Economic Indicators

Coincident Economic Indicator -- Sept. 2014
Measured yr/yr, this important measure of US economic activity stood at 2.3%. Real sales
and production gains remain OK, but the income side of the equation is still lagging at 1.8%.
The momentum of hiring has picked up some, but the real wage rose by just 0.3% as
employers hold the line on wages. Tightfistedness at the payroll window continues to hold
back the economy. It has led to a longer and deeper period of de-leveraging by households in
the wake of the recession and has contributed significantly to a reluctance by consumers to begin
to leverage up again five years into economic recovery. Consumer Debt Service

Business Sales And Profits
Business sales in current $ have been at 6% yr/yr in recent months. Transactions volume has
been running slightly stronger than I expected, but pricing power remains anemic. Pricing has
recently turned negative for materials and energy resource providers. My selling price /
cost ratio has turned negative and is partially offsetting profit margin improvement stemming
from higher volumes. On balance, profits yr/yr are up, but would likely be stronger with a
better pricing environment.  The ongoing refusal by business to reward workers for productivity
gains inhibits both business volume and pricing power.

Liquidity Situation
The growth of the economy in current $ is exceeding that of the liquidity provided by private
finance. Hence, the capital markets are more reliant on dwindling growth of liquidity provided
by the Fed as it unwinds the QE 3 program. Portfolio manager cash reserves increased
modestly in Sep., but players are having to do more selling of securities to make new placements.
Without more QE and assuming the economy holds up in the months ahead, this process will
intensify.

Stock Market -- SPX

The market closed today right on downtrend resistance at 1940 SPX. A top side break
through resistance would signal that the market might be reversing course while failure
would signal that the counter trend rally may have run its course. The market remains
volatile and unstable and is now trading on hopes for more QE. Daily SPX

Staying Away From China Now

I traded China stocks aggressively this year and particularly over the June - Sep. period. The
case for China was a course reversal on monetary policy back to easing over the past year or
so. Now China is tightening up on the broad measure of monetary easing and instead is using
targeted liquidity injections into its major banks. I have argued this year that China's profligacy
on monetary policy in the new century and particularly since 2009 - 2010 would eventually
necessitate a regimen of monetary stop / go to try manage growth plus control a dramatic
proliferation of real estate debt that is taxing the country's internal cash flow capabilities.
A vast shadow banking system has sprung up featuring the marketing of credit instruments
backed ultimately by real estate and managed by property trusts and companies which are
at debt servicing risk as property prices fall and land sales slow.

the recent tightening in growth of broad liquidity measures has prompted me to take to the
sidelines where it may well be appropriate to stay until there is clarification on policy and
this irrespective of the targeted liquidity injections.

Here is the chart for the Shanghai. $SSEC It may still be proper to argue that the Shanghai
deserves to trade at 2400 - 2500 as I have for several  years, but since it nearly reached that
area recently while at the same the PBOC was shifting policy gears, I took what I could get.

the post on June 3, 2014 started the idea and is attached. Big Red Dragon....

Sneak Peek Into The Abyss....

Yesterday morning I happened to be watching Bloomberg TV and Jim Bullard, President
of the St. Louis Fed, appeared as a guest. Jim is an influential guy in Fed-dom. The market
was in free fall and Jim just happened to opine that with all the turmoil, the Fed could have
a look at extending the QE program past the October demise date. He was asked to repeat
that message, which he happily did. As word swiftly got out, the stock market ended its free
fall and by today's close had rallied nearly 3%. Jim stopped the carnage for the week, and
with this trial balloon gave the Fed a fall back position if the current policy course continues to
rattle the Street. Jim did say new QE would be considerably more modest, but that fell on deaf
ears.

You will read far more 'learned' commentary about last week and you will have a chance to
peruse far more sophisticated fundamental and technical commentary than what I just said.
But, I think the Bullard remark is what did the trick. For me, it is becoming ever more difficult
to take  this business seriously, but let that be a subject for a different occasion.

In essence, and rightly or not, markets players are saying that the global economy will go kaput
and that painful and corrosive deflation may await without further dollops of stimulus from the
powers that be. With conditions in the absence of new sources of liquidity seen as so perilous,
it is fair to wonder why the SPX is trading at 16x net per share and not 10x.

If the markets (bonds included) are right, then that's some set of new clothes the emperor is
wearing.

Stock Market -- SPX

The end of QE by the Fed has hit home. The SPX has been closing below its Aug. '14 low
and this means we are looking at a down market. The SPX has broken important trend support
dating back to the autumn, 2011 lows, so this latest and long lasting powerful upleg of the
bull market has ended. Whether this important break of trend marks the end of the cyclical
bull market in force since late winter of 2009 or merely indicates the bull is alive but now on
vacation remains to be seen. The market is now volatile and unstable and I am not about to
start throwing numbers around for the SPX. History shows that sudden endings of large QE
programs are quite negative for stocks, but since this is the very first time we have had a
period of extended tapering of the program before its conclusion, I am content to let the chips
fall where they may (no joke intended).

The indicators show the SPX, despite its partial reversal today, remains oversold in the short
run and this is further confirmed by noting that the market is over 5% below its 25 day m/a.
the trend of the SPX and both the 10 and 25 day m/a 's are down, and the market is probably
a little overextended to the down side as well. SPX Daily

So, after nearly three years, we have a new ball game.

The Capital Markets' Own Forecast

Reflecting the Fed's very large QE program dating from late 2012, my new order index for the
US economy rose from lows of around 50 at intervals in mid - 2013 and in Jan. 2014 to a lofty
level of 66 in Aug. this year, before tipping down to a still strong 61 in Sep. Readings above
the 65 level on this diffusion index seldom are much stronger. So, there was a substantial
acceleration of business activity and profit results along this year.

However, since the spring of this year, progressively fewer stocks could match the performance
of the S&P 500 (SPX) and the relative under-performance of less than top tier capitalization
stocks began to nosedive at the end of Aug. right in line with the interim peak in new order
activity in the economy. As we all know, the SPX itself began to slide in mid-Sep. as concern
about an economic slowdown began to take hold. The Treasury bond market has seen a down-
trend in yields since the get-go in 2014, and a progressive reduction in the yield curve this
year indicates that the bond market is expecting economic progress to slow and the inflation rate
to moderate further. 10yr - 2 Mo. Yield Curve

Though not at extremes, the Treasury bonds are overbought and the stock market is now in a
growing oversold position. The US liquidity cycle has passed its peak, and economic growth
should moderate from the Aug. 2014 momentum thrust, but it does not guarantee future
economic progress will be so slow that resource utilization will stagnate or that inflation
pressure will end and deflation pressure begin.

There has to be some time given to determine how the real economy will respond to the
absence of QE. Investor psychology is now more fully defensive and this attitude could
foster further volatility in the markets until players get a handle on how the economy behaves
without its "training wheels" (expired QE).

Monetary Base & The Stock Market

The Fed has made its balance sheet available only back as far as 1989, but the St. Louis Fed
has compiled data for the monetary base, a very close proxy for the Fed's balance sheet, back
to 1918. History shows that when the growth of the monetary base, when adjusted for inflation,
turns negative on a yr/yr basis, trouble invariably follows for the US economy and the stock
market. The lead time between when the growth of the real monetary base zeros out and trouble
for the real economy and the stock market starts can be very short as happened over the late
1930's - early 1940's or very long as occurred during the 'roaring twenties'. My work over the
many years I have been at this game suggests that the continuing availability of private sector
credit is the deciding factor as to when removal of the Fed punch bowl starts to pinch the
economy and the stock market. Fast rising short term interest rates often telegraph trouble
ahead, but when private lenders are leery of the economy, the supply of loanable funds can
begin to dry up well before short rates begin a steep ascent during an economic expansion.

I have told of these observations, because as the Fed ends QE 3 in the weeks ahead, the growth
of the monetary base will likely flatten out as will the growth of the basic money supply. Then,
as an investor in the US, the Fed will no longer have your back. The easy money part of the
bull market will have ended. The risk / return profile for the market will be less favorable
because risk will rise given the growing dependence of the economy and stocks on the
generation of private credit in the system.

The current bull market need not end. The market will have to adjust to being credit driven as
opposed to being driven by monetary liquidity. Adjustment can vary from painful to nearly
seamless depending on how well confidence in the economy holds up and whether bankers
will continue lending now that they all know the Fed does not have their backs, either.

So far, investors have adjusted to the forthcoming new period by reducing holdings in most
smaller stocks and through increasing exposure to big cap names and Treasuries. So, most
stocks are oversold in the short run and it remains to be seen whether confidence will ebb
further or if players decide the economic prospects are solid enough to move some funds
back into the market.

Stock Market -- Here We Are Again

The SPX has again declined to the neighborhood of it 100 day m/a. This has been the fail
safe point for all of the sell-offs since the end of 2012. SPX Daily

This is the eighth time we have seen this adventure. In the prior seven, the bears have started
growling, only to see the SPX rally on to new highs. Recalling an old Wall Street saw, My
wife said at lunch: "Yom Kippur can't come fast enough" (An old rule tells one to buy on
YK). Well, the SPX is mildly oversold in a market that has rolled over in the short run, and
we are simply going to have to wait and see if the bulls can snatch victory here for the eighth
time or whether something less positive or even outright negative is about to happen.

I have stayed with the technicals in recent posts because the pattern of the advance in the SPX
has been remarkably consistent since the end of 2012, and it has seemed unwise to start huffing
and puffing on the fundamentals until this little drama is resolved. More on the basics this
weekend....

Gold Price

My view on the gold price has been that there would be a decent long side trade off the late
2013 price of $1200 oz. The figuring here was that strong global liquidity growth especially
from the US would foster faster real economic gains in this year and that an acceleration of
inflation would not be far behind in time. It was a good idea for the first half of the year, but
has run into trouble in recent months as economic progress in the EU and China diverged
negatively from the US, and operating rates failed to rise enough to generate some cyclical
inflation pressure. This was the case for one commodity near and dear to gold bugz, namely
the price of crude oil. Since mid-year it has weakened also failed to rebound here in Sep.,
a normally strong seasonal period.

the EU is under greater pressure to re-inflate the economy monetarily and folks have mis-
read China where monetary policy has been easy through the bulk of the year. With US
liquidity still strong, the potential for inflation down the road remains. But first there has
to be a firming in the balance of global economic / supply demand, which has yet to take
shape. Even in the US, where production growth has been stronger this year, the operating
rate is still a little shy of 80%, a kick off point for inflation pressure.

Meanwhile, the gold price has fallen enough to begin piercing long term trend support
and is a bit above intermediate term trend support at $1200. Weekly Gold

The metal is fast approaching a significant oversold on weekly RSI and may need to have
the oil price stabilize in the next few weeks to hold its ground. If gold can hold support at the
$1200 level there should be a bounce but more cautious traders may consider watching
global demand measures such as the forthcoming Markit global mfg. PMI due next week.

Stock Market -- Yet Another Technical Note

The current nasty little sell off is threatening to change the pattern of the SPX. The SPX
closed at 1983 today, and it will break the uptrend line in place since late 2012 if it breaks
and closes below 1980. To conform to the bullish pattern set since late 2012, the SPX should
have developed stronger positive momentum off the recent early Aug. low and be moving
toward the upper band of the trading range, now above 2050. It has not and instead is headed
for another test of trend support. The market is not yet at a classic oversold, and intermediate
term downtrends in MACD and RSI suggest there may be more negative chop ahead.

If the SPX does break below 1980, then there is "fail safe" support at the 100 day m/a. The
100 day m/a has been breached a few times since late 2012, but never by much and has served
as a springboard for the next up leg. We may see this play out once again but the recent
stumbles leading up to this possible crucial test of support suggest careful observation.
SPX Daily

Stock Market -- Technical Note

Ms. Yellen's latest attempt to 'kite' the market shows some of the magic has been lost. The SPX
has been on the flat side here in Sept., and the NYSE adv. / dec. line has turned down noticeably
this month to diverge negatively with the SPX. The chart I've set up to accompany this post
includes the cumulative NYAD line, the relative strength of the SP 500 on an unweighted basis,
the relative strength of the Russell 200 Small Cap., and the relative strength of the utilities sector.
NYAD Chart

As most know, the breadth of the advance in the broad market has become more exclusive as the
year has worn on. Small cap. indices like the Russell are down on the year and are trailing
significantly in relative performance (3rd. panel of chart). Now, with Sep., the SP 500 on an
unweighted basis has broken down in relative strength as has the NYAD (top 2 panels).

The bottom panel of the chart shows the relative strength of the utilities sector vs. the broad
market. Portfolio managers often use this group as a place to hide cash and earn some
current return. It is often a maneuver that managers resort to when they wish to become
more defensive but remain relatively full invested. The recent rise in bond yields has dimmed
interest in utilities somewhat, but interest has been reasonably well maintained since late last
year when it was announced that QE would eventually be terminated.

I think the downturn in market breadth and the decline in relative strength for the unweighted
SP 500 have recently begun to bother investors just a little bit so far. As we learned over 1998-
2000, market breadth can diverge negatively and substantially from the broader market before
a more substantial and far-reaching break comes. But that might have been the exception, and
it may well be that players would like to see the oversold medium sized and smaller cap. issues
regain some positive footing before the bull market moves up solidly from around the SPX 2000
level.

Economic Indicators

Coincident Economic Indicator -- August, 2014
Measured yr/yr, my version of the CEI rose by 2.3%. This represents the strongest improvement
in two years, but remains shy of what would count as vigorous, well-balanced economic growth.
The sales / production side of the indicator rose a solid 3.7%, but the income side increased by
only 1.9%. Within the income portion, civilian employment growth rose by 1.5% and the real
wage by 0.4%. The real wage has started to benefit form a slight increase in wage rates as well
as  from a recent deceleration of the inflation rate. With the benefits of productivity gains
continuing to accrue primarily to capital and not to labor, households must expand borrowing
to finance an increased level of spending. Scrooge lives on and so does widening income inequality.

Business Profits Model
Top line growth was about 6% for the year through Aug. Looking back at my projections for
2014, unit volume growth has been faster than I expected, but pricing power has lagged and
broadly so. Progress in advancing profit margin from productivity gains has been partially
offset by slower growth in pricing with my price / cost ratio now under some pressure. Without
stronger pricing power, a number of businesses may step back from more full blooded hiring.

Liquidity Situation
Over the past few months, liquidity generated by the private sector has matched the progress
of business sales. There has been excess liquidity in the system generated by the Fed's QE 3
program and this has helped power the stock market to some some extent in 2014. However,
with QE expected to wind down to zero later this year, investors are likely to find themselves
in stronger competition with the demands of the real economy if business sales growth can
hold around or exceed 6%.

Monetary Policy

The Fed is keeping Its focus on the Phillips Curve -- falling unemployment leads to rising
inflation and rising unemployment leads to falling inflation. Currently, the US is experiencing
moderate real economic growth with falling unemployment and low and relatively static
inflation with the CPI averaging below 2%. Significant slack remains in the economy and with
little inflation pressure, the Fed appears content to continue unwinding the QE program but
keep its ZIRP until the Phillips curve aligns properly with strong enough jobs growth to foster
faster inflation. With plant capacity growing at 2.8%, there is enough supply / demand balance
for the monetary authorities to not hasten to raise interest rates and see how the economy
responds to the wind up of the QE program. On certain fundamental measures the Fed can be
seen as suppressing short term interest rates and hawkish sentiment is clearly growing on the
Board. But Ms. Yellen is not yet under duress.

US Stock Market

Fundamentals
There was some profit taking this week. Continuing strong monthly economic data is worrying
some players that the Fed may end its ZIRP sooner, and begin a series of hikes to short rates
not long after QE3 ends next month. Bond prices also weakened as a result. Evidence from
recent Fed governors comments on the economy reveal that Ms. Yellen will have to fight harder
to keep the ZIRP in play in support of the labor market. Also, there are no doubt some players
who want to raise a little cash ahead of the snuffing out of QE3 which is down to a pilot light.

The weekly forward looking economic indicators have come in on the flat side since Jul. 25
with a lack of progress in weekly jobless claims and sensitive materials prices looming as
important.These indicators are volatile, but there is enough of a pattern to wonder whether
the stronger monthly data may soften some ahead. The liquidity cycle is still running strong
but is fading from peak yr/yr readings suggesting a period of growth moderation lies ahead
eventually.

Technical issues surrounding the close - out of QE and the need for the Fed to provide an
extra measure of liquidity around the holidays may preclude action on ending the ZIRP until
after the beginning of the new year. And, if there is evidence of a more moderate tone to the
economy by then, Fed Chair Yellen may have a stronger hand to confront the policy hawks if
she chooses.

The larger issue here still remains: Whether private sector credit generation will continue
vibrant enough to pick up the slack created by the cessation of QE. If such happens, and
private sector lenders have not just been piggybacking the QE program, then Ms. Yellen
will find her back at the wall if she demurs on raising short rates as the economy would
likely be strong enough to warrant further calls to end the ZIRP. Since I regard this
transition in liquidity sourcing to be a major experiment with little empirical backing, I
would suggest keeping enthusiasm tempered.

Technical
The sell off this week has turned the short term indicators negative but did not do enough
damage to trend to signal worry yet. The intermediate term overbought alluded to in the
prior post has eased a little. Major trend support is around the 1970 level  with crucial
backstop support at the 100 day m/a.

the market has traders' attention now because of the possibility that the recent highs in the
SPX just above 2000 might constitute a possible secondary and bearish top. This is due
diligence only now as there have been several such patterns in the long run up since late 2012.
SPX Daily Chart

US Stock Market

Fundamentals
Core fundamentals continue positive. Important liquidity growth factors are past their peak
yr/yr, but momentum is declining gracefully. Corporate profits gains have accelerated recently
with strong growth indicated in the current quarter. Monthly business new order data has
trended strong too, but weekly data has started to flatten out, a cautionary sign regarding
earnings momentum down the road.

As QE 3 winds up next month, liquidity growth will decelerate more. Business sales and earns.
progress should slacken as we move toward and into 2015. With milder liquidity expansion on
tap for 2015, competition within the capital markets for funds will intensify.

the coming end of QE 3 has so far had a significant but hardly fatal impact on stocks. SPX
positive momentum has shrunk from last year's barn burner level but is decent. Smaller cap
stocks have not fared nearly as well. This sector is flat after having sharply outperformed the
SPX last year. Portfolio beta is being reduced.

The mantle of greater monetary policy accomodativeness is passing from the US to the EU.
The EU stocks have underformed the SPX pretty steadily since the end of 2012, but relative
performance for the STOXX 600 has picked up recently and may challenge the downtrend
line against the SPX going forward (See SPX chart bottom panel below).

With slow global economic demand growth in place since the end of the deep recession of
2008 - 09, more geopolitical turmoil should be expected. The are millions upon millions of
younger people out in the world with deepened struggles to find their way. Risk has been
contained regarding the capital markets, but that can change. Also, UKR vs. Russia has
entered a new and less easily predictable phase.

Valuation
The SPX is not overvalued yet, but investors are paying a premium multiple for cyclically
elevated earnings. The risk / return profile is thus deteriorating as the market rises with
cyclically advanced earnings. The SPX is now trading at 22.3 times long term trend net
per share of $90. This is not a record by any means, but the high valuation suggests that
players who want to stay in the market review their liquidity requirements carefully.

Technical
The SPX continues in its third and longest upwave since the cyclical low of Mar. 2009.
It is mildly overbought in the intermediate term (3 -6 mos.) on the indicators. SPX Weekly
The consistency of trend since late 2012 remains astounding.

Inflation Potential

One very probable eventual outcome of a strong liquidity cycle such as the US has been
experiencing is an acceleration of cyclical inflation. QE's 1 and 2 helped push the CPI from
a deflationary reading of -2.1% yr/yr in Jul. 2009 up to +3.9% inflation for Sep. 2011. In
the absence of strong QE until early 2013, the CPI dropped back below 2.0% yr/yr in Apr.
2012 and did not rise above 2.0% again until this spring and then only barely.

The US has experienced a continuing long term decline of Its inflation rate since the early
1980s. There have been periodic cyclical surges that have come when the CRB Commodities
Index rises 10% or more on a yr/yr basis. The mini - surge in the CRB earlier this year
helped boost the CPI from 1% to 2%. CRB Chart

There are a number of factors that have reduced US inflation over the years such as slower
 real economic growth, sharply rising lower cost imports and a progressive but sizable decline
in the growth of wage costs. Even so, the low pass through of higher commodities costs
to the CPI this year has been a surprise. I have been thinking that the CPI could rise to at
least 3% by the end of 2014, but this may be a tough go now.

If you return to The CRB chart, you will see a horizontal green line set at 335 for the index.
That is my educated guess of where supply and demand in the aggregate for this group of
commodities would come into balance. So, from my view there is still excess capacity in these
markets, particularly for grains and fuels. If there is not further firming in global economic
demand, the excess will likely continue, and the sort of sustained upward pressure on pricing
that is needed now to underwrite a further sharp cyclical rise of the CPI % is not likely to
eventuate.

NEW FORMAT FOR BLOG

When I set up the blog nearly ten years ago, my intention was to communicate with older
professional pals rather than spend my time on e-mail programs. about 20 guys were
involved and they all were in possession of monographs I had written over the 1980 -90
period on the major components of funds management. As a very successful money
manager, I operated on the "KISS Rule" -- Keep it simple stupid.  They had all the
short cut statistical and analytical tools I used so I did not have to re-invent the wheel
each time out with explanations .

I am going to be 75 this autumn and easily half the guys who the blog was intended for
have retired fully. Moreover the other guys have more far ranging interests. So, it
will be easy to communicate with them on a personal basis. That leaves a broad number
of followers and visitors numbering up to a 1,000 a week who read the posts.

My plan going forward is to write far fewer posts and to focus more on diagnosing the
markets rather than defending particular points of view. I am far more comfortable
doing this because I believe that people should make up their own minds and that they
prefer doing so anyway. The emphasis will be on market drivers and risk for return
both near and longer time. The writing style will remain cryptic and direct.

US Capital Spending

Capital spending new orders excluding defense and aircraft took big hits in the prior two recessions
but are once again in fairly strong recovery mode. Moreover, new orders have broken out to a new
high this year. New Order

The recovery track for capex orders is about 10% per off the 2009 cycle low and has accelerated
recently as higher business sector earnings are boosting cash flow. Companies have even cut back
some on share buybacks to support a higher level of spending. System capacity growth has been
recovering slowly after experiencing a rare decline over 2009 - 10, and reached +2.6% yr/yr just
recently. Capacity growth still lags output growth, but balance is slowly returning to the system
and this development acts as a damper on any cyclical acceleration of inflation.

The chart above shows that new order rates were volatile and basically range bound until very
recently. The US has not experienced a strong capex cycle since the late 1990s and has been
running on older, outdated equipment and plant. There has been a strong recovery off the
recession trough despite the extant slack in the system as companies move to modernize after
a long hiatus.

Capital goods stocks and related industrial service issues have lost ground in relative strength
against the SP 500 this year as investors have shied away in lieu of the closing out of the Fed's
QE 3 program. Understandable, but if the economy does not slow down as much as expected,
the group will retain interest because of business's need to continue to upgrade and modernize.
XLI Weekly

Gold, Oil, & The US Dollar

Gold got interesting as a long side trade in late 2013 at $1200 oz. When the US economy
does strengthen as it has on strong liquidity growth, the gold price normally gets a cyclical pop.
There may be some extra fizz in the pop if the US trade deficit widens on faster import growth and the USD weakens. The year started out that way for gold and I figured it could top $1400 by year's
end. That may still happen, but some important crimps in the story are unfolding. US oil
production is surging so strongly that it has tipped the supply / demand balance in the oil
market in favor of supply. The oil price has fallen sharply since the end of June. The weaker
price plus less demand for imported oil has resulted in a stronger dollar because the trade
picture is holding up better than expected. The weaker oil / stronger dollar combo has been
punishing the gold price and although gold is developing an oversold, there may be some more
downside because gold is at a small premium to the oil price. Gold et al Chart

Now winter blend fuels stocks will need to be built soon, so the oil price will move into what
is normally a strong seasonal period during Sept. / very early Oct. Normally, the oil price will
make a yearly high around then. This might not happen this year, but there should be some
degree of positive bounce and gold might well get a positive kicker. The oil price has broken
down from a basic rising trend dating back to mid - 2009, and this development may be very
much worth noting.

SPX -- Daily Chart

The market has regained positive footing again. It is maintaining the groove in place since late
2012, with periodic lows nearly every three months or so followed by moves up to new highs.
SPX - Daily

Bull markets are rarely boring, but this one has become so. I will not bother you with re-capping
the current picture or regale you with stories of the number of instances of seasonal weakness
that lie ahead in Sep. and Oct. Be advised only that if the pricing pattern begins to change in
a meaningful manner something important will be afoot because that is what it will take to
break this now comfortable pattern.

The one change in the broad market I would note (again) is the loss of positive momentum
relative to last year as the Fed's policy of QE winds down to zero this autumn. Incidentally,
and in regard to monetary policy, wasn't that a fine piece of tap dance choreography Ms.
Yellen executed at today's keynote for this year's confab on monetary issues in Jackson Hole
WY.? Not even the Cheyenne in their heyday could dance around the campfire like that.

Economic Indicators

Coincident Economic Indicator (CEI)
Measured yr/yr/ my CEI advanced just slightly more then 2.0% through Jul.  The indicator has
been flat since May after having hit a recovery period low of +1.0% in mid - 2013. I have been
hoping for better with the strong liquidity story as background. However, since business continues
to hire at a moderate rate of +1.5% and refuses to allow real wage growth, It remains a tough go.
The weak income situation combined with only moderate employment growth acts like an anchor
that bumps up and down off the bottom but holds the pace of the real economy slow. Industrial
output growth has been strong, but with modest progress at the retail level, there may be some
unwanted inventory accumulation.

Profits Indicator
My top line sales growth proxy -- the yr/yr change in the rate of the dollar value of industrial
production -- hit 7.1 % through Jul. '14. With cost growth more moderate, this suggests a
sizable rise in pretax profits, with the positive leverage coming mainly from strong physical
volume growth. The gains in sales and earnings represent what should emanate from strong
liquidity support and profits at a higher level should persist for a several more months.
However, as the post just below indicates, the strong liquidity environment is set to wane as
QE 3 winds down.

Long T-Bond Yield % Trend As Leading Indicator
The trend of the long Treasury yield % has a spotty record as a lead indicator of the trend of
economic momentum over a hefty span of years, but it has been very useful since 2007. Last
year the TYX rose sharply and correctly anticipated this year's strong improvement in
the pace of industrial output measured yr/yr. With QE growth slowing and set to zero out in
Oct. '14, the yield on the TYX has trended down steadily this year, signaling that bond
players expect the expiration of quantitative easing will lead to an eventual slowdown in the
growth of output. TYX Chart
 
To add some interest here, it should be noted that the TYX yield is getting "overbought"
relative to its 200 day m/a.

Liquidity Cycle

Reflecting the supportive power of the Fed's QE 3 program, business sales measured yr/yr
have advanced from a recovery low point of  3.0% up to 7.0% through Jul. 2014. this strong
acceleration is currently underwriting faster profits growth for the SP 500 companies of over
$30. per share per quarter from the $25. level.

However, a negative reversal is now underway in total liquidity growth (including the Fed's
balance sheet). So far yr/yr growth in liquidity has declined from a cyclical peak of 11.6%
earlier this year to 8.9% yr/yr through early Aug. Thus, it is likely that at some point in
late 2014, business sales momentum will have made at least an interim peak and be set to
decelerate. The ramp up of liquidity growth starting with the onset of QE 3 has led to a
muted acceleration of inflation.

The bond market, save for the junk sector, is enjoying the run down of QE, with players
figuring that the expected lower growth of liquidity will lead to an easing of economic growth,
reduced inflation stimulus, and a postponement of the day when the Fed ends its ZIRP and
begins to raise short term interest rates. Sluggish retail sales data for July also helped the stock
market this week as traders, who were concerned about an economy which could overheat,
welcomed the sign of a more leisurely pace to economic expansion.

Although I am concerned about how the US economy will perform as QE is zeroed out, the
slower pace of retail sales was a little surprising and also suggests that there maybe a minor
round of lower inventory investment ahead as the pace of sales at the wholesale level has
been quite a bit faster than retail. It may well be too early to buy off on a slowdown story
this soon, but it is worthwhile to keep it mind.

Relative Strength of the SPDR 500 vs. the long Treasury price: SPY: $USB

Stock Market

Since the end of 2011, SPX net per share has moved up a little over 17%. The market has soared
though with investors adding a little over 4 multiples to the p/e ratio to bring it a touch over 17x
latest 12 mo. earns. This jump in valuation constitutes a major upswing in market player
confidence. The key driver appears to have been the Fed's ZIRP on short rates and the provision
of ample liquidity. Looking back to the close of 2011, it took nearly two years for these policies
to breath life into the progression of of earnings, which appears to be on a stronger course in
2014. Now, the Fed is steadily unwinding the big QE 3 program, and with better business
performance and rising credit demand, has taken to suppressing short term rates to hold the
ZIRP at least until the easing program is fully zeroed out late this year. Measured yr/ yr,
total system liquidity growth is still very strong relative to economic progress but the liquidity
situation is likely to continue deteriorating well into 2015. The private  financial sector has
stepped up to provide more liquidity in the form of credit, but, as it does so, the hawks on the Fed Board will greatly increase pressure to end the ZIRP and raise rates.

Inflation has decelerated substantially since 2011, and with the economy progressing modestly,
investors have cut the rate at which they discount future streams of earnings and dividends. This
too, has allowed the p/e multiple to expand. Now, typically when there is rapid growth of
liquidity, profits respond but so does inflation with a lag. There has been a mild pick up in
CPI momentum recently but not enough to be troublesome yet.

From 12/11 through 12/13, the SPX compounded at a nearly 24% annual rate. The market is
up this year so far but it is running far below the 24% rate and many smaller stocks are down
on the year.

With net per share growth stronger, and monetary policy in transition away from super
accomodation, it is logical to expect p/e ratio contraction well into 2015, unless of course
investors want to press the advantage of a lengthy transition in monetary policy toward
normalcy to full if not reckless advantage. The fundamentals are very good now, but are
headed, gracefully I hope, downhill.

I have continued to regard the gradual reduction of the QE program as an experiment with
risks to the market and the economy and not as a done deal transition to a smooth continuation
of the economic expansion. I watch economic momentum very closely.

SPX -- Daily Chart

The low test zone for the current short term downtrend is SPX 1900 - 1930 based on several
different support markers. So, with today's rally, the SPX has closed slightly above the zone,
but it is too early to tell whether there is a positive reversal underway or if there is further testing
and even a downside breakaway in store. SPX Daily

The market at -1.5% the 25 day m/a is slightly oversold, and both RSI and MACD are negative.
Most of the time, I look for trend reversals to enter positions and this would be one of them. 

The market is still holding the groove it has been in since mid - 2012 when QE 3 by the Fed
was first promised. However, with this program now running ever closer to the zero level, we
have moved quite a ways fundamentally from then and as tempting as it may be to figure the
groove will hold and the SPX is, indeed, near another rally point, conditions are turning less
favorable as the Fed cuts the power of the liquidity tailwind.

Oil Price -- Unexpected Fade

Since mid-2009 WT oil has traded primarily in a rising trend channel of 11% per year and
mostly within a $18 - 20 bl. range. The range for Aug. is set at $99 - 119. WTIC today at
roughly $96.50 has slipped below the low end of the channel for the first time in five years.
Despite the chaos in Libya and potential concerns for the long term potential output from
Iraq and Iran, there seems to be a little surplus developing at the wellhead despite rising
demand. And, the culprit may be none other than the US which has fast rising domestic
production and which is cutting Its imports. Late Jul. / Aug. is generally a seasonally firm
time for the oil price followed by a strong seasonal pop in Sep. WTIC is trailing the seasonal
pattern. Crude Chart

This is the first little warning of a shift in the dynamics of oil supply / demand since the deep
recession of 2008 and it bears watching. Oil supply overhang carries significant implications
for inflation, the US dollar, and consumer real incomes and confidence. Naturally, sloppy
oil pricing and a stronger dollar are unintended economic sanctions for Russia as well as
oil developers in general.

Given the volatility inherent in the industry since the 1970's, it is too early to make a big deal
out of it, but sometimes change sneaks up on you.

Ukraine Vs. Russia

It has been more than a month since the UKR army began to make military inroads against the
separatist rebels in the east. I have kept on eye on this because the UKR forces have been
operating close to the Russian border in an effort to interdict or shut down supply lines to the
rebels from Russia. The catastrophic downing of MH 17 drew attention away from the ongoing
campaign, but UKR military progress has been a surprise to many and it has in turn prompted
Russia to put up to a dozen fully outfitted infantry battalions along the border in the contested
area. Now Russia may only have been drawing the UKR forces in close to have the option
to conduct a cross -border combat operation that does not strain logistics and also wears down
the UKR military.

The Ukraine economy is still suffering and Kiev is become more unsettled politically. On the
other hand, Russia is experiencing a little economic rebound after businesses there over-
estimated the negative effects of sanctions imposed to date upon demand. Exports remain
understandably weak, but Russian authorities are not under immediate pressure to escalate
military activity to keep the populace distracted from observing the continuing failure of
economic policy to curb the deterioration of the Russian economy.

The situation could turn more serious if the UKR military keeps progressing in breaking up
the separatists' hold in the east and is able to seal off more of the border.This would raise the
cost of an eventual Russian incursion into the Ukraine considerably and it may lead Putin
to exercise the option of limited invasion to force the UKR military back.

It is hard to say how much the action in eastern Ukraine has bothered the major markets in
the weeks since the UKR military began offensive operations. But now that Russia has
moved fully combat ready units to the border, and is preparing its own sanctions program
against the West, the situation may command a little bit more attention.

SPX Daily Chart -- Cliffhanger

As expected the SPX did register an interim top in Jul. No genius here as there were a fair
number of people looking for a near term top. The fates conspired to engineer a most interesting
end to the week. Thurs. had a raft of heavy profit taking that saw the SPX fall sharply. Selling
continued today until the market hit key support levels, and then like magic, the SPX caught
bids and set off a short squeeze. At the end, The SPX rallied above that "golden" support near
the 100 day m/a and also closed very near major trend support around 1930. Quite a feat!
Here's the chart: SPX Daily

Despite the sharp recent sell -down, the market remains in the groove it has followed since
Sep. 2012 when the big QE 3 program was set up. All the sell offs since then that reached
trend support and the 100 day m/a produced near term oversolds that turned into solid dips
to buy. The Street wants you to feel this way come Mon. Had the SPX blown through all
this support, no end of technicians would have flipped bearish. No way to send people off on
holiday.

So, over the next week or two perhaps we get to see whether despite receding QE and the
prospect of an eventual  end to ZIRP, players want to resume pushing the market up on a
strong course or whether the guys decide to take it easier and acknowledge rising risk.

The market is in a clear short run downtrend and is mildly oversold. it is also unstable
despite today's close above the low.

Monetary Policy

Short Term Interest Rates
The Fed continues to suppress the very short end of the credit market and there is no firm
indication when It will lift the FFR%. Using a model based on 100 years of short rate,
inflation and credit supply / demand data, the 91 day T-Bill rate should now be around 2.2%
reflecting continuing low inflation but rising short term credit demand. So, the Fed, concerned
with idle labor resources particularly, now trails the curve suggested by the economy by a
significant margin.The hawks on the Board will press Ms. Yellen so long as the economy
does not regress to stall speed.

QE 3
The FOMC today cut the securities purchase rate to $25 bil. a month, on its way to zero later
in the year. Measured yr/yr, QE has added 24% to the Fed Bank Credit through late Jul., but
looking forward to mid - 2015, Fed Credit may well only be 2% higher if the economy holds
up reasonably. Thus, the economy is going to become increasingly more dependent on the
private sector for liquidity growth and as we look out a year, the likelihood grows that short
rates will also start to rise.

There are plenty of discussions out there as to when and and how fast short rates will rise.
I appreciate all that, but I remain keenly sensitive to how well business and investor
confidence hold up as the QE program unwinds to completion. So far so good.

China -- The Boys Have Fired Up The Dragon

Back in early Jun. I posted that the PBOC had turned accomodative with monetary policy
and that the equities market could eventually get interesting for a long side trade. See
China -- Big Red Dragon Getting Cranked Again

That post has a link to the Shanghai Exchange index ($SSEC). This post has a link to the
SPDR China ETF (GXC) which is light on liquidity but has given long side traders a better
bet in recent years than the Shanghai. GXChttp://stockcharts.com/h-sc/ui?s=GXC&p=D&yr=3&mn=0&dy=0&id=p71321227542

The GXC has quietly followed along with the SPX  since late 2011 as a beneficiary of QE 3
liquidity from the Fed while the Shanghai has continued to unwind from the 2006 - 07
major bubble. The GXC hit a record high just above the $100 mark in 2007 and there is
significant resistance now around the low $80s. It is an overbought index and could under-
perform the Shanghai going forward if the Shanghai gets some long missing manic action.
But, GXC has been a nice trade for which I thank the PBOC.

The Shanghai is getting itself overbought, too. Next resistance level for this guy is 2250 with
big time resistance set at 2450. Long time readers of the blog will recall that if folks turn
more serious about China being able to continue real GDP growth at 7.5% annually for the
next several years, that I think the Shanghai should trade up around 2400 - 2500.

If you read the early Jun. post, I argue that China has put its economy in harm's way far faster
than I thought it would. The PBOC may have to be on a loose  / tight policy treadmill to
wring out its badly overextended real estate markets for years to come. This imperative may
provide attractive capital markets trades both long and short over the next several years.

No Stock Market Bubble

There is no stock market bubble in place. For openers, the price trajectory of the SP 500 (SPX)
is not steep enough to qualify. However, there are shifting long term fundamentals you should
keep in mind. Over the past 20 years, SPX earnings per share have grown more rapidly than
over the very long term. Since 1994, earnings have compounded at near 7% vs. 6.5%
historically. That corresponds to a  big change over time. Moreover, despite the rather evident
cyclicality of SPX net per share, investors and traders have tended not to shade the p/e ratio much
at all as earning rise to a cyclical peak.  The SPX has come to be treated more as a stable growth
entity than as a cyclical one.

The SPX companies have been buying more of their stock in over time. This has been a plus
to earnings. Back circa 1980, successful companies were urged to buy in stock when the share
price was below book. The SPX has soared well over book value since then, but companies have
continued and enlarged the practice. This has increased the cyclicality of earnings because
firms tend to increase buybacks as cash flow from operations rises and slash them when net
and cash flow turn down.

There has also been a nearly manic emphasis on boosting profit margin as well. Business return
on assets % is a product of asset turns in sales times profit margin. In a globally competitive
world, achieving the pricing power needed to boost asset turnover is tough, so the emphasis
has fallen on advancing margins. Since the late 1990's business sales growth has fallen well
below the long term trend, but earnings growth has not lost a beat thanks to increasing profit
margins.

Many SPX companies with help from their outside auditors have also adopted the practice of
taking very large writeoffs during business downturns and claiming these losses as "special"
charges which are not counted in operating earnings (but do come off book value). And, yes
most acquisitions and mergers are done on a purchase basis rather than a pooling of interests
basis so that acquired earnings are additive and not dilutive. It is amusing to watch purchase
acquisitions boost earnings during business expansions and when they fail, be written off
as non-recurring expenses.

So, faster earnings growth over the past 20 years involves both solid productivity gains to
boost margins and smoke and mirror elements to help net per share on the way up and
artificially cushion it on the way down.

Investors have loved it all -- poor sales growth but improving profit margin and add-ons
to earnings from share buybacks and accounting gimmickry.

At peaks in the business cycle, we now have cyclically elevated earnings plus earnings
overstatement to pore through. In short, there has been an era of bubbly earnings coupled
with investors who have not discounted such performance until too late.

Net per share growth in the current cycle has yet to reach extended levels that should raise
eyebrows and given the available resources in the system, that moment may be a ways off.
The best bet is not just to watch  market price action and the p/e ratio but the aging of the
cycle itself and the excesses that be developing.


True stock market bubbles are rare but exaggerated cycle peaks are not. 

SPX -- Daily Chart

The failure to take out the late Jun. high of 1985 today has the average toppy. It may smoothly
blow above 1985 as the week progresses, but a nearly month - long double top signals more
attention from you if you're a player since these minor fails can sometimes herald that a little
trouble lies ahead. SPX Daily

Economic & Profits Indicators

Coincident Economic Indicator
My CEI rose by 2% yr/yr again in Jun. This has the broad economy running at roughly  2/3
speed. Industrial production growth, paced by oil and gas output, was the strongest component
followed by real retail sales at 2.3%. Measured yr/yr civilian employment growth remains at a
mild level, rising 1.5%. Real wage growth again declined as senior managements pay themselves
royally and leave table crumbs for the rest of the workforce. With banks now lending, it is the
greed of business at the pay window along with significant fiscal drag that keeps the economy
below its potential.

Profits Indicators
My proxy for business sales -- the dollar value of industrial output -- rose again at 6.5% yr/yr
through Jun. Good volume growth coupled with a slightly favorable price / cost measure
suggests profit margins probably expanded again in Jun. yr/yr. SPX quarterly earning power
is very near to $30 per share, and annual earning power is around $120. for a p/e of 16.5X
(assuming the SP 500 companies can hold the $30).

Liquidity Factor
The business economy is growing faster than is private sector liquidity. Since business demand
normally trumps the financial markets, stocks, for example, have become increasingly
dependent on the Fed's QE program, which is wending its way way down to shut - off this
autumn, as well as asset allocation strategies of the big markets players. Interestingly, money
market levels have remained at comparatively modest levels for some time. Ready cash is
flashing slim pickings.

SPX -- Weekly

I have been expecting the stock market to make an interim or intermediate term top here in Jul.
The SPX was becoming substantially overbought on the weekly chart, and the weekly cyclical
fundamental indicator has lately failed to progress reflecting a flattening of sensitive materials
prices as well as a lack of progress in the reduction of unemployment insurance claims. The
SPX is trading a little below its 7/03 all time high of 1985, but it has hardly rolled over. This
leaves the question of whether a top is in place open. SPX Weekly

The heavy technical overbought remains in place, but one always has to realize that overbought
markets reserve the right to get themselves even more overbought. As the chart shows, such
occurred in May, 2013 when the SPX bolted higher before registering a pull back. Back then,
of course, the market had the powerful tailwind of the full-on QE 3 program, a luxury it no
longer enjoys to the fullest. For my part, we'll just have to see whether the bulls can push it
significantly higher or not.

Oil Price

With concerns about Iraq's production capabilities near term in abeyance, West Texas crude
is trending down to a normal seasonal low through July toward $98 bl. The mild uptrend in
crude since late 2013 makes it clear supply is not substantially constrained relative to demand.

The next period of seasonal strength for the oil price runs from late Jul. until the end of Sep.
Barring a major supply disruption, hopes for a big upside finish in the price are fading. My
guess here is that the best oil can do through Sep. is about $110 bl. Moreover, the sharp break
in the price since fears of Iraq production cuts have abated, suggests that the expected  $98
seasonal low which lies just ahead may not be all that secure. WTIC Crude

The deal restricting Iran's nuclear materials output is supposed to be inked on Jul. 20. There
has been a little more progress in recent days, but the ayatollahs are getting balky on the
premise that Iran should have greater freedom over the long run to develop their program.
So, it may be that Jul. 20 will pass by without a firm deal. If so, there will be calls to give the
negotiations more time. Some in the Congress here will say nasty, hawkish things, and Obama
will come under increased pressure to nail down a strong deal. With all that though, it may still
be early to drag the 'bomb Iran' scenarios out of mothballs. However, if there is no deal soon
the hawks in D.C. will use the impasse to flog Obama ahead of the Nov. off year election and
Bibi in Tel Aviv can be expected to weigh in as well. Oil traders will have to pick up the
threads soon.

Put / Call -- Speculative Zeal Apparent

The CBOE all - equities put / call is a good measure of sentiment because it represents real
money down on the table and not just advice. The $CPCE has been in a downtrend since
late 2011, signalling increasing bullishness as calls purchased has steadily outpaced put
buying. In recent weeks the longs have reached their most adventurous yet based on the 6
wk m/a of the put to call ratio. $CPCE Weekly

No law says the zeal of the bulls must end here, but experience suggests we have a fairly
extreme reading as we head head into next week and it may portend an exhaustion of sentiment
sufficient to suggest a short term top. Riding the long side when the p / c starts falling from
.70 and above on down has been a decent trade since 2011, but the low p / c readings have
warned of consolidation or market weakness ahead. A low $CPCE reading may only suggest
mild market trouble ahead, but traders at least should be aware.

Setting Germany Straight

The US State Dep't charted Germany's geopolitical ambitions prior to WW 1. We have
neither liked or trusted Germany ever since. We spy on Germany now and we will in the
future. The fanciful notions of friendship and alliance between the two aggressive, ambitious
and resourceful countries served both well during the Cold War and its early aftermath.
Despite Putin's grand ambitions for Russia, only inertia keeps NATO intact now as its mission
is vague at best.

Germany sees itself as a major merchant state to the world and even fancies itself as one of
the premier democracies. As it veers toward breaking out of the post WW 2 cocoon it has been
in, it shall eventually have to define its place at the table of nation states. Its democracy has
not been tested in the fire as has the US's a number of times. As Germany asserts its
independence, the US has no choice but to let that happen and to adjust accordingly. We'll see
how Germany does and whether it can keep itself out of trouble. Obama, after some eye
opening visits to Berlin, sees Germany for what it is now, although the next US president may
try to rebuild rapidly fraying ties. 

In viewing recent US espionage the German political establishment has been puffed up with
sanctimony and has been throwing out the idea of how stupid the spying is. Older Americans
like me listen to the rhetoric coming out out of Germany and hear the same vain sense of  tactless
arrogance we have endured for generations. We are not your friends Ms. Merkel. Far from
it. So the US will go right on snooping.

SPX -- Waiting For A Correction?

The  SPX daily chart shows the the market has been playing "peek-a-boo" with corrective
action for a couple of months only to break higher and cream the shorts. SPX Daily
Look first at the successful little series of tests against the 25 day m/a in over Apr. / May.
Now look at the succession of scrapes with the 10 day m/a since Jun., all resolved in favor
of the longs.

I have argued in recent weeks that the SPX was significantly overbought on an intermediate
term basis and appears toppy (scroll down). But the insouciance of the bull traders has been
fun to watch: "Hey if you think it's overbought, watch what we can do with it. we can make it
more overbought."

More and more seasoned and successful investors have been coming out to say that a market
correction is due if not well overdue. But the minor sell offs see the bulls quickly regroup and
tenaciously push it higher.

 As of today,  the trend off the Apr. low is still intact with no breakdown apparent.

Liquidity Cycle

Peak US system liquidity growth (including the Fed's balance sheet) hit 11.6% yr/yr in late
2013. Through June it is down to 9.4% yr/yr and by year end 2014 it will be an estimated
7.1% yr/yr. The powerful growth of liquidity from late 2013 through mid - 2014 strongly
suggested faster economic growth through the year, and we have seen that in the monthly
data so far save for bad winter related weakness in early 2014. System liquidity growth will
perhaps slow further in 2015, so the economy and business profits may have less of a positive tailwind as 2015 develops.

As QE 3 zeros out, a major source of easy money support for the stock market will have ended.
The SPX rose 30% last year when QE was in full bloom, but is only up about 6.5% this year
despite a slower but still bountiful pace of QE. My view has been that the wind-up of this
large program by the Fed would suppress the market's p/e multiple and perhaps substantially.
So far this year, the SPX has held up pretty well especially given that players are factoring in
the cessation of securities purchases that are additive to Fed assets by late 2014. It is fair to
say that so far this year, investors have ceased aggressively chasing stocks, but they do not
seem to be very intimidated by the withdrawal of this major source of strength for the market
since the bull began in early 2009. That may change as the zero hour approaches late this
year, and it would not be surprising if it did. But for now, confidence in the economy and the
markets is holding up pretty well.

The US is still a heavily leveraged economy and the Fed went to large QE programs and a
ZIRP to keep the deflation wolf away from the door so as to avoid a downward spiral of
deflationary debt liquidation that would have produced a deeper depression. It has been five
years since the economic emergency that prompted the Fed's actions and although the
recovery has been slow, perhaps there is enough confidence throughout the system and its
markets that these programs can be laid to rest and more normal policies pursued. If it turns
out to be a case where short memory works to our advantage, my extra caution will have
been misplaced.

Stock Market Overview

Fundamentals
Primary: Positive but starting to fade. Easy money policy is still in place with ZIRP and strong
primary liquidity growth. But, evidence suggests the Fed is now suppressing short term interest
interest rates and the QE3 taper program is progressing and is now below 50% of the original
$85 bil. in monthly securities purchases. Bond yields are above their absolute cyclical lows but
are not threatening.
Secondary: Business sales and profits are expanding and there is sufficient economic slack to
support a couple of years of further growth without overheating and toppy earnings. The
expansion has broadened out, but there is still a drag effect imbalance between demand and
income, with the real wage not progressing. Consumption is becoming more reliant on credit
generation. But, note that the banking system is quite liquid still. Somewhat faster economic
growth is absorbing more liquidity now, and QE3, although shrinking in growth, continues
to provide liquidity in support of the capital markets. Keep the QE erosion in mind as it
will become more of an issue.

Valuation
The market is significantly overvalued on trend earnings and investors are being asked to pay
a slight premium multiple on elevated cyclical earnings. It can be argued that with companies
having moved over the past 20 years to an elevated rate of earnings plowback (60%), there
should be a premium for the faster earnings growth that a higher plowback implies. But since
the global economic pie has not expanded to meet this improved potential, earnings have
become more cyclically volatile as companies have had to shuck a greater number of losing
or sub par investments when the economic environment softens.

With elevated valuation, investors are looking further afield at foreign markets, PMs, selected
commodities and bonds (chasing yields down to levels unsustainable longer term).

Technical
The cyclical bull is in place and it has been strong enough off the 2009 low to suggest that a
new longer term bull may be underway. It is a an extended market on a long run basis, but
lacks the spectacular trajectory that indicates a price bubble is underway. Just remember
about this latter point -- there does not have to be a price bubble to have a very nasty cyclical
bear market or even a sudden crash - like decline.

The SPX is now getting quite overbought on the weekly chart. The weekly comment recently
passed anticipated the strength of just prior days, but it may be now that an interim top is fast
developing. SPX Weekly

It is interesting to note that there has not been a deep oversold since the autumn of 2011.

Global Economic Supply & Demand

Global economic demand has accelerated moderately this year as expected, with industrial
output growth rising about 4% yr/yr to a more normal level. Operating rates have improved
slightly but not enough yet to cut heavily into still formidable industrial excess capacity. After
a very rocky start to the year, world trade began to improve in the spring but trails the growth
of global output. Pricing pressures are starting to build but are moderate so far, although CPI
advances are broadening out. Overall, the results have been modest given the very heavy easing
action by the world's major central banks.

With an improving picture for global economic demand, and, belatedly for trade, US investor
appetite for foreign stocks has been on the rise. But, the SPX has been the better performer
against the rest of the world since the kick off of the large QE program by the Fed in late 2012.
However, with the tapering of the QE program now well underway, the momentum of
improvement for the SPX vs. the rest of the world has itself tapered off considerably. Since
US industrial output is now running 4% yr/yr against an improving global picture, it could be
tougher for the SPX to hold the lead as we go forward. SPX vs. MSCI World (Ex. US).

Emerging Markets -- At Resistance

Back on Feb. 4, I wrote a piece on emerging market bond and stock funds. Back then, I found
both the emerging bond (EMB) and the emerging equities fund (EEM) at interesting technical
junctures. With global industrial output slated to perform moderately better in 2014 after a
sour period, it seemed appropriate to dust off these two trades. Now both are up at important
resistance levels Emerging Markets (Click on link and then click on the EMB and EEM Charts.)

The JP Morgan EMB has since moved up from the 106 level to 114.6. It has followed US
Treasury prices and is now well overbought and with Tresuries stabilizing after a good run, this
more volatile fund could be a bit risky following a nice recovery.

The EEM never reached the 35 level which would have made it a more prefect trade, but it
has rallied up to three year resistance and with the SPX weekly now moving up into overbought
territory, traders should keep EEM in mind as short term vulnerable.

Both the markets may be interesting over the next year, but the preference here is to let the
overboughts at resistance play out in the short run.

SPX -- Weekly

Technical
The cyclical bull continues on. Momentum indicators are trending positively but are starting
to approach overbought levels for the first time since late 2013. SPX Weekly There is room to
the upside short run, but the move off the spring low of 1820 is well advanced.

Fundamentals
The market has been more sensitive to the weekly economic data. My weekly cyclical funda-
mental indicator (WCFI) is up 6.2% for the year so far, while the SPX is up 6.1%. Moreover,
the strength in the WCFI this year was primarily from mid - Feb. to the end of May, which
corresponds to the bulk of the positive action for the SPX. The WCFI was essentially flat
through Jun. which also corresponds to the anemic positive action for the market during the month.
Two important items in the WCFI -- unemployment insurance claims and sensitive materials
prices --  have provided no lift to the broader indicator since May. Since both these elements
of the WCFI are forward looking, it means market players are looking for confirmation that
the economy is set to stay on a stronger footing.

Long Treasury Price

In The Short Term
The TLT fund has been an excellent performer  so far in 2014, rising from support at 100 to
115 recently before settling down some. TLT Weekly It has been my oft stated view that the
weakness in the stock last year was way overdone and that strength this year was a positive
reaction to a deep oversold that developed as last year wore on. There is a mild downtrend line
in price dating from mid - 2012 which is being tested now as traders ponder whether a new
bull leg is underway or whether we have seen an appealingly strong counter - trend rally that
is about to run its course.

I have a caution light for the TLT price now. My shorter term yield directional indicator
(industrial output + sensitive materials prices) has been trending gently up since the middle
of 2012 and has reached all - time peaks seen in 2007 and 2011. This means that the industrial
economy may finally be ready to lift out of a lengthy period of consolidation which has favored
the bond market into a more advanced cyclical stage of expansion which may be less friendly
to the fixed income sectors. That will be so if industrial production continues to expand at a
moderate pace.

In The Longer Run
The TLT fund fell to a price of 90 at points over both 2010 and 2011 when long Treasury
spiked well over 4%. When a broad range of monthly economic and financial data is reviewed, 
it turns out that there are no basic numerical differences between now and the 2010 and 2011
periods when rates spiked. What is different, and this may be crucial if the economy can keep
expanding at a rate fast enough to use idle resources, is that unlike both 2010 and 11, confidence
in the maintainance of the ZIRP policy by the Fed is much stronger now.  In short, TLT may
have substantial downside price risk if the economy progresses to the point when the Fed
decides to raise short term interest rates.

There has yet to be a decisive breakout in my yield directional indicator. But a test is ahead
and, since the Fed is already suppressing short rates, it is appropriate to recognize the major
downside price risk to TLT even if the Fed continues ZIRP in the months just ahead.

Gold Price

Gold has seemed ripe for a cyclical bounce on stronger monthly economic data and and
the assumption of a moderate cyclical acceleration of inflation. Since the autumn of 2013,
the dollar value of industrial output measured yr/yr has advanced from 4.2% to 6.5% through
May. In addition, the oil price has been rising from a seasonal low in Jan., 2014. These are
mild cyclical positives for gold but in no way supported the price rocket we observed for
bullion from late 2013 into Mar. Gold Price Daily

The gold price may have have benefited form the inability of the SPX to break out from the
1850 resistance area earlier this year. Note on the chart how it lost luster when the SPX did
subsequently move above 1850 (SPX is in bottom panel of chart).

The gold price is below its high for the year but is on a more sustainable path of recovery
to reflect expected stronger inflation. But there was a lesson in the early going which is
that gold may benefit rotationally if the stock market falters. Weaker gold and a stronger
stock market since the autumn of 2011 suggests strongly a stocks sell off, should one occur, may temporarily benefit gold even if the cyclical case for the metal is not consistently supportive
as some gold bulls return to the fold.

Oil Price & Oil Stocks

Since global economic recovery took hold in mid - 2009, the basic trend of the oil price has
risen +12% per year and the "normal" high / low range has been about  $20 bl on WTIC. The
current range is about $98 - 118. The market has been well supplied this year, so the oil
price has been rising comparatively gently until the crisis in Iraq caught the news. The oil
price is winding up a period of seasonal weakness and the Iraqi situation may have kept the
crude price above $100 bl in June. WTIC Weekly

Holding Iraq aside, it would be fair to see oil reach a bit above $120 at its seasonal peak based
on past experience, but since the price has had a relatively mild and stable advance so far in
2014, my $120 projection for this autumn looks a bit suspect, and it make take production
disturbances in Iraq to bring oil up to the $120 level.

Even if production disruptions in Iraq over the next 12 months are minimal, industry experts
are counting on Iraq to produce an extra 3-4 million bd over the long term, so unless there is
a relatively peaceable political reconciliation there, traders may add a premium to the price
of crude to account for the risk of a major production growth shortfall should Iraq remain
unstable or even dissolve into separate political entities. The risk of a production shut down
in southern Iraq's major southern fields now appears remote given the activation of a very
large group of Shia militias from Baghdad on south to Basra and the presence of US attack
aircraft in the region. In the current fluid situation, The US must first protect Its large
embassy in Baghdad, but since an unlikely run by ISIS down to Basra could trigger a large
increase in the price of crude, the US, however reluctantly, might launch air strikes down
in the region.

The relative strength of the oil group against the SPX is shown in the bottom panel of the chart.
As expected this large out of favor group has experienced a positive reversal of fortune on
expectations that stronger global economic growth coupled with low spare capacity at the
wellhead would be a a nice plus for relative performance. In addition, continuing price
recovery in natural gas is helping along.The RS line for the XOI is coming up on resistance
at .90, and may falter without further positive crude price momentum in the months ahead.

Inflation Potential

The view here since last autumn is that faster liquidity growth would lead to somewhat faster
global economic growth and that such would produce some acceleration of inflation. I have
been looking favorably on oil, natural gas, gold, silver and commodities in general. Measured
yr/yr, the CPI has moved up from a depressed 1.0% for Oct. '13 to 2.1% currently. My
forward looking inflation gauges are continuing to advance as well. Consider the yr/yr rate
of change in the CRB commodities composite (top panel) CRB Weekly

However, the world is after all still trying to shake off the effects of steep global recession, so
you need to exercise some discretion here. There is still slack in global productive capacity
and in key large developed economies such as the US, wage gains have barely kept up with
inflation as slack continues in the labor markets as well. To sustain accelerating inflation in
a normal cyclical fashion, there eventually has to be follow through to wage rates or else real
incomes can be punished enough to weaken growth of demand.

Materials and commodities prices have been rising and there have been some positive cyclical
moves for traders to capture. But it is still too early in the game to pronounce the return of
substantial inflation on a more durable basis.

The CRB has recovered up to the 310 - 315 area. The model I run on commodities suggests
fair value is at 335. At that level, there would be a better balance between supply and demand.
So, there is some value in the commodities sectors but realize that economic demand has to
remain firm for an extended period to take up the slack.

Monetary Policy & System Liquidity

Short Term Rates
The cyclical case for raising short term interest rates is in place, although it is not a table
pounder as cyclical pressures although present are not that powerful. So, the US is finally
in an era of rate suppression. Because of the technical difficulties in raising rates during
a period of substantial QE, the issue probably remains tabled until the QE program ends later
this year. The 2yr Treas. note shows signs that investors are putting biases on an end to
ZIRP and some upward pressure on the inflation rate. US2Yr.

Liquidity Cycle
Banks are expanding the scope of lending. There have even been upticks in home mortgage
and home equity balances. The broad measure of credit driven funding (excluding QE) is
up 6.5% yr/yr through May which is strong enough given inflation of only 2%. The monthly
growth of private sector liquidity funding now exceeds that of QE as the cycle edges into a
more mature phase. With the dollar value of industrial output rising at 6.5%, the Fed is likely
reasonably satisfied with progress in 2014 to date. Still, the responsiveness has been a long
time in coming, and the balanced growth and funding will have to continue after QE is retired
for the tapering program to be a success and for the Fed to have leeway to begin a return to
more nearly normal operation of monetary policy.

Economic & Profits Indicators

Coincident Economic Indicator
The US economy continues to strengthen over the stall speed levels seen from late 2012
through early 2014. The economy has picked up from one / third speed to two / thirds
with my CEI through May at + 2.0% yr/yr. There is a continuing drag on the economy from
low employment growth plus flat real incomes reflecting modestly higher inflation and
low wage and entitlements growth. Household confidence has improved and consumers are
willing to borrow more and this has helped sustain faster business sales and production growth.
Moreover, economic recovery / expansion is broadening out. Overall, still far from pretty but
better than it was.

Business Profits Indicators
My proxy for business sales -- the value of industrial output measured yr/yr -- was up 6.5% in
May. This is the strongest reading since mid - 2012, and hits my projection for what sales should
be doing for the remainder of the year. Profit margins should be expanding now on the
stronger volume growth and an improving selling price / cost ratio as a little extra pricing
power has developed. The one negative here was a faster build in inventories relative to sales
earlier this spring. This may be part of a bounce back from the nasty winter, but keep an eye
on it.

Production capacity shrunk from 2009 - 2011, but is recovering modestly, rising to + 2.4% yr/yr
in May. The addition of real capital for business is a healthy long term development, although
further strength in the growth of production and delivery capacity may eventually slow share
buybacks with a pivot in budgets.

Stronger business sales this year is crimping the growth of financial liquidity that may be
available to flow into the capital markets. The partial offset for equities investors is faster
earnings growth.

SPX -- Daily Chart

The market hit an overbought situation early in the week, and with no momentum follow -
through, traders are taking some money off the table. SPX Daily Chart Note the RSI and
MACD readings for early in the week. The SPX was not strongly overbought against its 25
day m/a. The market remains in an uptrend off the Apr. 2014 and will remain so if it can
hold above 1920 in the next couple of trading days. You should probably take note of a
prospective reversal in the downtrend of the VIX. If such occurs, this signal would imply
that the developing complacency among players could be evaporating and that a degree of
further price attrition may lie ahead.

Traders did not care for the data on retail sales released today. Sales were positive but less
than hoped for. There was also a strong move up in the oil price which is seen as threatening
the growth of discretionary income. With QE tapering proceeding, players are less forgiving
of economic data shortfalls.

Oil traders have their first little bit of excitement in a while and aim to make the most of it
as the news tape from Iraq unfolds. How much further down the road to Iraq's dissolution
this all goes is still a tough issue. The Kurds may well have opted out of the union today
by taking Kirkuk, a northern city / oil center they have long considered their own. Whether
the new jihadis can make into Baghdad remains to be seen. If the US is prepared to initiate
air strikes, the militants will need to disperse quickly as proud columns of troops in trucks
can be eliminated fast by US attack aircraft. And, if the US is prepared to use air strikes,
the militants will be hard pressed to carry their fight to the big oil fields and terminals in
the far south of Iraq. The other key swing factor in the early going will be Shia troops or
militias and whether and where they might be prepared to join the battle.

Appointment In Samarra

Samarra lies about 70 miles due north of Baghdad. That's where the Sunni Islamist militants
are nibbling at the outskirts of this ancient city. They have already overrun Iraq's northern oil
fields, refineries and pipelines. With  a small, combat seasoned, heavily armed force, they may
capture the northern half of Iraq. Native Sunni tribal chiefs, the military and the police have
largely quit their posts. No refugee flow has has grown so large in so quick a time in history.
The militants have naturally hit all the banks on the road to Baghdad and have scooped up tons
of abandoned weaponry. They hold a huge territorial area area with a small force but lots of local assistance.

The Iraqi government is imperiled, the Kurds rush to defend their border, and Turkey is busy
warning the Islamist militants off. It has the makings of a very big story, and how it plays out
from here will fascinate. But for the markets in the near time there will be the question of what happens to the production, refinement and transport of crude and downstream products from
this major producer. WTIC Crude Daily

Oil is in an uptrend and is challenging resistance again. Reaction to this explosive situation in
Iraq has been muted so far, but things are happening at lightening speed on the ground.

Google Shows The Story

Growth company Google resumed market leadership after the last substantial market
correction way back in 2011. A stock with a decent beta, it corrected sharply earlier this year
along with about 60% of the total market. GOOGL Daily Note the test of the 200 day m/a in
early May. Lots of technicians watched that action with baited breath. Note as well the action
of the intermediate term MACD. About 60% of the total market fell into a similar MACD
pattern including the fact that probably less than 50% of the market has experienced sufficient
price momentum to cross the zero line on the way up. You will note that Google like most stocks
has yet to cross over into positive territory on MACD. That tells you that despite the rally in the
SPX, there is still above average risk in the market.

Stock Market -- Weekly

Technical
As indicated in the 5/30 SPX weekly (scroll down) the market has broken out of a congestion
zone to new highs. The breakout extended this week with the SPX closing in on the channel
top in place since autumn 2011. SPX Weekly The MACD, though historically in an upper
register, has turned positive to confirm the breakout. You have to go back to the late 1990s
bubble years to find a weekly MACD reading which has remained so continuously highly
elevated. The market is also 7.5% above the 40 wk m/a and is inching up to another strong
overbought reading. Historically, buying into these sorts of elevated momentum and MACD
markets works out profitably only about 25% of the time, but investors have made it pay
nicely since the spring of last year when the market was propelled up to high levels on these
important measures. (In the interim, more conservative traders like me have been left out in
the cold.) The RSI is overbought, but the chart shows how an overbought reading can last
several weeks especially when price momentum hums along.

The VIX index shows new levels of confidence and complacency were reached this week,
and may be its time to take note of this even granting that a low VIX reading can continue for
a good several weeks running.

Price momentum is o.k. and market breadth is solid. Volume remains awful and this may well
bother players considerably more if prices continue to trend higher on light volume.

Fundamentals
Purchasing manager combined data for new orders have been positive throughout the recovery
but showed a trend of deteriorating momentum from late 2010 through mid - 2013. Save for
the recent winter (Jan. / Feb.), combined new order data has been relatively strong since mid -
2013 and weekly leading economic indicator data remain in an 18 month uptrend. Moreover,
banks have been lending in support of higher working capital needs. Investor focus has
meanwhile shifted from the Fed's QE program which is now winding down to the better
business fundamentals. Earnings estimates are inching up after months when estimates were
consistently cut and this has helped stocks recently.

With QE tapering substantial and ongoing and business data at the forefront again, investors
should be become increasingly sensitive to how well the economy is doing. This is a big
change from last year when mounting monetary liquidity was the dominant theme, and players
were very much more tolerant of slips in economic momentum.

Eurozone Quickly Revisited

With industrial output only marginally above 2010 and price deflation a couple of clicks away,
The ECB countered today by cutting rates, suspending sterilization of basic monetary liquidity
and via targeting more asset purchases and steps to make more credit available to smaller,
growing firms. All to the good because the steps increase liquidity that was on its way down
from modest positive levels. These moves are also designed to undercut support for the
Euro. Maybe these steps will postpone the development of dangerous deflationary pressures
by leading to an improvement in economic demand levels, but unless we see production growth
re-accelerate markedly, destabilizing social and political measures will intensify further.

The Eurozone stock market is getting overbought in the near term, as players have been
anticipating ECB easing action. But there could be more follow through in the near term
especially if business confidence responds just ahead because the ECB comes to be seen
as providing substantive cumulative support.

China -- Big Red Dragon Getting Cranked Again

Well, there was a spell or two in recent years when the the central bank (PBOC) tried to
tamp down the monetary press. Cumulatively, it hit the overheated real estate sector recently.
Now the PBOC has the long term growth of its money M-2 back up near 20%. The economy --
real GDP plus inflation -- needs only about 10% growth to function decently, so the rest of
the money finds its way into the property market and all the credit specialties that are in one
way or anther collateralized by real estate. In the early part of the past decade when China was
still in its super growth phase, I figured the authorities could balance growth against debt well
enough that a big and terrible blowout would not arrive until well after 2020. I did not change
my thinking much even after the collapse of the stock market bubble, but the gov. under Hu
and Wen panicked during the deep global recession  of 2008 - 09. Money and debt have
exploded up even as real economic progress has decelerated. So, in just five years time, China
has created a potential economic catastrophe for itself and those who are dependent on China prospering.

The authorities have far reaching reform plans and perhaps with periodic relatively short term
bouts of tight money that shake out the property and credit markets, China can re-balance its
economy and achieve sounder but very much more modest growth. Since patriotism is the last
resort of scoundrels, nationalism and militarism may play a more prominent role in China's
future as the authorities nudge the economy toward a lower growth path. The US sees that
China is in deep shit with its economy now, and will need to focus far more on China's offensive
military capabilities as time goes on.

Here is a chart of the Shanghai exchange. SSEC Daily I watch it because it is a post - bubble
depressed market and once in a while there is a good trade as occurred in late 2012 when the
Fed's QE program kicked in. I think if investors believed China had a good shot at sustaining
real GDP growth at 7.5% as is so often discussed as an objective, the SSEC would trade
more in a range of 2400 - 2500. Given the trend of the SSEC and the number of trips down
to the 2000 area, players have a lower target in mind for China growth. In any event, since
the PBOC is again adding liquidity, upticks in the economy could provide a nice rally for
a few months.

Eurozone: Kings Of The Phillips Curve

According to the Phillips Curve, inflation varies inversely to unemployment. The Eurozone
has persistent unemployment at a double digit rate and is veering toward deflation with a
recent CPI of 0.7% yr/yr. The ECB, which has struggled to keep the Euro economy afloat after Mr.
Trichet trashed recovery chances with an anti - inflation program in 2010 before he retired, is
set this week to ease policy further ostensibly with a cut to short rates and a program to make
more credit available to cash strapped smaller businesses. Euro M-1 money which had responded
nicely to easing polices under the Draghi regime has pitched down in growth to 5% yr/yr and
appears  on a recessionary and deflationary course unless the ECB engineers further liquidity
growth for the system. With private sector credit demand still falling and fiscal and regulatory restraint still the order of the day, the ECB is the only game in town. Moreover, social pressures
are building in the EZ and are fostering populist political movements. Further stagnation or
outright deflationary recession can only lead to more  social and political destabilization.

The Euro stock market could be interesting if The ECB can get away from minor tinkering and
fine tuning. Waiting much longer for further proof of economic deterioration before stepping
hard on the monetary accelerator could prove very risky in a deeply fundamental way.

IEV Euro 350 iShares  Note: the IEV is about 20% below the highs of 2007.