals slip some
later in the back half of the year, but this slippage may be

Tuesday, December 26, 2006

2007...Part 4...The Stock Market

In a 1/20/06 post on the stock market, I opined that the
market had the potential to rise significantly in 2006, with
the SP 500 reaching 1380-1405. We are up through that level
and did see some closing prints slightly above a revised
projection of 1425. All in all, it was a good call.

I also indicated I thought the market could rise into January
of 2007, before a nasty and substantial correction of 15-20%
ensued, primarily as a result of an acceleration in economic
growth and concerns for higher short rates and inflation.

At this point, the economic outlook is more muddled than I had
hoped. The inventory corrections that follow a slowing of final
demand may not yet have run their course, and the improvements
to real consumer incomes I anticipated as inflation waned may
not yet have boosted confidence and spending as much as I had
hoped. In fact, my macro profit indicators have clearly flattened
out as of late, and are not confirming general expectations for
final quarter 2006 earnings.

I am cautious about the outlook for stocks in general over the
first nine months of 2007, but I am not in any position now to
lay out a strong case for a 15-20% decline. So, rather than
push the conjecture, I am now content to forego the decline
projection and track developments as they move along until
I get a better sense of fundamentals and emerging trend.

I would say at this point that my caution extends well into 2007
because It is still early to say how good the balance between
economic supply and demand may turn out. In this cycle, growth
of productive capacity has proceeded slowly relative to output,
and even with recent modest upticks in growth, capacity is still
trailing output growth potential, which gives the economy an
inflationary bias.

There is another difficult issue which concerns me regarding
corporate profits and the stock market. This has to do with
the US trade position which has recently improved. If the trade
deficit is set to level off, as may occur, then the flow of
dollar liquidity abroad will flatten out, and this could
eventually stunt the profit growth of US multinationals as
the global economy adjusts.

Tuesday, December 19, 2006

2007...Part 3 -- Interest Rates & Bond Market

Short Term Rates

Well, it is a 5.25% market at the short end. My super
long term short rate model pegs the Fed Funds Rate at
about 4.25%. The current FFR 100 basis point premium
reflects both the recent rapid deceleration of inflation
coupled with fundamentals which support a continuation
of a 5.25% FFR, recognizing that said fundamentals do
now tilt slightly toward ease. I continue to expect the
Fed to hold at 5.25% with a bias toward tightening if the
economy holds up as I anticipate. For the short run, we
still have to see how much of an inventory adjustment will
take place in the wake of the slowing of the economy.

Short rates at 5.25% offer a positive after tax, inflation
adjusted return. There is now no economic compulsion to
spend or invest money. Maintaining a positive offering to
savers is important if the US is to regain better balance
between savings and spending, as it keeps the internal value
of the dollar stable. I suspect this is a secondary objective
of the Fed.

As mentioned in the previous post on monetary policy, I think
the Fed wants to avoid easing for as long as it can. However,
I plan to follow the financial market fundamentals closely and
will point out changes as they occur.

Bond Market

I have paid scant attention to the bond market over the past
eighteen months. By my lights, the market has been overvalued,
and not worth the time. I have missed a couple of good trades
but trades in equities more than made up for it.

The long Treasury at 4.70% provides a modest premium over
inflation of 2.0-2.5%. So, the market is ok to trade now, but
investors need a solid 300 basis points minimum over the CPI to
warrant long term positions given the uncertainties of interest rate
risk in the long run. You can earn 5.25% now nearly risk free,
so why saddle yourself with pre-maturity risk to principal that
comes with extending out? One can sing a different tune if the
economy is headed for a lengthy period of price stability or
some deflationary pressure, but that is not the view I support.

The bond market has proven to be most sensitive to the momentum
of industrial production and industrial commodities prices. I
use a combined measure computed on a six month annualized rate
of change basis. This measure had readings of +10 - 12% over the
first half of 2006, but has tailed off to a 2.7% annual rate over
the second half of the year -- hence the strong rally in the bond
market since May. Since my best guess is that this measure will
strengthen significantly later in 2007 and especially in 2008, I
would expect bond yields to trend up certainly by the third
quarter of next year if not sooner.

The powerful rally in high yield or junk bonds over the past six to
seven months coupled with an ongoing small spread between top quality
and intermediate corporates suggests the bond market is not concerned
about recession, inverted Treasury yield curve notwithstanding.
Rather, it appears there is considerable speculation that the US
economy is losing its inflationary bias in the intermediate term.

Sunday, December 17, 2006

2007...Part 2 -- Monetary Policy

Best here to briefly fast forward to 2008, first. This
upcoming national election year in the US currently looks
to be wide open across the board. All the more reason for
the Federal Reserve to desire to fly under the political
radars and not have either growth, inflation or the Fed Funds
Rate become "hot button" political issues. Thus for the Fed,
2007 is the year to do what might be necessary to have the
economy straightened up and flying right through 2008.

Working backward, the Fed would prefer to tighten in the early
part of next year if needs be, and it would prefer to loosen
up on the monetary reins in the second half of '07, provided
a "goose" to the economy would usher in a more balanced 2008.

The growth of industrial production and the strain it puts on
capacity utilization and resources at large is a key factor
in the setting of monetary policy. The Nation's operating rate
is likely to finish out 2006 around 82%. The growth of US
capacity has been inching up, but is still a little below 2.5%
yr/yr. The Fed wants the economy to grow but not reach effective
capacity of 85-86% until very late in 2008. Now since inflation
pressures tend to accelerate when the operating rate exceeds
82%, the Fed would likely most prefer to see production growth
stay modest for a while in the hope that nudges up in the
operating rate would push business to expand capacity
sufficiently to keep a reasonable balance, particularly in 2008.
Can the Fed fine tune with such precision? Do not bet on it.
However, since I believe this bit of analysis of Fed intent
is as right as rain, I suspect if policy tweaks are needed,
tight comes before loose.

Friday, December 15, 2006

2007...Part 1 -- Environment Overview

It's a "backseat year" for me...

There are years when it is fun to be out front and make
economic and financial forecasts and predictions. I did
pretty well on this score over the 2003-06 period. The
truth is that being in the forecast game is a pain in the
ass as it tends to force you to keep thinking about what
you said as events unfold. For 2007, I am slipping into
"humble" mode -- just a simple seeker of truth. So, I
take a back seat to those braver than I. The key here
for me is to make projections and forecasts when it is
easy to do so, ie. when you have a compelling case. Not
so for me as I look at next year.

I peg US economic growth potential at 2.75% on a longer
range basis. That'a low number for me, and it reflects
my expectation of slow labor force growth ahead and a
more moderate pace of productivity growth. It might not
be so easy to to hit 2.75% next year. The US may go into the
year with housing and commercial inventory overhang and a
consumer whose real wage is just beginning to recover. The
areas of positive intrigue are trade and business technology.
US exports have been sloppy in recent months but remain in
a strong uptrend, and the recovery in technology is just
now approaching levels where it might be wise for producers to
expand capacity. For now, I am content to view the outlook

The macro-indicators I follow to track profits growth are
deteriorating as the year comes to an end, and although
still in positive territory, are close to levels that
normally suggest a flattening of profit margins and the
potential for some negative surprises. Since I do not have
a strong case for a rapid, positive turnaround, I currently
view profit prospects for 2007 as much more subdued than
in recent years.

My longer term inflation indicator has tumbled since 2006
and is in a firm downtrend as we roll toward 2007. This
suggests we should go into next year with a benign inflation
environment. Even so, there are issues. US productive
capacity growth has picked up a little more to 2.4% yr/yr
through Nov. '06. That is nice, but capacity growth still
trails longer run economic potential which, in my book,
adds inflationary bias to the economy, despite productivity
gains. Moreover, capacity utilization in the extraction and
primary stage processing sectors is running high, with little
capacity growth yet in evidence. Couple these concerns with
a backdrop of firm global growth and rising capacity utilization
and you have inflation "in potentcy" as Thomas Aquinas liked
to say. So, I do not see a clear shot at saying inflation will
not be a problem next year. Hence, I am in the back seat on
this one, too.

We have completed nearly five years of economic recovery. The
years when business around the world is easily building its
book of business are the pleasant years of rising confidence
and expectations. But history suggests these periods have
rather finite durations, and I suspect 2007 may usher in an
interval when a maturing global expansion may produce some
events that begin to challenge confidence. I do not have
a bag of "surprises" to lay out, just a sense that it might
be wise for business and financial / capital market players
to switch off of cruise control and get back to day to day
manual operation and vigilance.

I am planning several more posts on the 2007 environment for
the various markets before '06 runs out.

Wednesday, December 13, 2006

Trade, Oil And China

The jump in the US trade deficit over the past two years
primarily reflects a rising oil bill. Not only did oil
rise sharply in price since 2004, but the US also added
substantially to its strategic petroleum reserve. The
sharp drop in the monthly deficit in October reported
yesterday resulted from the recent weakness in the oil
market. The chances now seem reasonable that the
deterioration of the US trade position will either end
or be substantially ameliorated for the next several
quarters as US growth may trail global growth in a world
with the oil supply / demand balance still in favor of supply.
A continuing sizable trade deficit will provide ample
liquidity to the global financial system, but the growth
of such may be at a trickle compared to the $100 billion
annual increments witnessed in recent years. This
expected slowing of liquidity increments may start to
affect marginal offshore credits adversely as 2007 progresses.

Control of the US Congress has passed back to the Democrats.
Old hands will hold leadership posts, but the new arrivals
are far more skeptical of the economic policies of recent years,
particularly free trade and globalization. I doubt we are
looking at a new crop of wild eyed populists, but rather a
group more intent on sensible inquiry into policies that may be
seen as hurting US jobs and wages. Moreover, small business, whose
views on the US trade stance have been continually rebuffed by
the staunchly plutocratic Bush administration, may find a more
sympathetic ear with Democrats. Couple this with a high oil
import bill compared to just a few years back and you have a
recipe for a far more prickly period regarding trade issues.

Treasury Sec. Paulson (good cop) and Fed chief Bernanke (bad cop)
are off to China this week with a high level delegation to
discuss economic and political issues with senior Chinese officials.
This could be a strange series of meetings, since the Chinese have
to admit that both Paulson and Bernanke could be lame ducks in
what is shaping up as an open race for the roses in 2008. Moreover,
antagonism toward China's economic policies has increased
substantially here in the US, and will receive greater voice in
the next couple of years unless China and other Asian mercantilists
suddenly reverse course and accelerate the opening of their
markets and push for stronger consumption at home. To add to the
tension, Europe, no slouch when it comes to protectionist policies,
is also voicing some concerns about Asian economic policies.

I bring all of this up because as Bush 43 fades into the sunset,
there could be some interesting and provocative discussions of
trade policies over the next couple of years that could just
be raw enough to upset the capital and currency markets from
time to time. Major Asian economies are well past the "take off"
stage, so mercantilism is now pointedly self serving. If all
the players, US and Europe included, are interested in cooperation
and compromise, a transition to a more balanced global economy
is feasible without substantial destabilizing events. Otherwise,
the road through, say 2011, could have some unhappy bumps.

Sunday, December 10, 2006

Monetary Policy

The Fed meets this Tuesday to discuss monetary policy.
The FOMC is widely expected to leave the Fed Funds Rate
at 5.25%.

The short rate indicators I track most closely are starting
to tilt toward ease, but not persuasively. Short term business
credit demand momentum is slowing but is still strong. Production
is slowing but services have perked up. Upward pressure on
capacity utilization has eased, but development of slack is not
assured. Finally, my short term credit demand vs supply pressure
gauge has eased some, but a fair portion of the easing up in
the reading reflects faster growth in the supply of loanable
funds. I guess if I was in the Fed's shoes now I might want
to leave the FFR% unchanged just because it looks easy to make a
mistake or a misread that could result in whipsawing the markets
within a few months. In short, a change here might involve too
fine a call.

The FOMC has expanded basic monetary liquidity for the holiday
season. It started the process late in the year and It may have
acted with even more forbearance had not cash and checkables
fallen to such low levels in the system.

Friday, December 08, 2006

Economic Notes


The US employment report for Nov. shows continuing
moderate jobs growth, a 4% yr/yr hourly wage increase
and a slightly faster weekly wage take. With inflation
now low, the real wage has again moved up modestly. The
labor market remains tight reflecting the ongoing slow
growth of the labor force (0.8% yr/yr). The improvement
in the real wage since this summer reflects a move up in
the nominal wage from a 3.5%AR to 4.0% and a break from
the sharp fall off in fuels prices.

A firm employment picture is helping to cushion the effects
on the economy of slowdowns in construction and manufacturing
output. An improving real wage is a decent leading indicator
of consumption growth. No guarantees obviously, since
confidence needs to hold up so that consumers do not seek to
bank all of the wage improvement.

Leading Indicators

The leading indicator sets I follow are consistent with the
notion that the economy should continue growing, but the
data is mixed with regard to the pace of growth. The broad
services sector seems to be gaining some momentum, while
construction and manufacturing show no turnaround yet,
reflecting inventory excess. On balance, it looks like more
slow-go ahead.

To see a view of the outlook for global economic growth
based on a weighted compilation of purchasing manager
reports, click here.

Thursday, December 07, 2006

Stock Market

The intermediate overbought condition of the market I
have been discussing in recent weeks has eased slightly
but remains very much in force. Since I give this
kind of overbought six to eight weeks to work off, it
looks like the caution light could be on until year's end,
barring a sharp sell-off that is tightly time-compressed.
Now, my primary indicators are proprietary internal
supply / demand measures, but the weekly chart of the SP500
shows the overbought in more conventional technical terms.
For a view of this chart, which features RSI and MACD
indicators, click here.

Friday, December 01, 2006

Stock Market & Other Thoughts

In a Nov. 13 note on the market, I opined that it would be
ripe for a correction this week reflecting the very low
level of selling pressure. Exceedingly low selling pressure
reflects investor ebullience and an overbought condition.
Instead, we got volatility and a slight decline week over week.
So, from my perspective, the market still needs a breather.
It can come with a sharp correction or a couple of weeks of
range bound movement. I am looking for developmet of a better
balance between advancers and decliners.

This week revealed increased player apprehension regarding
prospects for an economic "soft landing". Investors were jostled
by negative construction and manufacturing data as well as a
slow early-mid November showing for retail sales. To have a
soft landing this time out, the benefits to incomes and non-
energy corporate profits from a marked deceleration of inflation
need to kick in on the spending side to arrest faltering
demand before it hits employment and confidence. I have not
abandoned the soft landing scenario yet since the regenerative
capabilities of the economy are still intact, especially the
positive liquidity picture. There is no squeeze on.

Last weekend, the first Siberian Slammer engulfed most of Alaska
in below zero weather. The Slammer has moved east and southward,
sending temps down along its path and helping crude oil to kick
off a seasonal strong period with a 7% price gain. This too is
a nettlesome issue for stock players since it's too early to tell
how strong an oil seasonal we will get. It can help energy issues
but it can impair the market's p/e and economic confidence if it
gets too zippy to the upside.

My SP500 Tracker suggests a market of 1425 based on near term
earnings and inflation prospects. At a current discount of 2% to
the Tracker, the market has not caught up with the acceleration
up in fair value that came with the break of inflation pressure.
Moreover, since an intermediate term overbought has developed
in the "500", the market could lose more ground to the Tracker
over the short run. We'll see.