The Jackson Hole Gig

Tomorrow, Ben Bernanke is to keynote an economic conference
focusing on housing, housing finance and the economy. For BB
to talk about moving the FFR% would be a profound breach of
professional ettiquette as that is the role of the Federal
Open Market Comm. as a whole. He might reiterate that the Fed
stands ready to protect the economic expansion, but that has
already been factored in.

I am hoping BB opens an eventual wide ranging discussion on
the future for housing and how best to finance it. The
demographics are changing rapidly, with boomers looking to
downsize or find housing with more senior amenities, and the
prime buyers, aged 25 - 44, will gradually but persistently
fill with younger folks as well as immigrants. The market will
over time need to find ways to accomodate younger buyers yet
not destroy the savings of seniors wishing to simplify their
lives. I would doubt BB would carry it all that far, but this
will continue on as an important economic and social issue for
years to come, and he would do all a favor by starting to
address it.

Gold Price ($666. oz.)

On a seasonal basis, gold tends to do a fair bit better over
the second half of the year reflecting stronger commercial
demand.

In the interim, gold has lapsed into a $640 - 695 trading
range, and has fallen out of the very sharp uptrend seen
since mid - 2005. The break of trend has been mild, as most
players are attuned to the seasonal pattern. Moreover, there
has to be a contingent of bugs out there who are counting on
the Federal Reserve to cut its Fed Funds target rate and
re-inflate the economy in the hope of calming unsettled
markets and concerns about a loss of economic growth
momentum.

My macroeconomic gold price directional indicator remains
in an uptrend, but is only modestly higher than it was in
mid - 2006, when gold traded around $650 oz. The indicator has
grown more volatile, reflecting a wide ranging oil price over
the same period.

I still have the gold price as overextended on the upside. The
long term price trend going back to 2001 suggests gold should
now trade in a range of $550 - 630 oz., and the macro model
suggests gold belongs in a range of $530 - 540. The macro model
trails the chart range because it has trended up far more
slowly since the end of 2005, as both US monetary liquidity
and the oil price have progressed more modestly since then. In
short, long range inflation stimulus in the US has moderated
substantially in recent years.

Stock Market -- Short Term

Yes, the rally off last week's sharp lows has proven
irresistable. However, "spike" lows / no look back
rallies are inherently dubious. In bull markets,
straight climbs in the indices off spike lows work out
only about 40% of the time. In bear markets, the odds
are lower. Many seasoned traders will be looking
for a retest, and if they are long now, are working with
tight stops and hard sell points in mind.

I have included a link to the SP500 below. A couple of
observations:

-- It is disappointing the "500" could not take out the
downtrend line from the July highs, but closed at the
line instead.

-- The index also did not challenge the 25 day m/a today.
It would not be healthy if it rolls over under the
"25" as it did a few weeks back.

-- There was a positive turn in MACD. Let's see if the slower
red line follows black up.

Stay cool, stay disciplined. CLICK.

Stock Market -- Fundamentals

My SP500 Market Tracker has now moved up from the 1550
area on the "500" to the 1575-1590 area reflecting
stronger than expected earnings through July and mild
moderation of inflation pressure. At 1445, the SP500 is
trading 8.7% below the midpoint of the Tracker estimate
of fair value. Investors are far more concerned about
earnings potential than earnings capitalization at this
point. The S&P at 1445 implies the economy and profits
are going to turn down in the months ahead.

I am stuck with the idea that the US economy in concert
with the global economy at large will continue growing
and that profits will remain in an uptrend. The leading
indicator sets I follow have lifted strongly since the end
of 2006. They have moderated recently, and have done so
even before the financial crisis struck. Even so, the
evidence I work with does not yet signal either a precipitous
slowdown or a downturn.

It is a risky period now. Finacial liquidity, broadly defined,
has started to contract in the US primarily reflecting a
sudden run-off in commercial paper outstandings. Moreover, the
Fed has just begun to add some monetary liquidity to the system
and this will not stimulate the economy overnight. It is cold
comfort that the Fed is prepared to do more to maintain economic
growth as one cannot be sure the tumblers are not already starting
to slip in place for a downturn.

Economies normally blow out into recession when they overheat
and policy actions taken to suppress demand lead to large
inventory excesses and the need for business to cut jobs to
maintain cash and profitability. The US economy has a tight labor
market, but is nowhere near overheating. So, I think the proper
framework for now is to see the banks providing needed trade
credit for worthy borrowers and to resume mortgage lending at
a far more restrained rate than in days of yore. The hedgies
and private equity dudes will have to work out their own fates.

Leading economic indicators tend to pitch downward ahead of a
recession or downturn, so I'll continue to monitor the weekly
and monthly data. Capacity growth is a lame 2%, so we need to
monitor the inflation indicators if production growth exceeds
capacity growth by a significant margin.

My "500" Tracker will top 1600 by the end of 2007 so long as
earnings progress as expected and inflation stays modest. There
is no saying how soon investors will regain confidence to push
stocks higher again, and there is no saying for sure that my
vision of a positive and rational resolution of the current
liquidity squeeze will prove right.

At this point, the fundamentals still seem ok although only a fool
would refuse to see the short term risks. But, I'm willing
to give the lenders a chance to fire the dummies and rework credit
policy sensibly. I hope that the Fed's limited kind words and
actions to date will enforce confidence.

Stock Market -- Time To Get Back To Work

I have been cautious on the stock market all this year
and have stayed away fully. As such, I have missed the
good, the bad and the ugly. But, with a full cash position
plus a good T-bond trade, I am decently ahead on the year.

the market is down very close to 10% from the recent all time
high. By my analysis, that more than discounts the direct
fall out from the subprime business. The decline has proceeded
to the point where one must ask whether the economy is headed
for broader fundamental trouble. The leading indicators I
track do not point that way yet, and my longer term indicators
are starting to tick up ( A weighted combo of the Fed Funds rate
Fed credit, real M-1, the real oil price, real wages + job growth
and capacity utilization%). I have some concerns about whether
inflation will re-accelerate as the economy expands, but the
sizable price correction in stocks to date provides some cover.

I now think we are much closer to a price level zone in the
stock market where we could have a decent tradable rally. I
am no timer, so I will be looking for signs of a positive trend
reversal before jumping in. It does not matter much that the
market is oversold, because a market in a downtrend can get
even more oversold. Nope, now we look for strong suggestions
of a reversal.

Could it go lower? Sure it can. Folks are now running scared
after we broke support this week. It is getting emotional out
there again, and not everyone so inclined may have thrown in
the towel. But it is getting interesting, too.

Will the Fed be stampeded into cutting rates? I hope not as a
rate cut and an uptick in the economy could send commodities
prices higher and the dollar lower and push down market p/e.

If there is a good rally in the next week or two, I am back
to work. I am also thinking that if I get lucky on the long
side, I'll sequester some dough to buy puts, something I do
rarely. However, we are in a global economic expansion that
is now more mature and which will sprout more excesses and
deficiencies as we go along.

I have included a link to the weekly SP500. Note the very low
14 week stochastic (usually suggests a rally at these low
levels) and also that the MACD has finally come down from
the moon to more respectable levels. Click.

More On Liquidity, Credit & Monetary Policy

As discussed in the 8/08 post below, financial liquidity
is plentiful when viewed yr/yr, with the M-3 proxy ahead
by 9.2%. However, over the past three months broad
liquidity increased at only a 4.4% annual rate, as banks
capped off real estate exposure. Since a faster growing
real economy claimed the past three months' modest liquidity
increase, the financial markets have been squeezed. As
suggested last week, the Fed would have to be alert to the
squeeze. They were not alert enough and had to inject over
$60 billion in reserves in short order.

There are credit issues out there beyond the crummy real
estate loans. Spikes in overnight lending rates as occured
last week spell mismatches in deposit and payment flows
within the banking system and daylight overdraft problems.
That says late arriving money and stepped up redemption
requests from risky portfolios that cannot produce firm
NAV and are drawing on credit lines. Today we learn that
Coventree, a junior sized Canadian finance house could not
roll over its asset backed commercial paper and was forced
to extend. So, beside a liquidity squeeze, we have some
crunch in the credit sector.

As a former chief investment officer at a major money center
bank, it has been my distinct pleasure to sit through
bankerly meetings when the spit has hit the fan o'er lending.
The dumb guys who made the bad loans now do not want to
make good loans. The CEO sics the chief credit officer on
loan officers who have earned special contempt. The economist
is brought in to do his routine. Folks are marked for termination.
There is near endless paper shuffling and procrastination.
Finally, someone will inquire whether the lights should be
turned off and all go home for good. After a bit, people get
working to adopt policies sensible to the times. The bank
moves forward, no longer seized up and ready to implement the
new marching orders. Bad credits get dumped and the good
credits get taken out to lunch. We're not there yet in the
system.

The Fed has belatedly added a large measure of liquidity. It
remains to be seen how much they take back and how much they
leave on the table. The Fed has leeway to leave plenty on the
table without creating an inflationary surge as it has been
tightfisted with reserves for three years running.

Difficult moments in the credit markets take time to work out.
Smarter more decisive guys do not get the upper hand on the
dunderheads overnight. But progress will come.

Liquidity, Credit & Monetary Policy

The broad measure of monetary plus credit driven
liquidity increased at a still high 9.2% yr/yr
through July. However, for the April - July period,
this measure rose at only a 4.4% annual rate. After
factoring out an acceleration of economic growth
over this interval, it turns out the financial and
capital markets faced a liquidity deficit or squeeze.

The slowing of liquidity growth follows directly in the
footsteps of the emergence of default problems with
subprime mortgage loans in the late winter. Since April,
banks have effectively capped off real estate exposure.
The banks did increase business loan exposure, but the
leveling off of the much larger real estate book
resulted in reduced funding needs and hence, slower
growth of financial liquidity to the economy. Real
estate lending is now as slow as it has been since the
wake of the international financial crisis of 1998-99.

To maintain net interest margin, banks jumped even more
aggressively into the deal and share buy-back games over
the April - July period, with business loans increasing at
a powerful 20% annual rate. Come July, as other speculative
lenders such as hedge funds grew chary, the banks were
loaded up with deal flow participations, some intended as
short term, but quite risky. As the banks stepped back,
Fred Molinaro, the CFO of Bear Stearns, complained bitterly
about the stalled pipeline.

Over the long pull, commercial banks like to maintain a
balance between business loans and their Treasury investment
holdings. One can use this measure as a quick check on
balance sheet liquidity within the banking system. Despite
the recent bulge in C&I loans, banking liquidity is still
adequate with a C&I to Treasury ratio of 1.075 to 1. In
fact, liquidity may be a little understated as banks have also
been buying munis for investments as well. On a long term
basis, banks are hardly loaned up or loaned out, and can
re-claim some liquidity as the deal pipeline restarts, if even
hesitatingly. What the banks cannot do for long, is generate
business loans at a 20% rate. Continued rapid growth of C&I
loans from here would sharply reduce liquidity, force the Fed
to raise short rates and lead ultimately to crunch time.

Above all, the Fed is interested in the stability of the
banking system. Its decision to maintain the FFR% at 5.25%
is an expression of willingess to allow the banks to regain
manegerial control over their exposures. Key economic data
that have been bedrock in setting monetary policy are far
stronger than in late 2006 - early 2007, and the Fed could have
raised the FFR% yesterday based on that data. My guess is that
They doubt the strong readings will hold. Realistically, since
inflation of 5% (annualized) wiped out all but 0.1% of the
increase in real household wages over the first half of the
year, the Fed does not see growth running away to the upside,
and sees no compelling reason to aggravate the credit picture.

Fed policy is in a higher risk zone now. Monetary liquidity has
grown rather sparingly since 2004, and the larger component of
credit driven liquidity has financed the expansion and the asset
inflation. But with credit driven liquidity growth now also low
in the short run, the Fed must be on its toes.

Stock Market -- Technical Observations

Short term, the market is in steep descent. Reminds one of
the adage: "Don't try to catch a falling knife".

If you are charting the downtrend, the DJIA seems easiest to work
with.

The "average stock" is down 9.8% from its July peak, in line with
an ordinary, mundane 10% correction.

The market is getting strongly oversold on a short term basis, both
on price momentum and on breadth. The 21-day TRIN is also showing a
moderate oversold.

The market is just slightly oversold on an intermediate term basis.
Even mild price weakness, net / net, over the next week or two would
create the technical underpinnings for a rally.

My selling pressure gauge has been on the rise since early in the second
quarter, reflecting deteriorating market breadth. The uptrend in selling
pressure is intact, but is now signaling the market is getting oversold.

The major price indices have broken trend based on the 6/06 interim low.
My Basic Trend Index (NYSE A/D line adjusted by daily TRIN) is on the
verge of a breakdown but has not given up the ghost quite yet.

The SP500 closed Fri. 08/07 at 1433. A further decline to 1395 would
amount to a 10% correction. A decline below that 1395 level would create
concerns as it would trigger a break in trend from the 2002 - 2003 lows.

Link to the SP500 weekly chart.

Emotion is running very high with plenty of chatter about a credit
crunch or enough weakness from a weak housing sector to create a
recession. I'll pick this up later in the week. Note though, that
the FOMC is meeting this week. No doubt there are folks of influence
out there trying to push FOMC to ease up, either via a cut in the
FFR% or more benign language in the statement that attends the
decision.

Stock Market -- Cliffhanger Resolved

This week the bulls had a three day window to reverse the
slide and could not pull it off. Bear Stearns, apparently up
to its ass in alligators, got its ratings cut, and the bears
took over. The selling today was more emotional and
indiscriminate. So we have have another "feel bad Friday" when
folks head home to ponder their losses.

I have been cautious on the market this year and have stayed
away. As I pointed out back last December, the global economic
expansion has been strong enough and gone on long enough that it
was only logical to expect that some of its excesses and
deficiencies might start to haunt us and create more volatility.
So, I blew off the idea of a forecast of the market, with the
idea I would take a back seat and see how the year went.

I mentioned on this past Tuesday that a 10% price correction in
the SP500 down to 1395 might better wash out lurking fears, but
also pointed out that I did not have a good clue whether such
would happen. With the "500" closing today at 1433, we are within
hailing distance.

Growth potential for the US economy stands only at 2.8% in my book.
The economy picked up its pace this spring, but has not been strong
enough to present a case which would dominate the junk credit woes
that beset housing and the world of deals. So, legitimate uncertainty
has crept in, but so has emotional selling.

I am staying out of the forecast business for now, but I would note
that the uncertainty is being well handicapped as we go and that I
am getting my first inklings emotions are starting to get a little
bit raw.