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 !!!

Friday, December 31, 2010

Picking Up Russia Stock Market

A goodly number of readers of the blog are from Russia. Since the view on Russia of an old
US pro might be of interest over there, I am adding Russia to my list of foreign stock markets
of interest. Russia is a resource based economy. Their market tracks well with my global basic
industry indicator, the oil price and the US stock market. The Russian market trades at a huge
p/e discount to the global average, but features well above average volatility. So, despite all
the qualms one might have about Russia's financial, legal and political systems, there is value in
the market and the kind of "beta" or volatility that would warm the hearts of most traders.

The Russian market fell around 90% in the financial panic / global recession of Half 2 '08 -
early 2009. This compares to a 77% drop in the oil price and a 32% decline in my global
basic industry indicator over the same period. Since the bottom in early 2009, the Russian
market has recouped much of the loss, but still stands about 32% below the previous high.
The oil price has made a similar recovery, and the global basic industry index has rebounded
strongly on rising production and sharply higher industrial commodities prices.

The oil market is crucial to Russian fiscal policy and broader economic strategy, and with a
global economic recovery underway, elemental risk should be only moderate for the economy 
over the next couple of years.

So, Russia looks to be interesting for traders and investors in 2011 and beyond. The market
is presently overbought in the short run, having rallied nicely along with the oil price and
the SP 500. Time for me to watch it carefully going forward as there could be some nice
tradeable opportunities next year.

See chart for comparison of Russian, US stock markets and the oil price.

Tuesday, December 28, 2010

S&P 500 Profits

With a recent strengthening of the economic indicators, profits estimates are again being
revised up, but in typical modest fashion. SP 500 profits are expected to rise 47% in 2010
to around the $83.70 level reflecting about 8% sales growth and higher profit margins from
dramatic cost cutting. The bulk of the sales increase reflects higher unit volume, with pricing
power remaining modest. Higher profit margin is somewhat overstated by a rising level of
share buy ins as cash flow rises and companies gently increase underlying leverage and ROE%.

Analysts in sum now look for 2011 profits to rise to a record $94.80 per share, for a gain of
13.3%. Confidence in this good an increase is on the rise, in line with the recent improvement
in the economic indicators and further liberalization of fiscal and monetary policy. To do this
well in a continuing environment of modest pricing power, companies will again need to show
good volume gains and further operating efficiencies.

I am using a number around $90 a share for SP 500 eps in 2011. That would represent a 7.5%
increase over the current estimate for 2010. I am using the more conservative figure because
I am not as yet willing to make more generous growth assumptions beyond mid 2011, when
the Fed must again make another decision regarding quantitative easing. Moreover, I want
time to assess to what extent companies are willing to increase hiring and whether the
markets for private sector shorter term credit will begin to loosen up.

I continue to think there is ample slack in the US economy and that recovery / expansion
can easily proceed for another 4-5 years before the system would become well and truly
overheated. This view strongly suggests further significant progress in earnings and
dividends in the years ahead.

Sunday, December 26, 2010

Stock Market -- Caution Light

The bull run in place since late Aug. remains intact. But, it is getting overbought on  an
intermediate term basis against the 13 week m/a and the 12 week RSI. Moreover, it is
extended on the 14 week stochastic momentum measure. SP 500 chart. As well, the CBOE
weekly individual stock put to call ratio is at a low 50.5 average for the past four weeks.
That is not just very bullish sentiment, it is heavy betting on a rising market that is usually not
rewarded at such aggressive levels of short term speculation.

These warnings suggest the market is likely to pull back some over the next 10 trading days
and hardly signal a major turn of events on their own. But the market has put in a solid 17
weeks without major upset and it only seems fitting that it would stiff the optimists at some
point over the next couple of weeks.

Friday, December 24, 2010

Natural Gas Price

Last autumn, when natural gas fell below $3.00 mcf, I posted that it my might be worth more
work to get up to speed on it. There was a rally, but I did little in the way of follow-up. Since
the autumn rally, gas has fallen into another bearish funk. I still think gas is interesting, as it
is now trading just above $4.00, which is a pennies premium over all-in production costs.

Natural gas was in a powerful bull market over much of the first half of this decade, as solid
fundamentals allowed it to piggy back on the strong upswing in the oil price. With hurricanes
Katrina and Rita hitting the La. - Tx  gas hubs in 2005, gas surged to a crazy $14.+ momentum
driven peak in 2005. It made a secondary top of around $13.60 in the commodities blow off
of 2008 before crashing down to $2.90 during Sep. 2009.

Natural gas demand was on the flat side over the past decade, while production rose about
10%. With a rising price trend, exploration increased and proven reserves surged 67% and
is closing in on the old record set years ago. The 2007-09 recession punished demand as new
supplies came on, leading to a large 12% increase in carry stock or stored supply. With this
new and upward trending inventory overhang, the price has remained suppressed over the
past two years. The adjustment process has been extended because shutting in gas wells
is a costly, time consuming and tedious process.

With an economy that is continuing to recover and normal weather, consumption should
rise and the inventory overhang should dissipate over the next two to three years, although
inventory will remain near  historically high levels.

With gas having a strong reserve position and with new technologies at work to produce
greater supply such as shale gas, there is no explosive pricing story here. But, smart
companies like Exxon are bypassing oil properties to develop gas reserves, and that also
means the industry will be pressing to find ways to boost gas consumption through fluids
conversion and other technologies. Gas is cheap relative to oil, but the key here is to find
practical ways to boost its utility.

Gas players who have bought contracts around $4.00 over the past decade have had the
opportunity to profit each time out. Holding gas above $8.00 mcf has not worked out well
save for the Katrina and commodities price spikes of 2005 and 2008, respectively.

Continuing economic recovery and better inventory control would support a central $4.00 -
$8.00 range over the next couple of years. Moreover, if smart guys like Exxon want to own
more gas, it may be worth thinking about.

Ahead, I want to look at UNG, the direct ETF type participation in gas.

$NATGAS chart.

Tuesday, December 21, 2010

Oil Price

Over the period from mid 2002 through mid 2008, global oil consumption rose steadily and
excess production capacity fell sharply. The oil price accelerated dramatically up as excess
production capacity was drawn down to extremely low levels. So, the world wound up with
an oil  price bubble and subsequent crash as global oil consumption fell sharply once worldwide
recession developed. The demand contraction drove a growing legion of financial "round trip"
players out of the market.

Oil demand stabilized in latter 2009 and rose this year. It should rise again in 2011, but perhaps
more moderately as inventories have remained at high levels after the desperate scramble for
crude in 2008. There is now a substantial cushion of excess or shut in capacity at the well head.

The cost of oil extraction has risen substantially on new production during the past decade, and
this has raised the equilibrium price of crude substantially. My number for the equilibrium price
is $58. bl. Most industry specialists would peg the price at around $70.

The oil price, which fell to a little above $30. bl. in the 2008 price crash, rose to the accepted
equilibrium price of $70. by mid 2009 on speculation demand would recover in succeeding
periods. The upward price momentum of the oil price has cooled substantially since it recovered
to $70. After all, there is now a much larger spare capacity cushion and supplies in storage
are very much higher now than in early 2008 when the accumulation scramble started.

The volatility of the oil price has toned down substantially over the past 18 months. It is
currently enjoying a counter-seasonal run up as players have jumped in to position ahead
of the normal seasonal rise in price over the winter months as gasoline stocks are built.

With oil consumption set to rise further through 2011, I am merely guessing a range for the
year of $75. - $110. bl. The current price of $89. is slightly overbought. One thing to
watch for next year is whether  the oil price uptrend is passed quickly through to gasoline
prices as has been happening recently. Such a development could lead consumers to
re-allocate budget commitments away from other consumer items.

Oil $ chart.

Sunday, December 19, 2010

CRB Commodity Price Composite

The CRB - Jefferies commodites composite will enter 2011 with a cycle bull market intact.
It could even receive an extra kick in Q1 '11 if winter weather in the northern hemisphere
continues cold and snowy and if China does not accelerate credit tightening, which would
allow for normal seasonal stocking there.

However, the market is overbought, and as the linked-to chart shows, has exhibited fairly
strong discipline when it gets at a sharp premium to the 40 week m/a, as it is now. It will
be instructive to see how well the discipline holds up near term. $CRB chart.

Saturday, December 18, 2010

Stock Market -- 2011

My primary fundamentals are positive and improving as we approach 2011. However, I am
more curious than bullish about the year ahead. My SP 500 Market Tracker -- based on a
long term model that derives a p/e ratio based on inflation -- indicates the market should close
out 2010 around 1370. The "500" closed on Fri. 12/17 at 1244, so even if there is a "Santa
Claus" rally, the market is likely to finish the year well below the indicated fair value. So, for
me, this represents a big miss as I had no argument with the 1370 number at the outset of the

When the model fails, it is often because the earnings expectation is wrong. A failure of this
sort is easy to adjust as a year wears on, because the earnings indicators start suggesting that the
estimate is too high or too low. It is much tougher to analyze a miss well when it is the p/e
ratio implied by the model that goes wrong. Such is what happened in 2010. I used a multiple
of 16.5x, when it looks like 15.0x would have been the better number.

Having too high a p/e in this case did reflect the very weak growth in my broader measure
of financial liquidity as well as an underlying sense of investor caution about the poor
balance the economy showed between business sales growth, which was good, and the
growth of employment which was very lacklustre over the second half of the year. In my
view, the decision by so many companies to max out profit margin in preference to adding
more staff and conducting normal working capital financing may have resulted in
the punched up earnings being accorded a lower multiple as investors were left to wonder
who would buy the higher output if employment is stagnating.

The Market Tracker has the SP 500 going to 1470 by the end of 2011. However, rather
than make a specific projection for 2011, I am going to be content to see how cautious
investors remain next year, and adjust my thinking as the year goes along. Ditto liquidity
growth, which, as of today is only visible through mid 2011 on the strength of the Fed's
current round of quantitative easing.

Thursday, December 16, 2010

Stock Market & Financial Liquidity

Measured in 12 month intervals the US economic recovery has been at a far faster pace than
has the growth of my broad financial liquidity composite since late 2009. The resulting liquidity
"deficit" primarily reflects the shrinkage of private sector credit demand which has reduced the
need for funds in the system. This has created a headwind for stocks. This headwind has eased
substantially since the spring of this year, but it remains appreciable. Looking forward, the
decision by the Fed to buy an additional $600 bil. of Treasuries through mid 2011 will ease
the strain on the broad measure of financial liquidity, which increased by a tiny 1.2 % yr/yr
through 11/10 (and was essentially flat adjusted for inflation). But that $600 bil. pool will
be subject to claims by the real economy as well as the capital markets, so contrary to what
a number of commentators have said, it's not all gravy for the capital markets or the inflation
rate, for that matter.

The leading economic indicators point to a continuing acceleration of the pace of economic
recovery in the months ahead. Moreover, inventory investment by business, which badly
lagged the economy during most of the current recovery, has been catching up. Now, the
recovery of business sales and continued cost cutting has provided a sizable surge of
business sector cash flow which has been more than sufficient to fund expanding working
capital requirements, and, we will have to see whether rising new order books can
continue to be funded internally or whether business will need to increase shorter term
borrowing for working capital and to invest more in adding new workers.

Increased business borrowing would add credit based liquidity to the system, and that
would, other things held equal, diminish further the headwind the stock market faces.
Naturally, this more normal funding activity would come at a cost down the road in the
form of higher short term interest rates. But since rates are so low, the stock market
can accomodate the early phase of rising rates.

Investor caution and the liquidity headwind the stock market faces have trimmed 1.5
points off the p/e multiple based on 2010 earnings by my reckoning. We shall have the
headwind in place as we move into 2011.

Tuesday, December 14, 2010

1) Stock Market Quickie 2) Monetary Policy Quickie

Stock Market
The SP 500 made a new cyclical high near 1242 today, but NYSE breadth and my buying
pressure gauge are not confirming this high. The  NYSE TRIN index did show strong
buying pressure over the past two weeks, but the non-confirmation of breadth suggests
there are sectors and issues that are overbought and are holding back the broad market.
Watch carefully in the days just ahead.

Monetary Policy
I'll skip doing a FOMC wrap since such will be all over the web. But I did want to note that
my interest rate policy gauge has slipped from a 50% chance the Fed will raise rates soon down
to 25% on a weakening of non financial commercial paper activity. Now, although both short
term business credit demand gauges are now negative, they are in basing and bottoming patterns.
Thus, if the economy broadens in recovery momentum beyond stronger retail sales in the
months ahead, we'll need to see if  business credit demand reverses to the upside. Make a note,
as such developments would likely wind up giving me a reading of 75% in favor of raising
short rates and set off  Street chatter that the Fed is falling behind the curve.

Sunday, December 12, 2010

Financial System Liquidity

We are now nearly 18 months into a US economic recovery, and the loan book of the banknig
system continues to contract. By post WW2 standards, this is a truly extraordinary story,
although it is an understandable one given the depth and duration of the preceding recession.
At its peak in Half 2 '08, the system's loan book was about $1.5 tril. or 8.2% over the long term
growth trend. It is now only $220 bil. or 3% above the long term trend. The system is still
carrying loan loss reserves in excess of $200 bil., and there has been but modest improvement
in the ratio of nonperforming loans to total loans. There is ample liquidity on the system's
balance sheet and lending standards are starting to be relaxed. However, the banks are behaving
with great caution.

Consequently, the boad measure of system liquidity to include the basic money supply and
primary funding tools has incresed only slightly from it's recession trough and remains a bit
below the historic peak seen in late 2008. This is true despite the very large injections of
liquidity by the Fed ($1.5 tril.) to stabilize and grow the system since latter 2008.

From my perspective, the recovery has primarily been a "cash and carry" affair, with the
Fed's large liquidity infusions being the lifeline for the recovery.

With system cash and checkables accounting for only 16% of the broad measure of cash plus
the broader array of deposits and funding vehicles like commercial paper, the burden on the
Fed to supply supporting liquidity is enormous.

We are very much in the kind of situation the Fed and the economy faced in the years
after the Great Depression trough, when private sector credit availability was contracting.
Then as now, there is pent up demand for goods and services, but the very narrow base
of liquidity expansion reduces the visibility of growth nonetheless, and, with the Fed serving
as the main game in town, confidence stays restrained.

The consumer has begun to loosen up and spend more here in the closing months of 2010,
and now time is at hand for business and the banks to respond more positively with jobs,
investment and credit.

Friday, December 10, 2010

Stock Market Comment

The weekly cyclical fundamental market indicator remains in a firm uptrend off the 8/30/10
interim low and has been moving up faster than the SP 500. This result is partly a consequence
of investor preference for mid and smaller cap stocks as well as for selected foreign markets.
As well, investor confidence is lagging some, reflecting, I think, concerns about the weaker
credits in the EU and continued firming of China's monetary policy. On a weekly basis, the
correlation of the SP 500 to the cyclical indicator has dropped from +.7 down to +.64.

The market did break above resistance as the week wore on. We have new cyclical highs and
confirmation that the second upleg of this cyclical bull is intact. The shorter term uptrend has
been re-established, and I have the market as still mildly overbought.

SP 500 short term chart.

Thursday, December 09, 2010

Treasury Bond Strategy Factors

Today's post builds upon yesterday's entry on the Long Treasury bond. Here I want to look at
strategy factors and the difficulties involved in devising workable strategies.

Long term interest rates are sensitive to the trend and level of short term rates. There are
effective models one can use to get a fair bead on where bond yields should be when short
term rates are at moderate levels. Such is not the case when short rates are at extreme levels.
There is an extreme now with the 91 day T-bill rate at just around 0.15%. Moreover, since the
Fed has no intention to raise short rates in the near term, there is not a solid model application
here for the bond. My very long term model for the level of short rates based on inflation
factors implies the T-bill should now be yielding about 3.0%. My very long term model
for deriving the long bond yield from the short rate says I should multiply the bill rate by 1.5x.
The model implies that the long Treas. should now be yielding 4.5% (3.0 x 1.5), which is
close to the present yield for the bond and which also suggests bond players are assuming
that short rates will eventually rise moderately. This hypothetical run-through is interesting

To protect purchasing power, a bond needs to provide current return and re-investment of
interest received return  which exceeds inflation by a meaningful degree. With the current
CPI running about 1.2% yr/yr, the old rule of thumb is to add 300 basis points to the CPI
reading to get get a fair yield for the T-bond. This informal model puts the "proper"
yield for the bond at 4.2%.

Another approach I have used in recent years is to deduct a 3% inflation assumption from
the yield on the 30 yr. T-bond.  Experience shows the bond tends to rally in price when
there is nearly a 200 basis point premium over the 3% CPI assumption and to not do so
well when the premium is only 100 basis points or less. See chart. (Note too, the
sensitivity in yield to industrial commodities  prices such GS's industrial metals composite).

There have been few periods in US history when the inflation rate has sustained above 5%
for an appreciable period. Mostly, these inflation surges have come around war time when
resources are heavily in demand. However, if you wanted to look out past a few years and
were concerned that inflation could average 3% for a sustained period, then my work
suggests the T-bond yield would have to rise to 6% before it offered decent value. And, it
will do precisely that on evidence of a sustainable acceleration of inflation pressure from
the present low level.

With a rise in the Treasury's funding requirements, bondholders should expect a premium
to be built into the long bond yield to cover a much heavier supply of new debt and a
higher level of re-funding. I do not see that yet, but if confidence grows further in other
riskier markets, it may appear and could add up to 100 basis points to the bond yield.

In summary, the T-bond is reasonably valued now given the low levels of short rates and
inflation. Obviously if the recovery continues to advance, broaden out more and solidify,
then it would be no stretch to the see the long Treas. move up to 5.25 - 5.50%.

Wednesday, December 08, 2010

Long Treasury Bond

In posts dated 8/19/10 and 8/24/10, I argued that the long bond was strongly overbought and
that it was overdiscounting a presumably weaker economic environment. I stated that the $USB
which was trading around 135 could lose up to 20 price points in a correction, and warned that
with large pools of fast money such as hedge funds in the market, change could be fast and
dramatic when it came. Well, today the future is trading around 121.8 in a downtrending market.
The market is now oversold, but since major support lies down around 115, one needs to be
careful $USB.

The sharp reversal in the market reflects several factors. Shorter run leading economic
indicators turned positive in late Aug. and, consumer spending has strengthened. The Fed's
commitment to a quantitative easing of monetary policy gives concern to Treasury players
that economic growth potential may be enhanced. Inflation pressurge gauges have started to
rise here in the autumn, and finally, an outline of a "tax deal" between Pres. Obama and
congressional GOP leaders contains modest additional stimulus which would aid the
the economy but boost the budget deficit as well. 

the long Treasury yield has been anchored by a near zero 91-day T bill yield and a volatile
but low inflation rate. Seasoned bond players know that as an economic recovery progresses,
inflation pressures eventually build as does credit demand. The normal response of the Fed
is to cite inflation pressure and raise short term interest rates. There is little risk the Fed will
so respond in the months straight ahead, but a firming economy can bring more inflation
pressure and sour bond players on the bond even so.

The long Treasury has moved into oversold territory on both technical and fundamental
grounds. However, the long bond could easily fall to $115 support  and the yield could
easily rise to 4.85% resistance in an environment of firming production and rising
sensitive materials prices even as the Fed sits on its hands. There is not enough of an
extreme yet in the market level or in sentiment to warrant more than a long side trade
for an interval too short to suit my taste. I would also point out that bond players tend to
close their books for the year by mid-Dec., so liquidity in the market gets very thin.

I would suggest that should the long Treasury yield move up to and through the 4.80%
level, there would be a rather preliminary indication that the 30 year long bull market
in bonds could finally be winding up. Although such a development could trigger a torrent
of bearish commentary on investment sites, best to remember that a number of other
pieces of the puzzle would have to fall into place to legitimize the claim that the bull is

Long Treasury Yield.

Tuesday, December 07, 2010

Stock Market -- Short Term Technical

This one will be a quickie. The minor run-up in the market so far in Dec. has not yet
been strong enough to offer much to get excited about. The rally came off a mild oversold
and is encountering resistance at a mild short term overbought level. A continuation of the
upleg off the Aug. EOM lows should have more upside zip than has yet been exhibited.
The SP 500, which closed today at around 1224, should have no trouble moving right on
up to the 1250 level if this is going to be a solid upleg continuation and not a head fake.

I have linked to the "500" chart below and at the bottom of the chart is a panel showing the
% of stocks within the index that are trading above their respective 200 day moving averages.
When this index tops 80%, it normally signifies a higher degree of risk in the market, although
during powerful run-ups in stock prices, the % above the 200 day m/a can remain elevated
for extended periods. Even so, players should recognize that the market's risk level has moved
up since the summer.

SP 500 chart.

Friday, December 03, 2010

Economic Indicators

Both weekly and monthly leading indicators remain in uptrends which did restart in the
latter part of Aug. The linearity between most of these series and eventual economic
performance has declined primarily reflecting the increased volatility of sensitive materials
prices. In sum, though, a re-acceleration of both US and global economic recovery is

Weekly and monthly coincident indicators have also turned up since Oct. following an
extended flat period running back to Jul.

The slowdown of economic growth experienced over the late spring and summer of this
year lead initially to a flattening of total US civilian employment followed by weakness
in both Oct. and Nov. As a consequence, the unemployment rate has moved back up to the
9.8% level. The combination of nominal real wage growth and a weaker employment
picture over the past six months has substantially undercut the visibility for continued
economic recovery in the US. The recent decision by the Fed to accelerate the growth of
monetary liquidity and fresh life to the leading economic indicators are welcome
developments as is the faster growth of retail sales in recent months. However, if business
remains reluctant to hire and continues content simply to reap gains from a lower cost
structure, the odds that the economy will eventually sputter and cease recovering will
inevitably rise significantly as 2011 wears on. Ditto the banks, which are experiencing
a rising trend of earnings from a drop off in loan loss reserving as opposed to profits
gained from an expanding loan book.  

Thursday, December 02, 2010

Energy Sector

Back on 10/15, I mentioned that the energy sector stock group was starting to  reverse a decline
in relative strength in place since the bursting of the oil price bubble in mid 2008. I mentioned
several factors to account for the positive turn: The oil price has resumed a positive trend
following a sharp pullback over Apr. / May 2010. The natural gas price is building a base after
a huge price decline from mid 2008 through Aug. '09. These two factors in a recovering global
economy provide the basis for a positive turn in earnings for the industry. As well, continued
recovery will eventually return increased pricing power for oil especially as capacitiy
utilization at the wellhead rises. Thus, the sector may be expected to offer relative strength in
earnings, too.

When there is a sharply positive turn in relative strength for a sector against the broad stock
market following a significant period of decline, it is well worth notice especially if the
positive movement in relative strength is appreciable. This means investors are changing their
outlook quickly with some zeal and are doing re-positioning in favor of the group.

One caveat: The XLE energy sector is a market leader now but is coming up on a short term
overbought situation. XLE

Wednesday, December 01, 2010

Stock Market -- Short Term Technical

The recent sell off eliminated the overbought. I did not like the idea of calling for a correction
without a clear cut break of shorter term trend. The market bent down but did not break.
Today was akin to a do or die day to determine whether the market was set to break down
and head sharply lower. Lo, and behold, we get a dramatic 2% up day instead, which reverses
the nascent downtrend and leaves the market in neutral territory.

The chart link below shows a series of tests of support for the SP 500 around the 1180 area
followed by today's big bounce. This is an encouraging sign for the bulls, and if the market was
coming off a deep oversold, I would be even more encouraged. However, there was no
deep oversold, just some volatility around a very mild oversold.

I would then be looking for positive follow through. I would like to see the 10 day m/a, which
reversed up today, rise through the 25 day m/a and for the 25 day m/a to hold up as well.

Today was an impressive move up from well tested short term support, but since it may just
represent a sudden short squeeze, I think it's fair to ask for more upside here, especially
since the market is hardly overbought and could easily run another 4-5% if the upleg which
started at the end of Aug. is truly set to resume.


Saturday, November 27, 2010

Still Draggin' Dragon

I watch China's Shanghai stock market through the eyes of a Westerner, even though China's
capital controls keep the participation of offshore money in its market limited. The real
estate markets are the bigger plays in China, and I believe many of the locals use a rising
stock market as a stepping stone for capital accumulation to play the various real estate

I downgraded the market early in the year because I felt faster rising wage and materials
costs would pressure corporate profit margins. However, indications are that with strong
productivity gains in tow, profits growth has remained healthy. The market has fared poorly
this year anyway. The p/e multiple has been contracting, and from a Westerner's perspective
this development reflects accelerating inflation in China as well as efforts by the gov. and the
PoBC to trim asset speculation and inflation via a tightening of monetary policy and of
capital flows.

Viewed longer term, I regard the Shanghai Composite (11/26 2872 close) as reasonable
at the 3000-3200 level. With China a high growth economy, I use a 10% compound return
off the extended late 1990s base of around 1100. As the chart link ahead shows, the market
has been exceptionally volatile and has not often traded neatly in line with a 10% price
progression ( long term SSEC chart).

The market did recently come out of a year long downtrend, but has been buffeted in recent
weeks by additional gradualist credit tightening moves by the gov. The market is in a short
term downtrend, but there is no clear signal yet that the downtrend will extend and deepen.
The market is trading very near trend support, so a critical moment for direction could be
at hand. It is very hard to call turns with this market and it is much better to be a trend
follower when trading (shorter term trend).

The inflation momentum that has built up in China is significant and could require further
tightening steps including more deposit rate increases before authorities decide they
can ease up some on the tightening reins.

Friday, November 26, 2010

The Koreas

The latest provocation from Kim IJ and son, an artillery and rocket attack on a primarily
residential SK border island, has created more than the usual amount of risk that incidents
on the peninsula usually do. One can hardly be sure, but Kim may want to foster a crisis
wherein Kim the younger can be portrayed as a hero to the folks in NK. In the meanwhile,
SK has upped the ante on retaliation for future attacks from the north, and the US has
dispatched a carrier attack group to the region. This area is infamous for mis-calculation
by the major parties including the US and China. The history of the Korean war shows
a pattern of legendary blunders that flowed from everyone often misreading the intentions
of their adversaries.

Since another attack from NK against SK is likely to trigger a retaliation of significant
consequence from SK, We can hope NK will have the good sense not to overplay its
hand, since there is little reason to believe further actions could easily be retrieved and
settled diplomatically.

The easy and shorter term way out of this standoff is for the US and SK simply to signal
they are willing to buy Kim and son off.  But there could be severe political consequences
for both the SK gov. and the Obama administration if they were to do so right in the
wake of the recent incident, especially since SK's bluff has been decisively called.

The antagonists have bruted about in and around the peninsula without major damage to the
area for over 50 years now, so it is not unreasonable to expect that inaction ahead would
again lead to a dissipation of tensions. Let us hope papa Kim sees it the same way.

Tuesday, November 23, 2010

Inflation Potential

Technically, the US is still in a price deflation phase. The CPI  is recovering from its 12/08
cyclical low, but is still 0.6% below the all-time high of 220.0 set during 7/08. It will not
likely surpass the prior peak until 2011.

The CPI for the past 12 months is up but 1.2%. A higher fuels bill for the nation has been
largely offset by a continuing deceleration of price pressure for all items less foods / fuels.

The weak CPI performance largely reflects the fact that the US utilization of capacity and
labor, although improving, is still well below levels seen at this point during most
economic recoveries. Business and labor have little pricing power in the current

The broad measure of inflation potential I use has basically been flat since late 2009
after a strong bounce over most of last year. My inflation pressure gauge, which gives a
large weight to commodities prices and is usually a better short range indicator than
broader measures, has risen sharply in recent months on higher fuel and basic food
ingredients. So far, however, there has been little or no pass through of the recent rise
in fuel and food prices to the full CPI measure.

The inflation pressure gauge is in a firm uptrend off its early 2009 cycle low and with
further economic recovery in store for 2011, there is likely to be some degree of
acceleration in the progress of the CPI next year. Since there will still likely be a
fair amount of slack in the US economy by year's end 2011, it would appear wise not
to expect more than a moderate uptick in yr / yr inflation readings next year. I know that
looking at 2010, the CPI is going to come in lower than I originally thought by a fair

Saturday, November 20, 2010


Thought I would pick up India going forward. I do have an e-audience out there. Moreover,
a couple of kids from India are in our local NFL betting pool. Thirdly, the Sensex stock index
is moving directionally with the US stock market, but with more brio. $BSE chart.

The $BSE is in a powerful cyclical bull market. It too has entered a second upleg phase and
recently touched its prior all time high before running into resistance and news of a juicy
scandal that runs up high politically. Hope my timing is good, given that the market is coming
off a strong overbought and is headed down to a sharp oversold, and, perhaps, a rendezvous
with obvious support at 18K.

My plan here is to start on the technical side of the market and gradually move along to the
fundamentals. Should be fun.

Thursday, November 18, 2010

Commodities Market

I have run across many web articles in which it is argued that we are in a long term bull
market in commodities driven by rising demand from China and the battery of emerging
and developing economies going against longer term supply constraints. I think the broad
commodities composites are reasonable, but there is no evidence at hand to date that the
world is witnessing a long term bull run in commodities. There was a strong market over
the 1971 - 81 period, and then another good one from 2002 through early 2008. However,
at its cyclical low in the latter part of 2008, the CRB commodities composite was just
slightly above cyclical low points seen as far back as the mid 1970s.

There has been a cyclical bull run in place since late 2008, when China initiated its massive
fiscal stimulus program. The first leg was a strong run and ran from 12/08 - 12/09. A new
upleg started in the spring of 2010 and remains in place, with positive diffusion measures
for the main categories. The CRB composite has been in a nearly 40 year trading range. It
is now reading around 300, and when it crosses above long term resistance of 280, it
generally does well, provided the global economy continues to expand. In fact, it can
experience upside blow-off periods late in an expansion cycle when supply/ demand
conditions are tight.

Commodities are sensitive to the leading economic indicators, and are especially
sensitive to monetary policy. Thus, the CRB has benefited from hype about the Fed's QE '2
program, but we have also seen a recent whipsaw when China again raised bank reserve
requirements and announced an interest in seeking tougher  management of the rise of
inflation pressure it is encountering. China greatly desires to maintain relatively strong
growth, so it is doubtful they have entered crunch mode with their monetary policy.

The CRB is coming off a strong short term overbought. There is shorter term trend support
at 285, chart pattern support at 275, and longer term trend support at roughly 265.
CRB chart. I have included Goldman's agricultural composite along with the CRB chart.
Note how the "ags" have forced up the CRB since summer and remember that farm /
grain prices can be extremely volatile and  be subject seasonal weakness in cold weather.

From a cyclical perspective, it is likely too early to try to top spot the CRB at this point.

Tuesday, November 16, 2010

Financial System Liquidity & Stock Market

Let's take note of the status of financial system liquidity here at the outset of what is, in
prospect, another susbstantial round of money printing by the Federal Reserve.

My broad measure of financial liquidity is up a scant 4.5% over the prior two years. Of that
increase, 80% comes from a rise in currency and checkables. So, quantitative easing by the
Fed accounts for the vast bulk of the paltry gain in the total. Bank funding growth has been
sharply curbed by a nearly $1 tril. run-off in private sector shorter term credit demand and
there has been an outright $700 bil. collapse in the market for asset backed and finance co.
commercial paper. This degree of liquidation is unprecedented in the modern era.

The Fed waited through most of 2010 to see if a a rather moderate economic recovery
would trigger a rebound in private sector credit demand. It did not, and the Fed, concerned
about the sustainability of the recovery, opted to begin another large ($600 bil.) program
of quantitative easing to assure a significant measure of funding for the economy.

Whether they will actually need to buy the $600 bil. of Treasuries is an open question in
my book. The weekly leading indicators suggest the economy is set to regain faster growth
traction and if this occurs and credit demand responds in a more positive, normal fashion,
the Fed will have the option to consider slowing the printing press as credit demand takes
on its accustomed role in helping to drive the economy. If private sector caution continues
and households and businesses refrain from borrowing more, than the Fed will proceed
with its program through mid-2011. It will be up to the Fed to tackle the issue of finding
the "right" balance.

The stock market has been keenly cognizant of Fed balance sheet mangement activity over
the past 18 odd months. The last three substantial downdrafts in the stock market -- early
2009, mid 2009, and spring 2010 have all occurred during periods when the Fed was
temporarily shrinking its balance sheet. Likewise, the bull moves in the market over this
period have come when the Fed has been expanding its balance sheet, or has been
promising to. When credit demand is shrinking or is flat, investors know that the Fed is
the only game in town when it comes to providing liquidity to the system. In this regard,
I suspect that if credit demand does pick up, then equities players will become a little
less sensitive to the ups and downs of the Fed's balance sheet.

Saturday, November 13, 2010

Stock Market -- Investing

I regard investing in stocks as an enterprise with a minimum time frame of 5 years. I am not a
buy and hold advocate. Never have been. An investor should add to commitments when the
market is cheap up to reasonable and lighten positions when the market gets expensive.

There was no investment case to be made for stocks from the latter part of 1996 until the
end of 2008 in my view. I think there has been a good case for long term investment over
most of the past 18 months, with the early 2009 time frame the best time to invest for the
longer term since the early 1980s. As all know, the market has improved dramatically and
quickly since early last year, and although stocks are now far from cheap, I regard the market
as still being reasonable.

I am primarily a trader, but if I was a long term player, I would not be uncomfortable
making new commitments up to SP 500 1240 over the next year or so. That level works out
to 16 x long term trend earnings and about 14 x projected 2011 eps for the "500". If I was
only a long term player, I would be reluctant to add to holdings above the 1240 area. There
could be good trades from that level, but I think true longer term players should wait for
significant dips before committing.

My SP 500 Market Tracker has the SP 500 fairly valued at 1470 for year end 2011 on
a continuing but far less dramatic recovery of earnings to $89 per share. I watch the
performance of earnings in the context of a long term, static channel, and because of the
cyclicality of profits, I grow progressively more cautious about the market as earnings
expand up to the top of the channel or exceed it. Such happened over 1997 - 2001 and
again over mid 2006 - late 2007. The next challenge to the top of the eps channel would
appear to be several years away. I also keep an eye on the long term price channel
running back over 60 years. The channel top for 2011 for the SP 500 is about 1500 and,
in my view, long term players might use the 1450 - 1500 level to lighten the commitment
to equities should the market do that well.

Since investors have all manner of objectives, I never presume to offer advice. I let you
know my views and leave it to you decide whether the perspectives are of use. I would
say my strategies for longer term commitment to equities have been conservative and sound,
but do not register at all well with players who try to use market timing or trend following
in making longer term investments.

Wednesday, November 10, 2010

Stock Market -- Fundamentals

The stock market has a good shot at returning over 20% in price gain through 2011 provided
the pervasive sense of caution among households, businesses and the banks eases up enough
to allow the economy to function with more normalcy than we have witnessed so far in this
economic recovery. Business will play the most critical role as it must invest, hire and
compensate at more elevated rates if the economy is to recover prosperity. Investors have a
clear sense of skepticism about whether the economy can recover confidence and may not
be easily won over until there are more tangible signs of progress.

Core Indicators
The core group was positive but running out of gas until the Fed announced its new liquidity
injection program (QE '2). Now, the core indicator group will strengthen as the Fed assures
faster growth of monetary liquidity at least through mid  2011.

Secondary Indicators
Measured yr/yr, the growth of the $ value of both production and total business sales is
moderating. With quantitative monetary easing, there will be some acceleration of system
liquidity growth. Thus, the liquidity headwind will continue to moderate as the demands of
the real economy ease, allowing less of a strain on liquidity available to support the stock
market -- a plus.

The inflation adjusted or real oil price is again moving up sharply as financial traders have
jumped into the oil market to "play" QE '2. So far, the rapid recovery in the oil price since
early 2009 has not appeared to have inhibited the stock market.

Profits Growth Momentum
Following the initial recovery surge over late 2009 - mid 2010, profits growth momentum
although substantially positive has been decelerating and is likely to continue to do so
right through 2011. with slower profits growth ahead, investor confidence will become a
much larger factor in determining returns through 2011.

SP 500 Market Tracker (Modeled P/E Ratio X 12 mos. EPS)
My Tracker puts fair value for the "500" at 1370 for 2010 and 1470 for 2011. The SP 500 is
now trading at 1217, or about 11% below fair value for the model. This discount is a
direct and primary result of  investor caution about just how good the earnings outlook is
for the global economy over the next year. In addition, investors continue to prefer smaller
US cap and faster growing foreign economies over the large cap "500", preferences that
have been in force over most of the prior decade.

Fundamental Weekly Coincident Market Indicator
This proprietary indicator advanced an amazing 62% off its deep cyclical low in 3/09 to
its cyclical high to date set 4/30/10 and supported the very rapid advance in the stock market
over the same interval. The indicator fell sharply from 4/30 until early Jul., 2010, and
following a consolidation phase, has been on an upswing since early Sept. So it has moved
in line with the recent rally in stocks and it points to an eventual re-acceleration of economic
growth. However, there is a "hall of mirrors" effect here as regards the indicator and the
stock market. For example, the indicator assigns a heavy weight to a broad basket of
sensitive materials prices such as copper, which, reflecting the financialization of the
commodities market, have mirrored stock price trends. So the unadulterated economic
content counts for less.

Longer Term Economic Indicators
This set of indicators shows there is substantial economic slack and that the economy has
the capacity to expand another 4-5 years easily if it can maintain reasonable balance. The
new round of liquidity injections planned by the Fed strengthens the case substantially
looking out through 2011. However, the indicators do not account for the psychological
states of consumers, businesses and the banks. Additional easing by the Fed provides a
financial framework for caution to abate and for all sectors to loosen up a little more
to realize rather moderate but decent economic potential. It is up to the private sector
now to follow through. The 11% discount of the SP 500 to the Market Tracker reflects
investor caution about just to what degree the economy will return to more normal
operations, with special focus on whether business will unlock and invest and hire
more people back.

Monday, November 08, 2010

Stock Market -- Technical

The rise in the market last week to a new cycle high reconfirms that the US is experiencing a
cyclical bull market. I count this new upleg as #2 and of course hope for a third down the
road. Second uplegs can last longer than the first, initial surge but can be far more gradual.
However, there are enough exceptions to this generalization that it can only be used as a
very rough rule of thumb.

The market is clearly overbought now on measures going out 13 weeks and is very mildly
overbought on measures running out to 40 weeks. Since overbought markets can get even
more overbought, it is wise to give trend break measures more weight in making both
trading and investment decisions of consequence unless you have a specific objective
in mind (like loafing through the holidays as in my case).

The trajectory of the market off the 3/09 cyclical low is very strong and anticipates a
period of fine performance in earnings as well as a degree of recovery in the market's
p/e ratio. Nothing slouchy here, but you need to remember the power of the trajectory in
the recovery in cyclical earnings to date as well.

The NYSE adv / dec line has over the years developed into a very broad, primarily mid
and smaller cap measure. Since the mids / smalls have been the US leaders for over a
decade, I have found this line to be helpful in analyzing the market. It is around a new
all-time high and is well worth keeping an eye on. $NYAD.

Friday, November 05, 2010

Economic Indicators

Both weekly and monthly leading indicator data sets continue to point to an improvement in
the pace of economic growth. There was a nice pick up in the October diffusion indices for
new orders which brings these important measures back up to satisfactory levels. The Bank
of Tokyo weekly coincident indicator, a conservative measure, remains flat as it has been
for several months. My monthly diffusion index for US output did improve in Oct. after
several months of decline. On balance, the indicators suggest the economy did progress in
Oct. there was also a pick up in global activity for the month.

My Economic Power Index -- 12 month % change in the real wage plus employment -- was
flat with the Sept. reading at a weakly positive 1.4%. This measure has improved well off
its cyclical low at 12/09, but it still makes for grim reading. The economy has made up well
less than half of the total job losses resulting from the recession, and employers are using a
still weak job market to hand out very small wage increases that utterly fail to compensate
employees for the large increase in productivity achieved in the recovery. Around here,
management of major companies are scoring large bonuses on sizable earnings increases
while handing out cheapo 1-2% wage increases to the rank and file. As a consequence,
the economy, although improving, remains vulnerable and unstable. Without faster real
wage and employment growth, consumption will remain very subdued unless people step
up on borrowing or cut savings, both of which they have so far been very reluctant to do.

The Fed is about to take action to improve the liquidity situation of the economy. This
measure may eventually lead to higher inflation.  That does not present a problem for
economic supply / demand balance unless  the real wage falters and people are again
thrown back to borrowing and dissaving to meet needs and wants. That would undercut
the chances for a return to greater prosperity.

From an editorial or value perspective, I say American business is failing to take care
of its people as the top guys pocket the dough. Over the long run, this kind of behavoir
will be revealed as a very destabilizing force, both on economic and socio - political

Thursday, November 04, 2010

Have Closed Out My Positions

Took a 12% profit on my USO position and nicely hedged my fuel costs with $ to spare.

Gold Short
Took a 6% profit on my DZZ holding before the run-up in gold chased me out. I still am
interested in this trade and will be back at some time.

Long Treasury Short
Made 10% on this leveraged trade. Thought I would do much better (See 8/19, 8/24 posts).

SP 500
Caught the 6/30 and 8/30 lows on the broad market. Two of the best long side short term
trades I have done in a while. Was lucky on the 8/30 trade which I did mostly on the basis
of extraordinarily negative sentiment then prevailing (See and end of month posts for Jun.
and Aug.). I closed out my long participation today as the market is now heavily overbought
in the short term.

US Dollar
Wanted to go long here, but never found a comfortable opening. USD remains deeply

My habit near the end of the year is to close out positions ahead of the holidays, especially
if I am running solidly in the black. Two of the worst trades I've made in over 40 years of
trading occurred over the holidays -- leaving me superstitious.

Although I am going to enjoy my retirement here for a few weeks, I plan to post regularly.

Wednesday, November 03, 2010

Monetary Policy -- Quantitative Easing

The  Fed today opted to keep its zero interest rate policy on short rates and to expand its
balance sheet by $600 bil. or 26% through mid-2011. Assuming that private sector credit
demand remains flat or in slight decline, this $600 bil. infusion via Treas. purchases would
allow my broad measure of financial liquidity to expand by up to 5% through mid-2011. 

This represents adequate liquidity to fund the economic recovery well into next year and
puts and end to a risky liquidity freeze imposed by the Fed in early 2010. As I have
discussed several times, the Fed underestimated how cautious the private sector would
be during this recovery and finally had to scramble up a plan when it became clear that
the economy was not strong enough to engage private sector borrowing to maintain
economic growth.

The size of the package is in my view overstated because the Fed had allowed nearly $200
bil. to drain from the adjusted monetary base before finally taking action, but it is large
enough to provide strong liquidity back-up to the economy going forward.

I think the Fed will halt this program when private sector credit demand begins to firm
up and show some vitality. For now, it is unclear when that will happen.

It is also important to recognize that although this new round of money printing may be
a necessary condition to have continued economic recovery, it may well not be a
sufficient condition of same, since even deeper private sector caution and fear
could still undermine it. But, and thankfully, this new round of liquidity infusion will
give the economy a fighting chance.

Monday, November 01, 2010

Stocks -- Technology Sector (XLK)

With political, monetary policy and employment news ahead this week, the technology
sector should provide some insights. As the relative strength index shows, this sector
remains the market leader in this cyclical bull. It has moved up to a new cyclical high,
as well as a new high in relative strength for this go. The XLK relative strength line is
short term overbought as well, which means that it will be hit hard if the boyz decide to
sell the news after after having bought all the rumors (quantitative easing, a return to
political gridlock etc.). XLK relative strength.

Thursday, October 28, 2010

More On Value Of Cyclicals' Relative Strength

I am here adding a bit more on to yesterday's post re: the relative strength line for
MSCI's $CYC index. I view the relative strength line as a decent indicator of the
market's expectation for economic momentum potential. I think it ranks somewhere
between a leading and a coincident indicator since it keys off not just pricing power
for cyclicals (leading) but full profit potential (coincident) as well. The RS line
is not used by economists as a formal economic or profits indicator, but it does
reflect the opinion of the market's players. Since the "smart money" by definition
moves into and out of stock sectors first, it is wise to watch for changes of trend in
the RS line of all stock sectors and industry groups and to also ask yourself whether
investors know something you do not. $CYC RS index chart.

Wednesday, October 27, 2010

Cyclical Socks -- Relative Strength

Among the broader stock groupings, the cyclicals have been the leaders in the cyclical bull
market, with the $CYC measure of relative strength nearly doubling against the SP 500
since the market started up in 3/09. However, the relative strength line has flattened out
since April despite continuing strong sector earnings as investors ponder whether the
economy will be strong enough in 2011 to generate relative strength in earnings sufficient
to secure superior relative price action for the group. The weekly leading economic
indicators, which fell sharply from 4/10 into early Aug. have been recovering. My
monthly profits indicators are still positive, but momentum has decelerated since mid -
year. so, there is some uncertainty building about relative performance potential for the
group, although we have not seen the kind of break that would signify that investors have
begun to give up on the cyclicals. Chart.

The chart shows clearly that relative strength for the $CYC has been consolidating and
that the extended period of flatness without a new positive breakout could easily be
read as a topping process. A downward break in performance, should one occur, would
not necessarily confirm a top for the entire stock market. Rather, it might only mean that
the outlook for earnings for cyclicals is no longer so positive relative to other sectors.

This point about cyclicals is worth keeping in mind as the group could suffer badly in
relative strength if investors decide that economic recovery will be slow enough to
warrant much broader diversification and a lower exposure to very cyclically
sensitive earnings.

The ability of the cyclicals to hold up in relative strength so far in 2010 shows that
investors have been curious about the prospects for an economic "double dip"
recession, but have by no means bought off on it.

Sunday, October 24, 2010

Stock Market -- Attention Please

The SP 500 generated a short term mechanical sell signal on Fri., 10/22, when it failed
to take out the interim high of 1185 made back on Mon., 10/17. Friday's close was 1183.
Sometimes, a failure of this sort simply portends a couple of sloppy days before the
uptrend resumes, and sometimes it signals that a more significant downtrend may be at
hand. Because of the latter factor, short term players should proceed with extra diligence in
the days ahead. Here is the SP 500 chart and notice the 8/2 - 8/9 period before the sell-off

Coincidentally, my weekly fundamental business cycle pressure gauge did hit a 22 week
high on 10/22. However, it has lost most of its upward recovery momentum over the course
of Oct. which might not go unnoticed before long despite the excitement about a much
anticipated new round of monetary easing by the Fed. Again, not a warning, but a "heads up".

Friday, October 22, 2010

Economic Indicators

After rising from late Aug. through early Oct., the weekly leading indicators have leveled
off leaving the recent improving trend unpersuasive. The  weekly coincident indicators
remain essentially flat and have not sustained progress since the end of Jun. My heavy
industry indicator -- steel output -- made a cycle-to-date peak in Aug. and has been
tailing off.

The monthly coincident economic indicators are on the flat side as well with the
exception of retail sales, which has firmed up over the past two months and will help
the Q3 GDP report.

One factor which has contibuted to the flattening out of the data has been a round of
quantitative tightening by the Fed which, by various measures, has been in effect since
Feb. 2010 (monetary base especially).

There has been no positive turn yet in private sector credit demand. On the plus side,
here are a couple of factors: The banks have amped up the deposit base somewhat, and
the system wide loan loss provision has finally started coming down. That reserve
has dropped over $17 bil. or 7.3% since this past spring. Let us be thankful for little

With a deterioration in positive momentum of the recovery, the stage is set for the
Fed to put up or shut up for awhile on fresh easing, and the stage setting is ripe for
an interesting couple of months for a lame duck Congress as well.

Wednesday, October 20, 2010

Stock Market & Financial Liquidity

For recent 12 month periods over 2010, total financial liquidity growth has been 
between 1-2% or barely above the inflation rate. For the 12 month period ended 6/10,
total Us business sales rose by more than 9%, as did the $ value of industrial output.
Thus, the velocity of money + credit rose sharply and liquidity declined. Relative to the
growth of the economy, liquidity has been in "deficit" since early 2010. The strain on
liquidity peaked around Jul. 2010, and has been improving sharply as 12 month economic
growth momentum has eased. The absorption of liquidity by the real economy has been a
headwind factor for the stock market this year. The situation is improving but is still a
drag factor on stocks.

Financial system liquidity growth made a cyclical top over  Half 1 2007, and trended
down from 10% yr /yr back then to an astounding -3.5% in early 2010 when measured on
a comparable basis. As mentioned above, the liquidity situation has turned positive in
recent months as the worst of the contractions of private sector lending and funding has
ended. This process may well improve further as banks are stepping up funding growth
and liquidity would accelerate sharply if private sector credit demand rebounds.

The moderation in the recovery of business sales and production momentum is not
unusual after the initial sharp bounce that ends a recession, and so long as it remains
moderately positive, further liquidity improvement would be normal as credit demand
responds. These processes should eventually alleviate the liquidity strain on the stock
market over the next 12 months. Further quantitative easing of monetary liquidity by
the Fed will be a plus, obviously.

Now, you have to keep in mind that the liquidity analysis is but one facet of looking at
the stock market. If economic momentum slows too much, then profit margins will
decline and earning power will be hurt. That would not be good. However, if the
recovery proceeds even at a mild pace, then liquidity should follow suit, which
would eventually roll into a nice tailwind for the stock market.

The visibility of liquidity growth going forward is not nearly as good and clear as
it has been after most post recession periods. I have a positive stance on this issue, but
we really need to see how the Fed plans to manage quantitative easing and the
credit situation as 2010 draws to a close. Not to make a pun, but the Fed needs to get
off the dime on these issues soon.

Over the past 50 years, economic growth has been fueled more by the expansion of
credit per se than money per se. But, form 1933 - 50, in the wake of the Great
Depression, it was money growth more than credit which drove the economy. the
stock market can rise in either environment, but it would sure be helpful to glean
the drivers going forward and that the Fed needs to address pronto.

Tuesday, October 19, 2010

Stock Market Note

This quick note updates yesterday's post on the short term technical situation. Today's
sharp sell-off breaks the uptrend line going back to the end of Aug., 2010. As I noted
yesterday, a break of the short term trend (based on daily closing prices) would signal
that traders need to take the market's short term overbought condition more seriously.
Scroll down to yesterday's post and click on "Chart" for an update.

Monday, October 18, 2010

Stock Market -- Short Term Technical

The rally underway since the end of Aug. remains solidly on track. It displays a sensible
trajectory and is confirmed by rising 10 and 25 day m/a's. The NYSE adv / dec line is
closing in on a new all time high and my Buying Pressure Gauge is at a cyclical high.
My 40 wk. oscillator reading remains solidly positive and is only slightly overbought
for the intermediate term.

The market is overbought short term, but no topping process is yet underway. However,
the RSI and MACD readings are extended enough to warrant that traders take careful

My cycle work suggests a low point over the next 7 - 10 trading days, but the market
has hardly set up yet for a decline. Experience here suggests not altering a positive view
until there is a crack in the current rising trend line based on closing prices.


Friday, October 15, 2010

Energy Sector

The relative performance of energy stocks has been a substantial disappointment in the
current cycle, particularly so for 2010, when industry operating earnings were projected
as relatively strong on a comparative basis. Now, many non-energy producers have done
very well with earnings in 2010, and the oil price has not matched earlier expectations,
either. Importantly, nat. gas price realizations have been continually suppressed by ongoing
excess supply.

However, the relative performance of energy provider stocks has recently improved
sharply on a firming of oil prices and a possible extended basing interval for nat. gas.
The performance of the sector is noteworthy because a lengthy downtrend of relative
performance has recently ended following successful testing of a bottom. Consider:

Note as well that the energy providers often have stronger pricing power as an
economic recovery progresses.

The Bernanke Hint...

Today, in Boston during a parlay on monetary policy in a low inflation era, Fed chair BB
again made it clear that further financial asset purchases by the Fed would be a continuing
policy option to keep the economy out of the clutches of deflation. But he made it clear
that since quantitative easing was indeed high octane stuff, the Fed would need to be
both cautious and careful in using it. Since floating the idea of additional QE this summer,
the Fed has observed a fast decline in the value of the dollar since mid-year, and more
recently a sharp jump in the oil price. The US probably wants a lower dollar to foster
continuing good exports performance, but there is no way the Fed or the Treasury wants a
large, disorderly slide. The speed and depth of the dollar's recent slide tells them care is
needed with QE. So too with the oil price. A big QE could trigger a run-up in oil which
would badly punish consumer discretionary purchasing power and help undercut any
value to QE. The Fed has received stern warning from the markets concerning the risks
of large scale QE going forward.

Retail Sales

Sales rose 0.6% in Sep., extending the recovery off the 12/08 trough. Retail has been
progressing rather moderately and has not exhibited as strong a bounce as might have
been expected following the steep decline in sales over Half  2 '08. I had an aggressive
8% growth target for 2010, but it now seems unlikely sales will do nearly that well.
Part of the reason for the shortfall reflects the continuing very low inflation rate -- 1.1%
yr / yr -- but it is clear that consumers remain cautious. Retail Sales Chart.

Thursday, October 14, 2010

Junk Bonds

Junk is now trading slightly inside of 8%, and some new issues have fetched 7.5%. That
is a far cry from the 25% yield level the Bloomberg High Yield Index sported at the height
of the financial crisis in late 2008. I thought the junk market was terrific when yields went
above 15% in 2008 because you could earn out your capital within 5 years time. Not often
do you get deals like that!

Increasing confidence in this market has perked right along. The economy has been
recovering, the Fed says it will backstop the recovery with additional liquidity, and It has
pledged to keep short rates low for an extended period. So the market has been drawing in
funds from big and small players alike as the yield hungry feast on this sector.

Being a stingy guy, I do not like to put capital at risk unless I think the potential is there
to earn 10% a year. If I buy junk now, I pick up only 8% in current return or less, and am
in the position of having to see the market rally mildly but regularly going forward. Since
junk yields are subject to business, inflation, interest rate and supply risk, I get edgy
buying junk inside of 9.75% as a matter of principle.

Junk bonds can rally in price for a spell even after the Fed reverses course on monetary
policy and begins to raise short term rates, so many players no doubt feel they have a
"cushion" of time to squeeze out more price gains from holdings.

Still, if you own junk bonds and have been doing well, it is probably a good time to
review whether these issues still meet your strategic goals. For now the trend remains
your friend. Chart.http://stockcharts.com/h-sc/ui?s=MHCAX&p=W&yr=3&mn=0&dy=0&id=p49435614194

Wednesday, October 13, 2010

Financial System Liquidity

As discussed in recent posts, the monetary base has been shrinking. The Fed has also
shrunk its balance sheet in recent months as well. Even so, financial system liquidity has
improved some since mid-year owing partly to an acceleration of basic money M-1 and
modestly faster time deposit growth within the banking system. Private sector credit
demand continues to shrink, so the banks have been using increased deposits to buy
shorter term securities. Annual growth of M-1 has been 6.6% yr / yr and the same for the
past six months on an annualized basis. The growth of M-1 is critical to provide offset to
a broad base of funding, which is up but 1.2% yr/yr. More banks have been expressing a
willingness to increase loan portfolios, but there have been few takers. Households in
the aggregate are operating on a cash and carry basis, and business has yet to expand its
inventory commitment by more than a small margin.

The Fed is actively exploring how to increase money within the system and is now
widely expected to disclose a plan either early next month or at its mid-Dec. policy
meeting. Since the trend of the monetary base forshadows that of M-1 money (cash and
checkables), the Fed is running low on time to fund continuing recovery in the face of
private sector credit contraction. There has been dissension and vigorous debate on
the Board about providing more liquidity because doing so could make policy
execution far more difficult when credit demand finally does turn up and accelerate.

The guesses about Fed intent range from occasional piecemeal asset purchases out to
a grand "nuclear" infusion of $2 tril., which would increase total system liquidity
an extraordinary 17.5%. Most guesses by observers put the size of a new round of
liquidity infusion within a range of $500 bil. - $1 tril. My advice to the Fed is to go
the piecemeal route. Start out with a sizable asset purchase of between $100 -200 bil.
and state clearly that the Fed stands ready to provide limited but substantial further
assistance if and as needed to sustain economic recovery.

Saturday, October 09, 2010

Gold Price -- Looking To Short

I have gold in a price bubble. Gold closed out the week at $1345 oz. From my study of
financial bubbles, I can make a case for a bubble top in gold of $1500. There is sound
empirical evidence for this view and I would submit that arguments for a much higher
gold price rest on flimsy evidence. So, I am ok with a further run of gold up to $1500,
and I would have to say that calling for a further dramatic upmove above $1500 is more
guesswork than anything else.

My plan going forward is to use a small part of my trading capital to gradually initiate
a position in a leveraged gold short fund such as DZZ. I will primarily use technical
analysis to help me follow through on the plan, and expect to complete most of the
purchase over the next six months or so. I am not at all proud of getting chased out of
the position from time to time which you must do when you are short and the asset you
are shorting is as volatile as the gold price.

I believe there is large, fast money on the long side of gold and that the uncertain
financial / economic environment may well draw more fast money in. I also think
that when folks start to turn negative on gold, you can easily see a 50 - 70% decline
over a 12 month period.

I do not think most players out there should even contemplate such a strategy as I
am going to deploy. Too risky and tough to execute particularly in the early going
when gold is attracting so much positive attention.

Here is the DZZ chart. I shall keep you posted periodically.

Friday, October 08, 2010

Economic Indicators

The weekly coincident activity indicator has been on the flat side since Jul. (DJ-BTMU).

The weekly leading economic indicator sets have been improving since the end of Aug.
and suggests the US economy may experience a re-acceleration of growth in early 2011.
The monthly leading indicator for Sep. shows a continuing deceleration in the % of
companies experiencing new order flow. The downtrend has been in effect since Jun.
and has been as steep as  the May - Aug. decline in the weekly leading suggested it
would be. New order rates are wanly positive, not negative, and if the new uptrend in
the weekly leading indicators holds up, should improve before long.

The Global monthly leading index has yet to turn negative but it does show a marked
slowdown of growth since Apr. of this year. as the effects of fiscal stimulus programs
wind down. The loss of momentum in global growth underlies the recent development
of trade tensions as nations seek to shield domestic output from exports. These tensions
are "normal" in the wake of deep global recession and will require continuing
attention from G-20 and maturity from national leaders.

My profits indicators were strong in Jul. and Aug. but did show some evident
moderation in Sep. And so it may be that Q4 '10 profits may come along more modestly
as well.

The Economic Power Index has been improving steadily since the end of 2009.
However, at +1% yr / yr,  it is still too low to support more than low growth in
the current economic environment of reduced private sector credit demand. The
The real wage rate component of the index is still positive but has slowed sharply
from late 2009, as slack in the labor market keeps wage progress slow. The main
positive has been the steady improvement in civilian employment growth, which
registered the first positive yr / yr comparison in Sep. since early 2008. The total
index looks a little better if longer work week hours and overtime are added in.

There remains very sizable capital slack in the system. The rate of capacity
utilization is still below levels seen at the bottom of most recessions and total
employment is still dramatically below the prior cycle peak despite the addition
of 1.6 million jobs off the low point. Finally, the $ level of short term private
sector credit demand remains well below the prior peak and continues to
validate nominal short rates.

If you scroll down the DJ-BTMU link to the longer term chart, you can see that
although the US economy has made a partial "V" shaped recovery, it remains  a
long ways below the 2007 high of this index.

Wednesday, October 06, 2010

Stock Market -- Technical

The rally since the end of Aug. remains intact. However, it is clearly overbought in
the short run. My 6 week breadth flame indicator is a +87. A reading of +100 suggests
a strong short term overbought, with a + 50 to indicate a mild overbought. My buying
pressure index has advanced strongly in this rally to a new cyclical high as has the
NYSE adv. /dec. line -- good signs. My intermediate term 40 week oscillator has
turned up and its smoothed moving ave. has been rising for several weeks -- another
good sign. As the chart link shows, the 13 week m/a is closing in on a rising 40 week
m/a -- I like that too. Chart.

The chart also indicates a rather mild and volatile uptrend off the early Jul. and end
of Aug. lows. If this pattern holds, you can have a continuing advance with some steep
downdrafts thrown in. That would not be a happy pattern and may be an unlikely one,
but that is what is shaping up now.

There has been an 85 trading day cycle that has been in effect at least since the middle
of 2007. Of the cycles I look at, this one has been reasonably reliable. The next low
in this cycle is slated for late Oct. Since lead-ins to these lows have been relatively
gradual, the cycle suggests that the market might retreat over the last two weeks of
this month (Remember pay attention to cyclic movements, but never bet the farm on


Tuesday, October 05, 2010

Stock Market Fundamentals

The last detailed post on the fundamentals was Tues. 7/27/10. I concluded then that I
was still positive on the market, but very watchful. The major issues remain strong
private sector caution resulting in household, business and bank cash hoarding along
with private sector credit contraction and a Fed that misread the economy in early
2010 via curtailing monetary liquidity in anticipation of a turn around in private sector
credit demand that has yet to materialize.

Despite the massive simulus programs and initial large easing by the world's major
banks, we have a global economic slowdown which includes the US and a de facto
liquidity freeze in the US financial system. The freeze has left the US economy to
recover primarily via internally generated funds, and this has been hampered by the
ongoing strong private sector caution in evidence.

The Fed has opted to hold off on providing additional monetary liquidity as it has
been awaiting the loosening up of caution and the advent of a more normal credit
cycle to underwrite moderate economic expansion.

My core fundamentals have gone from being tremendously positive over the first
half of 2009 to moderately positive now. Moreover, the trend is moving toward
less positive as we go along. What's more is that there is still the issue of whether
and when the Fed will see fit to  resolve the liquidity freeze and by how grand a
means (As discussed last week, the Fed has in effect put an ace up its sleeve by
trimming the monetary base by 9% or nearly $200 bil. this year).

Since there is no evidence the economy can grow without a measure of financial
liquidity growth, I plan to go fully negative on the stock market by this year's end
if the liquidity freeze extends and is unresolved.

My stock market fundamental coincident indicator -- the weekly cycle pressure
gauge -- has improved modestly since July when the market correction ended. The
strong run in stocks in recent weeks is likely due more to speculation about a
new round of quantitative easing by the Fed later this autumn than the behavoir
of the indicator.

The US has the potential for an extended bull market in stocks but this may well
not happen if folks remain too uptight about the economy and if the Fed does not
"man up" and inject more liquidity if that's needed.

Saturday, October 02, 2010

"Watch What They Do................"

Veteran Fed watchers like the old expression "Watch what They do, not what They say."
Various Fed governors have talked extensively about a new round of quantitative easing.
The new conventional wisdom is that the Fed plans to begin a fresh plan of easing right
after the Nov. elections. But, the Fed has been tightening since Feb. 2010, and continued
to do so through the last reporting date of 9/22. Specifically, the Fed has shrunk the
monetary base by nearly $200 bil. or 9% since Feb. This regrettable and record move
did the recovery no good and damaged the stock market.

Now, if there is a new round of quantitative easing, the first $200 bil. will only bring
the monetary base back to where it was in 2/10 and will not count as easing at all but
will only end the punishing squeeze the Fed applied over much of 2010.

Traders across most US markets are smitten with the prospects for a new round of
fresh monetary liquidity. With trader attention focused on what the Fed could be
planning for early Nov., you might want to keep in my mind that they have tightened
liquidity by a substantial margin as prelude.

Friday, October 01, 2010

Gold Price

A couple of pals of mine talked me into playing the gold market over what was roughly
the 1975-80 time frame. Those were terrific trades, but as I met more gold players, I
found that aside from the momentum players, these were different folks. Let's just say
that if they were earthlings, then I was from Mars. I have never forgotten the range of
differences in world view that existed between the gold guys and myself. There are
such sharp points of departure that I realized that to belong with the goldies, I would
have to occupy alternate worlds. I've always found enough opportunities in my areas of
interest, that I have not attempted to re-enter Goldland. I did think gold made decent
sense as an investment over 2001 - 2005 because it was undervalued. Since then though
things have been getting out of hand. I even did a nice SLV silver trade in early 2009,
but for the most part, other markets have offered fertile enough ground. With that as
prologue, I'll make a couple of observations about the stuff.

I thought gold was a little toppy at $1250 in Jun. of this year, but the upleg has been
maintained and extended. Gold is obviously short term overbought on RSI, but less
so on MACD and against its 200 day m/a. My fundamental macro-directional
indicator has turned up moderately in recent months, but there may be up to $100 oz.
in short term exitement in the price now. My "proprietary" frothometer now has gold
at about a 55% premium compared to the base trend going back to 2001. That is
a big premium and is a warning that gold is now very extended, much as it was in mid-
2008 and in the spring of 2006. I am also still of a mind that the leg up which began
in Feb. of this year is the last one before a much larger correction. So far, that last
observation has proven off-base.

If there are gold players in the audience, then I hope these comments are of interest.

Gold Chart.

Thursday, September 30, 2010

US Dollar & China

US Dollar
Back in early June I argued that the dollar was getting overbought and wondered if it
would test longstanding resistance at 92 ($USD). Well it did not and it turned down
shortly after. Traders have been shorting the dollar on the premise of renewed
quantitative easing by the Fed and the credible assumption that othe major central
banks may not be prepared to follow suit. There are now a few reasons to think
about taking a long position in the dollar over the next few weeks. 1) It is deeply
oversold. ($USD Chart). 2) Based on recent signals from the Fed, it is far from
clear whether They would want to provide massive quantitative easing if the economy
falters, or whether they might move in a far more modest, piecemeal fashion (which
I believe they should do anyway). 3) I still think it could take another six months or so
before financial stress in the global economy unwinds enough to rule out another
"risk off" flight-to-quality rally in the dollar.

Since I started the blog in 2005, I have argued that China's heavy handed policy of
mercantilism was no longer appropriate and would harm them just as Japan's very
aggressive mercantilist trade policies hurt them. China has been far too slow to
install policies which would bring better balance to their own economy and It has
let the Party fatcats feast off the trade profits at the expense of its workforce. The
policy of rapid money growth within China to maintain the dollar peg produced a
stock market bubble in 2007 from which they have not recovered, and has fostered
speculation in real estate which could eventually become increasingly difficult to
control. Money growth has been so rapid that if I was a Chinese local, I would
regard the yuan as play money.

Trade tensions with the US are rising. Matters may quiet down after the  US election,
but China / US relations are now headed firmly downhill. The shame of it all
is that although China's GDP may now rank #2 in the world, its per capita income
is not even in the top 100. That represents piss poor progress.

I have attached a link to a piece by China based economist Mike Pettis which
discusses the formidable challenges China faces if it is to re-balance its economy
appropriately. Well worth reading. Pettis on China.

Monday, September 27, 2010

Global Stock Market

Following a hellish, large decline in 2008, the global market -- as
measured by exchange values -- has recovered sharply from the
cycle lows in early 2009, but still remains a little more than 50%
below the 2008 high.

Last year, all the major exchanges achieved positive rates of return,
and 73% of them outperformed the US market as investors bet
heavily on the markets of faster growing, more volatile economies. It
was a banner year for global investing and enticed most US market
sages to recommend strong participation in foreign markets in 2010.

This year has been tougher going. Only 64% of the world's exchanges
are positive so far in 2010 and 48% of them have underperformed the
US. The relative strength of global markets has improved markedly
since late Apr. 2010, as US economic and profits growth prospects
are seen as slowing (For Apr. 2010, only 11% of foreign bourses
were stronger than the US for the first four months of the year).

The US market has fared well in Sept. Short term cycle indicators
have improved some and investors have responded favorably to the
Fed's promise to backstop the economy should it appear to falter.
This has served to re-invigorate interest in foreign markets, with
the global index outperforming the US in Sept.

The Dow Jones Global Exchange Index has failed to get through
strong overhead resistance since the cyclical bottom of the market
in early 2009. The market is presently moving up toward the 600
resistance level on the Index, and is also starting to signal a more
positive trend for relative performance.

Strongest markets are: Jakarta, Colombo, Sensex, Istanbul, KL,
Manila, Santiago, Caracas and Bangkok. The Nordics are doing well,

Dow Global chart.

Saturday, September 25, 2010

Quantitative Easing

Since Aug. 2008, the Fed has increased the monetary base by a factor
of 2.2 via purchases of financial assets. This was done to refloat the
economy during the massive recession and to help generate economic
recovery during a period of private sector credit contraction. This has
excited reams of pro and con commentary. Interestingly, it has been a
far smaller version of what the Fed did during the Great Depression
period when it increased the monetary base by a factor of nearly 5.5
times over 1932 - 46 to generate economic recovery during an
extended period of debt "deleveraging". The Fed steamed right along
with this policy during WW2 to backstop the war effort as well.

During the 1932 - 46 period, the Fed also kept short term interest
rates exceedingly low, much like today. Over this same period,
inflation compounded at 2.7% per annum, and the purchasing power
of the dollar contracted as funds left in short term risk free assets
failed to generate returns sufficient to "cover" inflation. However,
the bond market did provide yields above the inflation rate and the
stock market recovered dramatically. Investors had ample
opportunity to protect their assets during this period despite the
extraordinary and sustained easing of monetary policy.

The super accomodative monetary policy of 2008 - present was
designed by the Fed to provide the same initial boost in liquidity
It provided in the dark days of 1932. The Fed would dearly like
to avoid the sort of super quantitative easing it provided over 1932-
46. The decline in US production during the recent recession was
roughly only a third of that sustained during the Depression, so
more serious inflation could develop this time if the Fed does not
maintain sensible balance in trying to coax the current economic
recovery along. Yet, if private sector credit demand remains
subdued, the Fed may have little recourse but to provide further
liquidity to support the economy and prevent deflation pressures
from taking further hold.

Thursday, September 23, 2010

Inflation Vs. Deflation

Inflation in the US has been trending down now for 30 years(Chart).
As seen on the chart, the downtrend has not been a narrow, smooth
one as inflation -- driven periodically by surges and declines in
commodities prices -- is volatile. However, the chart shows clearly
that this data series (yr/yr % chge) is becoming deflation prone at
cyclical low points. This is not a welcome development for an
economy that has grown much more strongly levered by debt over
the same period, as collateral values become more suspect in such
an environment, which, in turn, is an impediment to further growth
of private sector credit.

The consumer price index (CPI) has recovered from a cyclical low
point registered at the end of 2008, but remains slighly below its all-
time high reading set in Jul. 2008. So, technically speaking, the US
is still in a deflationary period, which will not end until the CPI starts
rising above its old high.

The recovery of the CPI since YE 2008 pre-dated the end of the
recession, but was a normal enough cyclical move which was
correctly captured by the inflation pressure gauges I use. However,
the gauges have flattened out over the course of 2010. This reflects
the leveling off of commodities prices coupled with a further
unwinding of inflation pressures excluding the volatile but critical
food and fuel measures. After all, there is still a large amount of slack
in the US economy.

There has been a moderate pick up in commodites prices this month
but it is easy to understand the Fed's concern about the spectre of a
return to a declining CPI (deflation) if the economy does not begin to
re-accelerate in growth.

My longer term inflation pressure gauge -- built off the momentum of
the leading economic indicators and the trend of capacity utlization --
is still signaling further recovery of the CPI over the remainder of this
year and into 2011, but it has lost substantial momentum since the
spring of this year.

My long term inflation potential measure still has inflation set to
rise eventually to near 3.5% a year, but that too has eased reflecting a
dip in the long term (10 yr.) growth of the broader money supply.

The economy has entered its second year of recovery and it is not
unusual to witness a loss of growth and inflation momentum. Since my
principal economic leading indicators are still consistent with
continued economic recovery, I have not abandoned the idea that
inflation pressure will re-emerge in this cycle. However, I have this
view on a short leash as I strongly prefer to see improved financial
liquidity conditions and a lessening of strong private sector caution

Continued strong consumer, bank and business caution would put the
US on the razor's edge of economic decline and renewed deflation
pressure. Thus, you have to take developments month by month and
see if folks do finally "loosen up" a little.

So it is that the Fed is holding further quantitative easing in abeyance.
It would greatly prefer to see the economy loosen up and see credit
flowing to meet rising demand without further intervention on its part.
As discussed in the prior post, I would like to see the Fed  begin to
ease up moderately now and certainly hold off on a massive bout of
additional easing as the latter could be quite obviously problematic.