Stock Market Update -- S&P 500: 1250

In the prior two stock market posts (4/13 and 5/20), I
opined that a weak market might be at hand, with the S&P 500
vulnerable down to 1200.

I have been looking at various technical and "black box" sites
and I have noticed that warnings and "crash alerts" seem to be
cropping up just below 1250 for the 500. Whoops. Did I miss
something? Here I thought a nice 10% price correction or haircut
following a decent period for the big caps and a spectacular
twelve month run for the small and midcaps seemed reasonable.
'Tis the season for a little weakness and most stocks were
extended to the upside. I do not know whether the "500" will
fall to 1200, but if it did, I would not find it particularly
troubling. Folks have to be allowed to take good money off the
table from time to time.

I have included a weekly chart of the S&P 500. It shows a
developing intermediate term oversold (RSI and Stochastic) and
it shows the market against its 40 and 69 week M/Avs. Click here.

Note that the 69 wk M/Av has provided excellent trend support for
the market in recent years. A firm hold at or a little above
this average would be an encouraging short term sign.

Stock Market -- Technical & Psychology

S&P 500: 1267

As discussed in prior posts, I thought we would be turning a new
page for the market as breadth and momentum compression was so
intense in recent months. In the 4/13 post I opined a signicant move
was in order come May. My strong hunch was that it would be to the
downside. The sharp breakdown of the market since May 9, leaves it clearly
oversold, but also in a no man's land. To reward the bears valiant
battle since Jan. '06, which produced such tight compression, the
market should move down at least another 5%, leaving the SP500
lower at around 1200.

I was concerned we could get a spring time correction not only
for seasonal reasons but also because the powerful + 35 - 50%
moves of the small and mid cap groups over the past year was an
insouciant advance to high levels of valuation in an evironment
of rising risk. These stocks are correcting, but it does not seem
like justice has quite been done yet.

I am cautious about making any predictions in here, because I do not
know if I have much of a handle on market psychology. I do not have
a bearish macroview as many have expressed so suddenly. I just thought
many stocks were too extended and needed a good hit and that May
was a dandy month for it on a seasonal basis.

The economy is entering a transition period to lower growth and, I
trust, more moderate inflation. With these sorts of fine tuned
scenarios, the markets can be very jittery if the ball does not
stay right in the middle of the fairway as it rolls to the cup.

I would like to see the market lower, especially the small and midcaps,
but I do not not want to miss a positive swing in psychology should
one be shaping up quickly. So I may follow the trend for a few weeks
until I have a better handle on the market's intentions.

Stock Market -- Fundamental

S&P 500 : 1280

Based on my fundamental models, I have the S&P 500 as currently
fairly valued in a range of 1290 - 1320.

The October '05 - May '06 rally reflected a significant net
liquidity injection by the Fed, continued double digit profits
AND dividend growth and a recovery in the market multiple
following the autumn spike of inflation. I also like to look
to see if there is "excess liquidity" in the system. This
occurs when the growth of the broad money supply exceeds that
of the growth of output plus pricing, when both are measured
yr / yr. Excess liqudity does provide fuel to support the
market, and it was in place until April '06, when the economy
surged.

The sharp sell off of stocks in recent days reflects a shift of
investor focus away from earnings and dividend growth toward
concern that inflation has strengthened which may result in
short term interest rates that could run higher than previously
anticipated. Players see that the higher fuel costs of recent
years are working their way through the system and, of course,
there may be concerns about whether oil and petrol could
surge further later this year, what with the hurricane season
ahead and with Iran trying to kite the oil price up with a
continuum of incendiary chatter.

At this point, my longer term economic indicators are pointing
toward slower economic growth ahead, and my inflation thrust
indicators suggest moderation of inflation going forward.
I am still projecting the S&P 500 to wind up '06 in a range of
1385 - 1415.

Basically, I look for a slowing of earnings growth momentum,
but a boost to the market multiple to reflect a moderation of
inflation. The housing industry is slowing, and I look for
the growth of consumer spending to moderate significantly as
the higher cost of credit curbs the appetite for borrowing.
On the inflation side, I look for development of a better
balance between supply and demand in fuels and throughout
the industrial sector. My major concern at this time concerns
the prospect for a reduction of private sector credit growth. To
counter that, the Fed will need to cap rates and add liquidity
directly to the system, and it will have to do so with alacrity.

The next post will focus on technical dimension and the short term
side of the market.

Gold Price

Gold: $712oz.

By the end of next week, gold will have finished a very well
defined parabolic up move that could, but not need not,
culminate at $730oz.(It traded that high today.) After next
week a new pattern will be set into motion. Normally, when a
commodity comes off a parabolic, there is a correction with
a subsequent retest of the high.

I am leaving go of further comment on gold for a month or so since
I think I have said all the sensible things I can say about it. We are
in a gold-friendly inflationary milieu, there is a well defined longer
term bull market in gold and it is receiving wider sponsorship and
interest. But gold is extremely overpriced by well founded technical
rules of thumb, and is fundamentally overvalued as well.

We have witnessed development of a gold mania since last autumn, and
manias, being what they are, can end abruptly or continue. Chart
wise, this is the right time for this one to end, but only a fool
would try to rule definitively.

The 5/10/06 FOMC Meeting

Well, they meet tomorrow. Most all observers expect the
FOMC will push up the FFR% by another 25 bp and are reserving
their curiousity for the wording of the statement.

The cyclical pressures are there -- fast rising shorter term
business loans, strong purchasing manager reports, rising
factory orders and the uptrend of capacity utilization.

Moreover, the Fed has not followed through in the injection
of liquidity that came in the wake of Katrina/Rita. The FOMC
has been very measured on the liquidity front since January.

Gold -- Parabolic Upswing

Gold: $678 0z.

Parabolic price moves are most easily seen on a linear
chart. The price of gold is on a happy upward curve.
This parabolic would complete at the end of May with gold
at $700-710oz.

Gold likes an inflationary milieu: economic expansion, rising
operating rates, cyclical inflation pressure, and as often
happens in such an environment, a rising oil price. We have
the proper milieu in spades, plus a growing geopolitical dispute
between the West and Iran over the development of the latter's
nuclear fuels. Iran has kited the oil price with success, and
there is no shortage of observers who see economic and/or military
conflict which could result in a shortfall of Iran's large oil
output.

So, the gold bugs and buggettes have run the price of their beloved
up and through the roof. There are several rules of thumb in the
commodities futures markets for measuring when gold might truly
be overbought and at risk and the price is there. However, since
feeding frenzies can often exceed expectations, there's little
that can be said about when an interim top might be struck.

At this point, I cannot argue with the basics of the gold case.
Economic supply/demand measures show continuing cyclical pressure.
Moreover, I doubt the Fed is ready to purposely squeeze the
economy to the point of recession. That type of action could
actually be several years away. And, it is still early to say
that continued economic expansion will involve growing imbalance
between economic supply and demand.

So, I would simply say that although gold may be in a high return
environment over the next few years, the metal is also in a high
risk one as well. An economic slowdown, oil price weakness,
reduced geopolitical belligerency, all could conspire to blow
$100 oz. of foam off that gold brew in short order.

A word about the situation with Iran. The easy worst case scenario
here is that either the US or Israel or both could launch a military
assault on Iran to impair or destroy its nuclear programs. My
guess is that this kind of action, should it come at all, could
easily be several years out in time. After all, Iran has
been muddling along with its programs for years. My concern
centers around another possibility, which is that Iran, grown
tired of taunting the West and unable to solve pressing economic
and social issues at home, might commit the first act
of war. Should Iran lead off, the response from the US could be
much larger and more devastating. Thank goodness I do not take
myself too seriously on such matters. Whew!

Monetary Liquidity

Both the monetary base and Federal Reserve Credit continue to
run flat with late Jan. '06 levels. Thus, the Fed is tightening
the monetary string, its words notwithstanding. For now, players
in the capital and commodities markets remain smitten with the
idea that the Fed is very close to ending the current round of
boosts to the Fed Funds rate. Chair Bernanke's testimony to
Congress last week that the Fed might consider pausing the hiking
of the FFR to determine the responses of the economy to the
foregoing rate hikes is regarded in some quarters as further
evidence of a growing desire by the Fed to wind up the current
round.

The recent Fedspeak has provided cover for the fact that They have
been in a tightening mode. Plus, the idea of a pause in raising
rates, however sensible from an economic perspective, gives the
Fed "room" to stop raising rates as the off-year election draws nigh.
As I have previously mentioned, this promises to be an important and
nasty campaign for control of the Congress, and the Fed would be wise
not to have itself become a political football that partisans can kick
all around the field. After all, Bernanke is a Bush appointee.

This mismatch between the Fed's expression of its future intent and
its present course of action hardly means that bets based in the
markets which are discounting a soon-to-occur leveling off of
short rates must fail. After all, the markets are discounting
mechanisms. But, recognize the increasing risk levels as well.