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.