Stock Market -- Technical

On the basis of trends, the market is obviously positive.
It is also short term overbought and extended. Moreover,
the longer term momentum work I do suggests an extended
market in the sense that investors and traders have been
unwilling to keep pushing shares up with the market at its
recent premium to the 40 week M/A during the upcycle underway since
late 2002. There have been periods in the past, especially
during the raucous 1990s, when no such discipline was observed
and the market went to very large premiums to the underlying
trend. But this cycle has shown far more constraint and
discipline.

It is also interesting to note that May is becoming an "iffy"
month seasonally. Longer term, May exhibits seasonal strength
that builds on April, but in recent years, May has triggered
some aggressive selling as some players like to exit the market
in the spring with an eye to re-entry in the autumn.

It has been my view that the market entered a topping process a
short while back. So far, that view has proved incorrect as the
market has pushed to new cyclical highs without breaking a sweat.
I have hesitated to make a 2007 forecast of the market based on
fundamentals, and perhaps I should have buttoned my lip on the
technicals as well. From my perspective, the suggestion will have
proven a big disappointment without a solid 5-6% sell-off in the
next couple of months.

Stock Market -- Fundamentals

In Monday's post, it was pointed out that the SP500 (1488)
was closing in on fair value of 1500. That works out to a
p/e of 17.0 x twelve months of operating earnings for the
index through 3/31/07. The big change in the environment
since mid-2006 was the sharp drop of the inflation rate.
Thus, from my perspective, the run-up in the market since
mid-2006 does not represent a blow-off but a move up to
reasonable levels based on an advancing economy and a return
to a more moderate inflation level. If you were to push the
envelope a little to incorporate a 2.5% inflation rate, you
could argue for 1550 on the SP500 (2.5% represents the yr/yr
change in the "core" CPI through 3/07).

The persistent upward momentum in the market over the past
nine months also obviously reflects positive investor assumptions
about the future. The market is in the process of discounting an
eventual re-acceleration of US economic and earnings growth and
the continuation of a moderate inflation rate.

Top line growth for both industry and finance has slowed
appreciably since mid-2006. The growth of wages has accelerated
modestly, but there has been just enough productivity growth to
avoid a broad reduction of profit margins. So, yr/yr, corporate
profits could be up 4-6% through the March quarter. It is not at all
likely that the market could hold a 17 p/e if investors did not
expect earnings comparisons to improve markedly later in the year.
Analysts expect earnings to rise serially in Qs 2 & 3 of this year,
but no major breakout to new highs in quarterly earnings is projected
until the final quarter of 2007, when the SP500 index earnings are
projected to top 25.00 for a 100.00 annual rate. To get there, it
sure would appear that the US economy will have to accelerate.

On top of this assumption, comes the idea that a re-acceleration of
US economic growth will not lead to a cyclical acceleration of
inflation. This latter assumption has looked dubious for some
months now, as US productive capacity has not kept pace with
production growth potential in a faster growing environment. I have
stayed cautious on the market until I see how well companies respond to
a resumption of faster order growth rates.

Another factor to keep in mind is that the average small and mid-cap
stock is trading between 19.0 and 19.5 x earnings. In fact my unweighted
universe of 1750 stocks is trading at an average of 18.5 x earnings. This
underscores the high expectations for future growth and benign inflation built
in to the market.

More on the fundamentals later in the week.

Stock Market -- Fundamental

By my Market Tracker, the SP 500 -- now around 1480 -- has
been fairly valued in a range of 1500 - 1550 since the latter
part of 2006. This is a broad range for the Tracker and it
reflects above average swings in analyst sentiment concerning
earnings prospects as well as continuing high volatility in
the inflation readings. At present, the Tracker is at the bottom
of its recent range for the SP 500 -- 1500.

The rally so far this year has carried the market closer to the
estimate of fair value. The strong surge in stock prices since
mid-2006 primarily reflects an upward adjustment in the earnings
capitalization rate reflecting the sharp drop of inflation pressure
since the middle of last year. SP 500 earnings are still seen as
rising this year, but the estimate is about 3% below the consensus
forecast for 2007 as of late 2006.

I am going to leave it here for the day, but will return to the subject
a few more times over the next several days as I figure out how best
to strategize with a foggy crystal ball.

Inflation Notes

The sharp uptrend in the broad CRB Commodities Index underway
since early in the year is starting to break down as a reflection
of developing weakness in fuel feedstocks. This index can be
volatile over the short run, so one does not want to make a big
deal out of a break in the short term trend. Even so, it is
worth noting.

US productive capacity growth continues to lumber along at a
modest 2.3%. This continuing low rate of growth is below US economic
demand growth potential and remains a sore spot in the US outlook.

It is good to see Def. Sec. Bob Gates spreading balm around in
discussing the middle east, particularly Iran. The Cheney Show,
which involves threatening talk in Iran's direction, is not smart
as such talk helps kite the oil price, suppress US consumer real
incomes and puts more dough in Iran's coffers.

The headline CPI advanced at a 4.7% annual rate in Q1 '07. Looking
short term, this has pushed the inflation adjusted, after tax
return on 90 day paper into negative territory and has led to
weakness in the US dollar. The dollar now needs the attention of
US officials since it is trading down near long term support. It
will be interesting to see if moderation in the broad commodities
composites might give the dollar a lift and stave off the issue of
whether the US is willing to allow the dollar to fall below support.

Stock Market -- Technical

The stock market is overbought on all measures for
the ten day short term. It is also on the verge of making
my intermediate term view the wrong view. I have argued in
recent weeks that 6-13 week breadth and momentum indicators
portrayed a developing topping process. But, at this juncture
I would have to say that unless there is a sharp sell-off
starting at some point over the next week or two, the idea
of a topping process may have to be shelved.

The last technically strong entry point I had was in June/July
2006. The rally that began then was a terrific one to trade or
ride. The rally that kicked off in the first half of March, 2007
did not have the deep oversold pedigree I prefer and I have passed
on it. The tough thing for me is that viewed short term, this is
a respectable run-up, nonetheless.

So, from a technical perspective, I am on the beach for the next
two weeks, left to hope we get a sharp correction to a stiff
overbought. Now the existentialists out there will chuckle at
this, remembering as they will that Albert Camus was fond of
saying that "to hope is to despair"....

Liquidity Factors

This is an update post which builds on the original "Liquidity
Factors" memo posted on 2/14/07.

Monetary Liquidity
The Fed continues to maintain basic monetary liquidity growth
at low levels. M-1, the basic money supply, has shown barely
any growth for some time now. Monetary policy remains firm.

Credit-Driven Liquidity
This wide measure of money remains in a strong growth pattern,
although yr/yr growth has leveled off at about 9.0%. The growth
of bank lending to key sectors -- mortgage and real estate
development, home equity and C&I loans has moderated in recent
months, although the real estate and C&I books are still up
smartly yr/yr. The real estate loan book did dip in March reflecting
the turmoil in the mortgage market. Bank funding remained aggressive
and sales of asset backed paper resumed growth. Funding tends to
follow loan growth, so there could be some moderation of broad money
growth ahead. The slowing of the economy since mid-2006 is beginning
to be reflected in asset generation and funding.

Economic Liquidity
With a more sluggish real economy and still high broad money growth,
there is surplus liquidity in the economic system to support financial
and real asset investment and speculation. There is a liquidity
tailwind for areas that are viewed positively. Unfortunately for the
Fed, commodities speculation has picked up some, which reduces the
efficiency of monetary policy management. The loss of Fed control
traces directly back to the Greenspan Fed liberalization of reserve
policy implemented in late 1992 and never reversed.

Trade-Driven Liquidity
The outflow of dollars through the trade window remains high but
relatively static. The leveling off of dollar outflow will negatively
impact offshore growth with a lag.

Crude Oil Quickie

After a bizarre meet with Pres. Ahmgonnabebad, the 15
Brit mariners were sent home with pink goody bags late
last week. Today, Iran started hyping its ability to
produce larger amounts of enriched uranium. The market
ignored this latest price kite job, and continued to
sell off crude in the wake of the capturees' release, with
oil down over $5.25 bl. to $61.50.

April is a strong seasonal month for crude and I am hoping
the geopolitical bunkum will stay quiet long enough to get a
good fix on supply / demand fundamentals. Tame fuel prices
would take pressure off the global economy, so let's see if
we can get a clear read on these markets in the weeks ahead.

Jobs And Indicators

For Q1 2007, civilian employment gained an average of only
109K jobs a month, with all of it coming in March. Slow going
for the quarter. Measured yr/yr, employment is up 1.8% and
wages are up 4.0%. That would be fine, except that a bump in
inflation is cutting into the income growth. Fuel prices need
to settle down or else consumer spending in constant $ will be
undercut.

Leading indicators are sluggish. Breadth of commercial and
industrial new orders is still positive, but is at a three year
low and is trending down. Indicators suggest GDP growth of no
more than 2.5%.

Stock Market -- Technical

Gee, how often does the market do what you advise it to
do? Last Tuesday the technical post hinted at immediate
weakness -- the market obliged -- and opined a drop in the
SP500 from the 1428 level down to 1420-1410 could set the
market up for a more reasonable rally. Again the market
obliged. The market now features more stability, is in a
short term uptrend and has solid enough technical credentials
although it could be getting a little overbought short term.

The recent rally does not leave me in that happy a position. The
short term trend deserves respect, but my intermediate term
indicators continue to suggest the market remains in a topping
process that could run for several more weeks. So, for now, I'll
watch along and we'll see whether this rally has some staying
power.

Oil Price

After the big pratfall from the summer '06 high of $78 bl.
oil bottomed near $50 in January and has rallied strongly since.
Yearend through late April - May is a strong seasonal period
for oil as refineries switch over production to gasoline. It
is also clear that the price weakness seen in late '06 and early
'07 likely led to rebuilding already significant coverstocks.
The recent run-up in price to the $65-66bl area has to be very
much a reflection of perceived supply risk owing to the new
presence of two full US battle groups in the Gulf and the
realization that the flag officer, Admiral Fallon, commands the
whole shebang, Iraq included. That plus the Iranian promise to
engage in "illegal acts" in retaliation for further UN sanctions
on its nuclear development program set the stage for a strong
rally when Iranian special forces illegally took 15 Brits into
custody recently.

Now short of some further ugly and draconian actions, the Iranians
have about milked the value of displaying the captives, and the
pit traders would have to be a little dumb to rally off old news.
But it appears this will be a pressure area for awhile, with the
Iranians having to be careful not to overplay their hand. The US
has the Iranians very tightly contained militarily, and further
sanctions may well, in cumulative fashion, put more economic
pressure on Iran, which is now nearly a basket case.

Oil is getting somewhat overbought, and is due for a rest, but
could still finish out its normal spring rally. The trend off
that $50 low when projected out is ominous, so capital markets
players will have to watch the action in the pits carefully to
make sure oil settles down soon.