Stock Market -- Short Term

With yesterday's release of the 1/13 FOMC policy meeting notes, the Fed poured a full
cup of uncertainty into the punchbowl (See the 2/20 post just below). It came as news to
an overbought, extended stock market which was experiencing momentum loss anyway. So,
traders have lined up to book profits after an extended positive run since early, Jun. '12.
The SPX has broken below its 10 and 25 day moving averages although the latter two have
yet to roll over. My extended time MACD which had clear sailing since the end of Nov. '12
is still positive, but it is operating on a wing and a prayer now. In the upcoming SPX chart link
I also show the money flow index (MFI), a price and volume based relative strength index.
One use for the MFI is when it begins to trend down ahead of the market, especially if it
is from an uptrend that made an overbought reading. SPX With MACD & MFI

I also have linked to a five panel chart that shows the SPX with some risk measures.
SPX & Indicators The SPX portion of the chart shows the market against its 200 day m/a.
It reached a nearly 9% premium just the other day at 1530. That sort of premium represents
a significant overbought. The top panel of the chart shows the VIX or volatility index.
Readings down around 10 signify a confident, complacent market. You'll need to see whether
the VIX moves up further to clear 20, as that would warn of a correction. I would also call
your attention that price corrections which begin off a low VIX / high confidence reading
can get nasty. The fourth panel down measures the relative strength of the SP 500 ETF vs.
the long Treasury price. It is toppy at resistance in the 1.05 area and reveals a possible
transition to "risk off" mode by equities players. The bottom panel of the chart shows the
relative strength of cyclicals against the SPX. The clear uptrend here which signals growing
confidence in the earnings outlook is now being challenged via the Fed's new caution about
the future of QE 4.

The Fed: Let's Try For The Best Of Both Worlds

Minutes of the late Jan. FOMC meeting show a Fed planning to keep the large QE program
going, but in deference to the inflation hawks, plans are afoot to look over alternatives
which feature possible modifications that could wind up reducing the $ volume of QE.
Has the Board lost its collective nerve? Well, not quite yet as I will endeavor to point out.
First, let me say uneqivocally that I regard this kind of ambivalence as bullshit. The
instruments the Fed has at its disposals are large hammers and not the tools one could use to
fine tune anything. You either need the bigger hammer or you do not.

The game here as I see it is that the Fed desires to push QE 4 along but is afraid that strong
liquidity flow into the financial system could weaken the dollar and set off hefty speculation
by financial types in the oil and commodities markets. I doubt the Fed stays up late nights
worrying about what the prices of gold and silver might do except in so far as rallies in
PMs  might re-inforce the speculation in oil and commodities. The Fed's concern here is that
a run-up in commodites will accelerate inflation and pinch real incomes which are already
under pressure from the recent increase in the payroll tax. By crying wolf as they allow the
beast to roam, the FOMC hopes to keep folks from running up the prices in the oil / fuels
complex via concern that the Fed may curtail QE and leave the guyz with unsustainably long
speculative positions. The Fed has spooked the PM market by adding strings to the QE $
program, but oil and gasoline players were more nervy and so the FOMC has now trotted out
its QE curtailment in "potentcy" as Aquinas might have said. This could be clever stuff as
long as the Fed does not have to cry wolf but rarely.

I see the progress the economy has made off its lows in 2009, but I am not yet convinced
economic expansion has reached self sustain mode. therefore, I am still happy to see the Fed
with a robust QE program.

The Fed has punished the gold players since latter 2012: GLD Gold Trust ( Yes, a big
test of support could lie ahead).
 

Stock Market -- Weekly

Technical
This week I return to the broad, unweighted Vale Line -A index and the NYSE advance -
decline line. I use these two measures in tandem as a sort of informal model of the stock
market.

First up is the Value Line 1700 + issues chart. $VLE  By this measure, the market is trading
at an all-time high. Using the Sep. 2011 low, my trend work suggests this market is over-
extended on the upside for the first time since the spring of last year. No red light here, but an
amber warning signal. The VLE is also overbought on RSI and MACD, and the weekly
price momentum indicator is just coming off an overbought +20%. The market is on a rising
trend, but this is a very mature rally.

Next we turn to the NYSE weekly A/D line. $NYAD The chart includes the VLE in the top
panel. Here again, we have an uptrend in breadth which is also making new highs. We also
have an overextended market reading and overbought indications for stochastic RSI (momentum)
and plain RSI. The stock market when rising tends to start to have difficulties when the
weekly A/D line begins to get tangled with its own 6 week moving average. It is running free and
clear above the 6 m/a now, and a toppy suggestion is not likely to come unless the A/D line
starts to break down against  its 6 wk. m/a. Keep this in mind.

Fundamentals
The Fed remains on a relatively vigorous QE program, with the QE trend remaining strongly
positive after a slow start last autumn. The weekly cyclical fundamental indicator has eased off
modestly in the past couple of weeks as sharp progress in the reduction of new unemployment
claims and in sensitive materials prices has ebbed. Continuing progress in stocks in the past
few weeks represents a divergence to the WCFI, but note as well that stock price momentum
has started to slow.

Stock Market / Economy

The rally in the market to a new cyclical high over the past seven months primarily reflects
the expectation that substantial new QE by the Fed would eventually translate into faster
business sales and earnings growth. Now the QE4 program of liquidity infusion did not
get going until early Nov. 2012. In turn, my weekly cyclical fundamental index (WCFI)
 -- a forward looking measure as far as the economy is concerned -- began to recover in
June. On balance, the advance in the stock market has mirrored the WCFI, but the economy
has yet to confirm the WCFI with an acceleration in growth. I have not been so concerned
with this issue because I figured that since QE 4 did not start in earnest until early Nov., it
would be best to tack on a 3-4  month lead time to the unofficial onset of QE before looking
for faster economic progress. Well, we are there now, and it is fair to look for the economy to
start performing better PDQ (quickly).

Sales and production data for Jan. '13 were not good, and it appears that the business
inventory sales / ratio is running a little higher than earlier in the recovery. Moreover,
US trade data for Dec. '12 showed both imports and exports to be flat on an extended basis.
And, to cap off matters, the WCFI has started to flatten out as well in recent weeks following
a strong initial start (Confirms the recent loss of momentum in stocks).

I do not find the stock market at all interesting as a long unless we not only see business sales
pick up soon, but get on a track that would begin to lift US sales out of the 3 - 4% pattern we
have seen for months. For me, it is unwise to bother putting capital at risk for more than a
short term trade unless I think I can earn a 10% return per annum at the minimum. The
prospect of 3 - 4% top line growth for US business is not likely to support the return hurdle
I use. The SP 500 is trading around 15X 12 month earnings and a slow struggle, modest growth
muddle - through is not going to be good enough.

The US economy needs to start performing pronto.

Weekly SPX Chart

Strategists Warn On Bonds

Way back in 1981, I was SVP and chief investment officer for NYC based and since long
gone Irving Trust (1 Wall St.). Relative to our size, the trust unit was among the biggest
bond buyers in the US. Sentiment was so bearish, I used to get the occasional phone
call from an economist on Fed Chairman Volcker's personal staff inquiring about my
job standing and whether I still liked the bond market. My stock answer was that I was on
tenuous ground but still a buyer as bonds were 1) yielding more than most companies
earned on their equity and 2) with a blended bond portfolio, we could earn out our clients'
capital inside of five years (There were call protected corporates available for 18%). It
was not the last time I faced career risk in buying bonds, but it was the most memorable.

The bull market in bonds was one of the greatest and most durable in history and also one
of the easiest to trade ever known -- far easier to trade than stocks or currencies or just
about anytrhing else. It was simply like shooting fish in a barrel.

looking at the very, very long term for bonds, it is easy to note that yields are at or near
historically low levels, and it is hardly difficult to wisely surmise that yields will not
stay so low forever. So,what to watch for.

From a finance perspective, bond yields have had two anchors: 1) a long term decline in
short term Treasury yields, and 2), a long term deceleration of inflation. A lengthy bull
market in bonds has  instilled such investor confidence that the "spread" between the 30 yr.
Treasury yield and the consumer price index measured yr/yr has shrunk dramatically.

The US 91 day T-bill now yields 0.07%. Even with economic recovery, the 36 month
centered CPI is but 2.3%. With low inflation and the Fed's ZIRP policy on the Fed Funds
Rate (FFR%), it makes perfect sense for bond yields to be low.

Now, despite an achingly slow path, the US economy is moving toward more normal
bounds and is very gradually recovering the ability to self sustain. It can still certainly
backslide, but within the next year or two, economic expansion may be stable enough
for the Fed to not only have curtailed liquidity infusions but to raise short term interest
rates. Ending ZIRP will send a shudder to the bond market, and yields might be
expected to rise dispropotionately to the initial moves up in the FFR%. as bond players
assume there will be more upside to the FFR% over time. This series of events will be
a strong bear signal for bonds at least on a cyclical basis.

But, rest assured, the near collapse of the financial system and the damage to the economy
that came with the near economic depression of 2008 - 2009 created great caution that is
only slowly dissipating and which can be set back by premature Fed tightening, stepped up
fiscal austerity or the continued punishment of the wage earner.

In the meantime, I will be watching my favorite standbys -- the direction of industrial
commodities prices and the 6 mo. % momentum of industrial production.

Financial System Liquidity

1) My broad measure of credit driven liquidity or bank funding capacity is continuing to
show accelerated growth and is now up 6.8% yr/yr. This is good news for the economy
and it is also nice to see that all major funding categories are finally on the rise. The basic
M-1 money supply is still contributing to broader liquidity growth, but it is counting for
proportionally less as time moves on.

2) Banking system total interest earning assets are up about 6% yr/yr, the minimum rate
I would like to see to sustain economic expansion. The banking system's loan book is up
about 5%, held back by continued ever so modest expansion of the real estate book as
housing activity and real estate development remain well below pre - recession levels
and as banks concentrate on booking fees for mortgage refinancing and portfolio quality
upgrading.

3) Fed Bank Credit has been expanding rapidly in recent months via the new QE program,
but assets on the Fed's book are up but 2.9% yr/yr. Since broad business sales growth rose
only 3 - 4% over the past year, the slow pace of QE measured on a 12 month basis did the
economy no favors. The practically wise course for the Fed would be to stick with the
now more rapid QE program until business and private sector credit demand strengthen
and confidence increases to levels which can allow self - sustaining economic growth.

4) Recently, the annual growth of broad credit driven liquidity did exceed the advance in
business sales measured yr/yr, thus allowing liquidity to flow beyond the needs of the
real economy and primarily into equities. This flow of liquidity was last seen in late 2009
and is a measure of how tight the banking system has been in extending credit to the private
sector. Excess liquidity relative to real economic demand only helps stocks when investor
confidence is reasonably strong which it has been since mid - 2012 when the Fed first
signaled new QE. Folks have been happy to buy stocks on the premise that major new QE
from the Fed will lead to faster business growth. But, such must begin to unfold soon to
keep confidence levels up.

5) Money market fund (MMF) balances were drawn down heavily from mid - 2009 through
2011 as money flowed into the capital markets with some also finding its way into the
purchase of goods and services. Since the end of 2011, fund balances have remained
fairly steady even with scant returns on MMFs. If fund participants have invested or spent
their discretionary cash, future moves in the capital markets are more likely to remain
strongly rotational.

Stock Market Factors

The SPX closed out today at a new cyclical high to confirm the uptrend. The market is
moderately overbought against the 25 day m/a as well as against the 200 day m/a. The
SPX stands 8.2% above the 200 day m/a. Your careful attention is required when the SPX
goes to a 10% premium to its 200 m/a. The market remains extended in price compared
to its price channel up from Nov. '12. SPX And Indicators

The top panel shows the VIX or volatility index. Traders often use the VIX to measure fear
and complacency in the market. You can peg an uptrend in the market off the late Sep. 2011
interim low through the present and note that the VIX has been trending down over this period
suggesting rising confidence. When the VIX falls to a reading of 10.0, investors are seen as
smugly complacent. The current reading is now a low 13.2. When the VIX rises, players are
thought to be growing fearful. When the VIX crosses 20.0 on the way up, you should take note
as well.

My advisory / polling sentiment indicator is excessively bullish at a reading of 65.0. Over
the last couple of weeks. the index has moved up from the mid - 50s to a range of 61.0 - 63.5.
Opinion is indeed starting to warn of optimism that is cruising toward the fringe of exuberance.

The first of the bottom panels in the chart compares the relative strength of the SPX etf to the
long Treasury. Rising strength indicates players are in "risk on mode". This ratio is again up
to the substantial resistance levels seen back in 2011. No reason the ratio cannot motor up
through resistance, but good reason to know we are there now.

The final lower panel looks at the relative strength of cyclicals against the broad market and
is a good gauge of investor opinion regarding SPX earnings potential. This is an important
measure because: 1) earnings leverage resides with the cyclicals; and 2) Players like relative
strength in earnings when structuring portfolios. The uneven uptrend in the ratio shows how
carefully investors are weighing earnings potential this year.
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We in the New York area are experiencing our fourth annual "Storm Of The Century", this
time in the form of a blizzard tabbed as "Nemo"... Hope the power stays on, but if not, the
next post will be a few days out.

Stock Market -- Daily Chart

The market rally, which has been humming along since mid - Nov. has hit overhead
resistance on the SPX just under the 1515 level. The market is working off a short term
overbought condition and has yet to move into a situation which would generate strong
warning signals that a significant correction may be at hand. The SPX is mildly extended
on a three month price channel basis now bounded by 1450 - 1490 and could fall to test
the 1450 - 1460 area in the short run without violating the base uptrend line in place since
mid - Nov. Since the short term seasonals call for weakness in Feb., and since a nine
month cycle price low is due this month, you may want to switch off from cruise control to
manual for a spell if you have been coasting mentally through the recent advance. SPX Daily

Global Economic Growth Momentum

Global real growth momentum tends to decelerate as an economic recovery gains in maturity.
Boom / bust indicators show powerful recovery momentum surges in both 2009 and 2010,
but growth did decelerate persistently and substantially from there when measured yr/yr and
seemed destined to start courting contraction as late as Jul. 2012. Global PMI

The global leading indicator, based on new business order flows and sensitive materials
prices, turned more positive in Aug. of last year. Its momentum suggests an end to the
deceleration of real growth, but the pick up in momentum so far has been modest and needs
to firm up further to support the profits growth acceleration which is currently being
discounted by the world's major stock markets. Moreover, with a number of countries now
employing QE programs by their central banks, global demand should strengthen enough to
support a  revival of trade to avoid the development of conflicts centered around
accusations of deliberate currency devaluation which can ultimately undermine economic
stability. A substantial re-acceleration of global trade is needed as an important safety
valve in the economic growth equation for 2013.

Commodities -- Important Resistance level Ahead

It has been my view that with broadscale central bank QE in place, the global economy
should soon experience a reversal in growth momentum from negative to positive. In
2008, the CRB Commodities Index experienced a price bubble top of near 475 before
crashing to long term support around the 200 level in early 2009. There was a strong
recovery out into 2011, but the CRB has languished since then as China, the major
commodities consumer, experienced a sharp deceleration of growth. With Beijing now
showing better production numbers, the CRB has been drifting higher again recently,
and at 305, is set to challenge the five year downtrend line in place since the 2008 top.

Index indicators for the CRB show the index is slowly turning positive, so speculation
about whether it can take out the longer run downtrend is not idle. CRB Index Chart

A break above the downtrend does not by itself imply a new longer term advance may be
in store. Commodities are too volatile for that. Moreover, the CRB would have to take out
the 370 level interim high set in Apr. 2011 to solidify the bull case.

The 320 line on the chart does reflect my judgment that 320 represents minimal long term
fair value for the index based on a macro view of the curve of production costs. It would
be disappointing not to see the CRB hit the 320 level this year especially since continued
global economic growth should be sufficient to wipe out the small amount of excess
commodities production capacity which is still apparent.

US Monetary Policy -- Looking Ahead

I keep a carefully drawn chart of Fed Bank Credit. Since the Fed first moderated QE in late
2008, they have worked hard to keep the flow of credit within a $250 bil. band. At the
present rate of expansion, Fed Credit will exceed the top of the growth band near mid -
2013. They may just allow the flow of liquidity to go  right on and exceed the top of
the band by a handsome margin, but chances are that if the economy is expanding and the
unemployment rate is coming down, more of the voting governors are going to take issue
with the current powerful trend up in credit flow and there will be a stronger voice behind
the idea of scaling down but not eliminating the QE program. FBC Chart (PDF p.7) 

This very possible surge of concern about Fed expansiveness is not a done deal, but it is
a contingency for equities and bond investors as well as currency traders that needs to be
kept in mind.

Oil Price

1) My base case for the oil price in 2013 is a range of $85 - 105 bl. WTIC to be paced
primarily by stronger demand in China and the various QE programs by major central banks
which can positively influence physical demand and price speculation from financial players.

2) Political stability issues in both the Middle East and North Africa to include a re-focus on
Iran's nuclear development program could easily pop up and drive the oil price sharply and
temporarily higher.

3) The oil price at around $97.50 bl. is now at the top of a huge pennant formation dating
back to  mid - 2008 (top of downtrend line) and early 2009 (bottom of uptrend line).
Oil Price 10 Year Chart It is interesting but not at all atypical that the oil price has not been
able to take out the price bubble highs of mid - 2008 and it is at least as interesting that the
price has settled into a very leisurely trend up from the early 2009 low. This triangle or
pennant formation looks to close out late this spring in the low $90's per.

4) Near term, oil did follow its normal late year seasonal pattern and allowed those interested
in the long side to accumulate positions. This seasonal window closed in Jan. of 2013, as oil
maintained its Dec. uptrend through a normally weak seasonal period. Feb. is also a seasonally
weak month and the market could still bow to seasonal forces (Late Feb. is usually when pit
traders and pundits put the bombers out on the tarmac to attack Iran and try to jump start a
rise off a seasonal price low).

5) The oil market is presently overbought short term and this is especially noteworthy now as
there is another month of possible pronounced seasonal weakness to work through before the
ramp up for the Northern Hemisphere driving season. WTIC Technical Chart The USO
exchange traded facility is featured in the bottom panel of the chart.

GDP -- 2012 Was A Slow Go

The fed. gov. has many ways to play with the GDP data. That is why I stopped forecasting
it over 35 years ago. I thought Q3 '12 was a politically inspired +3.1% and with the election
over, I am not surprised that the initial report for real GDP showed a -0.6%. Enough said on this.

It can be instructive to look at the data by sector, however. Consumption in real terms was a
punk +1.9% yr/yr reflecting continued heavy maldistribution of income away from the average
wage earner. Housing investment was strong as was to be expected, but business fixed
investment was up a scant 4.3% as slow broad economic growth kept capacity utilization at
low levels. Export sales ended up the year about where they were in late 2011, as global trade
slowed sharply. Total government spending -- federal, state and local -- declined in real terms
and damaged economic performance. Calls for sharper cuts in federal spending ahead look
even more stupid.

The Fed, which largely quit QE support for the better part of 18 months, must shoulder a goodly
amount of the blame for a very sluggish economy. I warned for months that the Fed was
gambling with the recovery with an extended liquidity squeeze after mid-2011, and the punk
result for 2012 bears out the concern.

The takeaway here for policy is pretty obvious and that is: do no more harm. That means
abandon raising taxes further, make no more than slight token adjustments to federal spending,
and keep QE in place at a strong level. It also again makes it clear that the administration and
the congress need to end the bozo circus sideshows and focus instead on how the gov. might
help a struggling economy move forward at a faster rate.
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Russia Stocks

Back on 12/5/12, I posted that the Russian market had some fundamental pluses in store for
2013, and that stocks had some potential. Well comrades, the market has made a fairly strong
move. Back then I pointed to the way the Russian market was shadowing the Euro stocks,
the EU being an important trade partner, and in today's update of the RTSI chart, I compare
it with the oil price. RTSI Chart  You will note that the market has no serious resistance
until the 1750 level but also note this baby is getting overbought in the short run.

Gold Price

Gold price direction fundamental indicators have turned positive over the past couple of
months following a nearly 18 month bout of weakness. With gold, I follow Fed Bank Credit,
the oil price, industrial commodities prices and global industrial production. The trends in
these indicators provide a decent enough picture of whether the gold price should be moving
up or down but viewed historically, only the oil price has provided helpful guidance on the
magnitude of swings in the gold price.

Right now the fundamentals plus my micro analysis of what the gold price should be based on
costs and a profit margin sufficient to encourage direct reinvestment suggest a gold price in a
range of $1050 - 1100 oz.

However, the gold price can also carry an enormous premium if enough investors and traders
become concerned about the potential for acute, systemic economic and financial crisis. On
the flipside, the gold price can languish when large crises are not perceived to be on the radar
as transpired over the 1983 - 2000 period.

When gold briefly topped $1900 in 2011 when fears of a Euro and EZ collapse were acute, the
crisis premium was 100% above what the ordinary fundamentals suggested. Now the crisis
premium is down to 54% as market players have become less worried about a serious blow up
in a prime economic region such as the US or the EZ.

If there is greater cyclical strength in the global economy this year, but players take this trend
as a signal that further, dramatic economic and financial upheaval may be averted or greatly
delayed, traders may opt to look for greener pastures for their money than gold even if the
ordinary fundamentals remain positive.

The daily gold chart does show the tensions in the market. Crisis fears have abated significantly
since the 2011 all-time high, but gold is nevertheless trading above the $1550 oz. support level
seen in 2012 and just as central bank chairs Bernanke and Draghi declared for fresh QE.
Daily Gold Chart

One move for traders as discussed last week (below), has been to rotate money into equities.

Stock Market -- Short Term

Weekly fundamentals continue to improve. The trend of the market remains up. The
SPX is now moderately overbought on a short term basis due to 14 day RSI and a
3% premium to the day 25 day m/a. The same holds for the intermediate term trend
based on a significant SPX premium to the 200 day m/a and the very high % of stocks
trading above their respective 200 day m/a's. SPX Chart

February could be tricky. Historically, it is a seasonally weak month and the next 9
month cycle low is due as well. Nothing biblical here, just reminders.

Rotation From Gold To Stocks

The gold price and the stock market reflect some key variables:
.... Fed policy in terms of both Fed Funds rate and monetary liquidity;
.... Leading economic indicators;
.... Trends of industrial production, sensitive materials prices and the oil price;
....  Broad measures of inflation.

Gold and stocks will often part company when investors fear severe systemic financial
problems ahead and / or when inflation is accelerating rapidly. Inflation has been a minor issue
in recent years, but fears of financial / economic armageddon have been hot button issues.

For years, smart equities players have gone long the gold market when systemic stress
anxieties have run up, and have moved back into stocks when such anxieties abate. That has
clearly been the case since the late summer of 2011 when worries about a possible collapse
of the Euro and disintegration of the EZ peaked. Since then, faster money equities players have
been rotating from gold back into stocks SPY Strength Relative To GLD

From a purely technical point of view, stocks are getting pricey relative to gold while the
SPY / GLD relative strength measure is coming up to resistance. So we are moving into an
interesting period when confidence in the potential for faster global growth in a mild and
systemically stable environment might be tested. If the idea of quiet economic progress holds
up, then the SPY / GLD ratio should easily surpass the 1.00 level this year. Keep an eye on it.

Stock Market -- Weekly

Fundamentals
The weekly cyclical fundamental indicator has turned up sharply reflecting rising sensitive
materials prices, reduced unemployment insurance claims and a stronger coincident indicator,
which measured weekly, has increased to 2.5% yr/yr. The coincident measure is not seasonally
adjusted, but it does suggest a good start for business in the new year.

The Fed continues to add more generously to its balance sheet -- a continuing positive.

Technical
The SPX remains in a confirmed uptrend. SPX Chart. Note that 12 week price momentum has
finally started to blossom after a lengthy muted period. The 40 wk or 200 day price oscillator is
positive and on a buy signal. The 6% premium of the SPX to the moving average signifies a
mild overbought condition for the intermediate term. SPX vs. 200 Day M/A

Cycle And Seasonal
The venerable 9 month cycle low is due to arrive near mid - Feb. The seasonal pattern,
distilled from long term studies, also suggests price weakness or profit taking going into and
during Feb. (Respect, but never bet the farm on theses measures.)

Sentiment
One hot topic currently is that "everybody is bullish" which is taken to imply that a downsweep
could be at hand. I use a compilation method to measure bullish sentiment from several opinion
and advisory services. An index reading of 65.0 suggests opinion is too bullish and does
carry a warning of a probable price correction not far ahead. The current reading is 55.3 and is trending higher (For comparison, the index at the market low in 3/09 was 21.7).

Stock Market -- Long Term

1) The stock market has experienced an extraordinary period over the past 16 years. There was
the classic price bubble of 1996 - 2002 and then another or "echo bubble" from 2003 - 2009.
Both markets saw very powerful cyclical earnings performance and elevated price / earnings
ratios and both ended with very large earnings declines, especially when one looks at net
per share as originally reported and to include all the writeoffs and one time charges.

2) In my view, the SP 500 remains in a long term bull market dating back to the end of WW2,
when the focus of buying stocks largely to reflect earnings and dividend growth first took hold.
We have not reached the end of this epoch yet.

3) I have attached the Yahoo! long term SP 500 with log scale. SP 500 Chart To form a band,
I would anchor the low part of the channel with 1950 and 1980 as thr bases, and for the top of
channel, I suggest drawing a trend line up from highs recorded over the late 1950s and 1960s.
The bubbles of the past 15 years exceeded the top of the upper band of the channel and the
bottom in 2009 came in about 10% over the bottom of the channel. Time will tell of course,
but the Mar. 2009 low could be a very substantial one.

4) What is interesting to me about the chart now is that the SP 500 is starting to inch up to the
top end of the channel which stands at around 1700 for 2013. The index stands at 12.6% below
the top of the channel, and wouldn't you know it, SP 500 net per share stands very close to the
top of the 1950 - 2013 channel for earnings. Viewed over the very long term, price and net
per share performance now stand in decent balance. There seems to me there is no good
reason not to look for the SP 500 to go on to new all time highs as long as the current economic
expansion stays intact.

5) The price chart also suggests to me that if it is true that grand bull markets have three clear
uplegs, then the final leg up for the "invest for growth" era could be underway. But, do not jump
too far ahead of the story. Even though the 400 industrial companies composite within the SP
500 is on to new high ground as is the NYSE A/D line, we ain't there yet for the lagging 500.

Business Profits & The Stock Market

1) SP 500 net per share measured quarterly have been flat now for 18 months on both
decelerating sales growth and modest profit margin pressure. Leading economic
indicators, both weekly and monthly, are signaling an upturn in the US economy. My
coincident indicators (measured yr/yr) have moved up from a very sluggish 1.2% for Oct.
to 1.6% through year's end. Most important for the market, the Fed has embarked on a
strong new program of QE. Although economic data do not yet reflect the rise in the payroll
tax and how it might impact consumer spending, the indicators on balance point to faster
business sales and earnings growth. Good thing, too as it is doubtful investors are going to
stay interested in the market without confirmation from improving earnings. The market has
been discounting a bounce in sales and profits for over 6 months and it will become
increasingly vulnerable without stronger, positive news on the economy early this year.

2) SP 500 eps is now running about 22% above the very long trend line for earnings. This is
not at all unusual during an economic growth period. You should also note that during extended
periods of sales and earnings growth, net per share can stay well above the long term trend for
a lengthy period of time. Also note, that to have a long economic cycle, a range of balances
need to be struck between various measures of economic supply and demand. My view since
early 2009 is that the US, coming out of such a deep recession, has a good chance for a lengthy
expansion period, but note the prior post for drag factors that could upset the apple cart.

3) Earnings rarely rise or fall more than one very broad standard deviation from trend. When
net per share has risen well above one standard deviation over trend, the recession which
follows brings a larger than normal decline in earnings. SP 500 net earns. is now running about
$10 or 10% below the upper band of the long term channel. So, a strong year in 2013 would
set up a rather early warning signal about the cyclical durability of eps.

4) Return on equity at book value is now running about 15.5% for the SP 500. The earnings
plowback ratio is now running 67%. ROE% x Plowback = implied growth. 15.5% x 67%
gives you implicit growth of 10.4%. History does not suggest a bright new era. History does
suggest companies are retaining too much of earnings to make share buybacks and to do deals.
the huge writeoffs we have seen at the end of the past two expansion periods in this first
decade of the new century attest to that (Let's hope the Rio Tinto and Hewlett Packard fiascos
are not the opening wedge of a wave of new writeoffs resulting from dopey CEO empire
building). Shareholders would be better served by higher dividend payout ratios.

Stock Market -- 2013

The US starts the year with ample resources of physical capacity, labor and financial
capital. The country is in the midst of the most powerful liquidity cycle since the 1930s
which would normally assure both an advancing economy and stock market. Since the
inflation rate has been tame in the recovery environment, the stock market should be
trading at an elevated p/e ratio, and with $100 per share earning power, the SP 500
should be trading in a range of 1650 - 1700 and not the low 1480s.

But there are significant drag factors. The Great Recession, now more than 3 years past,
has left the private sector with a shared case of post traumatic stress syndrome. Consumers
have been spending, but have also worked to reduce debt exposure. Bankers, who threw
money at people over the 2004 - 2007 period, have just begun to slide out from hiding
under their desks and do some lending. Business as a group has been accumulating cash at
almost no return, and has been maintaining a salary policy which enriches the top guys at
firms and impoverishes the rank and file through reduced real wages for over a decade.
Even the Fed, which has greatly expanded its balance sheet as it should have during the
recovery, has instituted temporary bouts of liquidity shrinkage which have introduced
volatility into the economy and the markets and which have undermined one of the most
precious commodities in hard times -- confidence. Official Washington is meanwhile
engaged in a center vs right battle over raising taxes and cutting spending when it should
be looking at how to grow the US economy and to define its role in positioning the US
to perform well in a changing global economy. Austerity measures are for boom times,
not for times when folks are down on their luck, which they still surely are.

So, when I look at the stock market's potential for this year and next, I see strong positive
forces arrayed against large batteries of scaredy cats, corporate piggy dudes and a nation's
capital that is mired in doubts (the Fed) and political squabbles based on incorrect
perspective and destructive impulses.

Keep up your courage chairman Bernanke and maybe we can snatch victory from the jaws
of defeat.

Profits & Economic Indicators

Corporate Profits
Since the spring of 2010, business sales momentum measured yr/yr has declined from
+10 - 12% down to +3 - 4 as 2012 ended. Historically, when sales growth has dropped
below 5% yr/yr, it has been difficult to maintain profit margin and this time is no different
although my indicators suggest only minor pressure. Top line data is consistent with modest
progress in profits. I would also note that when my top line sales indicator drops below 5%
it signals vulnerability to further sales weakness ahead although not necessarily a recession.
Decelerating Production Growth

Forward Looking Economic Indicators
The leading indicators I follow remain in an uptrend but have been unusually volatile during
this economic recovery. No recession has been indicated, but there have been low points
in each of the past three years which have triggered QE responses from the Fed. The last
of these low points occurred in mid - 2012, and since then, the forward looking measures,
both weekly and monthly, have turned up mildly, with new orders measures for the industrial
sector improving but nominally. On balance though the forwards suggest a mild degree of
acceleration of business sales (and profits) in early 2013 (But, see final paragraph below).

Coincident Economic Indicators
Mine reflect momentum of real retail sales, production, employment growth and real wages
put on a combined basis and measured yr/yr. On my scale, +3% yr/yr for the group
represents solid growth, with +1.5% indicative of anemic growth. The US closed out 2012
with a reading of 1.6% yr/yr. That's a little better than The Oct. '12 reading of 1.2%, but is
still on the slow side.

Inflation gauges are still rather mild, but real take home pay could still take a hit of up to 2%
this year with the payroll tax returning back up to 6%. To keep retail sales growing, consumers
can hope for better wage gains this year, but may have to dip more into savings and increase the
use of credit to keep retail afloat. This change in fiscal poilicy can clearly work against Fed
QE, although we'll have to wait and see by how much.

Financial System Liquidity Factors

Cash & Checkables
The basic money supply M-1 has increased by 13.5% over the past year. When credit
demand growth is low, it is vital for the Fed to supply the system with monetary liquidity
to keep the economic recovery on track. More vigorous private sector credit demand in
2013 might well pressure the Fed to cut back on the now generous QE program.

Credit Funding & Demand
My broad measure of financial system liquidity increased by 6.4% over the past year. This is
the strongest reading since Nov. 2007 and indicates that system liquidity is finally approaching
levels needed to support economic recovery for the private sector. Note though that the strong
growth of the basic money supply has played a major role in allowing liquidity to expand
since mid - 2008 but that non - money sources of funding are now rising as well.

The banking system loan book (excluding the Fed) has been recovering modestly since early
2011, but, reflecting the depth of the past recession and tighter loan policies, is just now
at prior record levels seen in the autumn of 2008. Interestingly, by mid - 2008, the banking
system's loan book was running about $1.5 tril. or a whopping 31% over the long term growth
rate of 6%. The loan book is just about at the long term trend line now, and this signals still
tight demand as the loan book tends to jump moderately over the 6% trend during economic
expansion periods.

The Fed did push forth QE 4 partly because private sector loan growth had decelerated as
2012 wound down. The Fed is doing its bit to foster faster credit growth in 2013. I have
included an interactive chart from the Fed which you can use to measure the growth of all the
major interest earning asset categories since the mid - 1980s. Good stuff for chart buffs.
Banking System Credit Chart

Cash Reserves
The market meltdowns of 2008 - early 2009, led to a jump in the total of money market fund
(MMF) balance of roughly $700 bil. to $3.6 tril. by the spring of 2009. Over the following
two years, the MMF balance declined from the $3.6 tril level to $2.4 tril. as investors moved
back into stocks as well as buying a boat load of Treasuries and private sector bonds. MMF
balances have been relatively stable over the past 18 months, with new flows and reinvestment
proceeds going into the markets and elsewhere, but with ending balances held firm.

The total MMF balance can be drawn down further, but the recent extended stability of ending
balances does suggest that preference for capital assets may now involve rotational moves
between categories such as stocks, bonds, PMs and real estate. So, for example, a strong
stock market for this year could again come at the expense of the bond market while an expanding
economy could also draw far more resources to real estate development and investment.

Stock Market -- Weekly

Fundamentals
The weekly cyclical fundamental indicator continues in a mild but volatile uptrend. The
volatility is traceable to initial unemployment claims date which, in turn, reflects the
interruption of business as usual by Hurricane Sandy. Effects of this shake up should be
about complete.

The Fed has accelerated the current round of QE. This remains a positive, but it should be
noted that the FOMC is running a bit low in implementation and also that Its balance sheet
has yet to exceed the all - times highs set in late 2011 / early 2012.

Technical
I am back to the weekly for the SPX. SPX Chart I did finally get a buy signal on the this
chart this week, a signal which has come late owing to the tame momentum of the advance
over the past three months (See ROC% in chart).

I did not play this rally because I have been trading only deep oversolds on the long side.
Based on the 40 wk price oscillator, rallies from very shallow oversolds have very seldom
been powerful through history, so I am reluctant to say this current but belated buy signal
will have that much "juice" on the upside. Rallies of the sort we have seen over the past
six months are typical of an advanced cyclical bull market.

---------------------------------------------------------------------------------------------------------
I am updating my SP 500 earnings models and will post on such one day next week along
with a longer term SPX chart.

China Stock Market Divergence Resolved

Last month I discussed how the Shanghai Composite remained in a pronounced bear market
even in view of rising China based indices which focused on the larger companies the
China authorities leave open to foreign investment. Using traditional western standards, the
case for anticipating a cyclical bull market fell into place in early 2012 as monetary policy
eased and economic momentum began to stabilize. Perhaps there was an awaiting of the
announcement of the new leadership and their respective portfolios before the boys hit
the green light. The Gov. appears to want to give the Shanghai index a better standing. The
exchange is pressuring listed companies to institute and pay out higher dividend rates and
authorities appear to strongly desire to limit real estate speculation all of which could provide
more stability for the highly volatile Shanghai which players have used to try and build "kittys"
to play the more highly esteemed real estate markets.

There has finally been a sharp positive turn for the index which started as 2012 drew to a close.
The impulse has been strong enough to reverse a downtrend in place for several years duration
and the market has crossed above its 200 day EMA to stand around 2275. Projections for
China's  growth vary greatly, but if you take formal assumption from the authorities of 7% real
GDP  growth, the SSEC should trade eventually up around 2700. Shanghai Composite

Commodities Market

The global economy did grow over the past 18 months, but production growth has
continued to decelerate over this period, and significant spare capcity is evident. In
China, the major buyer of a broad range of commodities, mean annual production growth
over the past decade has averaged 15% per annum. however, even with the recent pick
up in production growth to 10% yr/yr, China likely is growing along with depressed
operating rates. Slower global growth and significant excess capacity in China has
continued to pressure commodities prices. CRB Commodities Composite

There was a burst of improvement in the CRB in the early summer of 2012 as the Fed
began to talk up further QE. At about the same time, China's production growth trend
bottomed and began to improve at a modest pace. The decline in the CRB Index to the
270 level did provide a nice long side trade starting in June, but the market has given
up a fair amount of ground since in the absence of a re-acceleration of global growth.

By my stripped down econometric model, there is presently economic slack with the CRB
trading below the 320 area. With considerably stronger global production growth, the model
suggests the CRB should trade between 320 - 380 during 2013. With the index now at
295, it is evident that more slack needs to come out of the system and that speculative
financial interest in this market remains well muted now despite various QE programs.
The indicators for the CRB have a slight positive bias and interestingly, the index is putting
in a short term base right under the 50 and 200 day m/a's. It is distressing that with the
recent popularity of the "risk on" trade, the CRB has yet to again reverse to the upside.
There are many financial market types who have speculated in this market over the past 5-7
years, and, given its volatility, there are probably many cases of "burned fingers". Keep an
eye on it.

Stock Market -- Weekly

Fundamentals
My weekly cyclical fundamental indicator (WCFI) finished up 2012 on a strong note.
Through the first trading week in in Jan. 2013, the WCFI rose 10.8% from year end 2012.
This compares to a + 16.5% up move for the SPX. Part of the difference reflects only a
6.2% rise for the sensitive materials price component, but the bulk of the differential
stems from the QE programs from the Fed (which are not in the WCFI). The stock market
has responded very positively to the major QE effort, despite the volatility that surrounded
the fiscal cliff saga around year's end. The Fed is ambivalent about how long to push on
with the large QE now in place and has attached an inflation "string" to it, but through
history, the market has rarely failed to respond positively to sizable quantitative easing
and very low short term interest rates. The stock market is discounting an eventual
significant move up in profits for 2013 and is running well ahead of developments for
sales and earnings at this point.

Technicals
This week I take a different cut. I like to watch the movement of a broad, unweighted stock
index and I prefer the Value Line Arithmetic Index ($VLE), which features over 1700 stocks. In
tandem, I keep an eye on the cumulative NYSE advance / decline line. The NYSE  A/D is
basically a very broad mid - and smaller sized capitalization measure.

The $VLE has just surged to a new all time high. It is in a strong uptrend off the 2011 interim
low, but is now moderately overbought against its 40 wk. m/a and is approaching overbought
on shorter term measures as well. $VLE Chart:  http://stockcharts.com/h-sc/ui?s=$VLE&p=W&yr=3&mn=0&dy=0&id=p55102470047 It could be niggling on my part, but
the MACD in the lower panel needs to establish a much smoother trend up in the weeks ahead
or else it would be fair to suspect the market's trend.

The bottom panel of the chart shows the strength of $VLE relative to the SP 500. Notice the
positive reversal in relative strength for the $VLE as 2012 worked to an end. This shows
action by investors to position themselves more aggressively to capitalize on the assumed
benefits to the economy and profits from QE and also is an expression of conviction that
the dollar will not rise sharply to allow foreign firms to penetrate smaller US growth sectors.

The next chart shows the cumulative weekly NYSE A/D line. It reveals that the NYSE A/D
has also reached a new all time high as well and that it is getting overbought against its
6 wk. m/a. Note too, that it is getting elevated on RSI and is also a little shaky on its MACD.
NYSE A/D Chart

The market is clearly up on price and breadth trends. The shaky MACDs may merely reflect
interference from the volatility caused by the fiscal cliff brouhaha. But as most of you know,
there is more to come on the fiscal front as there will be a request to raise the debt ceiling
(Feb.) and Obama and the Congress will have to address the mandated spending cuts in
Mar. The talk in the capitol is already getting nasty and threatening. More markets volatility
may lie ahead. As well, most US workers are going to see take home pay recede by up to
2% as the increase in the payroll tax takes hold. There could be a jolt here, too.

US Long Treasury Bond

The yield on the long guy has been trending up since 7/12. The market took its cue from
the Bernanke promise to re-engage QE programs and just as industrial commodities price
indices began to turn up. The T-bond market remains as highly sensitive to the direction
of industrial raw prices as ever. Now I use a 6 mo. momentum indicator which combines
production with sensitive materials prices to give me a a little bit of a longer term
perspective on the direction of yields. This indicator has also recently turned up but is
still comparatively quiet. Nevertheless, the fundamentals have turned in favor of higher
yields. I would note that although my production / industrial pricing indicator has turned
up, there has yet to be a decisive positive reversal of momentum on a trend basis. The
implication here is that if US and global business pick up strength in the months ahead,
the long Treasury yield could climb sharply while the bond's price falls.

I have included a long T-bond yield chart with the bond's price in the bottom panel.
30 Yr. T-Bond Yield  Note the line at the 3.50% level. Should the yield rise to 3.50%,
I'll add the bond back to my list of tradeables. Note as well the reversal of trend that has
occurred following a nearly 18 month downswing in yield. Experience says "Respect
that".

I have also included a 5 year chart of industrial commodities input costs. The chart runs
through 11/12 and does not reflect another significant 3% jump in the index for Dec. '12.
Index Mundi IC

Both the T-bond yield and sensitive materials prices do ok as leading economic indicators
in my book.

US Economy -- Outlook Sketchy

In terms of physical capital, the US now stands at levels seen after a garden variety
recession. Both capacity utilization and the unemployment rate have recovered significantly
from very depressed levels. So has banking balance sheet liquidity and capital bounced
back from deep lows. As all know, housing and construction activity remain depressed.
The Fed is providing ample monetary liquidity and interest rates remain low.

Viewed long term against its potential, business sales, although at an all time high, remain
about 20% below trend reflecting not only slow domestic demand growth since 2001, but
a significant loss of market share to imports. Profits, however, are around record levels
reflecting both stronger offshore growth as well as a surge in the price / cost ratio as wages
have remained painfully tame and productivity growth has been strong. So, profit margins
have been exceptional.

The economy has been recovering for about 3 1/2 years, and since the US has moved up from
a very deep bottom to levels that are normal for recession lows based on physical capital, the
economy has the potential to grow for about another 4 years if it can maintain decent balance.

Per worker real income has remained weak during the recovery from 2009, and to develop
a moderate growth scenario, demand for goods and services must accelerate to foster sales
and production rapid enough to generate at least 2% annual employment growth going
forward. The stronger level of jobs growth is needed to provide aggregate income growth
to support demand. With individual wages growing slowly, the void between income and
demand must be filled by credit growth and, perhaps, the further drawdown of household
savings.This is not an unusual challenge. After all, home and auto purchases as well as
sending kids to college are all funded with liberal amounts of borrowing. But do not forget
that confidence has recovered very slowly.

The sketchiness in the outlook reflects several factors. Wage increases of 1 - 2% are very
low and are not conducive to confidence. Individuals have also been delevering and
using debt more sparingly. Because strongly accomodative monetary policy can drive
commodities speculation, modest incomes can be punished further by even mild bouts
of accelerated inflation. And, let's not forget the banks. Lenders remain very conservative
and are clipping consumers especially with loan rates that are high relative to the cost of
funds.

Let consumers get concerned about rising gasoline prices or a stall out in the recovery of
housing prices and still low confidence levels could erode further, damaging the economy.

And let me say that collectively, business continues to act stupidly. With much better
earnings and low dividend payout ratios, CEOs are buying in stock at elevated prices but
are still accumulating far more cash than they need, which suppresses the returns earned
on assets and leads to a mal - distribution of money within the economy as shareholders and
employees do not share in the rakeoff of profits as top management does. Fat cats get but
fatter.

It remains a hard grind to keep balance between income and demand reasonable enough
to generate the demand that will fill more purses and spread the return to prosperity. And,
wouldn't much stronger income growth boost tax revenues to better cope with US budget
issues.

Stock Market -- Technical

My favorite daily, weekly and monthly price charts closed out 2012 flat neutral, leaving
the early weeks of 2013 to signal direction. The charts basically the future a well guarded
secret. I mentioned recently that the technical side of the market might be of limited utility
in view of investor and trader pre-occupation with the fiscal cliff show and other very
short term fundamentals. With today's boffo strong opening for the year, it may be the case
that very short term senitment or emotion may dominate for a bit, as resolution of the
cliff issues have twists and turns ahead. Moreover, the initial move on taxes is a net negative
for the economy as it will reduce take home pay for most US workers owing to the shifting
of the payroll tax from 4.2% to 6.2% -- a 2% hit to income for the many around $50K.
Today's glee could see a more sober view out ahead.

The selloff in the SPX going into the end of the year reduced the angle of ascent for the rally
in place since mid - Nov. Today's spike took the SPX to a short term over - extended  point
and to enough of a premium to the 25 day m/a to invite fast money profit taking. SPX Daily
The trend band off the Nov. interim low is wide enough to allow elevated volatility.

The red horizontal line on the chart shows the cyclical high to date for the SPX, and the green
HZL line shows 5 year resistance at 1400. It is good that the SPX is spending more time above
long term resistance and it would also be nice if the SPX can take out the prior cyclical highs
in that 1460 - 1465 bracket.

Wall St. Finally Sends A Little Message...

Them's supposedly in the know were saying earlier in the week that the stock market
had already discounted a topple over the fiscal cliff, with the idea being that official
Washington would quickly patch everything up in very early Jan., 2013. As the chart
link below shows, not everyone appears to have received this meassage. Not only
was the SPX weak into the close on Fri., but the futures market kept right on tumbling
into early evening. SPX Future

The sell off took out short term support, knocked off the better part of the rally gain from
Nov. and left the SPX future at levels seen back in late Mar. of this year.

Perhaps this pounding of the market will impress the Congress enough to take some action
to curb apparent overdue and mounting anxiety about the fiscal cliff. At any rate, the boyz
in the capitol are running out of places to hide.

The schedule in the Senate now calls for a vote on cliff legislation tomorrow, Sun. 12/30.
The vote could reflect a deal betweern the two Senate caucuses or failing that, perhaps
an up or down vote on a heavily streamlined Obama proposal. If a deal is announced,
it may come before the SPX future resumes trading. Check your screens.

When Go Long The Yen

Every few years, I will go against a very popular trade. In Oct. 2010, I started using a
small amount of capital to short the gold price via DB's DZZ offering (goes up in price
when gold goes down). That plus the very occasional futures trade has enabled me to
double my money on my initial gold short. I suggested back then that this was not a trade
that was suitable for most, that it was my way of having fun against the pro - gold super
bombast.

The JP Yen is now in free fall mode as a resuscitated LDP talks the Yen down to break
the deflation and start moving JP exports more heavily. The currency has been rapidly
sold down and is now rather deeply oversold. So, I have added it to my list of potential
long positions for the next month or two. If it starts to work, maybe I will add some
leverage to the position. Check out the chart of the JPY ETF

I plan to wait out the tank job now in force and look for some technical underpinning
for a long position.

Japan has come to be known as the land of the setting sun. Mr. Abe wants to defer the
sunset.

SPX -- Weekly Chart

I use weekly charts as a very important aid in determining how much capital to allocate to
the equity market. The oversold in Nov. was not deep enough to capture my interest and the
indicators I rely on most are all not yet positive owing to the sluggish 12 wk. ROC or
price momentum measure. SPX Weekly Chart  I also pay careful attention to the behavior
of a 40 week price oscillator. You can do about the same with a daily SPX chart and a
200 day m/a oscillator shown here via Index Indicators. This latter chart shows a weak
upturn in the smoothed 200 day m/a oscillator for the SPX. Neither the 200 day or 40 wk.
m/a oscillators have been strong enough to confirm an intermediate term positve reversal.
So, I blew this one and if the market continues to rally, I'll have to decide whether to chase
it (ugh!)

If you return to the II chart of the SPX and the 200 day m/a oscillator you will note that there
is a downtrend in place for the oscillator itself. Looking back over the past 25 - 30 years,
that downtrending pattern in the oscillator is usually not a good sign for bulls. One way to
get around this type of situation is to look for a positve reversal of the downtrend in the
oscillator which is strong enough to create a reversal that breaks the downtrend line to the
upside. History says the longs usually get hurt while waiting, although there are two very
interesting counter - examples, namely Q 3 2010 and Q 4 2011, when rapid sell offs were
followed by powerful positive action in line with QE developments by the Fed.

Final Week Of 2012

The US economy rebounded some in Nov. My weekly cyclical fundamental indicator is
up nicely here in December and the Fed stepped up with a large securities purchase this
past week. The table would appear set for continuation of rallies by riskier assets with
only a hint so far about concern for slipping over the fiscal cliff. The odds are low now
to avoid hopping over, but there is still a chance for a deal or a motion to move the cliff
further out in time. Weekly Markets Chart

10 Year Treasury (Top Panel)
The 10 year is up slightly in price for the YTD and should be trading down sharply now
on the basis of strengthening production and sensitive materials prices. So, as of tonight,
the bond guys are leaning toward a negative fiscal cliff outcome with taxes set to rise
enough to cut into economic growth next year.

SP 500 Index (2nd Panel)
Positive for the year, but the vast bulk of the gain came in the opening months. The market
suffered from an extended economic slowdown over much of 2012, but has rallied recently
on better economic news and the return of the Fed to QE. Stocks so far show no real anxiety
about the fiscal cliff. (Because it is so late in 2012, fund managers with a calendar year
performance bogey are loathe to sell lest a non-punitive fiscal deal is reached.) SPX still
yet to prove it can stay above 1400 resistance.

US Dollar (3rd Panel)
The USD started a downtrend right as Fed Chair Bernanke began to pound the table for more
QE around early Jun. Dollar bears are holding off now because a nasty fiscal cliff spill
could punish not only the US but the global economy as well.

Gold Price (Bottom Panel)
The gold price can be shaky around year - end, but I think the bugz do not like the inflation
control strings on the new QE program and have their positions under review. The sharp
drop in the gold price over the final months of the year does invite the question of whether
the bugz know something about the fiscal cliff that other markets do not.

The Risk To Raising Income Tax Rates

In my view, US history shows that the biggest risk to raising tax rates is that political
forces can conspire to keep raising them over time to the point where the wealthy and the
successful can, in effect, wind up working for others to whom income is redistributed.
The elixir of tax rate boosts spurs politicos to find ways to spend the revenues and reduces
incentives to manage government spending. Solid fiscal conservatives can accept raising
taxes to fund national security and other emergencies as well for funding government
investment programs that enhance longer term growth potential and wind up paying for
themselves. Here in the new century the major evident funding requirements are for
consumption via social insurance and medical care outlays. The revenues will feed back
quickly into the economy, but unless there are sensible cost management controls, serving
the income and medical needs of the huge Boomer cohort, allocation of resources to
these sectors could create imbalances which might damage the economy in the lon run.
Top Marginal Income Tax Rate Through History

So, as most economists recognize, there will have to be tough balances struck between not only
revenues and outgo but between sectors requiring resources. Our problem is compounded
by the fact that the US has not run up a large surplus to meet the needs ahead and is instead
running a large budget deficit in a fragile economy in which the budget shortfall reflects
inadequate cumulative revenue generation.

Budget management going forward is going to be a dominant socio-economic issue, and
there may be wisdom in making a modest initial down payment on the eventual restoration
of fiscal integrity in the near term.

The problem now is that the House GOP is trafficking in an alternate socio-political  reality
of which "never raise tax rates" is but one facet. And, the GOP is using that leverage they have
in the House to try and force a set of social and political judgments on a society which is not
 by and large accepting of this regimen.

I hope that GOP members of the House are verbally savaged over the holidays in their districts
so that they return to DC with a far more balanced perspective regarding the fast approaching
fiscal cliff. Minority movements in the US are often right, but this one is not. This one is
tyranny, and what should concern us is that minority tyrannies in the US can last for a long
time if the power base remains intact. Serious business is this.

US Financial System Liquidity

In this post, I take a little different approach to the issue of financial system liquidity.
Over the 2000 - mid 2008 period, US bank financial assets grew at a rate of 9.4%
annually. This dramatic growth was sufficient to fund a major boom in real estate
plus moderate levels of economic expansion and inflation. Then came the grand bust in
both the economy and finance. Since the middle of 2008, total bank credit has grown
by 1.1% per year, with this lowly rate of growth supported and backstopped by a $2 tril.
expansion of credit by the Federal Reserve Bank. When you toss in the Fed's $2 tril.,
total bank system credit has compounded by only 3.7%. That is still a low number, and
if you use total cash and credit to determine the velocity of "money", compared to GDP,
there has been a modest increase in a relatively well balanced MV = PT equation. There
has been no "liquidity trap", but the modest growth of total financial system liquidity
and the economy reflects the damage done to supply and demand for credit within the
private sector since the deep recession.

The new round of large QE the Fed is set to start is in large measure intended to assist
a still very conservative commercial banking system that has been intent on maintaining high
balance sheet liquidity and on re-building capital. The banks have been very slow to
return to normal cash flow analysis as a basis for credit decisions and away from collateral
value based lending. Solid borrowers with strong income and cash flow profiles are
still finding it difficult to to obtain credit, especially in the real estate sectors. Obviously,
one cannot lay off the slow growth of private sector credit entirely on the banks. Housing
affordability measures are very strong assuming borrowers can put 20% down on a home
purchase. The 20% down hurdle is going to remain a barrier for a goodly of number of
applicants whose incomes have grown very slowly since 2008.

The plan for QE 4, which could be quite large if the Fed steps up buying MBS as well as
Treasuries, is to speed the thawing of private sector credit growth. Prior QE programs
have helped with the tahwing out process and so we'll see if the new round of support will
push bank lender confidence higher in the year ahead.

Stock Market -- Daily Chart

The SP 500 is in a confirmed short to intermediate term rally. It is now mildly overbought
only on shorter term price momentum, but has the potential to run significantly further on the
extended time shorter run indicators shown. SPX Chart

The trendline support for the rally is inconclusive and will remain so until the SPX can move
decisively above resistance / congestion in the 1460 - 1470 area on the SPX. In fact, even if
the SPX was to close out 2012 in the 1475 - 1500 area, it would still not be entirely above
suspicion on a cyclical trend basis, given my admittedly conservative reading. I do not
intend this as a bearish comment on the chart because there may just be sufficient momentum
in the current rally to bring the SPX above 1475 by year's end.

The reality here could well be that very short term fundamental factors could be the key to
seeing an extension of the rally through 12/31/12. My weekly cyclical fundamental indicator
has reversed nicely to the positive side, and, as of this writing, all is not lost yet regarding
the avoidance of heading over the fiscal cliff. By the same token, you have to keep in mind
that deals can get blown up in the 11th hour, and that even if effective compromises are
struck, investors and traders may not like the results very much.

Economic Indicators

Coincident Indicators
There was improvement in this data set for Nov. on better real retail sales, industrial
production and a reduction of pressure on the real wage reflecting weaker fuels prices.
Measured yr/yr, the coincidents rose by a combined 1.6% compared to +1.2% for Oct.
Moderate growth is signaled at +3.0%, so economic momentum remains subdued.

One issue to check closely going forward is the ratio of inventory to sales for business
which has jumped through Oct., indicating an imbalance between sales and production.
The build up of inventories to sales is the largest since early 2010, but is not yet critical.
Business I/S (Scroll down a little bit.)

Corporate Profits Indicators
My sales growth measures are running about +3 - 4% yr/yr. Volume growth has eased and
pricing power has come down substantially over the past 15 months. There has been an erosion
of profit margins outside of the financial sector as the premium of selling price over costs
has nearly evaporated. Banking sector earnings  and the profit margin are strong as a reduced
loan loss reserve continues to add to profitability and book ROE%. Corporate profits have
flattened out.

Inflation Potential
My primary inflation thrust indicator fell sharply from mid - 2011 through mid - 2012. Over
this same period, the 12 month CPI dropped from 4.0% to a low of 1.6%. Inflation has
picked  up modestly over the latter half of this year measured yr/yr, but the thrust indicator
remains quiet for now.

Next year could be a different story. There will be QE 4. China, the major buyer of commodities,
could well move back to faster growth. Finally, I expect the US to return to pressuring Iran to
give up on weaponizing its nuclear materials. Wholesale Gasoline Spot Price

Gold Price

The gold price pulled out of a mild bear market in June of this year following heavy hints
from Fed chair Bernanke of further QE to come and ECB chair Draghi who set out open
ended liquidity back up support for seriously troubled EZ members.

My monetary and economic indicators remain negative for the gold price, but the monetary
component will shift positive in 2013 as the Fed re-opens the monetary tap. The very clear
loss  of growth momentum for the industrial side of the global economy has yet to reverse to
the upside.

With the fiscal cliff issue unresolved, the bugz have been treading lightly with gold, concerned
that possible significant austerity in the US could well have negative global repercussions.
The bugz have merely joined large segments of the capital markets that are on cliff watch.

Of particular interest with gold is the Fed's idea that QE 4 could be suspended and, possibly,
temporarily reversed if US inflation accelerates markedly. This control for the new policy
adds risk for QE - based speculators in PMs and commodities. As well, although there is
substantial slack in the US labor market, such may not be the case with regard to plant
capacity utilization. In the depths of the recent recession, the US operating rate fell to 68%,
a level not seen except before WW 2. Capacity use has recovered to around the 78% area
since, and once it crosses 80%, it is wise to start looking for a cyclical and not merely
commodities driven acceleration of inflation. Since capacity growth is exceptionally low
now, the US economy could get into a tighter capacity utilization mode if there is a major
positive response by the economy to the new QE program. The Fed is now freer to respond
to that and that could move gold fanciers into a riskier position.

In the world of the gold bugz, much is made of the "destruction" of currency value and the
presumed very large inflation potential of the Fed's QE programs. Now, I have a much
broader view of money and credit, and by my calculation, all the Fed has done so far
with the $2 tril. it has added to its balance sheet is replace most of the slightly more than
$2 tril. in short term credit that has evaporated over the 2007 - 12 period. Had the Fed
not done that, some of us would be selling apples dirt cheap to others. But, by current
convention, the Fed's QE actions are seen far differently by many.

I have linked to a gold price chart and you will note there is short term price support at $1660
and significant support at $1550 oz. Clearly evident resistance is at $1800. Gold Price Chart

Update of 12/5 Russia Chart

$RTSI Link

US Monetary & Fiscal Policy

Monetary
The Fed has moved on to QE 4. QE 3 was a place holder wherein the Fed was supposed
to buy $40 bil. a month of MBS a month. It has been running behind in fulfillment, but
maybe it will make it up quickly. With QE 4, the Fed will continue the MBS purchase
program, and It will add $45 bil. a month in Treasury note and bond purchases starting in
Jan. 2013. It will continue the program until the inflation rate edges up to 2.5% and /or
the unemployment rate declines to 6.5%. With these guideposts, QE is designed to support
the labor market by providing liquidity behind an economic expansion until unemployment
falls to a more reasonable range and to protect the real wage from the ravages of an
inflation induced by commodities speculation if players use the large increments in monetary
liquidity to pour into the commodities markets, especially fuels and foods. In short, the Fed,
with this new controlled QE program is not going to issue a "blank check" for guys to chase up
commodities prices with impunity as occured from early 2009 through mid - 2010. The
inflation consequences of hefty rallies in commodities prices have penalized the real wage
over the past couple of years in concert with reduced current $ wage growth as businesses
moved in to exploit a weak labor market. This move by the Fed is a positive for the stock
and commodities markets, but the inflation limit control factor adds more risk to the
equation, risk that would normally reflect boosts to short term rates (which the Fed does not
now plan to raise soon.).

Fiscal
Obama has failed to sweet talk the GOP into the 21st century. So as the Nation's chief
executive, it falls to him to kick ass with gusto over in the GOP side of the House. As
much as I would like to see that, putting on income constraints for 2013 to raise more
tax revenue requires a very light touch else the weakest part of the economy -- household
income -- could be punished enough to create some significant drag for the economy. I
am particularly concerned about restoring the 2% cut in the payroll tax.

The polls show that folks do not mind raising taxes on the wealthy and deplore the idea
of trims to Social Security and Medicare. Both the president and the Congress have to
free themselves from lobby driven and ideological constraints to figure out ways to sensibly
corral the world's most expensive health care delivery system, a system that is highly
inefficient. Soaking the rich is not the solution. Intelligent cost management is. Neither the
Dems or the GOP seems ready to tackle this urgent task yet.

There is a decent level of investor confidence that official Wash. DC will work out a
deal on the cliff which will be punitive short term in but a minor way. A fast 700 points off the
Dow would hasten the process of closure, but barring a tantrum on Wall Street, the show
along the Potomac may just drag on.

Monetary Policy -- Clarity Needed On Liquidity

The Fed will update us on monetary policy this Wed. Dec. 12. Operation Twist winds up
at the end of this year, and the Fed is running out of short term Treasuries to swap out for
longer dated  T-notes and bonds. The Fed needs to indicate whether They will elect to
continue expanding the longer dated Treasuries and whether They will buy same outright
to do so. The Fed should also explain the irregularity of QE 3 MBS purchases and why
They have been running 50% below the purchase pledge made in Sep.. Bernanke will also
face questions regarding Fed policy options viv a vis the fiscal cliff.

My broad measure of credit driven financial liquidity continues to expand, but measured
yr/yr, it is still growing  slowly and could be inadequate to support an expanding economy
without a QE program that provides sufficient monetary liquidity to offset the very slow
rate of credit funding growth. Bernanke's persistent criticism of the very conservative
lending practices of banks reflects his awareness of the issue.

Based on the growth of monetary liquidity in the financial system this year, the real economy
should have performed better. But stock market  and economic performance both lost
substantial momentum after the large $100 bil. currency swap the Fed put on in late Dec. '11
ran off by springtime and the Fed allowed its balance sheet to contract. So, there does
appear to be a confidence factor that reflects Fed policy and intent. But note also that money
M-1 grew only at a 2.4% annual rate over the past three months. The three month time frame
is admittedly a short one, but the deceleration of growth in the basic money supply is exactly
what one should expect after an extended period of a $ flat Fed balance sheet (Fed Bank Credit
is now around where it was at the end of QE 2 on 6/30/11).

US Economic Indicators

Overview
On balance, the economic indicators are ever so mildly positive and  the trend downturn in
momentum for these various indicator composites bodes ill for 2013 without more quanti-
tative accomodation by the Fed, more aggressive lending by the banks and a willingness by
businesses to pay a living wage instead of handing out 1 - 2% wage increases to so many
workers. For business to stop impovershing the work force, The Fed and the banks need to
provide liquidity and credit to underwrite enough economic growth to help alleviate the
large slack in the labor market. Right now, cheapskate CEO's are damaging economic
potential. Official Washington needs to tread very lightly tightening fiscal policy next year.

Recovery progress has broadened out and the credit markets are thawing, but the economy
should still need policy assistance next year to draw more resources back into the game.
.........................................................................................................................................................

Weekly Leading Indicators
The WLI I follow suggest that the economy is set either to grow slightly or possibly flatten out.
The trend of the WLI shows persistent growth deceleration from 2010 (confirmed by actual
performance). The volatility of the WLI has attenuated but is still above average on an
historical basis.

Monthly Leading Indicators
New orders measured by breadth have also been decelerating since 2010 and, like the weekly
leading indicators, are now less volatile. Improvement in orders is clear since the lull in mid-
year but has recently flattened out as manufacturing has lost momentum.

Weekly Coincident Incicators
The WCI composite is flat since making a cyclical peak in April.

Monthly Coincident Indicators
Fresher data will be available over the next couple of weeks, but my set of coincident
measures is up just 1.2% yr/yr compared to a normal solid growth measure of 3.0% yr/yr.
Distressingly, the real wage has been decelerating since late 2009, and is currently again
in negative territory. The recent expansion of consumer credit only partly reflects some
improvement to consumer confidence as many folks are using credit to buy essentials as well.
The Economic Research Institute uses indicators similar to the ones I use to argue that the
US is aleady in recession. ECRI has been good at cycles over the years although many
economists take issue with Their current call. ECRI's The Tell - Tale Chart is worth a read.

Longer Range Indicators
The longer term downtrend of real earnings because of very low wage increases for the rank
and file remains disturbing. At best, too many folks are being pushed to use credit to buy the
necessities. Continued pressure on the real wage undermines the visibility of the economic
recovery and increases business risk. A rising oil price has penalized real earnings and a
very sharp spike in oil / petrol prices could be fatal. A tougher stance from the US toward
Iran is likely next year and could well have economic consequences.

Fed bank credit and the monetary base have changed little for over a year. QE 3 has been
more nearly a dud so far, with the Fed having only fulfilled 50% of its QE pledge to date.
Private sector credit growth and broader measures of financial liquidity are improving, but
I think it is risky not to push QE 3 harder until credit and credit - driven liquidity show
more acceleration.

An ongoing ZIRP and positive yield curve would normally be cause for celebration of an
economic recovery / expansion. But the sluggish trend of broad liquidity expansion does
undercut the reliability of  ZIRP and the yield curve. The slope of the yield curve has
come down this year as a strong Treasury market reveals investor concern about the
economy's potential.

US Stocks Out Of Favor -- Trade Is Getting Crowded

Back in June of this year, when the Fed made clear its intentions to start a new QE program,
foreign stocks began to outperform the US market. US basic economic fundamentals and profits
performance has deteriorated over the second half of the year. Yet, by some measures such as
comparative PMI data, the US has continued to be one of the stronger economies. Moreover,
the QE 3 program is off to a very slow start. The ability of the Fed to buy up MBS at attractive
prices has proven a tougher than expected go, and mortgage lenders are not passing on the
lower rates in the secondary market to borrowers. Experienced observers wonder whether the
Fed may choose to modify the QE program. Even so, the US dollar has weakened  since the
announcement of QE 3, putting US equities at a competitive diasadvantage that so far has
interested traders more than decent relative fundamentals. As well, buying foreign stocks
is a way to reduce short term risk exposure to the still unresolved fiscal cliff issue. Note,
however, that the relative strength line for foreign stocks is beginning to reveal that this trade
is getting crowded in the short run on extended RSI and MACD.

The chart linked to below shows the RS line for SPDR World - ex US (GWL) against the SPY
and also features the PS bearish dollar fund (UDN)which rises when the USD falls. GWL/SPY

Stocks -- A Push From Russia

Russia plans to privatize another and very substantial $100 billion of Its industry next
year. Bloomberg mentioned that Russia may retain Goldman Sachs  to provide support
for the effort. So, there may be another push coming to interest outside capital in the
Russian market.

The RTSI index is up slightly on the year even though the economy has held up better than
most forecasters expected given Russia'a economic ties to the EU. Among larger economies,
the Russian market does have a very low -- 5 x earnings ratio. Fact is though that the economy.
though growing consistently, has experienced both a deceleration of economic growth
momentum and an acceleration of inflation pressure up to 6.5% currently. With investors
wary of capitalizing earnings too generously, the p/e for Russia is not that cheap given the
inflation scenario. Russia GDP

I have traded the Russia etf RSX in the past as a high beta way to play a rising oil price.
Oil is still critical to Russia's economy and budget and because I think 2013 could be a
volatile year for oil given turmoil in the mideast and the likely return of US focus to Iran's
nuclear program, the Russian stock market could have a couple of strong price rallies as
the oil traders seek to handicap developments in the greater middle east. In addition, a
large broadening of industry privatization and, perhaps, support from Goldman's bankers
and research for Russian equities, could add some excitement to the market next year.

I have linked to the RTSI index below. The market is nearing another positive turn
following a recent correction. You should also compare the RTSI to the oil price and to
the S&P EURO STOXX 50 (both of the latter are on the chart). RTSI Chart

Next year could see the US and Russia on different sides of major geopolitcal developments.
Many Americans wish Russia could be more like the US. But, Russia is Russia. I love the
music, dance, literature and the older architecture, but not the politics. I am not fully at ease
with Russia, but great nation, great people.

China Stocks Divergence

China has operated through most of this year with easier monetary policy and, in line,
the economy has been performing better over the past 4-5 months. So has the pricing of
residential real estate. The real estate market remains at the center of speculative interest
in China as the Shanghai Exchange index continues in a bear market despite easier money
and an improving economy. Major investors and traders around the globe remain
focused on the quality, big cap liquid names (GXC) which have fared better than the
broader SSEC. China remains a tough market to trade. SSEC with GXC In Top Panel

Stock Market -- Daily Chart

The uptrend underway since mid - Nov. is intact, but is not well defined. There is not as
yet solid confirmation for the short - intermediate trend although the indicators are moving
toward positive. Traders so far have shown no inclination to worry about a retest of the
recent spike low and rally, a development that has grown more common during the cyclical
bull. The SPX 1400 line is the last important resistance level to take out decisively. The
SPX has been unable to hold above the 1400 level with much consistency since late 2007.
So, staying power above 1400 remains a big deal. SPX Daily Chart