Stock Market

Back on 11/18, I posted that the stock market was deeply
oversold and that a rally might not be far off in time. Well,
in the interim, the market got even more oversold, and with
better news over the past 2 days, it rallied powerfully, to
the point of leaving only a slight short term oversold in its
wake. Hard to say how it will do in the days straight ahead
after a 4% 2 day pop, but there has been a positive break in
my shorter term momentum trend, and that's an attention getter.
So is the prospect for a positive turn in MACD (12/26/9 day).

At this point, I continue to see enough economic uncertainty
out there to feel a degree of comfort in plunking the SP500 into
a rough 1400 - 1550 trading range until matters sort out
further.

For the daily SP500, click.

Bond Markets

The long Treasury closed under 4.3% today. This market is
now getting seriously overbought. The Marketvane index of
bullish advisories on Treasuries has reached 77% and is
trending up. As a contrarian reading, 77% bulls is signaling
an eventual rebound in yields (and lower prices).

The strong rally in Treasuries since this summer reflects
prospects for a slowing economy and a strong flight to quality
from riskier assets, especially CDOs of varied stripes. But
yield spreads between top quality and medium quality corporates
are widening, and the high yield market is now once again the
junk market, with yields here jumping from under 8.0% a few
months back to 10.8% presently.

One indicator I watch closely is the industrial commodities price
composite. Broad measures of industrial commodities prices have
leveled off in recent months, a normally bullish development for
bond prices.

I had a nice trade earlier in the year when long Treasuries were
oversold, and now I am looking carefully at a short on the Treasury
price. I am also getting intrigued by the junk universe, which
is deeply oversold. Yields above 10% are attractive for risk capital
since you have a shot at a 10%+ annual return for the risk taken.
So maybe there is nice long / short trade coming up. (I rarely hold
positions in bond trades past 2-3 months.)

I regard Treasuries as fundamentally unattractive for investment.
Investors are not being adequately compensated for inflation and
interest rate risk, nor are they being compensated for the vagaries
of the offering calendar in the years ahead. Flip the coin and you
could make a good argument for offering long Treasuries to the
market to lock in these yields.

For the long Treasury price ($USB), click.

Holiday Season Sales

As all know, sales for the holiday season are avidly watched
by many. Business and investment people enjoy debating the
prospects for the season when it comes to hand, and this time
will be no different, especially since the Fed's FOMC is to
meet on monetary policy on 12/11.

The fundamentals are far more somber this year than last.
Yr/yr, employment is up only 0.5% and the real wage is up by
only 0.5% as well. That yields a base case for a 1.0% gain
in sales before inflation and maybe 4.0% in current $ terms.
But beyond that, it is hard to say how consumers will do at
the register. From my perspective, much depends upon whether
there's an interesting cross-section of newer stuff to buy and
also the weather will play an important role. A good cold snap
with some snow around the US can do wonders at the malls as
folks stock up on easy stuff -- hats, gloves, boots, coats etc.
Another interesting issue is how tough it is to stick to
a modest budget. That requires shoppers have a plan and that
they carry it through with ruthless precision. If you head out
to shop with a vague idea of cutting back, you may find yourself
in trouble when Christmas Eve comes, and the same old large
pile of goodies is under the tree. Debate the outlook if you
wish, but do not fail to miss the magic of the season, for
magic it is.

Short Term Rates & US Dollar

Short Rates

My 3 mo. T-bill yield indicator spans more than 90 years
of data. It is a diagnostic tool and not a forecasting
model. Based on recent inflation readings, the T-bill
should be trading in a range of 5.10 - 5.50%. The bill
is now around 3.50%. Part of the discount to the model's
value reflects the recent 75 bp. of cuts to the FFR%, but
most of it reflects investor flight to quality. Some
players are anticipating further FFR% rate cuts as the
economy slows, and some have moved into bills and notes
hurriedly as they dump or reduce positions in higher
risk assets.

A 3.50% T-bill yield is not attractive at all to the
average investor and saver. With inflation at 3.5% on a
yr/yr basis, the after tax return is negative and savings
are being confiscated. For higher net worth savers, 6
month CDs at 5.10% are even a bit below breakeven.

Holding taxes aside, the real or inflation adjusted rate
on the bill has fallen from a cyclical high of 3.8% down
to zero since late 2005. Retirement funds have been put
under increasing pressure to increase risk levels to
maintain beneficiary purchasing power.

My longer run measure of inflation has been running about
3.1% this year. On this measure, short rates and shorter
duration T-notes are just too low and unless inflation
pressures ease, savers are going to continue to take it
on the chin. With the economy slowing, consumers may
be pushed to increase savings anyway, especially with a
soft housing market.

US Dollar

The rapid decline in the real rate of interest since late
2005 has greatly reduced the appeal of holding dollars for
US householders and businesses. That alone is a good
reason for foreigners to avoid dollars in preference for
stronger currencies. The cost of doing business in and
with the US for Asian mercantilists like China is rising
sharply as US rates and the dollar decline. The weak dollar
is sharply increasing US competitiveness abroad and is
producing large currency translation gains for US multi-
nationals. Even smaller US companies are getting into the
act.

I genuinely like the fact that US exporters are doing very
well, and if it takes a low dollar for a goodly time to
put our exports out there successfully, fine. However,
The Fed owes savers as well and must move as quickly as is
prudent to restore short rate equilibrium for savers.

Stock Market

The market oversold has deepened. The SP500 remains at a
nice discount to its 25 day m/a, and my six week selling
pressure and buying pressure gauges are in deep oversold
territory. So, a tradable rally may not be far off. I would
also note that there are two distinct 20 week cycles and
one nine monther that point to lows within the next 30 days.

That's the good news. The bad news is that the SP500 Market
Tracker is coming down fast reflecting both earnings estimate
cuts and pressure on the p/e multiple from accelerating
inflation. The Tracker is undergoing its sharpest decline
since early 2001, falling from a July 'fair value" estimate
high of 1610 to just slightly below 1500. Analysts are cutting
Q4 '07 estimates and are just starting to trim Q1 '08 numbers
as well. The weekly leading economic indicators have stopped
falling however, but are flattish and suggest slow or "drag
ass" growth. The inflation thrust indicator remains in a
substantial uptrend, pushed hard by the oil price and, more
lately, a recovery in the retail gasoline price. The momentum
of inflation thrust has slowed a little bit over the past ten
days. You have to respect all of this, but not get carried
away with it as there are at least short term indications the
economy is stabilizing. There is no end of print about the
problems of the financials, but the banking sector is
functioning -- loans are ticking up and funding is not unduly
constrained. Loan losses are rising, but cash flow for this
sector has mushroomed to $150 billion annually in recent years.

Visibility to sustain the cyclical bull market is low now, but
my indicators do not yet suggest throwing in the towel.

I plan to give discussion of the stock market a rest for a couple
of weeks and look at some other topics. I include a link to the
weekly SP500 chart.

Quick Note On The Short, Short Term

As discussed on Sunday, we entered the week with a deep
short term oversold. As expected, traders jumped on it and
rallied the market strongly yesterday, right up to short
term downtrend lines. The market failed to break through
today and ended on a weak note. There is still a moderate
oversold in place, and players may have to watch the oil
price carefully because the strong bounce in oil today
following a steep, fast sell off, did not sit well with
the stock market in my view.

Stock Market Comments

The recent weakness in the market has brought it into a
deep short term oversold condition at about 4.5% below
the 25 day m/a. Oversolds at this level have proven very
attractive to aggressive traders in recent years. In turn,
my six week selling pressure gauge is heading into oversold
territory which is another positive.

Intermediate and longer run measures have turned negative.
Breaks of trend on market and breadth measures, weakening
momentum against the 40 wk m/a and a downturn in the 14 wk.
stochastic all signal caution. There have been no breaks
in any of these measures so decisive that a whipsaw move
in the market to the upside can be readily precluded.

Speaking more broadly, the volatility in the market since
mid-July suggests that players are re-appraising fundamentals
that guided the market sharply higher from mid-2006. Signs
of a slower economy, earnings estimate cuts and re-ignition
of inflation pressure have forced the re-appraisal.

The suggestion to me is that any forthcoming rally may be
more subdued and of shorter duration than we have seen in
recent months.

Stock Market Comments

My SP500 Market Tracker is weakening. It is now signaling
fair value at 1570, down from a range of 1600 - 1625 several
weeks back. Analysts are cutting earnings through 2008, and
with a fast rising retail gasoline price, headline inflation
is likely accelerating. The result is a lower market P/E on
lower earnings.

The subprime mortgage reset volume is peaking now, and that
assures more defaults and foreclosures going forward. One
difficulty here in trying to restructure these loans is that
law rquires you deal directly with the lender -- tough to do
with sliced and diced collateralized obligations. the larger
problem is that most of the delinquencies involve inadequate
collateral and fraud as to opposed macro-conditions. Not much to
work with even for sympathetic lenders. Net of foreclosure $
and tax writeoffs, I am thinking the total tab will be $145
billion. That figure could equal 10% of total underwriter
capital. The regulators will need to allow recognition of
these losses to be gradual or even amortizable so as not to
impair primary capital. A tough but not unmanagable situation.
The banking industry throws off about $150 billion a year in
gross cash flow.

So, there are more financial sector losses to come. On top,
leading economic indicators do not yet signal a recession but
are in a downtrend. Global indicators are still solid, but are
trending down as well. My inflation thrust indicator is moving
up sharply from a steep low set early in the year and is being
paced by the oil price, up 92% from the Jan. '07 low.

The Fed has so far taken 75 bps off the FFR%, and there are clear
signs that system liquidity is repairing. I'd advise the Fed to
maintain a stable policy course for the next few months to better
sort out economic and inflation potential and to glean how the
financial sector is coping with the mess it created.

The financial system is repairing and the problems, although
very large, are managable with deft regulatory handling. Also,
a little time is needed to take the measure of the oil price.
Yep, supplies are tight, but the action suggests a full scale
blow-off may be well underway.

Bottom line? Patience is needed here. I am not uncomfortable
with the idea that fundamental direction may remain elusive for
another four weeks or even longer.

Treasury Bonds -- Heads Up

I am strictly a contrarian when it comes to trading bonds.
I get very interested in bonds when the long Treasury yield
has drifted far from its 40 wk M/A and / or when trader
advisory sentiment moves to extremes. The Long T is a little
overbought relative to its M/A, but advisory sentiment,
specifically Marketvane, is moving into territory that is
starting to signal excess bullishness. In recent weeks, the
Marketvane compilation of sentiment has kissed 70% bullish
once or twice and most recently stood at 69%. These are the
highest bull readings since mid-2005. Bullish sentiment is
not yet flat out extreme, but the 70% area signals to me
I should starting to think about shorting the bond.

Quick Notes

1. Leading economic indicator set weakened slightly more
in Oct., but growth indication still posiitive, albeit
slow.

2. Yr/yr growth of employment through Oct. was a slim 0.5%.
Wage growth was 3.8%. Underlying consumer purchasing power
continues to erode.

3. Heating oil has broken out to the upside and on deck is the
wholesale price of gasoline, set to break out
above the 2.35 - 2.40 per gal. area. Retail gasoline price
continues to inch up, but now has potential to run up to the
$3.25 area again.

4. Support for SP500 has firmed at 1500. Let's see how they take it
out today.

The Fed "Zinger"

This past Monday, I opined that should the Fed choose to
blow off the speculators in the markets by standing pat
on Halloween, it would cause a ruckus. Well, the Fed did
cut the FFR and discount rates by 25 bp, but in its
statement it cited economic growth and inflation risk as
of equal concern, hoping folks would infer that it was
going to stand pat on rates going forward.

The message did not sink in right away, but today it did,
and with news of economic slowing and concerns about
Citibank's dividend in hand, market players took stocks
to the woodshed.

Since mid-August when the Fed addressed the fallout from the
subprime debacle more earnestly, oil prices have rocketed as
all know, and industrial commodity prices have surged at a
25% annualized rate. Inflation potential has been growing
quickly. The Fed's gambit here is to posture tough enough to
crack oil and materials prices in hopes of taking steam out
of the inflation thrust underway. The Fed knows that an
inflation surge domestically will punish consumer real incomes
and confidence down the road and damage the economy. So, they
hope to scare the commodities markets and the US dollar shorts
in the interim. The Fed knows only too well that capacity is
constrained in oil and industrials, but they also know there
is plenty of speculative interest as well.

Many market players appear to have all but dismissed inflation
in favor of tracking economic potential. Let's give it a week
or two to see if they can connect the dots, and whether an
apparently firmer stance by the Fed will shake out some of
the commodities speculators.

Federal Reserve -- Trick & Treat

I would not pretend to know what the Fed will choose to do
with the Fed Funds Rate come Halloween Wednesday. The heavy
betting is on a 25 bp cut then followed by another 25 at the
upcoming 12/11 meeting to stoke holiday shopping. The markets
have all but stampeded the Fed into a cut on Halloween. At
some point, the Fed is going to need to reclaim authority at
the short end of the yield spectrum. Blowing off the speculators
on Halloween would be terrific fun, but it could create a ruckus
not soon forgotten.

So, the bettors are counting on a FFR% cut treat this week. The
"trick" is that the Fed is continuing to run a very tight ship
in terms of monetary liquidity. Federal Reserve Bank Credit and
the adjusted monetary base, cornerstones of policy, are up a
pittance this year, despite the July crisis. However, the Fed
also sees that a third of the funding lost in the lock up of
the commercial paper market has shown up in the banking system's
jumbo deposit category (over $ 200 billion just since July). So,
credit driven liquidity, although barely growing short term, is
repairing nicely.

Things may change, but so far the Fed is holding off on the kind
of fast liqudity infusions we saw in Uncle Al's heyday. We'll see,
but right now, a modest US liquidity situation does not of itself
support all the excitement in the various markets we have seen
since last August.

Gold Price -- A Less Glib And Flippant View

Yesterday, I had some fun with the wilder side of the stories
surrounding the recent price action of oil and gold. Today,
I look at the more normal measures for gold.

The weekly macroeconomic price directional for gold continues
to track the ups and downs of the gold market rather well. The
macro indicator hit a new all-time high this week reflecting
the powerful surge underway in the oil price. For 2007 to date,
better than 90% of the move up in the macro indicator reflects
the combine of oil and industrial commodities prices -- elementary
building blocks of inflation.

Over the long term, a one point move in the indicator has translated
into a $7.50 oz move in the price of gold. However, since the end of
2005, a point move in the macro indicator has translated into roughly a
$25. oz move for gold. That's a dramatic increase in gold's volatility
relative to the indicator and it reflects a greater speculative
interest in the metal coupled with the deployment of more borrowed
or leveraged money moving into the market. Much the same can be said
for the oil price.

Prior to the speculative jump in the gold price in early 2006, it was
tracking a 13.6% annual return trend. That's very good relative to the
inflation that developed over the period. With the price channel
established over 2000 - 2005, gold would close out the year at around
$625. But gold at the current $788 is well above that level and is
rapidly getting extended relative to the speculative leg in place since
early 2006.

I'll keep reporting on gold, but the action is too zippy for me.

The Artist Zu Sheng Yu

I promised some links to interesting artists whose work
deserves a look. Below is a link to the work of Zu Sheng
Yu, whose stuff I first saw only two years ago. China's
loss is our gain. Lovely work.

Note: I have a long position here. A few years back, some
canvases could be had for $800 - 1k. We are talking $26K
now.

If the link does not pick up, go to www.zsyu.com. There
are 20 pages of work to view.

Oil & Gold -- Wild & Wooly

Oil and Gold prices took off in the immediate wake of the
subprime financial crisis circa mid-August. Speculators have
bought the whole nine yards of the "Helicopter Ben" pastiche.
The Fed's decision to cut the FFR% in mid-September only added
fuel to the story. Ben has not complied, except seasonally.
Then there's GWB / Cheney and Iran's Ahmgonnabebad kiting the
oil price with an ongoing pissing match regarding Iran's
nuclear ambitions.

Now, we have both oil and gold in speculative blow-off mode,
with prices for each now in danger zones viewed long term.
Both markets are getting extended and vulnerable. So, I
would say that whatever your upside targets for these entities
may be, recognize that prices are in zones when even slight
dents to the mantras can lead to unsportsmanlike tumbles.

The Fed normally adds to liquidity as the holiday season
approaches, and the FOMC is moving at a remarkably leisurely
pace. GWB and The Shooter want to sound tough vis a vis Iran
and help out their oil buddies as well. Their macho routine
has been ineffective geopolitically and has been a disservice
to the US from an economic perspective. With the troop "surge"
of this year and the large naval build up in the Gulf, I would
have thought that US aircraft would have lit up the border with
Iran already to disrupt supply pipelines to Iran's Iraqi
clientele. And, I doubt we can count on the Turks to hit oil
production in northern Iraq.

So, lots of talk all round, but not any action. Oil and gold
might need some of that wilder action to keep the runs going.

Stock Market Comments

As discussed in several recent posts, the stock market
experienced a strong bullish impulse off its mid- August
low that went too far, too fast. I had a nice run off those
lows, but exited in early October as the action was too zippy
for my taste. The crunch came last week as earnings
disappointed, oil surged and G-7 came out grumpy. My plan is
be thankful for the recent surge and bide my time, allowing
the market to sort itself out short term. These are uncertain
times and the Sep. / Oct. high flyer discounted a rapid return
to sunny prosperity.

The SP500 bounced off classic pivotal support today at 1500.
That may bring in some fast super short term money, but I have
to confess that textbook bounces like today leave me a bit
leery because the action seems facile. More as the week
wears on.

I owe some links to some interesting art I have seen recently
and I am readying that.

Stocks, Inflation & Liquidity

With the latest inflation readings, the fair value estimate
for the SP500 Market Tracker has been reduced from a range
of 1600 - 1625 to 1575 - 1600 to reflect downward pressure
on the p/e multiple from an acceleration of inflation.
Looking forward, the p/e may be downshifted further, as this
year's surge in the oil price works its way through to the
retail level. The oil price has moved well above parameters
long seasoned traders would be comfortable with, but
speculative interest has been bubbly in recent weeks.

The broad measure of liquidity I favor has been flat since
May, '07, due entirely to the sizable contraction of the
market for financial org. commercial paper. Measured yr/yr,
broad liquidity has dropped from the 9+% level to just 6.3%
through Sep. In turn, the yr/yr % change in the $ cost of US
production has inched up to 4.8%(also through Sep.) Thus,
excess liquidity in the system has dropped from over 5% earlier
in the year to just 1.5%. Much of the rally in stocks since
mid-August then likely reflects the put back of cash raised
during the immediately preceding sell-off. The liquidity
tailwind for the capital markets has thus moderated in
dramatic fashion.

My longer term inflation indicator has turned sharply upward.
Sustainability of trend remains a question as the indicator
is being powered by the oil price which is heavily overbought
and which could turn volatile at any time.

Stock Market -- Short Term Technical

As posted on 10/2, I opted to close out my longs at 1547 on
the SP500. These were good trades, but as usual, I left some
money on the table. The market was overbought and on too fast
an upward trajectory. That frenetic run was broken late last
week and we've dipped to 1549. As the chart below shows, the
10 day m/a has been violated. The market is still well over
the 25 day. As well, the MACD looks set to roll over.

The dip buyers have been frozen out of the market since 9/10
and going long since then has basically involved chasing them
up. Whether today's sell-off was strong enough to pull in
sideline money I do not know. Equally, I do not know if we
will see a test of the 25 day m/a soon, either, although I
sure would like to see it to get a handle on follow through
potential in the wake of the spike following the Fed's 9/18
action.

Look across for the link to the SP500 chart.

Corporate Profits...

Earnings season has kicked off. Expectations for total
yr/yr profits performance for the Sep. Q are the most
subdued for a good several years, with analysts having
circled this Q up as the worst momentum-wise months ago.

For earnings expectations, Q3 results are normally quite
important. It is now October, and analysts have to get more
serious about company earnings potential for the new year
ahead. That's an annual rite. And this year, there is more
on the line since the Sep. Q is widely seen as the bottom
in yr/yr earnings momentum with acceleration in profits
growth foreseen from now clear through 2008.

My top line overview for US only sales is about 4% yr/yr
for Q 3. This suggests some margin pressure and the likelihood
that a number of companies will report mildly down earnings
prior to share buybacks and gimmicks. The smaller cap. companies
with only US operations would be the most vulnerable. Companies
with a hefty export book of products or services will do much
better, as will the larger firms with substantial foreign
operations. About 30% of total US profits is now earned abroad,
and there are a number of SP500 companies with better than 50%
exposure. There will be additional positive leverage to foreign
operations in the quarter as the USD averaged about 80 compared
to 85 last year. Basic industry scored moderate sales growth,
but has nice leverage from continuing pricing power, and has
also exhibited more stability in performance than in many years.
Tech and capital goods are expected to have improved. Oil lifting
profits continue to accelerate, but integrated producers are
experiencing poor refining margins. Financial service revenue
growth for the quarter will surprise to the upside, but as has
been well documented, many providers will show large loan losses
and writeoffs related to subprime.

As discussed last week, the indicators suggest slower global
growth ahead, and it may be difficult for the broad market
to benefit from rising oil and materials prices as well as a
falling USD, as these variables, though positive for sector
earnings and relative performance, are inflationary and are
negatives for earnings capitalization overall.

A positive stock market environment for 2008 may well require
stronger and more balanced US economic growth along with
expanding foreign operations. Such is not in view yet, and
is a critical reason for keeping a strong short term focus.

Stock Market Fundamentals

When I look at consensus earnings estimates for 2007 and
2008, it is easy to build a case for a 1625 - 1650 close
for the SP500 for this year, and 1825 - 1850 for next year.
As a group, analysts expect earnings growth to accelerate
significantly from a very tepid 3rd Q '07, and many
economists are looking for inflation to stay under reasonable
control. The 50 bp. cut to the FFR%, stabilization of key
weekly economic indicators and stabilization of financial
system liquidity have reduced risk and form a decent down
payment on a positive market turn.

We have the down payment, but a fair measure of uncertainty
remains. The global economy is more likely to slow down
before it would regain sufficient positive momentum to support
the presumed earnings outlook. We still have to see whether
US liquidity will turn sufficiently positive to support faster
growth, and just as important, we have to see whether faster
liquidity growth will drive commodity prices sufficiently to
produce an acceleration of inflation pressure and a consequent
reduction of the market's p/e ratio.

It is reasonable to assume that managers of large pools of
equities are thinking that the Fed will attempt to do what's
needed to keep the economy growing. After all, 2008 is a wide
open national election year, and the Fed would not like its
failings to be a major campaign issue. I agree with this view,
but like many other greybeards, know the Fed does not always
succeed at what it intends in a timely fashion. However, recent
Fed action has likely earned a measure of investor and politician
patience.

So, it is easy to lean positive. Yet, I think it could take
five or six months before the uncertainties inherent in the
economic environment are resolved. This translates to thinking
about return potential in the context of elevated uncertainty.

My SP500 Market Tracker currently has the "500" fairly priced at
1600 - 1625. The market closed at 1562 today, suggesting some
continuing investor wariness despite the recent strong advance.

I am anticipating elevated volatility through Q1 '08, and am more
interested in trading than taking investment positions.