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, January 31, 2007

The Fed, Economy and Stock Market

The FOMC's decision to keep the FFR% at 5.25% was widely
expected and was well discounted in the markets.

The preliminary GDP report for Q 4 '06 was better than
expected, featuring moderate real growth and a low inflation
number. The markets liked that. Measured Q 4 yr/yr, real GDP
rose 3.4% and real final demand rose 3.5%, reflecting an
acceleration of inventory run-off. Final sales to US purchasers
rose 2.8% -- in line with underlying demand. Real GDP topped
sales to US purchasers reflecting substantial improvement in
the balance of trade in recent months. Personal consumption
advanced 3.7% -- on the strong side-- compared to real disposable
income growth of 3.1%. Dis-savings shrunk but not as much as I
had hoped, now that short rates are well above inflation.

Final demand growth has pulled ahead of production growth and
this could continue into the first quarter, but the US now may
be setting up for stronger production growth. Capacity growth
in the US continues to lag both production and final demand,
which keeps the internal inflationary bias of the economy in

It was a "goldilocks" day for stocks as investors moved in on
the moderate growth / low inflation combo.

To add zesty irony to the day, GWB, the ultimate plutocrat, came
to Wall St. and admonished the captains of corporate America
about over the top fat cat compensation practices.

Tuesday, January 30, 2007

Monetary Policy

There is broad consensus the Fed will leave the FFR% unchanged
when the two day FOMC meeting wraps up tomorrow. Last month, the
data veered a bit toward ease, but the Fed ignored it as expected.
this month the key data series I follow have firmed modestly, so
I do not see any reason for change, either.

Based on my super long term model, the FFR% should be around 4.5% -
4.7%. The FFR% is 5.25%, and it is above "target" primarily because
of the rapid drop off in inflation pressure over Half 2 '06 and
the Fed's reluctance to respond immediately in kind. As I have
discussed, the Fed needs to take full measure of the effects of
earlier FFR% hikes on the economy (negative) combined with the
beneficial effects of a rapid deceleration of inflarion upon
real incomes and consumer confidence.

Over the last few weeks, the Fed has drained the extra liquidity
provided for the holiday season from the system. Noteworthy is
that currency and gold traders reacted in a more tame fashion
to the holiday inflation. Noteworthy also is that with short term
business credit demand having flattened out in January, the
Fed drew down heavily on official reserves to maintain the
FFR at 5.25%.

Thursday, January 25, 2007

S&P 500 Earnings

Quarterly "operating" net per share made a recession bottom
of $9.02 at Q2 2001. Since then, quarterly net has progressed
sharply and fairly evenly to an apparent interim cyclical
peak of $23.03 for Q3 2006. That translates to about 16.5%
annual growth off the trough -- impressive.

Over this period, companies saw profit margins widen as unit
sales growth outpaced unit cost growth reflecting rising
productivity, modest compensation increases, lower interest
costs and translation gains from a weaker dollar. In addition,
energy and industrial materials companies generated large
inventory profits as pricing rose strongly in these categories.
Finally, US companies saw profits from foreign subs and
affiliates rise sharply in the context of strong international
economic growth.

It appears profits fell in Q4 and projections indicate that no
major upside breakout in quarterly net can be expected until
Q4 2007, when operating net is seen rising above $25. Recently,
a slowing economy has cut yr/yr sales growth from a peak
level of 9.5% down to about 5.5%. Wage growth has picked up
and productivity gains have decelerated noticeably. This means
an increasing number of companies are experiencing profit margin
erosion. Moreover, oil and gas prices are well below peaks
and sensitive materials prices have been on a plateau. These
developments eliminate the vast bulk of inventory profits.
Note also that funding costs are up for non-financials and that
dollar translation gains have narrowed. On the plus side,
foreign ops continue strong.

The financial services sector has also been a strong performer
during the current expansion, with revenues growing 10 - 12%.
It was only Q4 2006 when there was some slight slippage.

This is not the most congenial environment for investment
managers. The US economic slowdown has brought pressure on
company profit margins and analysts are not expecting a strong
lift to earnings until late in the year. Managers also know
that a sluggish economy and a smaller trade deficit may also
herald slower business conditions in foreign markets. If it
was a sold out stock market, there would be little edginess.
But the market is only modestly below fair value, so managers
should not be sanguine.

It appears that to get operating net up from the Q4 2006 level
of about $21.50 to over $25 by late '07 / early '08, the
economy will need to strengthen appreciably, and this may
imply that Fed easing is also part of the expectations game
plan. On the plus side, note that the leading economic indicators
are starting to firm up.

Viewed long term, a rise in quarterly operating net above $25.
by late 2007 would signal the advent of the arrival of the
cyclical earnings peaking process which could carry over into
2008, but which would put me on notice as well as some other
old hands. A goodly volume of water will flow 'neath the
bridge before then, but at that time, it will be critical on
this hypothetical to look at the balance between economic
supply and demand.

Tuesday, January 23, 2007

Stock Market -- Technical

Not much change in the technical situation for the
past week or so. The market remains in an up mode, but
has taken to grinding slowly higher. The favorite internals
are pointing up, although momentum measures are flattening
out. The link ahead to the SP500 chart shows RSI (overbought)
and MACD. Click here.

The MACD (12/26/9 --weeks) is a longer measure than I usually
use. It is deteriorating along with momentum, but what is
also interesting is how extended it is. That attests to the
power of the rally overall for the past seven months, but it
also serves to put one on notice how carefully one needs to
proceed near term.

Thursday, January 18, 2007

Oil Market

Over the past four years, my analysis has seen the equilibrium
price for oil rise from $37.50 bl to around $45.00 bl. The actual
price was far stronger than the equilibrium price reflecting
healthy underlying demand growth, a very tight supply situation
and powerful speculative purchasing based on the dimunition
of spare production capacity to an exceptionally low 1 million
barrels a day. The bear market, which began last summer when
crude topped out at $78 bl., has seen the price drop to just
a tad above $50 bl. Cover stocks were built to multi-year highs,
demand growth has moderated, and supply growth has picked up,
creating up to 2.5 million bd in spare capacity currently.

In short, the market has begun to return to balance, and because
new supply comes on in size and not in drips and drabs, there
may be a moderate build up in spare capacity over the next few
years, even as demand grows. These developments have led to a
groundswell of comments by industry observers about how low the
price of oil could go over the next year or so. I'll have none
of that. With demand now over 85 million bd worlwide, the
industry needs a higher margin of excess capacity to provide
assurance to economic growth. Moreover, I could be on the low
side with my cost estimates, as new supply will come on with
higher finding, development and lifting costs embedded. So, oil
at $45 bl. is fine by me as a working assumption.

Ever since the US moved against Saddam's regime in Iraq in 2003,
a number of geostrategists and pundits have been speculating
about a US strike on Iran to cripple its nuclear dvelopment
capabilities. I have viewed this as a crock of BS. However, there
are now two full US battle groups in the Persian Gulf and the
entire theater is under Admiral Fallon's flag. I still doubt that
the US plans a pre-emptive strike on Iran, but the US may go
after overland and ratline supply routes leading from Iran into
Iraq, and such action, should it occur, might give a substantial
goose to anxieties about oil supply from the region at large. So,
we will have to watch for this little saga as the year unfolds.

In the meantime,If oil gets down into the $40's, it will be time
to dust off the oil stock groups for a look. I have avoided this
industry for a couple of years now because the crude pricing
assumptions have been on the generous side. There has been lots
else to trade, so I have not missed it.

Tuesday, January 16, 2007

Stock Market -- Technical

It remains an up market, obviously. But the uptrend is
more tentative. There have been some short term price
and breadth breaks of trend, momentum has slowed
noticeably, and there is a hint in the longer term
momentum work that the market may be entering an
interim topping phase. The strong intermediate term
overbought condition I have discussed in recent weeks
has eased some, but the market is near enough to being
overbought that it is hard to justify an expectation of
a sharp short term advance from the current level. In
sum, the market is rising but the trend is far less
assured and it appears to be maturing.

Wednesday, January 10, 2007


My primary inflation gauge has dropped as rapidly as it does
when the economy is entering a period of recession. As all
must know by now, the primary culprit behind the blowout is
energy pricing -- oil, petrol products and natural gas. In
fact the weakness in energy prices dominates the fall in
commodities, especially on a usage basis. So we do not have
the kind of broad based erosion in materials pricing that
attends a business downturn.

Spare capacity in oil at the wellhead, which might have dipped
slightly below 1 million bd at its nadir, has now advanced to
around 2.5 million bd. Demand growth has moderated, first because
of how high the oil price went, and now because of a strong
contra-seasonal factor in the form of warmer weather. Supply
capability is expanding as expected and there is word that OPEC
is cheating on announced production cuts, again as expected.
As discussed in earlier posts on oil, carry stocks had reached
multi year highs this past summer. So I see the weakness in
oil primarily reflecting the unwinding of speculative excesses
and the return of the market back toward equilibrium. Much the
same can be said for the collapse in natural gas over the past
year as well, except that gas is a tougher call because of the
continuing tightness in storage and pipeline throughput capacity.

I have equilibrium pricing for oil in the mid-$40's per bl and
for gas at $4-5.00 per mcf. Whether either commodity will trade
down to and remain at those equilibrium levels for a while is
anyone's guess as far as I am concerned, but I suspect there are
enough sadder but wiser beavers out there to leave these markets
tamer for a spell, once the proverbial dust has settled.

Since the leading inflation index has not bottomed yet, odds are
that so-called "core" rates of inflation may not have either.
Discussion of the outlook for inflation does need to be tempered
by the fact that the leading indicators rarely make extended
bottoms, but tend to turn up quickly when they turn. What is
interesting here is that we have witnessed blowouts in certain
commodities composites not so much because final demand has
tumbled, but more because of the unwinding of speculative excess.
The re-energizing of the speculative appetite could take a bit
longer in such circumstances.

There are a couple of other factors to keep in mind regarding
inflation. The Fed remains tight with monetary liquidity. Measured
yr/yr, Fed Bank Credit has advance by only about 3% a year since
the end of 2004. That is a "disinflationary" factor to say the
least. Secondly, with the US trade deficit appearing to stabilize,
a primary source of incremental dollar liquidity to the global
economy has dried up. That is both an economic growth and inflation
headwind factor.

Friday, January 05, 2007

Stock Market Discussion

MY SP500 Market Tracker puts fair value for the index between
1450 - 1480 as we move into January. The mid-point of the
range, 1465, is up nearly 16% from the 6/06 Tracker reading of
1265. About 2/3 of the gain reflects imputation of a higher
p/e ratio reflecting the very rapid deceleration of inflation
since mid-2006. The market had a strong second half, with
closing prints at 1427, but it has tailed off in recent weeks.

Mainly, I think this reflects the fact that the rapid run-up
in the Tracker was a bit too fast for a market that retained
a reasonable amount of discipline and did not chase stocks
willy-nilly. As it was, the actual run-up in prices produced a
strong intermediate term overbought which was likely corrected
this week. But today's sell-off introduced more into the mix,
as improving economic data, highlighted by today's stronger than
expected jobs report, has weakened investor conviction that
the Fed would cut the Fed Funds rate before long.

As discussed in postings over the past month, I have expressed
the view that the Fed would resist cutting the FFR for as long
as it could, and that it would tighten instead if the economy
firmed up. I took a cautious, but not bearish view toward
much of 2007, because the case simply has not been there to
support a rate increase. Higher short rates would cut the
positive differential between the market's earnings/price yield,
now about 6%, and the T-bill yield, to a very narrow 50 basis
points, which would bother a fair number of players. To
make matters a bit more confusing, consider also that a sluggish
economy in the recently ended final quarter, may produce an
increase in the volume of earnings disappointments even as
the shorter term and longer run economic leading indicators are
in the process of firming up.

In summary, there's enough uncertainty in the economic outlook
to make it understandable that investors might not eagerly
embrace the 1450-1480 range for the SP500 envisioned by the
Tracker straightaway.

For now, I am just along for the ride. My powder is dry and my
conviction this is not the kind of year for a guy with my
type of approach to be running around making forecasts, remains

Wednesday, January 03, 2007

Stock Market -- Grumpiness Prevails On Day 1 '07

As discussed yesterday, there was good technical reason
to be grumpy about the start of the new year. The edgy
money moved quickly out of stocks today when the SP500
again failed to break out to and sustain a new high
above that 1427 resistance level. The release of the
FOMC Dec. minutes only helped grease the skids.

Today I have included a six month daily chart for the
SP500. Note how as the market rose, the 10 day MA was
the first line of support followed by the 25 day as the
primary support. The market tested the "25" today and
closed above it. Keep an eye on the action relative
to the "25" in the days ahead. Click it.

Tuesday, January 02, 2007

Stock Market -- Technical

In recent weeks, the stock market has been working off a
powerful overbought based on internal supply / demand
fundamentals. It still looks like this process is not
yet complete.

Internal fundamentals -- varied measures of breadth -- show
a positive bias to the market with fading momentum as this
overbought is worked off. The weekly SP500 chart looks less
healthy based on some conventional technicals. Click it.

Note the overbought on the 10 week RSI, and the downturn on the
short run MACD. Note also that the current MACD at around plus
20 equates with recent tops that ushered in very sluggish
intervals. On balance, I am not bearish, but I am grumpy about
the set up for the opening gambit of the new year. The grumpiness
is elevated by the fact that the SP500 has twice failed to take out
the cyclical high of 1427 in recent sessions as well as recent
strongly bullish sentiment in the advisor sentiment surveys
such as II, Consensus and Marketvane.