Stock Market Diagnostic

With the moderation of inflation pressure underway, my
S&P 500 Market Tracker is accelerating to the upside.
By October, the Tracker could cross the 1400 mark on
the "500." The main reason is that the Tracker is
quickly translating more modest inflation into a higher
p/e ratio (the twelve month earnings estimate is running
a little below consensus). So the Tracker says the market
is adjusting to prospects for less inflation pressure
more slowly during this often nervous seasonal period.

The "500" is running modestly ahead of my monetary base
model. I interpret this to mean that investors are betting
on a benign monetary policy going forward. The monetary
base has been on the flat side since May, '06. Soon, the
base will be due for a seasonal expansion to accomodate the
holiday season, and the market appears to be anticipating
same.

My dividend discount model has been in a strong uptrend
for several years reflecting the excellent 10% growth of
the S&P 500's dividend. The model's value trails that of
the "500", because over the long run, it seems too risky
to posit a continuation of 10% dividend growth. However,
the market is not at enough of a permium to this model to
warrant much concern now.

The premium of the S&P 500's earnings / price yield has
narrowed further relative to the "risk free rate" (91-day
T-bill yield %), but not enough to trigger a warning.

Summary

Investors are counting on a continuation of good progress
for earnings and dividends through 2006, and are betting the
Fed will not take action which could damage the market.
Investors are also more cautious about the degree of
deceleration of inflation in the short run, which is
holding back the market.

Long term, investors are exhibiting no caution about the
prospects for earnings and dividend growth, but such
lack of caution is not yet overdone.