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.