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.