Oil Price

Technical
WTI crude broke a nice five year uptrend featuring an $18 bl. price range in Jun. A fast and
deep downside breakaway has taken place since which knocked out supports at $80 and $70
and which currently leaves the market a little above long term support running back to 1999
and which now stands at $60 bl. The current speedy bear market is typical of a substantial
oil price decline and, in the modern era, such declines usually do not reverse quickly with
fast carry to new highs.

A break in long term support below $60 certainly cannot be discounted. If this occurs and
the market extends trading below the long term support line, it would raise the question of
whether there is a new ball game afoot for industry fortunes.

The market is deeply oversold. With WTI crude now trading at more than a 30% discount to
its 40 wk m/a, it will have the attention of short term traders looking for a positive bounce.
Note also the hefty oversolds now being registered by RSI and MACD. $WTIC Weekly

The oil price tends to trend strongly up or down. Thus, when a reversal of trend arrives,
trading it can be done with surprisingly little risk over the intermediate term. In short, it
is not worth the effort to try and catch tops or bottoms but is worth the effort to trade
when there is evidence of a trend reversal.

The oil price does tend to enjoy a seasonal bounce which begins in mid - Dec. and whch
runs into early Jan. Continuation of the current strong downtrend right through Dec. would
veer toward the ominous.

Wealth & Liquidity Transfer
Excess production is now a relatively modest 500K Bd. However, with fast rising US output
and modest demand growth, the oil gurus have the rate of excess global output rising to 1.5
million Bd. by year's end 2015. It is this longer range view of supply / demand that has the
market so worried. Should oversupply widen out as many now expect, there could well be
a huge wealth and liquidity transfer of up to 1.3 $trillion from net producers of oil to net
consumers over the next year. Such a grand transfer would lead to some major changes in
fortune for a range of countries on either side  of the production / consumption divide, and
might spur unrest and geopolitical bad behavior among countries least able to lose the petro -
dollars. As for oil companies, remember that the lever on the way up is the screw on the way
down.

Strategy
When you reach my age of 75, you will find you have to obtain a Papal Dispensation to short
markets. So, any interest I have in oil would be on the long side. On this issue, I plan to
see if still large oil futures positions by financial speculators need to be wrung out and to wait
for indications of a trend reversal.


  

SPX Monthly -- November, 2014

Fundamentals
Bull market in place since early 2009 remains in place. With the termination of QE, the easy
money portion of the bull is over. Profile is now moderate return for the assumption of much
higher risk. Liquidity cycle still strong at present, but progressive deceleration in growth of
liquidity measured yr/yr % suggests a moderation of business sales and profits growth in
2015 and early 2016. History makes clear that the cessation of large QE programs can work to
destabilize the economy unless consumer / business / banking confidence remain high and
private sector liquidity growth progresses at a moderate pace. Capital resources including
physical capacity, underutilized labor and banking system liquidity remain ample enough to
support moderate economic expansion through 2016. Inflation potential is modest so there
is no visible need for the Fed to raise short term rates enough to curb economic overheating.

Valuation
The market's p/e ratio stands at 17.5 x likely 2014 net per share. there has been a sharp
elevation in the p/e since 2011 reflecting a strong deceleration of inflation, the major QE
program and rising investor confidence in  the modest growth / low inflation story. Some
players remain convinced the Fed will re-institute some form of QE if the economy falters in
the months ahead.

I have the SPX  valued at a p/e of 17x based upon an assumed longer range earnings plowback
ratio of 60% (Currently, the breakdown is dividend payout 34%, plowback 66%).

Players must now pay a premium p/e on cyclically elevated earnings to be  long in the market.
The p/e on long term trend earnings of  $90 per SPX share is 23x. It is a very expensive
market on this basis.

Technical
The SPX is quite extended on the super long term channel as well as that of the current bull
market. Long term measures of RSI, MACD and price momentum are all at very elevated
levels. A substantial long term overbought happens to dovetail with a rich market on
fundamental grounds. SPX Monthly

Gold Price

Gold still has a chance to be an interesting long side trade, but some ground needs to be cleared
first.

Gold Bear Market
The deep but temporary break below $1200 support earlier this month re-affirmed the bear market
that has been in place since late 2011. It also showed an important break below the long term
uptrend line in place since the early part of 2001. The one bright spot on the gold chart is that
when gold broke the long term uptrend line at 1220 in Sep., there was indeed a breakaway down
move in price, but gold has since rallied up close to prior support at $1200. On the negative side,
there is the possibility that gold may now have the $1200 price as resistance. Weekly Gold

Poor Present Fundamentals
The gold price has been hurt by the deceleration of inflation underway since the autumn of
2011. More recently, weakness in the oil price and a strong US dollar have been negative factors.
Less well recognized is that a rising US stock market since the latter part of 2011 has drawn
risk capital away from the PM markets in a fairly steady fashion (See bottom panel of chart).
Gold had competed successfully with stocks over much of the 2001 - 2011 period and had
attracted the interest of many financial market players and not just the more traditional bugz.
This play has been walked back in earnest.

How Might The Environment For Gold Improve In The Year Ahead?
Quantitative easing has ended in the US. But, it has been accelerated in Japan, and China is
is moving toward more monetary ease. These moves could pressure more Asian economies
to follow suit. Moreover, even the ECB is slouching toward more monetary liquidity
expansion as the EU grapples with very slow growth and flirts with deflation. Thus, economic
growth offshore the US could firm up at some point next year. This might lead to stronger
demand for commodities in general and might reduce some of the excess supply in the oil
market. In turn, a better offshore economic environment might eventually lead to a reduction
in the "fear" trade which has recently favored the US dollar and brought it to an overbought
position. To conclude, there could be a sort of speculative three cushion billiard shot that
eventually benefits the gold market.

This sort of conjecture is not normally my cup of tea, but I am intrigued that the gold price
has been stubborn recently against a downside breakaway that seemed clearly in the cards.

China Eases Monetary Policy....

The PBOC cut benchmark short rates today and continued with targeted liquidity injections.
Following a nice increase earlier in the year China M-2 money growth has flattened out
despite liquidity injection measures in recent months. With real estate asset values in decline,
China's very large shadow banking system is likely experiencing cash flow difficulties and
rising debt liquidation. To counter shrinking sub-sector liquidity, the PBOC is likely  preparing
more aggressive liquidity support ahead.

the Shanghai was up 1.4% today and is closing in on 2500. With the Shanghai - Hong Kong
trading link in place and a turn to easier monetary policy, there may be further interest
in China stocks. Note though that IPO volume is scheduled to pick up sharply with dilutive
effect on the Shanghai. With a new year nearly upon us,  and The PBOC now interested in
goosing liquidity, I have raised my fully valued target to Shanghai 2575 for 2015. $SSEC

This past summer the long side trade was clean and easy. With an accomodative  PBOC, it
may continue so. However, I am far from sure we have seen the last of short term stop / go policy
and monetary experimentation. Since I am a world away from China, and have some other
trades in mind, I am likely to be more of an observer than a player for the forseeable future.
The idea here is not to bad mouth the market but to watch how the reforms program co -exists
with the obvious pressure to maintain 7% or better real growth. Mr. Xi is going to be "wing
walking" for a while.

Inflation Potential

Inflation pressure gauges I use are currently rather subdued. Put simply, the global economic
expansion underway has not cut far enough into excess capacity to sustain the normal cyclical
acceleration of inflation that comes with a recovery / growth period. Recent expansion of
global capacity has continued at a moderate pace and demand growth of 4% needed to reduce
excesses has not been sustained. In the US, for example, the economy has expanded for over
five years, but the operating rate is still below 80% as companies have been adding capacity
since late 2010, with the current yr/yr growth 2.1%.

I have a long term inflation model which compares money M2 growth against real economic
growth potential. This model is based on 10 year averages and currently pegs inflation potential
at 4% per annum. The US experienced peak cycle - to - date 12 month inflation of 4% for just
a brief period in 2011.

The strong cycle of monetary liquidity growth experienced over the past year should have
resulted in the beginnings of a cycle of accelerating inflation this year. One future gauge
of pricing pressure has been moving up in 2014, but the move has been exceedingly modest.
My primary inflation pressure gauge, which gives heavy weights to commodities prices
and factory operating rates, did pick up sharply this year, but has settled down in recent
months. $CRB Commodity Comp. Weekly

Note the top panel of the chart which shows yr/yr momentum of the CRB. When it rises to
10% or above and can sustain that level for a period of a few months, US CPI inflation
accelerates. As you can see yr/yr price action for the CRB  has spent a fair amount of time
in negative territory in recent years.

In the Nov. 10 post, I discussed why the economy has the available capital in terms of
resources to grow for several more years. History does strongly suggest there will be some
upside pressure on the inflation rate ahead unless capacity growth is fast enough relative
to output gains to keep operating rates from rising too sharply.

Over the very long run, US inflation has averaged around 3%. Conditions now do not
support a rise of inflation to the long term average.

Liquidity Cycle

Measured yr/yr, total US system liquidity growth (including the Fed's balance sheet) is in a
downtrend but remains a significantly positive 8% going into early Nov.. The stronger liquidity
growth since the latter part of 2013 has supported an acceleration in business activity with
US sales running about +6.5% yr/yr and SP 500 net per share rising more (Latest 12 mo. eps
is running about $115).

Hefty liquidity growth  normally underwrites an eventual cyclical acceleration of the inflation
rate, but that has yet to happen as slow global economic growth coupled with modest gains in
production capacity have kept pricing relatively stable at a nominal level.

Private sector liquidity growth has been averaging 5.8% on a yr/yr basis, and with no more QE,
total US system liquidity growth by late 2015 could be down to about 4 - 5%. This suggests
that looking out to mid - 2016, business sales and earnings growth could be very much more
moderate than today with business pricing power remaining muted.

Thus it is that at the G-20 summit this week in Brisbane, participants pledged to use fiscal
policy, trade deals and, probably, more monetary easing to produce an additional $2 trillion
in global GDP over the next couple of years. We certainly do not know whether they will
be successful, but we do know they fear the return of the deflation wolf to the door.

From this point on, I regard the base economic case for the US to be veering toward the grim
side eventually and I would be delighted to be too conservative and to be wrong. For now, the
US should find the sailing relatively smooth as the liquidity tailwind is still fairly strong and
is moderating at a measured pace. But this will change as time wears on.

---------------------------------------------------------------------------------------------------------------------

US Dollar -- Should Be Slow, Grinding Bull

It has been my view for the the past ten years that changing US demographics, recovering
energy output and increased demand for a range of domestic specialty manufacture and
technology would lead to a gradual elimination of the the trade deficit and the elimination
of a net outflow of dollars through the trade window. The US trade deficit has been cut nearly
in half from peak levels seen a half dozen years ago and may zero out by 2020. So, back at
points in 2009 and 2010 when the USD was at 75, I began figuring it could add 2 - 3 points a
year in value and may be close out 2020 with the popular $USD index at 100.

The sharp rally in the dollar this year has been the talk of the town, and it is likely well
overbought currently. $USD However, the economics to me suggest that the dollar should
continue to work slowly higher over the next five years, and could strengthen even more rapidly
if US hydrocarbon export restrictions are lifted.

SPX -- Short Term Overbought

This new upleg in the market which began in mid - Oct. has so far beaten the long term odds
against holding a spike bottom without a retest and has traveled up to new high ground. The
rally has started to lose some momentum but is still on an unsustainable trajectory. It is also pretty
strongly overbought on a short term basis. Despite the roll over in short term price momentum,
trader profit taking has obviously remained in abeyance and reflects the high expectations players
have that the year will finish strongly. SPX Daily

Most fund managers have underperformed the broad market this year and this sharp rally has
prompted stragglers to extend long lest they fall further behind in the relative performance derby.

US Stock Market In A New Period

Overview
The cyclical bull remains intact. However, with QE having ended, the Fed no longer has your
back. That spells higher risk, and it means you should now weigh a broader list of fundamentals
more heavily. True cyclical bear markets are preceded by rising short term interest rates and a credit
crunch that induces recession or worse. I will not get a sell signal on my cyclical model until short
rates start rising along with bond yields. Private sector credit creation is normally critical in
underwriting continued economic expansion and an extension of a bull market. Unfortunately,
credit demand is not normally a useful indicator for market timing as the private sector's loan
book can continue rising even after a downturn has begun. So, that is why you have to watch
a variety of factors.

Capital Slack
I use a compilation of indicators to monitor slack in the system to include idle production
capacity and labor as well as the trend of short rates and measures of bank balance sheet liquidity.
When slack has evaporated, the economy is in overheat mode with accelerating inflation. That
is usually when the Fed begins to crunch the economy. When my index reaches a range of 180 -
185, the economy is overheating and it along with the stock market are vulnerable. The index
is now lingering in the low 170s and banking sector liquidity is ample. In this broad framework,
economic expansion and the bull market can wear on for a couple of more years.

Business  Sales & Profits Growth Momentum
With QE having ended, the stock market can be expected to become more sensitive to the
momentum of business sales and profits. I use a variety of measures here, and they point to
an acceleration of business sales and profits growth starting from mid - 2013 and continuing
on currently. My Weekly Cyclical Fundamental Indicator is a forward looking measure and
that has weakened noticeably since early Aug. reflecting a pronounced downturn in
sensitive materials prices. I think stock market players have waved such price weakness off
on the premise that it reflects slower global economic growth and is not seen as a short
term concern. But it should not be sloughed off because slower global growth affects the
large US export sector, business pricing power, and can lead to negative translation penalties
which can accrue to profits should the dollar remain strong.

Often, S&P 500 net per share gets strong enough that it becomes very extended relative to
its long term trend. As fate would have it, this development occurs around market tops
because the Fed is usually in crunch mode. We are not there yet, but earnings could become
just so extended  in late 2015 or early 2016. It will be interesting to see where the Fed is
by then with policy.

Oil Price

Recent strong price weakness reflects two factors. First, growth of crude supply has exceeded
expectations of early this year as US crude output has surged to formidable levels. Second,
growth of global industrial output measured yr/yr has slowed from 4% earlier in 2014 down to
about 3% recently reflecting disappointing results in the EU, Japan and China. Small increments
in spare capacity at the wellhead can lead to substantial price adjustments when they first appear.
Hence, WTI crude has fallen from $107.50 bl this Jun. down to around the $78 area.

To counter the US crude production surge, the Saudi's are offering discounts on crude shipped to
the US. We can assume the Saudi's have been estimating break evens on new crude and we'll
see how that works. Since the US is the major arms supplier to Saudi Arabia, we are not without
a degree of counter leverage if we want to use it.

The US and China are now limiting liquidity support to the world economy. Japan is stepping up
with additional QE to ramp its exports. The EU is in turmoil about monetary stimulus and we
can only wait to see whether they will muster a truly substantive program of monetary easing
to counter a continuing sluggish and now deflation prone economy.

The crude price is in a steep downtrend and a deep oversold has developed. Chart indicators
show this point along with another technical item worthy of note: Crude is closing in on a
20% discount to its 200 day m/a, a discount that will attract trader attention. WTIC Daily

With the peak driving season well past, crude is in a seaonally weak period that can not only
last through mid-Dec. but resume again in Jan., and run through to the normal seasonal low in
Feb. Thus on a seasonal basis, the rewards to buying an oversold market may be more limited
than normal. As well, as the chart on the crude future shows in the bottom panel below, there
has been very large speculative interest on the long side from financial players who have only
recently begun to unwind their big positions. There are over 200K contracts out now and as
the chart shows those positions can zero out if players become sour enough. Crude fut. + COT

I like to trade crude, but I'll bide my time for now and watch for indications of a positive
reversal.

The Long Treasury Market

A rebound this year in the long T-bond price was to be expected after the needlessly bad period
in 2013. But recovery in price has certainly exceeded my expectations, topped off by the
furious rally starting in Mid- Sep. as equities players zipped out of stocks into bonds on the
wind-up of QE and global economic growth concerns. The TLT 20+ year T-bond fund has
sold down from a panic risk-off top in recent days but does still rank as overbought against the
200 day m/a. TLT Daily

The end of QE does signal a tightening of monetary policy and that is why the long Treas. has
rallied since the get-go this year. Overbought as it may be, the TLT remains in a well established
uptrend in price.

The trading band on the TLT has narrowed in recent years from 80 - 130 to a range of 100 - 120
which contains most of the trades. This reflects the Fed's determination to keep its short term
ZIRP policy in place until the economy and the job market improve further and until there is
more evidence that the inflation rate can sustain a cyclical acceleration which would further
indicate that the US is moving on a more nearly cyclical path. Now, it must be seen how well
the economy can do without QE.

Stock Market -- SPX

As discussed in prior posts during Oct., the stock market did get itself oversold. Moreover, it
did take out short term trend resistance at 1940, and did move higher as expected. The volume
has been better and the downside leaders like the Russell 2000 small cap index have led the
way in a broad based positive response off the closing interim low of 1860 put in several
sessions ago. The market is now 2.2% overbought on a momentum basis against its 25 day m/a
and it would not be surprising to see a little consolidation near the current level of just over
SPX 1980. You will note on the chart that the market has had trouble since early Jul. holding
the 1980 level. SPX Daily

The recovery off the 1860 low has been far too rapid to be sustained for very long. In fact,
in the days ahead, the SPX could drop 2-3% from the current 1982 level and still be on a respect-
able positive trajectory.

Naturally, there is no law against the SPX continuing its current moon shot upward course
until it hits a very robust all - round overbought with the SPX topping its 25 day m/a by 5%.
That would be a little freakish since the market never sold off that much to begin with, but
traders have been headstrong to re-establish long positions. Put less politely, the herd stampeded
out in mid - Sep. and has been stampeding back in during the more recent sessions.

SPX -- Weekly

Fundamentals
With QE expiry imminent, stock market is crossing from easy money bull with high return /
low risk profile to mundane bull with sharply elevated risk profile.

Market momentum has devolved in 2014 from powerful as seen last year to a far more modest
positive pace reflecting a lengthy adjustment to the wind up of QE. Further volatility and a
continuation of a downward adjustment cannot be ruled out given the evidence of prior periods
when large QE has ended.

Weekly Cyclical Fundamental Indicator is in a positive long term uptrend but a sharp interim
uptrend from Oct. 2013 broke down in Aug. and suggests lower business sales and profits
growth ahead.

Investor Psychology
Spirits have been lifted since J. Bullard, head of the St. Louis Fed, floated the idea last week
that QE could be extended in a more modest form. Bullard is not in the voting rotation this year
for FOMC and his idea would trigger a shit storm of conflict on the Board without evidence
of a critical economic need for further easing.

 Investors and traders are also keenly interested in the idea of seasonal strength from Nov.-May.
This rule has a good track record over the past half century and will have players carefully
watching.

Technical
With the Bullard comment, the market has recovered broadly from a short term oversold
on good volume. History shows that spike bottoms like we saw in the prior week have no
more than a 50% chance avoiding a retest.

The weekly chart of the SPX shows that the market has corrected down from a very extended
position and is no longer strongly overbought. SPX Weekly

Players who have low risk tolerance should note that the full universe of public issues still
shows that too many stocks are still in negative patterns with no positive MACD cross.

My three - six month momentum measure has been on a sell signal since early Sep. '14. This
measure has an excellent long term track rcord but has tended to whipsaw since mid - year
2013 as the "buy the dip" crowd has been very aggressive on knowledge the Fed stood behind
them with dollops of QE. It will be interesting to see whether the dip buyers prevail again now
that QE is expiring.

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.