Stock Market -- Still Just Looking

As previously discussed, the sharp sell off running from the
latter part of May through mid-July created a deep oversold
condition. Since this sell down also made it clear the US is
still in a bear market, it was suggested one be an angel and
not a fool in approaching the oversold. The market has moved
erratically up from the deep oversold and has even been nice
enough to form a channel. Even so, the signs I like to watch for
a change of trend have been scant indeed. So, despite the stray
thunderstorm, I have been relaxing out on the deck with the
occasional libation.

But, I have not lost heart, and continue to monitor the situation
for a long side trade. Specifically, I am watching the action of
the 10 and 25 day moving averages, and MACD and Stochastic
for the weekly charts. The daily SP 500 is here.

Liquidity Cycle

The Fed has tightened the growth of monetary liquidity for several
years. With the advent of the subprime mortgage and housing
debacle last year, the commercial paper market crashed to the tune
of $700 billion, sharply reducing the rate of credit driven liquidity
growth. Profit shrinkage generally follows hits to liquidity, and we
are seeing that, although the damage is primarily in the financial
sector. Economic slack has increased in the US and this usually sets
up a contraction of inflation. However, a strong global economy and
a weak US dollar stemming from cuts to the Fed Funds rate, did
keep the inflation pressure on an upswing until recently.

The commodities market -- the dominant inflation force -- has been
weakening in recent weeks, including the petroleum and gas markets.
Normally, once there has been a liquidity and profits recession that
results in a weakening of inflation, the Fed will relax the restraints
on the growth of monetary liquidity, and one can begin to look
forward to a stronger economy and a profits turnaround.

With slowing global growth, the Fed needs to assess carefully whether
enough slack will develop to underwrite further weakness in
commodities prices which would "green light" the Bank to allow
faster growth of its portfolio and the monetary base. The Fed has
been badly stung by the commodities boom of the past year, and has
been extremely tentative in providing liquidity to the system overall.
The Fed also knows that if it holds rates steady as inflation recedes,
the dollar may strengthen further, giving them another leg up on the
commodities market.

It naturally remains to be seen whether this liquidity cycle blueprint
develops as usual. For now, the pieces are starting to fall in place,
although the Fed remains very tentative, as it is hard to relax after
such a daunting and powerful run in the commodities market. The
latter has greatly inhibited the Fed in its liquidity provision
decisions, and has also punished business, consumer and investor
confidence.

Stock Market -- Fundamentals

I keep a short list of indicators to help me gauge the fundamental
outlook. The one clear positive has been the downtrend of short
term rates. My monetary liquidity indicators are turning from
negative to positive, but the readings are wan and have been
temporarily inflated by the addition of the Morgan / BSC deal to
the Fed's balance sheet and by the flow of income tax rebates.
On the negative side, corporate bond yields are rising across the
quality spectrum reflecting low confidence in the business
environment and the acceleration of inflation.

The SP 500 Market Tracker remains in a bear trend and sits
down at 1130, well below current levels in the market. The
Tracker may drop more as we head into August as a probable
further hike of CPI inflation measured yr / yr will suppress
the model's p/e ratio further. On the plus side, the recent sharp
decline in broad commodities indices points to lower inflation
readings down the road.

I would pay less attention to the Tracker if the primary indicators
were on a stronger footing. However, those indicators are too
weak on balance to support development of a cyclical bull market
at this point.

Shoot First, Ask Questions Later....

The above is a once popular adage for traders to move quickly on
dramatic changes in price and enquire at their leisure what the
causative factors may be. The idea is clear enough : If one plunges
into an analysis of factors behind sudden change, the work time
might bring one too late to the party. Balance that admonition
with the realization that many of you are competing against large,
mobile pools of capital that may have better short term info than
you and have the wherewithal to reverse course on a dime to
pursue a newly hot trade.

The fast downward break in oil and natural gas prices has helped
shepard in a rapid price decline in the commodities markets. The oil
move is complex -- rapid profit taking in the wake of a short run
momentum failure, concerns about greater demand weakness, the
spectre of Congressional meddling in the futures market. But a
rapid decline in costs to consumers and business promotes a
healthier economic environment. Presto! as commodities dip,
the equities market come back to life, with the most depressed
issues such as airlines and banks leading the way.

What is interesting in the moment, is the dramatic changes have
come so quickly and forcefully that new short term trend
confirmations have not been established yet. The charts are
"cuspy" but are not there yet. As one who likes to control his
risk, my impulse is to take profits, await the trend signal, then
return on the first test. Each of us has his/her own preferences in
fast markets like this. Just do not get greedy and go for the top or
bottom ticks.

Stock Market -- Chancy Action

A breakaway downleg ended this past week without the advent of
the furious, downside volume that would serve well to mark a low
point. Instead, we observe a "spike" bottom made by a powerful
upside burst led by the bedraggled financials. From a purely
statisitical / historic perspective, one should be sceptical of the
sudden spike low, particularly in a bear market.

Even with the surge up, though, the market remains oversold and
that leaves exploitable territory for the bulls who may wish to play
on for a few more days.

There is talk out there of a "reverse" trade -- short oil or, perhaps
the OSU ETF, and go long the SP 500 or even the financial sector,
like the XLF Spyder, which remains heavily oversold. This is
interesting concept stuff as the oil market has weakened sharply,
and a further decline would lead to better real economic growth
prospects down the road. But this is a trade only for the more
venturesome at this point, as there is little evidence that the oil market
has indeed shifted. Oil is still moderately overbought, so the "reverse'
trade could work further for only a brief while before the herd of
oil bulls try for a comeback.

The results of the meeting of Security Council members, the IAEA
and Iran in Geneva provided no resolution to the geopolitical issue
of Iran's nuke program. Attendance by US ambassador Burns seemed
to mark only determination to have the Iranians choose the carrot or
the stick within a couple of weeks. I mention this because all short term
players will need to watch the oil pits straight off tomorrow.

Oil Price

In a spate of infectious profit taking, the boyz in the pits have taken
oil from the $146bl. area to just under $130. As discussed over the
past several weeks, I mentioned that oil was spectacularly and
fabulously overbought. For the disciplined trader, oil is still
substantially overbought, although the current measure is within
reason and no longer silly.

The powerful price uptrend underway suggests oil can trade within
a range of $142 - 117 bl. for July. At the lower $117 level, oil would
not be overbought given the volatility of the price.

Now oil closed just under shorter term support around $130bl., so it
will be interesting to watch the action around that level for the next
few days.

It should also be noted that with August, comes a seasonally weak
period for oil as the market anticipates a drop off in gasoline demand
in the northern hemisphere as summer drive time winds down.

I am happy to see the oil correct, but I will be watching carefully to
see if oil breaks decisively below $117 over the next few weeks, as
that would be much stronger evidence that this ominous uptrend
is expending itself. The best you can say now is that the players
are taking profits in the wake of dramatic gains through 2008 to
date.

I will not insult your intelligence by pulling up some fundamental
explanation in a market that lacks both transparency and veracity.

Chart here.

Stock Market -- Fundamental Note

With today's big rally, let me sneak a little not so good stuff in
under the radar. CPI inflation hit 5.0% yr/yr for June, for the
highest reading since 1991. That news puts a significant crimp
on the SP 500 Market Tracker p/e multiple and sends the
reading for late June / early July down to 1130 (vs 1245 for 7/16).

Commodities prices, particularly energy, is by far the dominant
driver in the inflation outlook. Since commodities can be so
volatile, forecasting visibility is low. For example, broad
commodities composites are down by about 5% since July 4.

Inflation is gobbling up the liquidity in the US financial system,
suppressing output, profits, and incomes and leaving a liquidity
headwind for equities.

The SP 500 has trailed the Tracker on the way down over
the past year, but has stayed above the Tracker's line. This
suggests that despite a bear market, investor optimism has
not fully burned out yet.

There are two additional factors to keep in mind. The stock
market is highly sensitive to commodities prices now because
they dominate inflation. Secondly, even if there is inflation
relief ahead, one has to go along carefully and check back to
make sure the inflation surge to date has not damaged the
economy more than we've already observed. In short, should
the commodities scene cool off, it does not mean an automatic
free pass to a bull run in stocks.

Stock Market -- Technical

The market's oversold condition has deepened over the first couple
of weeks in July. As pointed out in the 6/27 comment on the
market, I have, as a gentleman of leisure, opted to spend quality
time out on the deck with the occasional drink and cigar. I have
stayed away from the market, and I may do so further. The
break below important support in late June reaffirmed the bear
market and, as subsequently mentioned, set up the possibility of a
breakaway downleg, which we have been experiencing. The
failure of the bulls to sustain a rally in recent weeks plus the
absence of heavy downside volume relative to upside volume
leaves me cold -- concerned that traders are looking for a
demonstrative capitulation to the downside before stepping in
to rally the market. In short, we have a breakaway downleg that
could spike down on heavy downside volume before this move
completes.

Hunches can get you into trouble as easy as not, and since I
have no trading capital in the market, I would like to find a spot
to play a rally from a deep oversold. But I am not going to push it
and instead will take my cue from the action ahead.

Financials Sector ($XLF)

My e-mail inbox is filling up with heated treatises about whether to
buy the financials in the wake of a year of searing losses or to punt,
figuring there are more searing losses to come.

The SP 500 financial sector Spyder (XLF) is down about 50% from
the record high set in spring '07. On a 12 month basis, sector net
per share is off about 90% through mid-year. The collapse of
earnings naturally reflects the subprime/CDO fallout plus the
ongoing substantial dilution to earnings from the replacement of
washed out capital.

In view of the collapse of earnings, capital impairment and the
leveraged financial structure of the sector, a 50% hit to group
value seems apposite. From a fundamental perspective, the XLF
deserves to be trading so low. However, the sector is spectacularly
oversold on a technical basis.

I think it is wisest to assume that 1) the system will be repaired and not
scuttled, 2) the repair process will take considerable additional time, and
3), that there will be additional hair raising incidents before the process
is complete. Repair should accelerate after GWB leaves office. The
laxity of regulation, the unpreparedness of Messrs. Paulson and
Bernanke, and the initial macho posturing of no bail outs by the GWB
crew puts this crisis a little bit a head of Katrina in the annals of
plutocratic indifference by the current resident of The White House.

It is reasonable to expect that the mere absence of mega writeoffs as
witnessed in Qs 3 & 4 of '07 and Q1 0f '08 will restore half of lost
net per share over the next 12 months. That would put the XLF at
fair value at the current price level.

I might be willing to take a flyer on this XLF pup on positive turns in
the 10 and 25 day m/a. There could be good 2-3 month upside if
it gets put into positive play. I shall pass it by until there are signs
of a positive turn in trend. XLF chart.

Stock Market Conjecture

Recent weakness in the market brought a new cyclical low and
re-confirmed the bear market. As recently discussed, the market
was deeply oversold, so today's moderate bounce cannot be viewed
as a surprise.

Since I think we are in a low visibility economic environment, I
do not have strong views about where the market goes from here.
Housing is in the dumper, and although pent up demand is building,
the experts claim that lender financials and housing affordability
will not be in decent enough shape to support a recovery this year.
Since the spring selling season was weaker than I had hoped, I
find it hard to argue with this view. The broader economy is
afflicted by a wage / cost squeeze on household incomes and a
price/cost squeeze on business profits. A continuation of these
patterns spell additional trouble. Yet, in just two days, as the
commodities market has weakened, the inflation thrust indicator
has taken a big hit to the downside, as players become more
concerned that global economic demand is imperiled. Now, if it
turns out that fuels and other commodites are set to contract
further, or even flatten out, the squeezes mentioned above may
well ease some, and the Fed may feel less constrained to keep
monetary liquidity on such a tight rein. With this view,
fundamentals can begin to improve quickly, and a market rally
would likely ensue.

So, like the recovering addict, I am tending to take matters day
by day as I have since the end of 2006 when the economic crystal
ball first clouded up. At any rate, the main point is that when
commodities play such a strong role in global economic weal and woe,
matters can turn on a dime when it comes to the forward view, and
that leaves investors and traders having to be prepared for abrupt
turns no matter their convictions.

Economic Indicators

The theme is easy enough: Weakening economic growth and
continuing inflation pressure. It may have started in the US,
but it has gone global.

The weekly leading indicator sets have reversed mild, shortlived
uptrends of early spring and are headed back down. They remain
consistent with development of recession in the US.

The monthly leading indicators weakened in June, but are not yet
consistent with recession as new order diffusion indices remain
significantly above recession levels. But, the trend is down in
both manufacturing and commercial sectors.

Underlying growth potential in the US (real wage plus employment
growth) has dropped to -0.9% reflecting a persistent slowing of
nominal wage gains, accelerated inflation in recent months, and a
slight downturn in yr/yr civilian employment. The situation looks
measurably better when the current flow of tax rebates are added
in. Potential swings to a +0.6% then, but, keep in mind that the
former measure was +3.9% at the end of 2006.

Inflation is reducing consumer purchasing power and is becoming
well established in the cost structure of businesses, with the latter
leading to reduced margins of profit for many companies worldwide.

My inflation thrust measure is as strong as it has been for many
years and is consistent with development of a 12 month CPI of
5%. The weight given to the commodities price component is now
dominant by far. This gives the thrust measure low visibility and
high volatility.

Stock Market

Technical

In last Friday's post I mentioned that the market had fallen to a
tradable oversold, but that I was not going to play this week, as
the recent action gave me considerable pause. Today, the SP 500
fell to a new cyclical closing low near 1260, taking out the double
bottom set earlier in the year around 1275. So, the oversold has
intensified, but now it may be wise to see if there is a breakaway
downleg in the offing. I am going to give it a few days, letting
everyone sleep on it over the long weekend.

Fundamental

The key elements I follow to see if there is a cyclical buy in the
offing are not in place yet. The drop in short rates is a positive,
but a rising level of corporate bond yields, particularly mediocre
credits, shows diminishing confidence in the economic
environment and is now a veto. As well, monetary liquidity
remains flattish and has yet to exhibit the "pop" that precedes
profit and market recoveries. (I do have a monetary base model
for the stock market, and this model stands a paltry 3% above
levels reached in early 2006.)

The SP 500 Market Tracker is in a clear cut bear market, with
the current reading of 1180 about 27% below its 7/07 high.
The drop reflects the recent acceleration of inflation and a decline
in the index of 12 month earnings for the "500" from 91.25 to
74.50 presently (-18.4% point to point). At 1261, the "500"
is trading 6.9% above the Tracker and has been losing its premium
steadily since mid-May, '08.

I'll pick this up tomorrow or Friday with a little conjecture work.

Stock Market

Well, there has been a roundtrip back to the Jan. / Mar. '08 closing
lows. The rally off the Mar. lows was a bit of a rocket, but it lasted
a couple of months and provided solid trades. The news needed to
ratify it as the opening run of a cyclical recovery -- evidence inflation
was set to moderate plus evidence that earnings would soon be
turning the corner -- was not forthcoming. So, the market has fallen
back.

There could have been a panicky downside breakaway move today,
but there wasn't. There could have been a hard driving rally off
important double support, but there wasn't. The SP 500, now near
1280, is deeply oversold on measures out through six weeks and
down enough to perk up trader interest. Guys who are thinking
"nice oversold and a triple bottom, no less" may be prepared to
move right in on Monday, an hour or two after the opening.

For my part, I think I'll wait a week or two. Today's wind up just
above '08's closing lows is too pat for my taste. Moreover, I would
like to see how much punch the bears have left in the short run,
and whether the bulls are more discouraged after a deflating round
trip.

I am also interested in whether this week's "in your face rally " in
the oil pits will go anywhere. They have called the Saudis' bluff and
have given an increasingly agitated US Congress the finger. Given
the damage a new and strong oil price breakout may do economically,
it will be well worth a look to see if producer and consumer leaders
are willing to turn a little nastier, and to what effect.

I have all my deck furniture spruced up and set up. The glass pitchers
are ready for whisky sours and vodka collins's. I have some nice hand
rolled leaf and my lighter at the ready. That's where I'll be this
coming week.

Monetary Policy

As expected, the Fed kept the FFR% at 2% today at its FOMC
meet. No surprise there, and no surprise on the more hawkish
talk about inflation (See 6/16 post).

Looking at the long history of the Fed's decisions regarding the
FFR%, this latest pronounciamento puts them about where they
should be, and maybe 25 bp. to the low side.

A current favorite among the pundits is that the Fed is "between
a rock and a hard place" or "caught in a box". The news here is
that the Fed is always between a rock and a hard place, since it is
charged with fostering full employment economic growth and riding
herd on inflation.

So, It is on now to incoming data. This being a national election year,
the Fed is going to be keen to see whether the current round of tax
rebates can spark an economic rebound over the summer.

Gold Price ($892 oz.)

The gold price remains in a well established long term uptrend
which is supported by my macro and micro economic indicators.

Since topping the $1000 oz. mark in March, gold has diverged
negatively from the fundamental indicators which have remained
in uptrends. This is the first substantial such divergence since
the bull run for gold started in earnest in 2001. It appears to
reflect a pullback from a super extended position for seasonal
reasons coupled with development of an interim bottom in the
value of the US$ following the Bear Stearns rescue.

By my dim lights, gold goes into bubble mode above $1000 oz.
It is interesting that after topping that milestone, gold has
retreated instead of taking off. Well, despite the recent correction,
gold remains in mania mode nonetheless.

My macro and micro economic indicators are attuned to the gold
price as an inflation hedge. I do not include currency values in
the calculations. That would be redundant from an inflation
hedge perspective, but not so in the case of financial crisis, when
there may be flight from a range of currencies.

As of now, the fundamental inflation hedge oriented indicators
suggest gold should be at a new high. With seasonal commercial
demand set to strengthen, it will be interesting to see whether gold
can regain the high ground, or whether this current consolidation
process is a prelude to the discounting of weaker commodities prices
and lower inflation in a more sluggish global economic environment.
In this regard, a break in the gold price below the $850 level might
be telling.

For a weekly gold chart, click here.

Jidda Bugs

Oil producers and consumers meet in Jidda, SA this weekend to
hash over the oil market. Since it's the king's dime, the Saudis
can be expected to put out an ass-covering spin, and also to
announce another moderate hike in production. On background,
the Saudis maintain they can add 500k bls daily production this
year to bring them above 10 mil. daily in total. They also claim
that by later in 2009, new fields output would give them production
capability of 12.5 million bd. More than a few think they are
using funny leaf in their water pipes.

At any rate, if the producers / consumers are smart, they will look
for ways to insure greater spare capacity than the current 2 mil
bd, whch has been a linchpin for the run up in the price. And they
will look at agreements to secure production when disruptions
could be at hand. A little co-noodling here and perhaps a dash of
fraud in the way of arriving at a larger surplus production estimate
would help. If the Saudis do have the goods, this would be a good
time for them to show off to the arriving poohbahs.

If I was in attendance, I would also urge the producers and the
major consumers to start fiddling in the oil and dollar futures
markets to make the speculative ride in these markets grow more
painful to the folks who have had rather a free ride for years now.
Periodic bloody noses for the hedgies, indexers and pension funds
might just build some respect. Unlikely? Maybe. But lots of guys
in the room can deliver and take delivery on crude and currencies,
and dropping a few $bil in the process may be much cheaper than
what transpires if oil remains on its happy course skyward.

The oil market is now range bound between (roughly) $130 - 140 bl.
The sharp intraday volatility of late reflects uncertainty in the
market. If Jidda is to be more than a Saudi PR show, the boyz in
attendance best come away with some actionable ideas to create
pain and suffering for the long side only whiz kids.

Notes on Profits, Economic Liquidity

Corporate Profits

Measured yr/yr, the $ value of production came in at 4.1% for May.
This matched the April reading, and the two months taken together
suggest that many US companies are experiencing intensification
of downward pressure on profit margins in the quarter. Even
offshore operations, where yr/yr physical volume comparisons may
be better than in the US, cost pressures are nibbling at margins.
The exceptions would continue to be primary materials producers,
many of whom have maintained pricing power that compares
favorably to cost pressures. In all though, and looking ahead to the
release of Q 2 results in July, we may find more somber reading.

Economic Liquidity

I like to compare the yr/yr change in the $ value of production with
the yr/yr change in the broad measure of financial liquidity to see
how much of the financial resources are being claimed by the real
economy. For May, $ production was up 4.1% compared to 5.1% for
the liquidity measure. The 1 point spread for May compares to a
5+ point spread in favor of liquidity over much of the middle part of
2007 when the stock market was strong. Now, the liquidity tailwind
for the stock market is far more subdued.

The modest readings for profit margins and economic liquidity
reflect a continuing sluggish economy, elevated inflation pressure and
the effects of the subprime fiasco on the banking system.

Interest Rate Comments

Of late, Fedspeak has been hawkish on inflation and has spoken
fondly of the US Dollar. Itchy trigger fingers? Well, inflation has
exceeded the Fed's expectations, and the economy has not yet
developed the deeper weakness the Fed has feared.

For example, take the ISM survey of manufacturing. This broad
diffusion index made an expansion cycle low of 48.3 for 3/o8. A
reading below 50 on this index signifies contraction, but it
usually needs to fall below 43.5 and stay down for awhile before
recession is confirmed. Importantly, it is rare for the Fed to
elect to raise short rates before a recovering ISM index breaches
54 on the way up. If the Fed stays true to its longer term behavoir,
the ISM index (now 49.6) and other critical data such as the capacity
utilization rate would suggest a FFR% increase could be down the road
some, especially since it is not clear that the economy has bottomed.

The entire Treasury yield spectrum has risen since the March
shotgun marriage of Bear Stearns / JP Morgan Chase. The 91 day
T-bill yield has moved up sharply from a panic low of 0.5% to nearly
2%, or in line with the Fed Funds Rate. Comparably, the 30 year
Treasury has jumped from 4.11% to around 4.80%.

Quality spreads at the short end remain quite elevated and are in
line with recession levels. So too at the long end. The panic in the
wake of the subprime bust may be over, but most players are
indeed conservative and are not yet avidly chasing yield.

The Treasury market is too low in yield relative to the inflation
rate. A 2% bill is a loser compared to the recent 4% yr/yr CPI
readings, and the bond market puts you out over 20 years just to
earn modest amounts in real terms. You have to assume that the
big money which needs to own Treasuries to match liabilities (such
as retirement funds) is hedging with oil or gold or other commodities.
So too, foreign players may also have been carrying long
euro positions on top of inflation hedges.

To wrap up, I have long found it tiresome to try to psyche out the
Fed. It is understandable with the run up in oil et al that They
would like to get back to spotlighting inflation. But well observed
history says that action to match this new yearning is premature.

Stock Market

Back on 5/29, it was noted that the stock market rally off the March
lows was discounting both an economic rebound and a moderation
of inflation, and that good news in both categories was needed "very
soon" to hold the rally in place. The news since has suggested the
advent of neither. Fundamentals are not good for short term
timing, but it was obvious back then that the rally had traveled a
fair way without the kind of positive news it needed and that
investor and trader patience was getting thin.

Now we have a substantial short term oversold developing, and
a further drop in the SP 500 from today's 1335 close down to
1320 or lower would yield the kind of decline that shorter term
players might well find interesting for a week or two play on the
long side.

The daily SP 500 chart is linked below. Note the RSI is moving
toward a tradable oversold. The chart.

Stock Market -- Technical

As discussed in the 5/27 post, the short term outlook for stocks
had turned shaky, as one could see the 10 and 25 day M/A s set
to roll over. And so they have on the SP 500, with the market now
mildly oversold in the short run.

Back in late May, it was mentioned that the market was also
working off a powerful intermediate term overbought (6 - 13 wks).
That has been completed and we are now neutral on the
appropriate oscillators. I am a little concerned about the 14 week
stochastic. That is on a mechanical sell (See chart link below). The
stochastic can whipsaw around, so I use it in conjunction with a
number of other measures.

From a trading perspective, I would not mind seeing the market
correct further as that would set up a decent short term long
trade. But alas, not being a timer, I would have to say the
intermediate indicators are in a "no man's land" as far as direction
for the next several weeks is concerned.

On a long term basis, the SP 500 is going to need to rise above 1400
and stay there from here on out by mid - 2008, or else the secular
bull case will need some significant revision in terms of the plot
going forward. With 1982 as a base, the secular case is fast fading.
However, I have long preferred the 1987 low as a base because so
many fundamental pro-earnings growth changes were implemented
in the corporate world in the wake of the '87 debacle. Since breaks in
a well established long term price trend should never be ignored,
we have a topic that will require more discussion as the year
progresses.

The weekly chart for the SP 500 is here.