Santa Stopped For Oil Instead

The rally in oil off recent support just above $56 bl. to a tad over
$61 sets the stage for an important January for both the economy and
the markets. $61 bl. is no threat, but if this yearend upmove in oil
is the precursor to a strong seasonal rally, it will force some rethinking.
It has been my view for several months that the behavoir of fuels in
this first month of the new year will be important in casting Fed policy
and in setting confidence levels for a decent portion of 2006.

HAPPY NEW YEAR TO ALL.

Economy in 2006 -- Short Version

As we roll toward '06, the inflation indicator for the short term is signalling
a continuing though less dramatic moderation than the Oct./Nov. period. This is
critical because with wage growth now up to 3.0% yr/yr, the real wage can recover a little. This sets the direction for consumer spending. I also believe housing activity
was shocked by the turmoil of the hurricanes and the spikes in fuels cost. Much
higher heating bills need to be taken into account. Even so, housing should recover
but progress will be modest. There is clear evidence of lost business sales, production
and employment in the wake of the storms. The hits were smaller than I thought they would
be, but bounceback potential is there for early in the year and release of nearly $70
billion hurricane damage relief will be a plus too. Overall the safest bet is to look for growth to accelerate off a flattish final quarter of 2005 and move nicely ahead into mid-year. There may be a slow quarter then, but I look for the year to finish out very strongly
because companies are going to have to begin to add some bricks/mortar capacity by then.
I am more concerned about 2007. Demand is outstripping capacity growth in the US, and
unless capacity grows markedly, the economy will begin to overheat. Profit growth in '06 should stay near 10%, although oil industry profit contributions could slip some as the year rolls on.

My biggest concern is with the continuing profound inflation in fuels costs. We are in a
seasonally quiet period now. Nat. gas is nearly $5 per mcf off its post Katrina/Rita peak
and oil is down $10. to $60 per bl. These are disappointing declines and leave me concerned
as we move into heating season. There is a decent consensus oil will average $54-55 a bl
next year. Devoutly to be wished for at this point. One also has to carefully monitor basic
grain and food commodities. These remain depressed and appear woefully overdue for some
positive price action.

My short rate cyclical indicators point to continued firming by the Fed ahead. Certain key
ones, such as the ISM manufacturing diffusion index have been far too strong to prompt a
let up. Moreover, with 3.0% inflation readings at several points this year, the Fed has no
business keeping short rates so low if they wish to see people begin to rebuild liquid savings.

As I have discussed in several prior posts, banks have been switching to offering jumbo
no or low reserve deposits to counteract Fed pressure on regular reserves. M-3 growth
has accelerated substantially to over 8% yr/yr. Not only will M-3 fund economic expansion,
it is well more than the real economy needs and will flow either into price or asset inflation. Uncle Al has the bubble machine on again, the old fool.

I plan to talk about the stock market in the next post or two. Many market prognosticators, mindful of the four year cycle low (year two of the presidential cycle) are jumping through hoops to find a basis for a hefty sell-off in 2006. As of now, I do not see it, but I have reserved one for 2007.

In all, if commodities do not run roughshod to the upside, it could be a decent year for
the economy/

Interest Rate Scorecard

The comparisons discussed below are based on super long term rgression
models built around the 12 mo. moving average of the CPI.

With a CPI of 3.3%, the Fed Funds rate should be between 5.0 - 5.25%. The
Fed is bringing the FFR%, now at 4.25%, steadily higher, but it still
remains well short of where it should be. That short rates have been too
low for some time is well attested by a continued zero savings rate for
the consumer sector and the increased use of real estate based leveraging
techniques by same. To preserve domestic purchasing power, dollars saved
need to earn returns which greatly offset inflation and the income tax bite.
Homeowners have come to regard unrealized appreciation in home value as a
prime source of savings. This has been nice to have, but it is an unwise
practice since the great Baby Boomer housing boom is winding up to a close
now, and appreciation in home prices above the inflation rate will be ending.

By my models, the 30 yr Treasury should be trading around 6.375%. The market
is currently at 4.65%. The model value is a little high since Fed tightening
should lead toward a flattening of the yield curve, but, that said, The Bond
is still to dear in my view. There is insufficient premium for key long
term risk factors such as market volatility and a prospective rising supply
of new issues. I love trading the bond market but I have stayed away since
March, 2005 because I would prefer to trade bond volatility around fair value.

Bond Market

10 yr Treas: 4.46%
30 yr Treas: 4.66%

As we near 2006, cyclical conditions for the bond market are
both negative and volatile. In addition there remains a good sized
coterie of bond players trying to handicap an economic slowdown
and presumed deceleration of inflation pressure. I conclude the
market is in a mild cyclical upturn in yields which may also feature
more occasional spikes both up and down in yield levels.

That conclusion above was brief enough, but one could easily write
on and on about the many "ifs" and nuances and shadings that could
be added to fully flesh out an intriguing picture. I will content
myself with just a few brief remarks.

The markets are neither overbought nor oversold.

Bullish sentiment, as measured by Market Vane, is still positive
at around 60%, but is hardly excessive. the best buying opportunities
come along when this gauge is down around 30%.

There is much speculation that the yield curve could invert. An inversion
would carry substantial forecasting weight if it reflected tightening
credit conditions. But credit conditions are still easy -- there is no
liquidity squeeze.

There is also intense speculation about when the Fed will end its firming
up of the FFR%. If that happens to be, say 4.75%, it could well turn out
that the Fed may maintain that rate for quite some time, in which case
players will gradually realize they may as well shorten maturities.

Looking longer term, the great bull market in bonds is technically still
intact as yield remains in a downtrend. There is an extensive base building
under the downtrend which could be signaling that the bull is coming to
and end, but it is still too early to conclude same. For example, the
case for an end to the bull would be more compelling if the long Treasury
yield takes out 5.00% and then 5.25% this year. We've a ways to go before
we come to those bridges.

Monetary Policy

FF Rate: 4.25%

Cyclical factors that normally govern Federal Reserve policy actions
remain in firm uptrends and it is not difficult to posit another 25
basis point add on to the FF rate at the close of 01/06.

At this point, key factors such as manufacturing order rates and breadth
of same, factory operating rates and the balance between the supply of
loanable funds and short term loan demand all look positive going into
'06, but the momentum of these indicators may well slacken enough next
year to allow the Fed to call a temporary halt to pushing up the FF
rate after it reaches 4.75% or so. At this point, I do not see production
and loan demand growth as strong enough to warrant the Fed to move from
a newly minted "neutral" position to a squeeze.

The action of commodities prices in the seasonally strong winter months
will continue to rank high on the Fed's watchlist. The momentum of the
CRB commodities index has waned in recent months, but not by nearly enough
to give the Fed any comfort. Oil and natural gas prices in particular
remain sticky, and industrial commodities composites are moving higher
as well. The action in the trading pits over the next six weeks could
establish the FOMC meeting for late Jan. next year as pivotal.

I have been very confident about monetary policy and right on in my
thinking concerning same for nearly two years now. But, looking forward,
I find myself much more tentative and less assured about my projections
for rates and basic liquidity.

Stock Market -- Technical

S&P 500: 1260

I am impressed enough with the upwave in the market since October
to look for it to move higher, with the S&P 500 now expected to
rise to the 1310 area at some point well into January.

The move in the S&P from 1248 to 1268 over the week of 11/18 - 11/25
was a pleasant surprise but the sideways to down action since then
was not a surprise, as the market had become short term overbought as
indicated in the last technical comment on 11/19.

The impulse up during October and November was clearly strong enough
to warrant an extended consolidation, which could easily last another
week or two before we begin to run out of time in looking for a resumption
of the rally. I am also uncomfortable with the high degree of bullish
sentiment I see in the popular gauges such as Marketvane and Consensus,
so a brief continuation of the sideways/down bias might be in order
to reduce the head on this glass of beer.

If I have a more substantive bother, it would be in the intermarket
area where the charts for oil and the bond yield are no longer
so hospitable to stocks as during most of November. The tenacity of
oil around $60 has been a surprise as this is a seasonally weak period
for oil.

I plan to discuss the stock market more fully as we get a little bit
closer to 2006.

Gold Bugs Frothing At The Mouth

Boy, higher inflation this year and then Uncle Al says the Fed will
no longer publish M-3 after 3/26/06! Sacre Bleu! The Gold bugs see
a plot hatched to hide the inflationary ways of the central bank!
Get the women and children off the streets! Buy gold in a hurry they
declaim.

The best time to buy gold is late in the first quarter or in the second
quarter of the year when commercial demand is in a lull. Commercial demand
gets rolling later in the year to provide the metal for holiday gifts
in the West, and the wedding seasons in South Asia (India, Thailand etc.).
Gold can spike up late in the year on last minute commercial needs and
speculation of a sharp seasonal move up in the commodities markets.

I put Gold's commercial value at $440 per oz. under normal commercial
supply/demand conditions. At $493 an oz. now, it is well over what I would
want to pay for it as an inflation hedge speculation. Maybe I'll wait until
spring of 2006 and hope to pick up some below $450.

Stock Market -- Technical

The "Day of Atonement" rally half-facetiously anticipated in the
10/12 technical note came to pass right on time, putting an
exquisite but understandable squeeze on the bears just after the
market seemed to have broken down clearly. The Street simply
spent part of September accumulating stock to distribute it out
on the turn.

The market is clearly overbought short term and is slightly above
the top of the lengthy compression range in effect since June.
However, it did bounce convincingly up from long term support
(70 week M/A) and my internal supply/demand indicator shows an
overbought but sturdy advance.

The longer term price momentum indicators remain very anemic and
directionless and raise the question of whether the advance is but
a seasonal one that could meander into early January following a
correction at some point in the next week or two.

Key intermarket factors have been positive for stocks, notably a
rally in Treasuries and a weaker oil price. Reversals in these
sectors would probably undercut the enthusiasm for stocks.

For me, stronger readings on long term price momentum measures
are needed to warrant more than light exposure.

Stock Market -- More On The Profile

S&P 500: 1233

I wanted to discuss further some of the risk factors in the
stock market environment.

Liquidity leading indictors such as Federal Reserve Credit and
the adjusted monetary base (St. Louis Fed) remain very anemic in
growth. Not surprisingly, real money growth -- M-1 and M-2 -- are
now down yr/yr on a % basis. Normally this is threatening to
prospects for continued economic expansion. However, as often
previously discussed, banks have switched funding to low and no
reserve deposits not counted in to M's 1 and 2. Even so, the
expansion is less well anchored because with no customary growing
base of liquidity, the economy is running on a mix of incomes and
increasing leverage only.

I also look at the earnings / price yield on the S&P 500 compared to
the "risk free rate" -- the 3 mo. T-Bill. The S&P e/p yield is 6.0%
based on 12 mo. earnings while the Bill is near 4%. This indicates
a still rather moderate risk level, but the gap has been closing as
the Fed raises short rates.

Important as well is inflation risk. The market has lost most of
its positive momentum over the past eighteen months because of a
sharp acceleration of inflation, which in turn, has reduced the
p/e multiple or earnings capitalization rate. In short, investors
have been raising the ROI% hurdle rate. Now the CPI yr/yr % change
may ease a bit for a couple of months, but the inflation rate trend
is still up.

To date, the gathering of incremental risk has acted only as a drag
on the market's progress and not as a negative trigger. But you have
to keep track.

Fed To Stop Publishing M-3 Money Aggregate

Or, Uncle Al's Revenge....

Readers of this blog know that way back in 1992, Uncle Al
and the gang eliminated or greatly reduced reserve requirements
on a variety of large and jumbo time deposits ostensibly to
provide extra liquidity as the commercial banks stepped in
to the mortgage market in place of the S&Ls which had failed
or were being merged out. This was a legitimate response by
the Fed at the time.

As the economic expansion progressed and the Fed started to
raise rates, the banks quickly learned to reduce the cost of
funding by switching to the reserve-exempt deposits to fund
lending operations. By 1995, the Fed should have reversed
course and re-imposed the reserve requirements on the big
deposits. It did not and the banks used this loophole for
years to feed the economic and stock market booms. The banks
also began to use the RP market more aggressively to fund
FX traders, hedge fund managers and the mutual fund industry.
They also started using RPs to fund lending out of the pot,
a cheaper way to raise money than Fed Funds where other banks
will charge 20% or more in a tight Funds market.

Rather than re-claim the control that is rightly theirs, Uncle
Al has decided to stop reporting the data and to leave analysts
to scramble to find appropriate proxies.

There will be a vigorous and vocal protest from a number of
economists. The Fed might spin an explanation, but many will
be unhappy and only time will tell whether the Fed will relent.

There are proxies that can be used in place of M-3, although
I will dearly miss the Repo data (now a $550 billion item).

Uncle Al has whipped a digit on his detractors in his final hours.

M-3 is slated to dropped starting 3/23/06.

Stock Market Profile

S&P 500: 1220

I continue to employ a "pocket change only" exposure to
the US stock market. We are well past the low risk / high
return phase of this still extant cyclical bull market.

Risk to the market continues to rise, but in fairness to the
bullish, the risk is coming up from extremely low levels seen
in Q4 2002. Moreover, confidence in the economy remains fairly
high as well. But it is not the type of "easy money" period I
favor.

My S&P 500 market tracker stands at 1150. It declined sharply
with the surge of the CPI in September to 4.7% yr/yr. I have
given some thought to smoothing out this unexpectedly large
lurch in the CPI to give the market a somewhat higher multiple,
but decided not to so as to avoid fiddling each month with
the inflation input. I doubt we will see yr/yr inflation stay
at this high level for too long, so the value of the market
may be understated at 1150 or 15.3x current operating earnings.

My earnings model has been holding up well, but there has been
some internal slippage, as the continuation of reasonable top
line or sales growth is increasingly more dependent on pricing
rather than volume growth. Cost inputs remain under control
reflecting good productivity growth and mild wage/benefit
pressures. So, many companies should still be experiencing
profit margin expansion.

To qualify as a "normal" cyclical bull market, the S&P would have
to reach 1360 by year's end or early Jan. 2006. Statistically, that
is a tall order at this point. The earnings underneath the market
have held up very well, but the market p/e ratio has been clipped
by the acceleration of inflation starting in mid-2004.

I have not given up on this market yet. With the overall operating
rate for the economy below 80%, we are far below effective capacity
and not in imminent danger of over heating. Secondly, the progress
of the market relative to a broad liquidity measure such as M-3
has not been so strong to date as to leave one concerned.

So, there is plenty of upside, but to realize it, the surge in
commodities inflation which has been driving inflation higher needs
to at least level off so that the Fed does not have to put the
economic expansion at ever greater risk to choke inflation pressures.
For now, the drivers in the commodity sector are fuels -- oil and
natural gas. We are in a seasonally weak period for fuels right now,
so a better test of the power of fuels pricing trends likely awaits
the closing days of 2005 and early next year.

I have been looking for weakness in oil and gas prices, but the
declines to date off the Katrina induced highs have fallen short
of expectation. Recovery of US production has been slow, and OPEC's
solemn promise to boost its output appears to have been a bluff.

I am guessing now that late January, 2006 will be a critical time for
the market and for the Fed as that will be an important window to
measure continuing inflation pressure, economic progress without some
of the recent distortions, and the arrival of new Chair Bernanke.

More on the stock market in upcoming days.

Commodities Inflation

As discussed in prior posts, I have pointed out that the
current surge in commodities price aggregates, although
not so broadly based, has been the most powerful we have
witnessed in over thirty years.

The historical record shows that grand commodities inflations
begin in sudden and dramatic fashion, almost "out of the blue"
as it were. They tend to follow upon long periods of price
stability and, on occasion, deflation.Thus, prior to a
sudden breakout of upward price pressure, there is usually a
long interval of underinvestment in the capacity to supply
the market which results in a jump in pricing when demand
does finally accelerate.

Grand commodities inflations can last for periods of up to
15 - 20 years. Commodities composites at wholesale can
easily triple and quadruple over such periods. Interestingly,
oil per barrel is now trading about six time above its 1999
low. In short, these are very powerful events, and when one
is underway, it will in a cumulative fashion have a pronounced
effect on the general price level, as measured say by the CPI.

I bring this up for a couple of reasons. first, the power of
the recent run in the CRB and wholesale commodities composites,
following a long dormant period, strongly suggests to me that
another grand bout of commodities inflation is underway.
Secondly, although run-ups in commodities prices can be
squelched for a while by rising interest rates and a tightening
of liquidity, the upward pressure on prices tends to resume
in a strong fashion when the rate / liquidity pressures are
relaxed. This occurs because of the long lead time necessary
to bring large incremental capacity on stream (Developing
small increments to capacity generally proves uneconomic.)

Thus, for the third time in the past one hundred years, we
may well have another major upleg of inflation to contend
with. I lay this out as a prima facie case, but one which
I think has some merit.

I did play the big 1968 - 1983 commodities cycle. I bought
some gold but enjoyed excellent fortune in the grain markets,
which as irony would have it, have yet to participate in this
round.

Surprisingly, it is possible to make good money in stocks and
even a little money in bonds during commodities booms. But
to be successful, you have to re - equilibrate risk and return
assumptions and not use the more favorable profile that likely
obtained during the lengthy preceding period of commodity
price stability.

Monetary Policy Update

We have now baby stepped up to a FF rate of 4.0%. Fed/FOMC
liqudity measures -- Fed Credit and the adjusted monetary base
remain constrained, although the money base did pop up for a
week or two past Katrina.

M-3 growth has accelerated sharply this year as bankers switch
funding from regular reserve deposits to the larger no or low
reserve deposits. The banks have the window open to lend and
loan growth continues brisk. Ironically, the system liquidity
embodied in M-3 has no doubt helped the energy pit traders and
hedgies keep rolling.

Uncle Al continues to push up rates gently, hoping to coax a break
in the energy driven commodities market. Tricky business. Just so
you know, recent experience (1995-2000) shows that the CRB commodities
index did not buckle until after market short rates exceeded 5.0%.

The Bernanke Appointment

As was widely expected, GWB selected Ben Bernanke to replace
Uncle Al come the end of 1/06. This was a wise choice. The
Bernanke facial countenance reminds me of a rotogravure of a
nineteenth century British scientist, someone like the great
empiricist John Stuart Mill. Unlike Greenspan, who, when all is
said and done, was a laissez-faire theorist on the economy
and the markets, Bernanke is much more sharply focused on
the-matter-fact and how economic developments cumulate to
produce the future path of an economy. In contrast to Uncle
Al, he is at once more of a pragmatist and far more plain
spoken as well.

His primary interest from a policy point of view is to have the
Federal Reserve provide a monetary environment of stability and
to avoid policies which are so one sided as to increase economic
volatility and produce economic trends which may be extreme.
His concern is that once extremes are met within the economy,
reactive processes may be needed which in turn will produce
their own excesses and deficiencies, thus taking positive,
directional initiative away from the Fed. Thus, he is at once
an anti-Greenspan and an anti-Volcker who sees the past twenty
five years of policy as having been needlessly tumultuous and
risky.

He has also expressed a strong interest in inflation targeting,
suggesting a longer term low inflation rate consistent with
assuring a stable, growing economic environment. This will not
be an easy sell at the Fed, since many on staff will be tempted
to say that they have been endeavoring to do that. Bernanke
wishes to de-mystify this process and to foster much clearer
communication with all constituencies. However, what most
interests me about the concept is that it may well free up the Fed
to use its tools -- rate setting, liquidity provisioning and
reserve regulation -- in more flexible and pragmatic ways.

Bernanke's practical and empirical approach is very congenial to
me and I am happy to give him the benefit of the doubt.

Inflation For Idiots

In its 9/05 CPI report, the Bureau of Labor Statistics again
but still belatedly acknowledged the growing impact of rising
fuel costs on inflation. The whopping 1.2% increase in the
monthly CPI puts the yr/yr rate of inflation at 4.7%. Note
though, that the BLS is still fibbing about the "core" rate of
inflation which it posted as 2.0% yr/yr. ("Core" inflation
excludes the volatile foods and fuels components of the CPI).
Apparently, no one at BLS ever goes shopping, because if they
did, they would know prices are popping up like dandelions in
springtime.

The statistical scam here, I think, is to more fully load the
fuels prices into the CPI first, which they are doing, and then
to start loading the effects of the several year fuels price surge
into the core, with the hope that the worst of the price surge
in the food and fuels component is now behind us. Then, as the
"core" inflation rate rises, the Street can say, "look the
leading edge of inflation is simmering down."

Now, don't get all indignant, Presidents have been cooking the
economic statistics for years now. Johnson and Nixon were
heavy handed chefs. Clinton was by far the most earnest and
attentive fibber, and George W. is just in-your-face cynical.
Fed chairmen from Arthur Burns to Greenspan have been their
willing accomplices.

Some of the idiots out there are going to try to keep the old
scam going. Here's Morgan Stanley chief economist Steve Roach:
"Energy is being driven by a unique set of forces -- supply and
demand -- that are not bearing down on other goods and services."
Guess Steve does not go shopping either.

So, where does all of this leave us? Well, based on 4.7% inflation,
Fed Funds should be at 6.5%. Long Treasuries should be at 7.5%
and the p/e ratio for the S&P 500 should be 15.3X with an index
value of 1146. Interest rates are so low relative to these indicated
levels because rates are being priced off the low "core" rate readings.
Depositors are being ripped off and bondholders are surrendering
wealth after taxes on the income streams are figured in.

I am expecting fuels prices to ease because those markets should be
coming into better balance. I also expect the "core" inflation rate
to go up. For example, US produced auto prices have returned up to
ordinary retail from the employee discount levels. Moreover, the
BLS will have to start showing the effects of higher fuel costs
on all items or the fib will grow too large to correct without major
dislocation.

My best guess now is the CPI, measured yr/yr, will slowly drop back
into a range of 3-4%. From my perspective, that implies that interest
rates remain too low and that the current market p/e of 15.9x estimated
12 mo. operating earns. through 9/30/05 is reasonable.

Realistically, given the hanky panky with the inflation rate,
each player has to decide for himself or herself what a reasonable
inflation estimate is and factor that into his/her return
expectations for the capital markets.

Stock Market -- Technical

S&P 500: 1177

My primary technical indicator gave me a sell signal on 8/16 with
the S&P 500 above 1230. I paid it no mind because I could see the
market in a compression zone. I got a short term buy signal on
9/6 with the "500" at about 1215 and ignored it as well for the
same reason. I then got another sell signal on 10/4 at 1214 on
the index. This one is more worth notice, because it heralded
a break down from the compression zone and raised the question
of whether a more substantial decline might lie ahead,
with the prospect of the "500" falling to about 1075.

For fundamental reasons I have been playing only with pocket
change since March, 2005, so I am not at risk on the long
side. Moreover, we have moved into respectable oversold
territory, so I am not contemplating a short position.

I have not yet given up on the idea we remain in a cyclical
bull market, which makes me doubly loathe to short this baby.
So, I am going to see how resolution of the oversold
develops before taking action, although my sense is the
time to trade has drawn nigh. Frankly, I also remember my
days on Wall St. where we had a amusing rule: Sell on Rosh
Hashanhah (10/4 this year) and buy on Yom Kippur (tomorrow
10/13). It's a fun contrarian rule if you know the holidays
and not a bad one at that. So, I'll wait to see what the
next few days bring.

US Economy

Since this spring I have been pointing out that the
Federal Reserve was engaged in a classic form of
Greenspan fine-tuning, to wit, gently but persistently
raising interest rates and curbing basic monetary liquidity
with an eye to slowing down the economy enough to produce
a flattening of or deceleration of inflation pressure.
The Fed also desires to raise short rates enough to restore
a better balance between savings on the one hand, and
consumption/investment on the other.

A slowing of economic growth was a "gimme" since it had
already began decelerating even before the Fed first swung
in to action in mid-2004.

The Fed, as discussed in past months, has not had any real
luck with the rest of its plan. Inflation pressure has
accelerated and broadened, and there has not been enough
of an incentive created to get folks to boost savings.

When I extend present trends on the relevant economic
charts, I see we are headed for trouble by the end of the
second quarter, 2006. By then the US would be at effective
capacity, inflation pressures would have intensified
further, and short rates would have reached levels high
enough to curb credit demand and produce an economic
retrenchment. This scenario would be entirely
consistent with development of cyclical bear markets in
both stocks and bonds prior to yearend, 2005.

And, as we have seen in recent weeks, investors are
already beginning to shade the market multiple and to
push up yields.

I have also argued that the Fed should be moving in
50 basis point increments with Fed Funds, but that appears
to be neither here nor there as things now stand.

I am standing back from the bearish scenario because I
suspect fuel prices have risen to levels sufficient to
induce rising conservation and a rethinking of household
and business budgets. My best guess is that should
such eventuate, fuel prices would roll over and come
down substantially from present levels. This adjustment
would temporarily pressure economic momentum but might
allow the US to escape far more serious trouble next
year. I also need to direct attention once more to the
continuing very low growth of productive capacity, which
in turn puts more of the weight on demand suppression,
if the US is to escape a nasty time.

Short term, I am going to be focusing on commodities
prices, the leading inflation precursor, and on personal
consumption factors, for these are the two spots where
it can best be determined if the softer landing can be
achieved. At this stage, a pick up in the growth of
productive capacity can only be devoutly wished for.

Stock Market -- Technical

Well, my momentum and internal market supply / demand
measures continue to show a pattern of compression which
could extend up to another 2-3 weeks. I have avoided
trading since early August, since the extended compression
period has left me bereft of a sense of direction.

My guess is that to have a positive breakout from this
compression interval, we may need to see a rotational
change in leadership to groups that might benefit from
a weakening of oil and gas prices. The prevalent
psychology in the market is that the fuels sector has
advanced enough to damage profit margins for a broadening
array of companies, enough so that improving margins
for fuels producers will be more than offset by reduced
profitability for net fuels consumers. Players have also
been shading the market multiple to reflect expected
higher inflation readings near term. Thus a rekindling
of positive momentum of oil and gas prices and the
energy stock complex could produce a fuels led rally
that might not lead far at all, whereas as a rally
led by beneficiaries of lower fuels prices could be
explosive.

But first, let's get through the compression period.

Oil Rolling Over

I have made some terrific calls over the years, but making
calls in markets is not my strong suit. So any call I make
requires a disclaimer as to veracity.

That said, oil looks like it's put in a top up at $70 and
change per barrel. There's support at $60 and again in the
mid-50s, but I think it will drop to $45-50 per barrel before
year's end.

Globally, conservation efforts should be taking hold. Household
budgets will also be trimmed some as well. OPEC may well push up
production in the weeks ahead. The US will gradually add back 1
million bd. It is not hard to see surplus at the wellhead move
up to 3 million bd. for a while before the end of this year.
That should be enough to assuage the shortage mentality that has
gripped a market yet to experience any shortages.

To me, natural gas over $10 per mcf is also hyper-extended, and it
would not surprise me to see gas down under $10 before long either.

Rita Readies To Go To Work

In the end, trading is about booking profits. You do not
have to be first on the right side of the market and there
is no sin to leaving a little money on the table.

Rita is going to hit land full force about 24 hours from now.
It will be a major event and forecasters say that with the
jet stream way north, the storm will linger and not dissipate
as quickly as did Katrina.

Next week will be soon enough for me to look at opportunities.
I am particularly interested in seeing what the total bill
might be for reconstruction / redevelopment in the wake of
both storms and how economic policy will respond.

Two Tough Broads

First, Katrina rolled in and did phenomenal damage
in Miss. and Louisiana. Now Rita is humming through the
Gulf, building strength as it is nurtured by the warm waters.
It reached Cat. 4 quickly and could easily attain Cat.5.
The tightening of the storm's bands and rapid build up in
wind speed now suggest a smaller but more concentrated and
powerful storm than Katrina.

If it makes landfall in Texas as a Cat. 4 or 5, it will
do tremendous economic damage, particularly in coastal
and nearby residential areas. It is too early yet to tell
whether the storm will pass close enough to the Houston
Channel to damage up to 1 million bd. of potentially
exposed oil refining capacity. The storm needs to make
a Northward turn first before specific target areas
can be singled out.

If the storm stays strong and slams coastal Texas, the
resultant damage, coupled with the destruction wrought by
Katrina, could well throw economic policy into a cocked
hat, as legislators and the Fed struggle to come to grips
with a suitable reconstruction plan.

Rita, unlike Katrina, has the President's attention and
you can bet that Rita's damagees would have considerable
clout with GWB.

Traders are looking for an opening to grab a rally
along the lines of "sell the rumor (Rita's spectre), and
buy the fact (Rita's arrival)". Not my cup of tea unless
Rita somehow weakens and or misses the US.

I plan to see just what this broad winds up doing before
I take a serious look.

Fuels Conservation

Over the last several weeks, I have been thinking about
easy ways to conserve on fuel use without making any
substantial $ investment. And, as I thought about it,
I realized there were indeed a number of ways to cut down
on both gasoline and heating expenditure without greatly
crimping lifestyle. I have been doing so with the car
as have the wife and kids with theirs.

I bring it up because I suspect that many in the US, Canada
and Europe are thinking similarly. What is interesting,
I believe, is that fuels demand may still be quite a bit more
elastic than many of the fuel demand models and projections
I see. I do not think it is that difficult to knock 2% off
my demand or that of most others. Globally, that would restore
about 1.6 mil. bls a day to supply, a sizable increment.

I suspect it may be worthwhile to begin to incorporate
allowances for conservation into one's thinking about oil
and gas, because I doubt the price channels for both that
have been in place for the past year or two reflect it.

Post Bush Speech Impressions

People are reviewing how they can cut their fuel bills and whether
to trim or defer spending on the most discretionary items. So, maybe
oil/gas demand growth will decelerate for a while in the US at least.
Ditto for Europe.

The massive mid-Gulf redevelopment program will favor heavy industry,
construction, technology and industrial and commercial services.

Rotation should be pro-cyclical in the stock market.

As orders flow in to production sites, operating rates should rise,
and inflation pressures will broaden.

The bond market viewed rising oil and gas prices as a tax on consumption,
not an inflationary development. It will be vulnerable to rising operating
rates and higher sensitive materials prices.

Gold is a mug's game. It was safe enough to buy it in recent years
when it was selling below its commercial value, but it has just
moved above that level and the gold bugs and hucksters will be
coming out of the woodwork to tout it.

The economy is slowing now, but looks to pick up speed in 2006
as the big project down south unfolds. I do not know what the Fed
will do Sep. 20, but if the redevelopment program is as large as it
now looks to be, short rates could eventually go quite a bit higher.

There should be no dollar dumping from abroad, not when the US is
working out of an emergency situation. US retaliation would be swift.

You know George, he is going to try and borrow all he needs to
run the war, redevelopment and other programs that may be on
his short list. That could be a negative for the bond market.

The mis-handling of the rescue efforts in the Gulf in the
early going gutted Bush's presidency. If this inept man drops the
ball on the redevelopment program, his Party could be badly mauled
in 2006.

Stock Market -- Technical

S&P 500: 1234

The rally underway since the end of 4/05 has served to extend
the second leg of the cyclical bull market.

There are cycle factors which suggest the broad market should be
in a topping mode over the course of most of this month. Curiously
enough, most of the short and intermediate term indicators I follow
suggest the market turned up around the beginning of the month.
However, what is most striking to me is the substantial compression
in the proprietary momentum and internal demand / supply indicators
I follow. I have never been able to figure a sound method to tell
how extended compression periods will be resolved (topping out vs.
consolidation). It is clear there has been an ongoing battle between
the bears and the bulls since early July, 2005. My charts suggest
this battle could go on for up to four to six weeks before it is
resolved. When extended compression periods are resolved, the move
in the market, be it up or down, is usually sure and powerful.

I am a discretionary trader and a trend follower, but I have hesitated
to go long so far this month because of the compression I see in
the market. So, I may just wait until that issue is resolved before
deciding what to do.

Stock Market -- P/E ratio Recovers

The sharp spike in the price of crude led the stock
market to shade the multiple in anticipation of higher
inflation readings for August and perhaps September.
The fast erosion in the price of crude since Katrina
struck and oil market fears were finally realized has
produced a sharp relief rally which restores the p/e ratio
back up close to 17x, and leaves the market content with
a 3.0% inflation expectation. Currently the market reflects
a consensus that the worst in oil's steep price rise has
ended and that Katrina will not produce long
lasting economic damage. Note again though how sensitive
the market continues to be to the price of crude.

Curiously enough, the stock market remains the most
reasonbly priced sector of the capital market.

Monetary Liquidity Indicators

Uncle Al talked tough the other week out at Jackson Hole, WY.
But, in vintage style, the Fed has removed its foot from the
brake. It has been buying bonds for its own portfolio, and its
version of the monetary base has started to grow. I think this
development commenced to meet seasonal "add" needs to cover
back to school shopping and then the holiday season down the
road. It remains to be seen whether post-Katrina economic
developments will promote further easing. Note that the Fed,
by jiggling reserves day-to-day, can push short rates higher
even as it adds liquidity to the system.

I bring this up not only because it is worth watching to help
glean the intent of monetary policy, but also because the large
primary dealers, who are also big players in the currency,
commodity, and stock markets, use their knowledge of changes
by the FOMC to trade. These advance notice liquidity indicators
are FALLIBLE markets guides, but players need to pay attention.

When the Fed is adding to its portfolio, it tends to benefit
stocks and gold, and to hurt the dollar. This easing can
also lift the commodities markets and bond prices, but given
the peculiarities of this cycle, the bond market might grow
uncertain since the bulls have been counting on tight money.

The Fed can run this type of easing for a few months without
compromising its longer term intent, which based on the longer run
growth trends of Fed Bank Credit and it monetary base, continue
to support a restrictive policy approach.

Short Term Interest Rate Fundamentals

Based on economic data available through today, 9/01, the
cyclical case for boosting the FFR% at the 9/20 FOMC meeting
remains in place. Moreover, with inflation at 3.1% and
accelerating, an FFR of 3.5% as a short rate anchor is a
savings dis-incentive, which continues to weaken the
internal or domestic purchasing power of the dollar.

Now, as indicated yesterday by Phila. Fed Gov. Santomero,
the Fed will have to take in a thorough briefing of the
likely economic effects of Katrina's punch to the system
in deciding whether to move ahead with another rate increase.

A key factor in deliberations should be the rapid rise in
fuel costs relative to consumer disposable income. The fuel
bill is rising rapidly from a very low base and is hardly
high relative to DPI historically. Even so, the momentum of
change, being very rapid, could disrupt household budgets
in the months ahead. Secondly, the Fed will have to gauge
direct output and income losses from Katrina since these
losses will be consequential, at least for the short term.

I have never found it helpful to probe the collective
psyche of FOMC prior to a meeting. So, I am just guessing
they will go ahead with a FFR% boost if there is no
major red flag in the data available to them on 9/20.

"Down On The Levee..."

As pundits and analysts were engaged in trying to figure on
the direction of crude and natural gas prices yesterday, Katrina
swirled past New Orleans. The backwash from the storm deluged
Lake Pontchartrain with rain. Waters rose overnight, several
levees were breached, and now the City has been inundated
with a toxic swill replete with petrochem, sewage and tumblin'
gators and water moccasins. Since The Big Easy is set in a bowl
below sea level, 80% of it is now under water with no natural
run-off. Although it may be true that the flashy Red Rhino
Dance Club near Bourbon St. may have survived, the City has
effectively been destroyed.

Katrina, for her part, is cruising north toward eventual
extinction in Quebec, but not before damaging the economies
of several other states. All told, probably upwards of 15%
of the US economy will have been damaged, with said damage
ranging from total devastation to the loss of power for a few
hours.

Them's that know me have seen an icy cool money manager
deal with tough issues over the years. I am no alarmist, but
it appears to me we have a national emergency on our hands.
President Bush will be in CA today to give a speech or two.
This curiously defective man is handling this blow to the US
with his customary nonchalance. Why he is not down south
where he is needed escapes my understanding. At the least,
they could have swept Cheney from his iron lung and deposited
him there.

Folks are only beginning to get an inkling of damage done and
the fully national effort that will be required to restore the
central Gulf and areas north. The effective loss of New Orleans,
a wonderful and unique American City is a national calamity, and
the sight of our President whistlestopping up in CA is a national
embarassment.

Katrina Damage To Be Widespread

Markets focus has been on the damage the storm may have done
to the LA petrol/gas complex. However, this storm could easily
wreak havoc in up to seven or eight states before it settles
down and begins to dissipate. Flooding, structural damage and
power outages will do severe damage to small and local businesses
from the tip of LA right up the midsection of the country through
TN. Homelessness will surge temporarily and job and business
losses and downtime could last many weeks. The breadth of the
storm and rainfall amounts are alarming. The losses sustained
here will have quite an impact on the economy.

Greenspan's Valedictory Part 1 -- Inside Scoop

Fed Chairman Alan Greenspan is winding up his tenure at the
Fed. He is using the Fed conference at Jackson Hole, WY to
discuss the history of the Fed, his tenure, and unresolved
issues that will carry forward. It will provoke quite a bit
of discussion among the pundits and will have the hard dollar
analysts in a tizzy of sardonic snickering.

Folks will work hard to unlock its many meanings and their
implications for policy, the economy and the capital markets.
As a semi retired senior investment executive with 40 years
of experience with the Fed, mostly at arm's length distance,
but occasionally up front and personal, I can tell you
clearly the meaning of what he said today in Part 1 of his
valedictory.

The speech was quintessential Fedspeak, but it can be
quickly boiled down to: "Whatever bad may happen to the
economy and or the markets after I leave ain't my fault."
There you have it, plain and unvarnished. Thanks Al.

Bond Market Profile

The long term bull market in bonds remains in place.

The most recent downtrend in yields, which began around
mid-2004, also remains in place, although the market is
overbought for the very short run.

At 4.40%, the long Treasury is discounting a return of
inflation to 1.5-2.0%. Moreover, there has been some
slight shrinkage in the longer term volatility premium
as well.

With the CPI now at 3.1% yr/yr, the market is running
entirely on forecast and expectation. Viewed historically,
this is very unusual behavoir for this market.

The forecast/expectation is that the combination of rising
short rates and fuel prices coupled with a tightening of
basic monetary liqidity will be sufficient to produce
enough economic slack to return inflation to 1.5-2.0%.

The market is likely also forecasting that oil and gas prices
will ultimately retreat markedly from levels seen as well
above reasonable. This seems a fair assumption since
continued significant strength in fuels will eventually
infect popular "core" inflation readings as producers and
service providers move to raise prices as they can to
protect operating margins.

Market players are also clearly chasing yield. Even though
the expectation is of a slow economy ahead, Medium grade
corporate credits have also rallied from the 7.0% level
seen in Q2 '04 to 6.45% recently. So, there has been but
a minor widening of spreads between Treasuries and lesser
quality investment grade corporates.

Advisory sentiment as measured by Market Vane is too bullish
but not at the extreme levels seen in the past quarter,
when the measure registered 77% bulls.

This is all heady stuff, particularly the willingness of
bond players to forecast the future with such confidence.

The market leaves me edgy. I am not used to seeing the bond
market look so far out in time with such confidence, and as
discussed in the prior post, it appears to me that the Fed
does not have as full control of the situation as the market
may think.

Business Expansion -- New Wrinkle

Historically, business expansions have been fueled by three
factors: monetary liquidity, internal cash flows and credit.
The key driver has been monetary liquidity. Expand it and the
economy follows suit. Contract it and a recession will
eventually occur.

Economic expansion over 1995-2000 was different. The basic
money supply M-1 was flat over this period, yet the economy
flourished, funded by cash flow and short term credit. Note
though that it took only a mild liquidity squeeze in 2000
to tip it over.

I bring this up because M-1 is not growing fast enough to
sustain economic expansion. This means that business must
rely on cash flow and credit to keep it going, as must the
consumer.

In my view, it is riskier when an economic expansion is
reliant on cash flow and borrowing alone. It does not
have the sure footedness it has when money is flowing
in and through the system adequately. My problem is that
I cannot quantify it. I can only say the resiliency of
the expansion is now being undermined to some degree.

How did this new wrinkle come about? It results from
the Fed's decision in 1992 to eliminate or minimize
reserve requirements on a host of large and "jumbo"
deposits to liquify a financial system stressed out by
the S&L and commercial real estate debacles. Regrettably,
I think, the Fed never re-imposed those requirements,
giving the banks a much freer hand to fund loan demand.

In giving talks to investment managers over 1995-2000,
I introduced these thoughts and issues. What I thought
was an interesting insight was met by shrugs. And it
paid not to worry for the longest time, right up to
the moment when the Fed tapped ever so lightly on the
brakes.

Now one piece of good news is that the adjusted monetary
base which leads the direction of M-1, has finally
started to creep up a little after a dead flat six
month period. We'll see.

Oil And Natural Gas -- Caution: Flammable

Sep. crude is printing $64.25 - 64.50 bl and gas is printing
over $9.00 mcf. On longer term charts these are spike breakouts
that signify an erosion of market discipline. There should be a
ton of overhead in each of these markets, and if demand can
continue to chew through it, the ball game will change to the
rankest of speculation and dramatically increased volatility.

From my perspective, we have moved beyond the pale of reason
and are watching these two markets move into fantasyland on a
speculative binge. As my Irish mom used to say, "The devil shall
take the hindmost."

Step Up To 50 BP Al.....

The Fed is widely expected to raise the Fed Funds Rate
by 25 BP to 3.5% today. I think it would be better if they
stepped up the FFR by 50 BP to 3.75% and then add another
50 BP at the September meeting to bring the FFR up to 4.25%.

I measure the domestic purchasing power of the dollar by
whether dollars left in money market and sweep accounts
provide a positive return after adjusting for inflation
and for taxes. In my view, monetary policy should only
act to depreciate the dollar internally when the economy
is in peril. The economy seems to be doing ok, and I see
no compelling reason to drag out the restoration of
internal dollar integrity. Presently, there is no
incentive for people to save, and this is a bad thing
to allow to drag on.

Brass Band Bear Parade Could Be Ahead

Well, it's that time again. After August comes September
and October, two of the diciest months of the year for
stocks. But wait, it gets worse, for next year is 2006
and time perhaps for the quadrennial low. As both the
big money and the smart money know, the market tends
to have a sell-off period every four years or so, and
2006 is it. I's well documented enough through time
that most market pros have respect for it.

As we move through the remainder of this year, do not
be surprised to see market punditry and forecasts start
to get tweaked to the downside. And, expect a number of
bears to proclaim that leg two of the long term bear
market is fast approaching. The spectre of 2006 will
change a fair bit of thinking across the grid.

The low volatility of this cyclical bull and the absence
of a good 10% correction so far does make one wonder. Still,
my strategy here is to stay with my disciplines and let others
do the tweaking.

In that regard, my advance monetary liquidity indicators
have started to perk up in recent weeks and the negative
divergence with the stock market has lessened. But it is
still early in the game to posit that the Fed
has made a directional change toward letting its foot
up on the liquidity brake especially since short rates
remain too low.

Tim Woods of Cyclesman hag good charts on the four year
cycle. Go to www.cyclesman.com/4-year_cycle.htm to see.

One Hand Takes; The Other Giveth In Abundance

For a little over a year, the Federal Reserve has been
"removing accomodation" by raising short term interest
rates and squeezing monetary liquidity. That would be
the Hand That Taketh.

But friendly bankers have swooped in on the scene. And
Giveth they have. Measured yr/yr, bank credit growth
has rapidly accelerated by 12% to nearly $5.2 trillion.
Loans to individuals -- mortgages, home equity and
personal have jumped 15% to $3.9 trillion. So not only
are folks not saving, they are happily leveraging up
to buy homes, cars and all of life's other necessities.
Sound money types and assorted other bears are seething
at what they see as wanton profligacy.

Now, after a couple of quarters of inventory rebalancing,
order rates for business have turned up, promising
higher production and more jobs. Earnings estimates will
inch up, and this has supported and extended the rally
in the market.

The Fed will likely press on with its accomodation removal
program and the banks will likely be glad handing both
consumers and business, at least for a while.

The issue here is that money left on deposit or in money
market accounts is still a loser.It depreciates in value
and in an expanding economy, it is going to be spent until
short term rates rise enough to protect its value and/or
economic developments occur which give consumers pause.

Inflation stimulus has originated with commodities in
this cycle, a typical development. And looked at seasonally,
the push to higher inflation is still in place, although
it has narrowed primarily to oil, gas and fuels. So, the
Fed has another reason to remain cautionary.

In the long run, the Fed will win out. That is why economic
and financial risks in the system are continuing to rise,
even if corporate earnings do better than many expected
in the short run.

The 0.0% Savings Rate

Consumer spending surged at a nearly 10% annual rate in
June reflecting strong auto price promotion and sales.
The savings rate fell to 0.0%. With money funds in the
2.8 -3.5% area, there is no incentive to save when the
real return on these funds is negative after adjusting
for taxes and inflation of 3.0%.

This is another reminder that short rates need to rise
significantly further to start to regain a better
balance between consumption and savings.

Earnings Trend Factors

I use a variety of economic data to try and track earnings
growth and momentum on a monthly basis. Some observations:

The recovery of SP 500 operating profits off the Q2 '01
recession low was very powerful, with quarterly earnings
basically doubling to $18. through Q1 '05.

Sales rose far more rapidly than costs, leading to sizable
improvement in profit margins. But other specific factors
were important, namely a weak dollar, large inventory profits
for basic industry and especially for oil and gas producers,
and the fact that many companies took huge writeoffs over
2001-02 that were not captured in operating earnings.

As is normal, earnings momentum is now decelerating after
such a remarkable bounce.

Business sales growth measured yr/yr peaked at nearly 10%
during Q2 '04 and has now slowed to the 6-7% area. This
still beats estimated cost growth of 5.5-6%, so gross margin
is still expanding, although far more modestly.

Currency translation gains are evaporating rapidly reflecting
a much stronger dollar, and basic industry inventory profits
have also levelled off. On the plus side, oil and gas
inventory profits are still surging.

Forecasters expect yr/yr earnings growth for the SP500 to
average roughly 10% each quarter through the end of 2006.
This is a reasonable projection provided sales can continue
to grow at 6-7% and margins can continue expanding via
further productivity gains.

What is troubling about the consensus expectation is that
it implies absolutely ingenious and faultless fine
tuning of the economy by the Fed. The continuous 10%
growth expectation is too high relative to the current
direction of monetary policy (now restrictive). I sure
do not know if the Fed can move through policy with such
perfection.

I guess I will be following my earnings indicators more
closely than I have recently, because the market seems to
me to be priced heavily on the assumption of strong earnings going forward.

Short Rates & Bank Liquidity

With the economy expanding and business short term loan
demand in a pronounced uptrend, The Fed still has
significant leeway to push rates higher without having
to drain the reserve base. A 4.00 - 4.25% FFR still looks
OK for year's end.

The banks remain in good shape as far as liquidity is
concerned. I define "liquidity at the margin" as the
ratio of C&I loans to US Gov't. securities holdings.
That ratio now stands at .85. This compares to a
reading of 1.48 at the last top in C&I demand in
March, 2001.

Yuan to Speculate?

Hu Jintao has authorized a baby step revaluation of the yuan, 2.1%.

Presumably, this will keep China under the radar when the US Treasury
again reviews currency management in Sept. '05. Hu is hard to take
seriously and Treas. boss Snow will look equally silly if the US
does not hammer China this autumn for damaging currency manipulation.

The dinky revaluation of the yuan sets promise of further dinky
ones to come. This will keep the speculative money flowing in and
will feather the nests of the Beijing power elite.

If this is the plan, US business and other foreign companies can
continue to invest in China with a wink from Snow.

Risk will rise even higher in China as more money flow will further
tax an already overburdened and corrupt financial system. Prospective
upward revaluations of other Asian currencies against the dollar
will up speculative flows to these spots as well, such as Malayasia.

Hu will be headed here some time over the next month or two. He
has earned the frostiest of greetings, but don't count on him
receiving such.

Stock Market Comments

Henry To of Marketthoughts was nice enough to invite me to be
a guest commentator. I chose the occasion to tie in recent
observations on the economy with the market outlook. Click below
fo more:

http://www.marketthoughts.com/

Stock Market -- Near Term

The rally in force since the spring tested important support last week and remains intact.
It continues impressive in breadth but not so in volume. Momentum in the popular major averages like the S&P 500 is subpar, mainly because there is continuing rotation into
mid and smaller cap. stocks. Fittingly, I do not have the large cap. indices as short term
overbought, but the broader NYSE Adv / Dec line is.

The S&P 500 is falling behind the course for a normal cyclical bull, partly reflecting monetary liquidity restraint but more so because of rotation toward smaller stocks.

My Basic Trend Index (NYSE A / D line adjusted by daily TRIN)remains in an uptrend and
is not yet overbought because TRIN readings have not been that low.

I have the S&P 500 as exactly fairly valued given the prevailing inflation and earnings levels.

The S&P 500 is trading at a modest 10% premium to my dividend discount model (Premiums or
discounts to the DDM of 25% or more require much greater due diligence).

My monetary liquidity trackers suggest the Fed is still tightening, which increases fundamental earnings risk in the market and keeps me with occasional, light exposure to
the long side.

Market risk is higher than that indicated by my work on monetary liquidity for two reasons:

> Oil and natural gas prices may be seasonally elevated, but the sharp long term uptrends
remain in force (inflation potential);

> Continuing rotation into higher p/e smaller caps puts many portfolios at greater risk if a correction ensues for valuation and market liquidity reasons.

I AM STILL HAVING TROUBLE WITH WINDOWS, SO POSTS WILL REMAIN EDITORIALLY PRIMITIVE FOR A
WHILE LONGER.

System Problem

Key blogger pages not accessible today. I'll try tomorrow.

Stock Market & Monetary Liquidity

Data for the Fed's own portfolio show a sharp rise in Treasury holdings, both via direct purchase and through the Repo window for the week ended July 6. It was a larger than normal holiday liquidity injection. The data was released late yesterday, and no doubt caught public notice. There are one or two other positive divergences in the liquidity data, but it does not yet add up to a more compelling case for stocks from my perspective. Even so, it all represents the first good news on the liquidity front in over six months.

The way I align the liquidity data, it does not add up to a case for a low risk / high return market. So for now, I continue to play nickel / dime on the long side with a very large reserve. I have done no shorting since 2002, and have not given it much thought this year.

I plan to do a more thorough analysis of the market over the weekend.

Monetary Policy -- Liquidity

According to the Fed, the Fed Funds rate is still at an accomodative level. Monetary liquidity trends paint a different picture. Liquidity has become increasingly restrictive. The economy has been growing faster than the broad money supply (yr/yr). Thus, the velocity of money is rising and, correspondingly, liquidity is shrinking, relatively speaking. As most know, short rates tend to rise with velocity. We do not have a full liquidity squeeze, because banks have their credit windows open. Monetary velocity is not rising fast enough yet to signal an economic downturn, but is consistent with development of a more pronounced slowdown. Timing is a tough issue, because the banks are friendly. Businesses are not stressed in meeting expanded working capital needs because cash flow is still on the rise and companies are tapping credit lines easily.

The Fed can let the economy coast this way for a while, but to avoid a serious crimping of growth or a downturn, It will have to begin providing fresh liquidity sooner or later. The Fed is interested in a long growth cycle because that assures a rising revenue take for the Gov. which must progress in reducing Its deficit. When the moment comes for the Fed to reverse course and ease up, follow through will have a substantial impact on the markets.

The liquidity deficit relative to the real economy began to show up over March / April, 2004. You will note that since then the stock and gold markets have made little headway, the 10 year Treas. has been rangebound, lower quality credit yields have moved up and even the US dollar, which been strong this year, is still a notch below levels of early spring, 2004. Only the Long Treasury has been able to hold a rally.

So long as the Fed allows liquidity to taper down, the capital and commodity markets are at elevated risk. Even the Treasury market is vulnerable, since players may turn bearish if they come to think that the process of slowing the economy to wring out unwanted inflation pressure may take longer than earlier anticipated.

The smart money knows that liquidity trend is every bit as important as the level and direction of the Fed Funds rate. In fact, the Fed may well signal an easing in policy first in the liquidity area, particularly if business credit demand begins to ease off. One place to watch is what the Fed is doing with its own portfolio (For this series, click here).

Finally, for an excellent e-chartroom briefing on the economy, click here.

Fed Funds Rate -- Gathering of The Clan

The FOMC has gathered to review the Fed Funds Rate target, which is now 3.0%. I am no fan of rate targeting, and have spent little time over the years trying to divine what the FOMC will do from meeting to meeting. The cyclical case for higher short term interest rates remains in place, so the Fed would be well within its rights to raise the the FFR target tomorrow if it so elects. The consensus says the FFR will be lifted to 3.25% (If I was Uncle Al, in the late twilight of my career and with cool porch sitting evenings at Jackson Hole beckoning, I would raise the FFR to 3.5% and call off the next FOMC meeting, tentatively set for August in sultry D.C.).

To further restore its integrity, the Fed should stop ripping off depositors and establish a FFR which supports deposit rates that offer a real return to individuals after adjusting for both inflation and taxes. Last year, when the FFR was a lowly 1.0%, folks lost less on savings by stuffing cash into the cookie jar than by depositing it at a bank. The situation is better now, but there is still a fair way to go.

The leading edge of the mighty boomer generation turns 60 over the next twelve months. As time passes, they are going to desire more of a savings cushion to protect against life's little shocks and hazards. It would nice to see the deposit structure accomodate them.

Housing Boom To Unwind

As an analyst back in 1970, I covered building materials companies like GP, US Gypsum, Masonite, American Standard and Carrier. Those were not bright days for the industry, but based upon baby boomer demographics, all knew a great residential boom was coming. The perfect time sequence would have been 1975 - 1995. The boom actually got off to an early start, but with several interruptions for rising interest rates and subsequent recessions, it has been extended well beyond 1995. The most difficult period was from the late 1980s through the mid 1990s, when housing languished. It took the Tax Relief Act of 1997 and the low interest rates since 2001 to bring the last stage of development to fruition.

Looking back to the promise for housing in 1970, I would have to say the eventual reality had only a few high points. Financial de-regulation and innovation provided the means of home ownership to many more families than one might have anticipated, but archaic zoning and building restrictions coupled with a profound lack of architectural imagination and a disappointingly small commitment to technological innovation produced a boom of mundane, boring and unnecessarily costly homes from which to choose. There are many upscale Levittowns out there.

But the boom has satisfied a strong desire for thirty and forty somethings who started families later in life to live in secure neighborhoods with better schools and community services and facilities. It has been a period of powerful demand based primarily on strongly felt need and not speculation. The strong pricing trend of houses since 1997 or so reflects the final boomer and early post boomer family demand crunch against light supply.

Looking forward, demand growth should progressively slow over the next five to seven years and may even contract in certain segments of the market from 2012 out to the beginning of the next decade. Over this same period, more supply will gradually become available as more and more boomers cross the thresholds of sixty and sixty five. The developing excess in the market will be seen most heavily in homes with square footage which tops the 3,000 mark.

The smarter builders will focus on the elder boomers' desire to downsize and acquire facilities and amenities that suit new needs and wants. Maintaining the value of expensive larger homes will require a new round of financial innovation, which will surely come, as maintenance of the Nation's housing stock will remain a continuing political priority. However, there will likely be no getting away from the fact that the US will have a five to ten year period of a buyers's market in residential real estate that should fall within the 2008 - 2020 time frame.

I expect to see another major boom in housing starting sometime around 2020 which should last for a generation, but which will not likely exceed the recent one in dimension or price inflation.

From an investment perspective, it is late to play the end of the current boom, not because of excess valuation, but because of the prospect that many builders and suppliers will experience a period of deceleration of earnings growth and, subsequently, down earnings. It may also be a little early to pursue the boomer downsize play, but this one is on my long term radar.

Do we have a BUBBLE now in US housing? It's a hot, buzzy word these days and in my view more apt to confuse than enlighten in this context. Is the end of the present boom drawing nigh? Yes, and house pricing will cool at some point and remain so for some extended time. That should figure in your thinking not only about stocks, but your own needs and desires regarding shelter.

Inventory Build

Output, sales and inventory measures for the economy show reasonable balance save for distributors or wholesalers. Spring sales are running about 8% ahead of last year, but inventories are 12% higher. With distributor sales stronger than both factory and retail, there is likely some involuntary inventory accumulation which will eventually feedback to the factory level. This is a normal development and may extend the slowing of the economy until inventories are trimmed. The imbalance at the distributor level may also affect imports mildy.

Bailing Out China -- Chapter 1

BofA announced purchase of 9% of China Construction Bank for $3 billion. What's the deal? CCB is on its posterior. A book of bad loans and officers who have regularly cleaned out the till. Bof A has a cadre of Chinese and Chinese Americans from its San Francisco hayday. These boys go to CCB to downsize it, put in top notch controls, state of the art payment and deposit systems and, eventually, set up retail banking operations. The bad loans will be sold to some combine of Chinese chieftains, call it Yuk Foo Finance. With the clean up and the BofA imprimatur, CCB can go to the Global capital markets to re-capitalize the bank properly. Look for Bof A and Morgan Stanley to head this one.

Let's spin. BofA and Morgan (who has a deal on with CCB) start to get plum loan and equity deal flow with major Chinese companies. BofA sets up a sino-dollar facility to accomodate deposit flows with BofA safety net. This facility will also recycle dollars to relieve stresses at the central bank in Beijing. Down the road, BofA jointly with CCB gets to issue up to 200 million VISA cards to the locals, backed by BofA's top notch credit card processing. China has a real bank that can help the country grow, and BofA has a diverse cash machine that will earn it a nice return on its investment.

CCB will cooperate as ordered by Beijing and of course it is doubtful BofA would have undertaken such a challenge without carte blanche from Hu and crew.

It is going to take lot of work like this keep China from flat running off the rails.

Do not expect the gang at Morgan to bad mouth the Dragon any time soon.

Inflation And Monetary Policy

Accelerated inflation over the past three years primarily reflects a powerful run-up in commodities prices. The Fed started to tighten with greater vigor at the end of 2004 and has continued that policy. A review of sensitive and raw materials prices shows most have leveled off in the past year save for fuels, which remain in strong long term uptrends and which, being basic to most commerce, foster a widening in business pricing as commerce seeks to recapture costs from a rising fuels bill.

Looking at oil, priced at $55 plus a barrel, it can be argued that with tight capacity but no shortages, oil should be selling in the low $40s per barrel (equilibrium price at $38.50). So there is a fear premium in the market as well as a few bucks per for speculative zeal. Pardon the presumption, but I doubt the Fed would argue with any of that. Because the Fed cannot know that there will be no significant oil or gas supply blowouts in the months ahead, it would be difficult for them to reason that it is ok to ease up now since the market will surely settle down soon. So, I expect them to lean into the wind for a while longer.

It is also worth noting that for oil to lead the inflation acceleration higher over the next year, it would have to move up to $75 or so a barrel at some point by 2006. I doubt the Fed would be willing to sign off on that either, and I also doubt the central bank would trash the economy if oil did start to move in that direction. This brings us back to perhaps having to lean on the economy a while longer and hope for the best -- that fuel prices will fall in line with the rest.

Drooping Dragon

The Shanghai Stock Exchange Index recently entered free fall. Now comes the story that Gov. authorities in Beijing are looking at a $15 billion bail out program to staunch the decline. The market has had a nice bounce on this rumor, although its position is still precarious. Through constant dilution of the market by conversion of state owned enterprises, the Gov. has made a mess of its native equities markets, including the Shenzhen Exchange. It is another example of a rapidly growing economy which has far outstripped the financial foundations needed to keep it on a sound footing.

China is planning a grand entrance on the world stage as a modern, major nation when it hosts the 2008 summer Olympiad. Rest assured it will be quite a show. Next year, Beijing plans to begin letting major foreign owned financial companies in to China to compete. Beginning with the year 2007, Beijing will become preoccupied with The Games set for summer '08. So, I figure there is an eighteen month window for Beijing to begin rapidly reforming its financial system before it is too late to keep the economy from a slide brought on by a weakened financial foundation. If Beijing fails to take action, it would not surprise me if the 2008 Games turn out to be a grand finale for the capitalist revolution underway since 1979.

Big trouble in Big China by 2010 would be big trouble for everyone.

To see a three year chart of the SSEC, click here.

Long Term Liquidity Trend

The Fed's tight management of the Fed Funds Rate during the Greenspan era belies enormous volatility in monetary liquidity. It is living proof of economist Art Laffer's judgment that you cannot consistently manage both the price and supply of money at the same time. Since the end of 1999, the Fed has been allowing one of the largest liquidity bubbles in US history to unwind. Much of the excess liquidity generated over the 1995 - 2002 period was burned off or consumed in the simultaneous crashes of the tech / telecom sector of the stock market and the economy. There has been enough liquidity spillover to give the housing market a good boost, but not enough to generate a serious general inflation.

Since the end of 2003, the growth of the real economy has consistently outpaced that of liquidity. The effects on the capital markets of the consequent substantial rise in the velocity of money have been muted by the continuation of a negative real short term interest rate. The bringing of the economy and liquidity into better balance has required considerable skill by the Fed and a fair measure of good fortune. Greenspan owed everyone this after the "banana boat republic" monetary policy he ran from 1995 into the new millenium.

Did the Fed lose its marbles over the 1995 - 2002 period? No, it worked with the Clinton team to engineer an economic and stock market boom that would provide a dramatic increase in revenue flow designed to put the US budget into balance. The effort was blessed by development of remarkable balance between economic supply and demand and a rising Dollar. But, alas, they lost control of the liquidity genie. It happened too fast, and the bubble was created. The budget went into surplus, but all hell broke loose anyway. The US went from soaring prosperity to the brink of economic depression in a mere half dozen years.

The US has moved back from the precipice, but there are tremendous challenges ahead, and the Fed must begin to work harder to maintain better balance in the execution of monetary policy. To this end, at some point, it must address the changes it made to reserve rquirements for jumbo deposits in 1992. It is still way to easy for the banks to evade the reach of the Fed by funding through jumbos with low or no reserve requirements. The latter is a technical but critical point. "Uncle Al" is in the home stretch of his tenure, and the Fed needs strong new command. I am hoping he keeps the monetary reins balanced to hand over to the new chief next year.

Bond Market Profile -- Brazen Bulls

10 Year Treasury: 3.91%, 30 Year Treasury: 4.24%

The Treasury Bond market normally prices off the FFR or 91 Day T-Bill rate. Based on very long term relationships, the Bill, at 2.99%, implies a long bond yield of 4.50%. This relationship is a rule of thumb, not a precise axiom of the game.

Short rates are too low relative to the recent inflation range of 3.0 - 3.5%. The Fed, leery of the strength of the economic expansion, has brought rates up very slowly. The Fed has faced a headwind, too. The ratio of short term credit demand to the supply of loanable funds in the system although rising sharply, is still quite low relative to the supply of loanable funds. Rather than drain permanent reserves and imperil the economy, the Fed has been pressed to move short rates up in small increments. A fine point perhaps, but an important one to keep in mind.

Bond managers, reluctant to sacrifice yield in the environment by staying short, have pressed to pick up yield along the curve and through adding spread by downgrading quality. The Treasury bond yield barely protects the purchasing power of the money invested in it, but it is still better than taking a very short duration position.

The recent sharp rally in bonds dating back to mid-2004 reflects bond manager awareness that basic cyclically sensitive data is flattening out, indicating a continuing economic slowdown that managers expect will eventually lead to lower inflation readings. So the bond market has felt comfortable long despite the nominal premiums in yield over inflation because expectations are strong in favor of a deceleration of inflation resulting from the slowdown.

There is no "conundrum" here. Bond manager behavoir has been normal. The group can get uneasy, however. Signs of economic strength or a short term boomlet in commodities prices can add 50-100 basis points to yields in short order. But so far, the underlying consensus conviction that inflation is headed lower, perhaps to 2.0% or slighly less remains strong.

As mentioned last week, the bond market is overbought and sentiment as measured by the normally reliable Market Vane survey of bond traders is now far too bullish, with 76% of repondents recommending the long side. It would be a surprise not to see the 10 year Treasury head right back up to 4.50% or beyond in the next several months.

One thing to watch out for is when the Fed says it has reached its goal of removing accomodation and is now in a neutral posture. Since "removing accomodation" has been a euphemism for tightening the reins, a neutral posture might well be consistent with rate and liquidity moves in either direction. This change could increase uncertainty among bond players and result in some premium building in note and bond yields, since it opens the question of whether the economic slowdown might soon end and give way to faster growth.

Link to a nice long term chart of the Treasury here. It shows the long term bull market in bonds is still intact. Note that as in the past we are basing under the yield downtrend line. I suspect if monetary policy is again set to support moderate growth, the downtrend line will likely be challenged once more.

May Employment Situation

Civilian employment increased by more than 400K in headcount during the month.

Measured yr / yr, jobs growth rose by 1.9% -- reasonable performance.

Growth of the labor force has been creeping up and increased by 1.4% over the past twelve months. This is still low enough growth not to force the Fed's hand on monetary policy.

Hourly earnings increased by 2.6%, which lagged inflation of over 3.0%. Bosses continue to be profound cheapskates, and are not rewarding the rank and file for productivity gains. This practice of "poor boying" the labor force undercuts sustainable consumer purchasing power and intensifies growing class differentiation. You do not have to be a populist to recognize that corporate greed is a long term economic negative.

Too Many Bond Bulls

10Year Treasury Note: 4.07%

The $USB chart shows that the 10 year note is mildly overbought. The Market Vane survey of bond trader sentiment has reached 74% bullish, the highest reading in over two years. Over the past fifteen years, bullish sentiment readings in the 70 - 80% area on the MV survey have been consistent with interim tops in prices and lows in yields. If this heretofore strong relationship holds, the yield on the ten year note should reverse by between 50 - 100 basis points, which would bring the yield on the note up to the 4.50 - 5.00% area at some point in the next several months.

Federal Reserve In The Real World

The Country needs a good five cents cigar. But even more, It needs a good five cent nickel. The roles of the Fed and the Treasury are to provide and maintain sound money. But the Fed Chair and the Treasury are there to serve the President, not the other way around. When sound money must confront realpolitik and its agenda, sound money is going to lose at least nine times out of ten. The Fed Chairman is necessarily a political operative and when the political agenda challenges sound money, it is his job to sand bag as he can and try to minimize the damage. There is no room for an adolescent hissy fit and resignation. Do that and you will not eat lunch in D.C. again.

Volcker, an anti-inflation and globalist fanatic, got in the way of a sensible political agenda and lost his job. Greenspan has been very different. A better politician, he learned to get out front of the Clinton agenda and lead it. Both Chairs made big, costly mistakes.

The internet is crammed full of the commentary of sound money advocates. Well and good, although the preachy sanctimony of most of these commentaries is an irritant. As an investor, I have always looked at the Fed as operating in a political maelstrom and have tried to figure what They are likely to do first and what, from a value judgment perspective, They should do second. You should too, because if you do, you will better understand the continuing situation on the ground.

Lately, Greenspan is under the glare of questions about whether the current level of short term rates is appropriate. The sound money gurus worry rates are too low. The growth advocates worry rates may be too high.

With 3% inflation, the Fed Funds rate should be 4.25 - 4.50%. But the Fed has been concerned with nursing the large US manufacturing and related industrial and commercial products and services sector back up from near oblivion. Nearly five million jobs have been lost here. From the prior peak (6 / 2000) to trough (2 / 2002), factory shipments fell nearly 20%, the largest decline since The Great Depression. Sales then languished until mid-2003, and it was not until early this year that shipments finally exceeded the 2000 peak level.

Easy money in recent years has triggered a housing boom and sharp growth in consumer spending. Have excesses been created? Likely so, but the policy pulled the industrial / commercial sector out of a deep nosedive which was its intent (including, perhaps, a planned assist from the war in Iraq).

Now, with the industrial sector back on its feet, the Fed has a freer hand to tackle other issues. More on the new game plan will come in future posts.

Stock Market Profile -- Cyclical

S&P 500: 1197

The market has meandered off-trend, but remains a cyclical bull, having again successfully tested its longer term move/avg.

To qualify as a "normal " cyclical bull market in a conventional four year cycle, the S&P 500 should move up to 1360 by early 2006. My market tracker (a model based on regressed p/e x earnings) has it moving up to 1310 by early next year.

Ordinarily, I would be reasonably comfortable with these projections. The economy is expanding, is not overheated (there's capacity to spare), and the stock market has not burned up all that much liquidity in its advance since late 2002. However, we are well beyond the "easy money" period of an advance, when earnings are in the "V" shaped recovery mode, short rates are falling, monetary liquidity has accelerated and confidence in business has turned up. Now, the pattern of earnings growth is maturing, short rates are rising, confidence is on a plateau and liquidity has recently turned mildly restrictive as the Fed presses on to contain inflation pressure.

As I read the situation, the Fed's efforts to "remove accomodation" over the past year have been ineffectual. The economy would have slowed anyway, as the recovery in the industrial sector from its deep recession low was too fast not to cool down. Moreover, there have not been the kinds of breaks in energy and commodities prices overall that would suggest the Fed is yet succeeding in containing inflation pressure. Yes, we could see some seasonal relief in primary sensitive prices in the months ahead, but the trends continue to point to higher prices down the road.

So, I read the recent drift of monetary liquidity into more restrictive territory as an attempt by the Fed to squeeze the structure of primary materials prices a little harder. What makes me a bit uncomfortable is the recent divergence between the stock market (in rally mode) and the tightening of the monetary reins. Risk is on the rise.

I see the US as in an economic "fine tuning" mode, where bullish or bearish views on the stock market are freighted with assumptions. For my part, It is an environment for putting nickels and dimes to work short term, not big bucks. I like the investment world simple, and the fewer assumptions that have to be made, the better.

I also use a dividend discount model to value the market. The current reading is 1125 for the SPX. The market has moved into overvalued territory. Valuation is a poor method to time the market, but excess valuation can act as a headwind from time to time.

If this round of "fine tuning" works -- the economy expands while inflation pressures abate -- the SPX has a good shot at 1360 by early '06. But, as in any case of such "tuning", good fortune will have to smile on us.

Keep The Oil Price In Mind

The price of oil has dropped by about $10 a barrel since early April. The rallies in the stock and bond markets and, to a lesser degree, the recent break of trend in gold heavily reflect the weakness in oil and its implications for inflation. The recent tape talk and US oil inventory data have favored lower oil. But oil is heading toward a short term oversold position and the bond and stock markets are heading into overbought territory. If you are a short term player in the capital markets, this situation begs to have you watch the oil market as carefully as your stock and bond positions.

Thanks, Al...We'll Take it From Here

The Danish philosopher Soren Kirkegaard argued that to embrace the Almighty, and by implication, all else not at all apparent, requires a great leap of faith. What we have in the stock and Treas. markets is a "Kirkegaard Rally"....You gotta make the leap....Fed tightening is now seen as having corraled the inflation beast, making it safe to think about a benign economic expansion ahead. Plus, no doubt hedgies are rolling out of oil and commodities as they sell off and are jumping on the equities and Treas. bandwagons. A "done deal."

The Fed has succeeded in this kind of maneuver before as discussed in recent posts, so it comes as no surprise that some would jump the gun and and run 'em in anticipation of success. Be careful with this. For example, do not use the "john" during trading hours, or have a ticker moved in there so you can stay on top of the action.

Running Dogs of Capitalism

That's what Mao and Chou used to call the US establishment in the 1950s and '60s. Now we have the fastest running dogs of capitalism in China itself. Yesterday, Treasury Sec'y. Snow pulled his punch on currency manipulation by China and greenlighted the dogs to run for at least another six months. This was a mistake. China's remarkable growth over the past ten years has far outstripped the development of its banking system and financial controls generally. There have been several bank bailouts and the private or "stir fry" economy has been allowed to circumvent the banking system entirely and flourish. The banks in fact are used as ATMs by thieving employees, the political leadership, and their lackeys (another favorite Mao term). Lengthy discussions about unpegging the yuan from the dollar and letting it float have drawn in extra billions of speculative capital awaiting a hoped for positive revaluation of the yuan.

Allowing the peg to continue for months more will give the speculators more time to pour more hot money into China, some to remain liquid and some to go into an already vastly overbuilt real estate sector. This will put increasing strain on a shaky financial establishment, already outgunned by the warm unofficial welcome given to speculation. It's big bucks for the mandarins in Beijing, but the house of cards, now well under construction, seems destined to grow as a result. Economic risk will continue to rise in Asia.

The US went through this with Japan in the 1980s. It mistakenly took a soft line on rampant Japanese mercantilism. Billions of speculative capital flowed into Japan behind the trade dollars, creating real estate and equity market bubbles the popping of which was long term ruinous to Japan. The US, faced with dealing with a large budget deficit, is currently poorly positioned to ride to the rescue should events knock China's house of cards down. The US is willing to take a possible upward hit on its long term rates in the shorter run to avoid the costs of financial catastrophe and destablization it foresees in China.

For now one can just hope that the ace of spades is not added to the abuilding house.

Gold -- Near a Breakdown

A break in gold below $420 an oz. would be a violation of the uptrend in place since 2002. It would not mean that the bull market in gold is over, but should a break occur, it would at a minimum signal a lower upward trajectory for the metal going forward. The Federal Reserve has been shrinking the size of its Treasuries / repo portfolio since year end 2004. This means anti - inflation determination on Their part. The US dollar has responded positively and gold
has entered a correction with support in the $410-415 area. The gold players have stepped up buying on prior dips, so the next week or so will be a good test of resolve. The XAU gold/silver stock index faced a similar test very recently, and broke decisively below its uptrend line. The dollar will figure in too, as it is approaching a short term overbought for the first time in a number of moons.

CRB Commodities Index -- On Fed's Monitor List

CRB Commods: 293.9

Q1 seasonal commodities price spikes in '03, '04 and a big one in '05 have contributed significantly to the acceleration of inflation. In this link you will see that the CRB is trending down fast. A further decline below the pivot line of 282-283 would tell the Fed that inflation pressure may well abate noticeably going forward.

Stock Market - Technical

SP500: 1154

1. The cyclical bull market which began 3/03 has had two distinct uplegs so far. #1 ran to late 3/04, and #2 ran from 8/04 until late 3/05.

2. The market then entered a 5-6% correction. A counter-trend rally began in mid - April from a significant oversold. The rally did produce very short term buy signals on a number of technical indicators. I have not chosen to play this advance so far. The main reason for staying out has been the mediocre price momentum of the major composites. As a consequence, key intermediate term indicators have yet to turn positive, although the NASDAQ Comp. is getting very close to making the turn. I approach a counter-trend rally with caution. Thus, I have been thinking that I might also consider buying only above key pivot lines such as
DJ 10400 and SPX 1180.

3. It is a critical time for the market on a technical basis. Nine month and twenty week cycle low intervals are imminent. At the same time, recent failure of the market to successfully challenge its 50 day MA and deteriorating intermediate term price momentum suggest the possibibility of a resumption of the correction.

4. Since I do not have to be the first kid on the block to do anything, I am going to wait a bit to see whether the market can develop stronger positive momentum. Click on this link and you will see the weekly SPX is nicely oversold (14 week stochastic) but that MACD is just now basing with no upturn at hand.