Fedblitz

Over the past week or so, Fed governors have painted the
news tape with speeches focused on the economy, inflation
and the US dollar. Analysts and pundits have had to scramble
from one speech to the next to look for nuggets of info and
hints about monetary policy. By design, the speeches have
featured different shades of emphasis and perspective. This
is an old Fed tactic which they deploy to tell people to
lay off them and start doing their own homework. What prompts it?

> Scrutiny by analysts becomes so intense, it is intrusive.

> The Street, the media and financial pundits shift from analysis
to trying to shape the Fed's agenda and manage them via pointed
editorializing.

> The chairman comes under personal attack for not telling analysts
what most might want to hear.

When the governors pop off and seem to be all over the map, their
intent is to wear out the horde that is reading the semantic tea leaves
to elicit policy info.

This device often works because so many Fed watchers do not have a clear
understanding of how the Fed actually develops and implements policy.

Fedblitz

Fed governors have been painting the tape over the past
week or so with a variety of comments about inflation, the
economy and the US dollar. In some cases, perspectives and
conclusions differ.

This is an old Fed tactic. It grows out of resentment that the
Street, financial pundits and investment managers lately have been
on their necks like white on rice, following every word, exploring
every nuance and, sin of sins, have been trying to manage
Them by continually setting the stage and trying to lay down
the rules of engagement. It is a transitional economic environment
yet the players want the definitive word. So, the Fed puts out
lots of views instead. The message? Back off and do your own damn
homework.

The Fed is also running another little caper here. On balance,
their remarks have been hawkish on inflation, especially Bernanke's.
The game here is to intimidate the commodities markets by talking
tough and keeping them off balance. The Fed wants to verbally
squeeze the speculators for added effect to compliment a slowing
economy.

Stock Market -- Fundamental

S&P 500: 1275

The fundamental models I use continue to put fair value
for the "500" at 1290 - 1320.

The models point to rising value. At the same time the
gauges of market risk are also on the rise, although not
yet at critical levels. So, the reward vs risk profile
is deteriorating although still positive.

Both short and longer term economic indicators point to a
return to more moderate growth. My profits indicators likely
made an interim peak in April, but still look solid. What
I do not like here is that analysts are raising estimates
for company earnings for both 2006 and 2007. Up earnings
are still indicated, but I suspect this is not a good time
to be raising estimates.

The case for a cyclical rise of interest rates has been
unabashedly strong since mid-2004 (Unlike Uncle Al, I would
have pushed up rates faster, but so be it). Now however, the
case is starting to weaken some. Manufacturing new order rates
are losing steam, and the yr./yr. growth of commercial and
industrial loans, although still strong, may well have rolled
over. The indicators still point to a 25 basis point upmove
in the FFR% for late this month, but the case for an additional
push beyond that is getting a bit "iffy."

Most disturbing near term is the upturn in the shorter term
inflation measure reflecting the recent rises in oil, petrol
and base metals prices. The longer term read on the indicators
is still tilted toward less inflation, but with atlantic hurricane
season here and Hurricane Khameini whirling in Iran, the outlook
is, shall we say, open.

This is not an easy time for investors in stocks to keep their
confidence levels up. Economic growth is going to slow, it is
a little early to be calling for a pause in the short rate uptrend
and there is uncertainty regarding the outlook for inflation in
the weeks ahead. Expect more volatility as investors struggle
to master this transition period.

Stock Market Update: S&P 500 -- 1278

Short term, the SP500 has been stabilizing in a range 1260- 1280
following the sharp drop from the early May interim high. Now at
the high end of this tight range, the market has moved up from
moderate oversold levels. My favorite indicators are headed toward
positive, and a break and hold above 1280 would turn the standard
MACD positive. That, in turn, might invite in some more money.

In quick review, the cyclical bull remains intact, reflecting trend
and the direction of the 40 and 69 week M/As. Six week measures of
the NYSE A/D line and market momentum are down but both have held
important support on a daily basis. The six week measure of internal
supply/demand is even-steven, but may tilt up some this week. The
market has been below its 13 week M/A for two weeks, and it could
easily stay down for another two based on experience in the current
bull campaign. The 14 week stochastic -- a good measure of bottoms --
is close to registering a full oversold. My 13 week momentum
oscillator has turned down, but it shows no break away yet. In sum,
there has been intermediate term damage, but no decisive break.

I had been expecting a sharper downward break in the "500" to the
1180 - 1200 area reflecting very strong overbought readings in the
leadership of the broad market and the period of extended breadth
and momentum compression that preceded the recent correction. The
market has failed to comply so far and is near a short term move
to the upside. I will likely wait a few days for confirming signs
before I would initiate a long position.

I plan to update on fundamentals in the next post.

Stock Market Update -- S&P 500: 1250

In the prior two stock market posts (4/13 and 5/20), I
opined that a weak market might be at hand, with the S&P 500
vulnerable down to 1200.

I have been looking at various technical and "black box" sites
and I have noticed that warnings and "crash alerts" seem to be
cropping up just below 1250 for the 500. Whoops. Did I miss
something? Here I thought a nice 10% price correction or haircut
following a decent period for the big caps and a spectacular
twelve month run for the small and midcaps seemed reasonable.
'Tis the season for a little weakness and most stocks were
extended to the upside. I do not know whether the "500" will
fall to 1200, but if it did, I would not find it particularly
troubling. Folks have to be allowed to take good money off the
table from time to time.

I have included a weekly chart of the S&P 500. It shows a
developing intermediate term oversold (RSI and Stochastic) and
it shows the market against its 40 and 69 week M/Avs. Click here.

Note that the 69 wk M/Av has provided excellent trend support for
the market in recent years. A firm hold at or a little above
this average would be an encouraging short term sign.

Stock Market -- Technical & Psychology

S&P 500: 1267

As discussed in prior posts, I thought we would be turning a new
page for the market as breadth and momentum compression was so
intense in recent months. In the 4/13 post I opined a signicant move
was in order come May. My strong hunch was that it would be to the
downside. The sharp breakdown of the market since May 9, leaves it clearly
oversold, but also in a no man's land. To reward the bears valiant
battle since Jan. '06, which produced such tight compression, the
market should move down at least another 5%, leaving the SP500
lower at around 1200.

I was concerned we could get a spring time correction not only
for seasonal reasons but also because the powerful + 35 - 50%
moves of the small and mid cap groups over the past year was an
insouciant advance to high levels of valuation in an evironment
of rising risk. These stocks are correcting, but it does not seem
like justice has quite been done yet.

I am cautious about making any predictions in here, because I do not
know if I have much of a handle on market psychology. I do not have
a bearish macroview as many have expressed so suddenly. I just thought
many stocks were too extended and needed a good hit and that May
was a dandy month for it on a seasonal basis.

The economy is entering a transition period to lower growth and, I
trust, more moderate inflation. With these sorts of fine tuned
scenarios, the markets can be very jittery if the ball does not
stay right in the middle of the fairway as it rolls to the cup.

I would like to see the market lower, especially the small and midcaps,
but I do not not want to miss a positive swing in psychology should
one be shaping up quickly. So I may follow the trend for a few weeks
until I have a better handle on the market's intentions.

Stock Market -- Fundamental

S&P 500 : 1280

Based on my fundamental models, I have the S&P 500 as currently
fairly valued in a range of 1290 - 1320.

The October '05 - May '06 rally reflected a significant net
liquidity injection by the Fed, continued double digit profits
AND dividend growth and a recovery in the market multiple
following the autumn spike of inflation. I also like to look
to see if there is "excess liquidity" in the system. This
occurs when the growth of the broad money supply exceeds that
of the growth of output plus pricing, when both are measured
yr / yr. Excess liqudity does provide fuel to support the
market, and it was in place until April '06, when the economy
surged.

The sharp sell off of stocks in recent days reflects a shift of
investor focus away from earnings and dividend growth toward
concern that inflation has strengthened which may result in
short term interest rates that could run higher than previously
anticipated. Players see that the higher fuel costs of recent
years are working their way through the system and, of course,
there may be concerns about whether oil and petrol could
surge further later this year, what with the hurricane season
ahead and with Iran trying to kite the oil price up with a
continuum of incendiary chatter.

At this point, my longer term economic indicators are pointing
toward slower economic growth ahead, and my inflation thrust
indicators suggest moderation of inflation going forward.
I am still projecting the S&P 500 to wind up '06 in a range of
1385 - 1415.

Basically, I look for a slowing of earnings growth momentum,
but a boost to the market multiple to reflect a moderation of
inflation. The housing industry is slowing, and I look for
the growth of consumer spending to moderate significantly as
the higher cost of credit curbs the appetite for borrowing.
On the inflation side, I look for development of a better
balance between supply and demand in fuels and throughout
the industrial sector. My major concern at this time concerns
the prospect for a reduction of private sector credit growth. To
counter that, the Fed will need to cap rates and add liquidity
directly to the system, and it will have to do so with alacrity.

The next post will focus on technical dimension and the short term
side of the market.

Gold Price

Gold: $712oz.

By the end of next week, gold will have finished a very well
defined parabolic up move that could, but not need not,
culminate at $730oz.(It traded that high today.) After next
week a new pattern will be set into motion. Normally, when a
commodity comes off a parabolic, there is a correction with
a subsequent retest of the high.

I am leaving go of further comment on gold for a month or so since
I think I have said all the sensible things I can say about it. We are
in a gold-friendly inflationary milieu, there is a well defined longer
term bull market in gold and it is receiving wider sponsorship and
interest. But gold is extremely overpriced by well founded technical
rules of thumb, and is fundamentally overvalued as well.

We have witnessed development of a gold mania since last autumn, and
manias, being what they are, can end abruptly or continue. Chart
wise, this is the right time for this one to end, but only a fool
would try to rule definitively.

The 5/10/06 FOMC Meeting

Well, they meet tomorrow. Most all observers expect the
FOMC will push up the FFR% by another 25 bp and are reserving
their curiousity for the wording of the statement.

The cyclical pressures are there -- fast rising shorter term
business loans, strong purchasing manager reports, rising
factory orders and the uptrend of capacity utilization.

Moreover, the Fed has not followed through in the injection
of liquidity that came in the wake of Katrina/Rita. The FOMC
has been very measured on the liquidity front since January.

Gold -- Parabolic Upswing

Gold: $678 0z.

Parabolic price moves are most easily seen on a linear
chart. The price of gold is on a happy upward curve.
This parabolic would complete at the end of May with gold
at $700-710oz.

Gold likes an inflationary milieu: economic expansion, rising
operating rates, cyclical inflation pressure, and as often
happens in such an environment, a rising oil price. We have
the proper milieu in spades, plus a growing geopolitical dispute
between the West and Iran over the development of the latter's
nuclear fuels. Iran has kited the oil price with success, and
there is no shortage of observers who see economic and/or military
conflict which could result in a shortfall of Iran's large oil
output.

So, the gold bugs and buggettes have run the price of their beloved
up and through the roof. There are several rules of thumb in the
commodities futures markets for measuring when gold might truly
be overbought and at risk and the price is there. However, since
feeding frenzies can often exceed expectations, there's little
that can be said about when an interim top might be struck.

At this point, I cannot argue with the basics of the gold case.
Economic supply/demand measures show continuing cyclical pressure.
Moreover, I doubt the Fed is ready to purposely squeeze the
economy to the point of recession. That type of action could
actually be several years away. And, it is still early to say
that continued economic expansion will involve growing imbalance
between economic supply and demand.

So, I would simply say that although gold may be in a high return
environment over the next few years, the metal is also in a high
risk one as well. An economic slowdown, oil price weakness,
reduced geopolitical belligerency, all could conspire to blow
$100 oz. of foam off that gold brew in short order.

A word about the situation with Iran. The easy worst case scenario
here is that either the US or Israel or both could launch a military
assault on Iran to impair or destroy its nuclear programs. My
guess is that this kind of action, should it come at all, could
easily be several years out in time. After all, Iran has
been muddling along with its programs for years. My concern
centers around another possibility, which is that Iran, grown
tired of taunting the West and unable to solve pressing economic
and social issues at home, might commit the first act
of war. Should Iran lead off, the response from the US could be
much larger and more devastating. Thank goodness I do not take
myself too seriously on such matters. Whew!

Monetary Liquidity

Both the monetary base and Federal Reserve Credit continue to
run flat with late Jan. '06 levels. Thus, the Fed is tightening
the monetary string, its words notwithstanding. For now, players
in the capital and commodities markets remain smitten with the
idea that the Fed is very close to ending the current round of
boosts to the Fed Funds rate. Chair Bernanke's testimony to
Congress last week that the Fed might consider pausing the hiking
of the FFR to determine the responses of the economy to the
foregoing rate hikes is regarded in some quarters as further
evidence of a growing desire by the Fed to wind up the current
round.

The recent Fedspeak has provided cover for the fact that They have
been in a tightening mode. Plus, the idea of a pause in raising
rates, however sensible from an economic perspective, gives the
Fed "room" to stop raising rates as the off-year election draws nigh.
As I have previously mentioned, this promises to be an important and
nasty campaign for control of the Congress, and the Fed would be wise
not to have itself become a political football that partisans can kick
all around the field. After all, Bernanke is a Bush appointee.

This mismatch between the Fed's expression of its future intent and
its present course of action hardly means that bets based in the
markets which are discounting a soon-to-occur leveling off of
short rates must fail. After all, the markets are discounting
mechanisms. But, recognize the increasing risk levels as well.

Oil Market

Oil rose to a record $75+ a barrel late last week. That is
close to 86% above its economic value in a balanced environment
with 3 million bd of capacity cushion. Cushion is negligible
reflecting contingency building of larger cover stocks by
processors, market participants seeking inventory profits and
non-oil market speculators.

The recent spurt in the price set off a political hullabaloo
in the US, and has set drivers again thinking of conservation,
as gasoline affordability has deteriorated rapidly. The crude
price has backed off to about $71.50.

In using industry fundamentals, I have not done badly at all on
guessing direction of the crude price, but the upswings have
been stronger than anticipated and the downswings have been weaker.

We are entering a brief seasonally weak period, and crude must
hold $64-65bl to keep the very sharp upturn underway since the
autumn of 2003 intact. The trend band for this May is $81-64bl
using late 2003 as a base and the longer term band is $70-38bl.

At my tender age, I am a conservative player and am effectively
priced out of this market on the long side above $45 a bl.,
just as I am priced out of gold above $450.

For a slightly different chart take on this market, click here.

Interesting Profits Picture

My top down corporate profits model indicates strong S&P
500 operating profits for Q1 '06. Yr/yr sales growth
accelerated significantly from late 2005, reflecting a
rebound in output in the wake of the storms plus a
continued broadening of pricing power. Sales were easily
strong enough relative to costs to allow a number of
companies to show higher pretax profit margins. In
addition, oil price realizations also accelerated,
likely producung strong inventory profits for the
integrated producers. About one third of the SP500
companies have reported quarterly results so far, and
surprise has been positive by far.

Varied sets of leading indicators point to a slower
economy in the current quarter. Moreover, profits in
last year's Q2 were strong. So, I'd be a little
reluctant to jack up the estimates for the current
quarter even though The Street may do so. The oil
price will remain difficult to project. Over the
past eighteen months the yr/yr price change has
varied from 15% to 60%.

Credit Driven Liquidity

The Federal Reserve has achieved some success in slowing the
growth of its prime focus monetary aggregates M-1 and M-2.
Part of the reason growth of these aggregates has slowed is
that banks have simply changed emphasis in how credit growth
is being funded.

Bank lending and leasing has been growing far faster than the
economy over the past eighteen months reflecting a sharp
acceleration of commercial and industrial loan growth as well
as a continued strong real estate loan book (mortgages and
development loans). Although growth of home equity loans has
slowed sharply, yr/yr growth of the real estate loan portfolio
tops 12.0% and has been trending higher so far this year.

Of interest now is that evidence of a slowdown in the housing
market has begun to accumulate. Should this continue as is
now widely expected, the real estate component of credit
demand at the banks will begin to slow, and this will reduce
the growth of bank funding, since the real estate portfolio
is by far the major component of the banking system's loan
book.

The Fed has to be on this like white on rice, because a slowing
of bank funding growth without a corresponding easing of
basic monetary liquidity can establish conditions that may well
lead to a liquidity squeeze and consequent damage to the
economy and the stock market.

Most real estate loans are still longer term, and it is the C&I
loan book that the Fed watches most closely in setting the Fed
Funds rate. The book of shorter term business loans is still
zipping along, and when momentum in this category rolls over,
the Fed normally stops tightening. Now, the Fed has to watch
both categories closely, because too rapid a slowing of the
growth of the real estate book could produce an unwanted
drag on liquidity. Time to watch all of this more closely.

A primary funding vehicle for banks is commercial paper issuance.
This category, which includes collateralized or asset backed
paper has grown rapidly over the past two years. The Fed
regularly releases data for the commercial paper markets on its
web site, and for a nice update from Haver Analytics click here.

Monetary Liquidity

The two precursors of basic monetary liquidity in the
US are the Adjusted Monetary base and Federal Reserve Credit.
As you know, they are both very close in content. Both have
flattened out since late January, 2006.

These series are fallible indicators of the markets. They work
best when interest in monetary policy is intense, as it has been
since mid-2004. It is not easy to trade this data, as the
primary dealers on the Street experience the data as order flow
and can act on it the fastest.

Interestingly, the big cap stock averages have returned to mid-
Jan. ' 06 levels. One plausible interpretation is that players
are getting a little edgy about monetary policy following the
major liquidity infusion which ran from late Oct. '05 through
early Jan. '06. In short, some players are now less enthused
the Fed will stop raising short rates right ahead.

The US Dollar has also fared a little better since the Fed took
its foot off the gas in Jan. In fact, $USD fundamentals are
currently nicely positive although there is concern that
the dollar will prove vulnerable once the Fed stops raising
rates.

The gold market normally gets jittery when the Fed steps back
and lets its own portfolio flatten out in $ terms. Both gold
and oil did sell off sharply after then chairman Uncle Al
pared back Fed Credit as January unwound. But both have
been on a tear recently, with the Iran - US trash talking
contest in full swing ( Note that Iran likes high oil
prices as does GWB's and The Shooter's Texas oil buddies).

Next couple of weeks will be interesting regarding these
liquidity forerunners as this data will further clarify
Fed intent.

Stock Market Technical

S&P 500:1288

Well, it's spring break for school kids this week and it is
quiet.My work shows another extended period of compression in
the market based on my momentum and A/D indicators, with the
latter adjusted daily for TRIN. The compression period extends
back to mid - December, '05. This suggests to me that the market
is setting up for another significant move, although the current
period of frustration could last until the end of this month.

It is so tempting to say that we'll see a sharp break to the
downside this time, especially since a traditionally weak seasonal
period lies ahead. Moreover, the broader market still looks
overbought to me. One measure I like is the Value Line Arithmetic
Index ($VLE). It is not capitalization weighted
and besides the SP500 stocks includes the majority of popular
midcaps as well as top smaller caps. The weekly is here.
The trend is strong (ADX black line) but the MACD below is starting
to weaken. You will note the index has made a big move since last
spring.

But, happily, I find it easier to avoid certain temptations at my
tender age. So, I merely note that we seem due for some tradable action
up or down soon.

Bond Market -- Again

In the immediate prior post, I mentioned that the bond market
is in a cyclical bear phase but that the long Treasury was
oversold short term (April 4).

As I study it, I realize that the market is proving capable of
considerable volatility. I am thinking about the very sharp
and temporary run-ups in the $TYX yield that happened in the spring
seasons of both 2004 and 2005. So, the $TYX which crossed over and
closed above 5.00% today, could easily rise another 30-50 basis
points in a hurry if the players are in panic mode as they now
appear to be.

There's a long side trade coming on the Treasury price ($USB)
but I think I will make no attempt to catch the falling knife but will
wait instead for the makings of a positive turn in MACD and the stochastic.

I have been playing in the bond market as trader and investor since
early 1970. The behavoir of the market over the last two - three
years is a bit ditzy or dotty in my view, almost as if there's a new
generation of bulls coming in just as a major sea change is forming.

Bond Market

1. The bond market remains in a cyclical bear phase.

2. Note, however, that the long Treasury is now significantly
oversold. The chart of the $USB shows o/s on RSI and the stochastic, but observe as well how far the price is below its 200 day m/a.

3. To view the long Treasury yield in longer term perspective, click here.
The bond yield is moving up to test long term downtrend lines. Over the
past two decades, the tests have provided excellent buying opportunities.

4. The market is approaching an important crossroads. If the current
cyclical bear phase in the yield remains intact, the downtrend lines
may well be violated and this would be a prima facie warning that the
long term bull market in bonds could be coming to an end.

5. Since the current economic expansion began, the bond market has been
sensitive to the trend of commodity industrial raw materials prices and
less so to the CPI and energy feedstock prices. Spot industrials
remain in an uptrend, but have moderated recently. Even so, the bond
market has been weakening, suggesting a broadening out of focus,
perhaps to include the oil price as well as ongoing moderate economic
expansion in the face of rising short rates.

6. One continuing concern I have regarding the bond market is the
possibility that once the Fed is done raising rates, the FFR%
could be kept at a plateau level, as the economy might well
continue to expand with growth of economic demand and supply rounding
into decent balance. I suspect that in such an environment, players
might opt to put some risk premium back into bond yields.

7. I have stayed away from the bond market for the past year, primarily
because I think it is overvalued, with too little premium in Treasury
yields to reflect interest rate risk, supply risk and future long
term inflation potential.

8. If the market does show signs of bouncing from the current oversold
condition, I might go long for a fast trade, but that would be it.

Inflation Picture

For me, the primary stimulants of inflation are commodities
prices and a range of key cyclical sector operating rates.
My inflation stimulus pressure gauge is essentially flat
for the past six months, suggesting little forward momentum
for inflation. As I have argued, the "core" inflation rate,
or inflation excluding volatile commodities such as energy
and foodstuffs, is overdue to show some acceleration following
the dramatic run-up in fuels prices in recent years. Nevertheless,
the inflation vanguard has slowed. Moreover, productive capacity
overall is beginning to grow a little faster.

The inflation pressure gauge remains on a high plateau, and
the recent positive bounce in oil and refined products is
putting a little stress on the financial markets. Iran, with
help from an equally belligerent Bush admin. is doing a swell
job of kiting the oil price and keeping traders in the game.
There is plenty of supply, but an abundance of fear as well,
and traders are thankful as it is keeping the oil price
up ahead of the forthcoming US hurricane season. After the
last two years, you can bet that weather.com will get a big
play as the air warms in July and August.

There is even a growing buzz on the web that the US is planning
to try and take out Iran's nuclear capacity. Understandable
given the Bush Doctrine of pre-emptive strikes when He spots
peril. And there's the low approval rating, too. Patriotism
as the last refuge of a scoundrel and all that.

Interesting stuff all, but at quite an advance to the economics
on the ground. There is a message here too for the Fed as well,
which is not to overreact to the powerful scarcity fear psychology
gripping the petrol sector.

The FOMC Decision on Short Rates

The first FOMC policy meeting under new chair Bernanke is
winding up over lunch, and their decision on rates etc. will
be announced in a couple of hours.

Most everyone out there is looking for business as usual --
a 25 basis point hike in the FFR%. Since the Fed also has a
God given right not to be psychoanalyzed, I would not presume
to say what the gang will come up with.

The customary cyclical fundamentals that are usually front
and center for the Fed are vibrant enough -- broad cyclical
expansion, rising operating rates and strong and rising
short term credit demand. there's enough rolling out there
to support a FFR% of 5.00 - 5.25% in my view, and we should
have been there already, save for Uncle Al's baby step policy
inclination.

The Fed has eased on the liquidity front since this past
autumn, but not enough to signal a policy change.

The one item in the usual mix that is of interest to me is
the mild acceleration underway in the growth of production
capacity. Over the past several months, yr/yr capacity
growth has moved up from a paltry 1.1% to near 2.0%.
The longer term trend seems to be turning up and this is
very important because, should it continue, production
supply / demand growth will come into much better balance,
and this will undercut inflation stimulus within the system.

I am hoping that Benny The Banker will step right up and
put his fingerprints all over the FOMC decision and
consequent statement rather than toodle along like a Greenspan
acolyte. We'll all see shortly.