Be Back Next Week...

Heading out for a long weekend lark. I'll be attending
my 50th high school anniversary reunion for our class of
'57. Then on to the galleries and the big Armonk Art Show
(IBM). Then come Sunday, I take the younger set out for a
bite and a screening of "Resident Evil". No blog entries
until early next week.

Stock Market -- Short Term

Following the larger than expected cut in the Fed Funds
rate, the market quickly surged to its heaviest short term
overbought in a good several years, as the SP 500 rose to
about 4.5% above its 25 day m/a. That kind of early overbought
is normally a bullish development. Yet, the market has been
exhibiting a deep staccato uptrend since the mid - August
low, and it could be that such a pattern may continue for
a while. From a strictly technical point of view, the short term
trend is up, and a few of the intermediate trend indicators
have turned positive as well. A round of profit taking in the
wake of last week's big overbought would hardly be an unnatural
development. I would happily concede we could see some more
jittery selling pressure, but the market favors the long side
of the trade until we see some technical damage.

Resolution Could Take Time...

My approach to understanding the US economy and the capital
markets has left me in an uncomfortable position at this
point. I do key heavily off the liquidity cycle on a
fundamental basis, and as of today's available data, liquidity
is flat or down some in the short run. I think it can take a
good six months to determine how positively the economy will
respond to changes in the liquidity picture going forward.
With the 50 bp cut in the FFR% to 4.75%, the Fed is signaling
that it is prepared to provide faster growth of monetary
liquidity via open market purchases of Treasuries and other
securities. It is far less clear when and how rapidly credit
driven liquidity will resume its growth.

The broad economy has yet to show the sort of imbalances that
assure a recessionary period, while on the negative side, the
level of residential construction is still running well
above levels seen in prior downturns, and could fall considerably
further before settling out. I also remain concerned that
system capacity growth continues well below underlying demand
growth potential. In this latter regard, should the economy
respond positively and quickly to an easing of monetary policy,
more sustainable inflation pressure could appear.

I have maintained since late 2006 that I would let the other guys
do the forecasting. I had hoped that by autumn of this year, the
horizon would be easier to discern, but, regrettably for me, the
economic horizon has a heavier layer of fog on it than it did
going into the year. For now then, I'll maintain a shorter term
perspective, since I cannot say with conviction that this stretch
of bumps to confidence and higher volatility has ended.

Benny B Jumps Through "The Window"

Yesterday, I suggested that if the Fed deemed it warranted to
cut the FFR%, They should give it a good go. So, we got 50 bp
on both the FFR% and the DR%. 'Twas the uncertainty of it all
that got them. "The Window" of course was the moderation of
short term inflation stemming heavily from a weaker gasoline
price. Bernanke and the Gang also departed again from the
formulaic approach that had governed policy for many years.

The problem as set out yesterday, was that there may be
inadequate liquidity in the system to fuel economic expansion.
Federal Reserve Bank Credit -- the raw material of the basic
money supply -- has grown a paltry 0.8% this year as the Fed
"leaned against the wind" to counter rapid credit growth.
Credit driven liquidity came to a screeching halt in August,
and since the Fed cannot be sure when the system will fully
unlock, It cut rates and may add monetary liquidity more
rapidly to shore up the reserve base of the banking system.
As I pointed out at the end of 2006, the Fed would wait as
long as it could before refueling, and the rate cuts say the
time is nigh.

The process of liquidity restoration sufficient to restore
stronger positive momentum to the real economy may happen
quickly, but could easily take up to six months. More on
all of this in the days ahead.

Monetary Policy

As most know, the Federal Open Market Comm. meets
tomorrow to decide on interest rate policy. Most Fed
watchers are looking for the FOMC to cut the FFR%,
although there is less of a consensus of by how much.

The time honored indicators that have made it relatively
easy to surmise the direction of policy over the years
may count for less with the Bernanke Fed. Those indicators
described a weakening of manufacturing and capacity
utilization in late 2006, and signaled a FFR% cut for
Jan., 2007. The Fed passed over that signal and kept the
rate at 5.25%. As you will recall, Mr. Greenspan quickly
followed with mention that the odds of recession for the
US in 2007 had risen to one in three. The economy did
rebound over Q 2 of this year, and now the same indicators
imply it is too soon to cut the FFR%.

The Street and many name economists are putting substantial
pressure on the Fed to follow up on the recent cut to the
discount rate with a cut to the FFR% in the hope that it will
further ease credit crunch conditions for weaker credits and
preserve the economic expansion. Within the technical domain
of money and credit, there is an issue of whether there is
sufficient liquidity in the short run to fund a growing economy
properly. This may be only a transitory matter, but it goes to
the heart of the uncertainty Bernanke says the FOMC faces.
Moreover, the speculative run ups in gold and oil along with a
weakening dollar in the forex arena are all signaling a
deterioration in the inflation environment should the Fed follow
through with rate cuts.

We'll see soon enough what the Fed intends. For the short run,
my suggestions for the Fed would be to cut the FFR% by well more
than a slim 25 basis points if They deem a cut is needed, and to
not fear reversing course within a few months if inflation
pressures materialize. Trying too hard to mimimize volatility
in short rates and in the economy creates unnecessary volatility
in the liquidity data and may be inappropriate for an economy
that is bound to be more volatile anyway now that inflation
pressures are showing up more often.

Stock Market -- Technical

One check I like to make on markets involves comparison
against the simple 10 and 25 day moving averages. the $SPX
is trending up as is the 10 M/A. Moreover, both have come
up through the 25 M/A. Interestingly, the 25 M/A has just
perked up a touch after a basing period. Check the chart.
The 25 M/A is likely to show some additional improvement next
week as well. It is a development that commands my attention,
as it is an additional sign that the market is turning positive
in the short run. There is much to cavil, of course. The volume
has been on the light side for several weeks, and the $SPX has
had trouble staying over the 1480 level. As well, it has yet
to take a good run at shorter term resistance at 1500. Note also
that there may be sharply increased volatility next week as the
FOMC announces on the Fed Funds target rate. Finally, recall
that many savvy technicians are looking for a retest of the
August low around 1371.

Did I damn the $SPX with faint praise? Maybe. But there is a
noteworthy positive development to be observed nonetheless.

Oil Price Tizzy

Crude futures tapped a record $80 a bl. today. Traders
blew off reports that OPEC intended to boost production
by 500K bd., preferring to focus on reports of tighter
crude inventories in the US and the rapid development of
a tropical storm just south of Galveston, TX and west of
major offshore producing fields. Storm warnings went up
from Houston east to Lake Charles, LA.

This is a strong contra-seasonal move for the oil price.
It also brings oil into clear overbought territory, as
it has a high weekly RSI and is now trading well above
its 40 wk. moving average.

Interesting moment. Traders are pushing oil higher as we
near the eve of the FOMC's forthcoming meeting on interest
rate policy set for the 18th. The Street and many leading
economists are busy steamrolling the Fed into cutting rates,
and now the price of crude remains on a role and hits new
highs.

Let's see how the traders handle a strongly gathering
overbought on crude with this interesting mix of variables.

Economy & Stock Market

My leading economic indicator composite fell sharply in
August after rising significantly over the first seven
months of the year. It signals possibly sharp moderation
of growth in the months ahead. There are no recession
warnings yet.

The BLS household survey of civilian employment, the
broadest and most current measure of jobs, shows no growth
of employment in the US for the year to date. Measured
yr/yr, civilian employment growth has decelerated from 2.0%
early in 2007 to 0.8% through August. Real wages are up
about 1.5% yr/yr through August. The combination of real
wage and jobs growth is 2.3%. This is a modest but not yet
perilous level. It does contrast sharply with the comparable
3.9% level seen early in the year, and is moving in the wrong
direction from a growth perspective. The subdued jobs data
seems out of synch with a rising level of corporate profits,
and I am not confident I fully understand it.

Headlines notwithstanding, the US banking system seems to be
functioning normally. C&I loans continue to trend up and
the real estate book has even inched up a little recently.
Part of the rise in C&I loans is however likely attributable
to deals stuck in the pipeline.

The change in inventory levels, which was strongly positive over
the second half of 2006, has been quite trim over the first half
of this year, a favorable development.

The economy is not on thin ice yet. The problem of course is that
thin ice comes along quickly, especially when liquidity flattens
out the way it did in August. As Mr. Bernanke recently said,
uncertainty is deeper in the short run.

The stock market seems almost haplessly unstable as investors and
traders try to handicap the economic outlook. The US economy is
the largest, and it is deeply diversified and stable. It is now
under stress from sizable pockets of disorder in the financial
markets. It would be nice to say something more positive than
"keep an eagle eye on it", but sometimes you have to suck it up
and go along until matters clear a little.

Inflation Issues

Inflation indicators have been volatile this year, reflecting
wide swings in the price of crude oil and gasoline. Both oil
and gasoline have been ticking up recently, partly for
seasonal reasons and partly in view of speculation concerning
hurricane activity.

Strong upswings in both gasoline and oil from 01/07 well into
the spring pushed up the inflation rate sharply. Real wages
declined over the first half of the year as a result, and this
development has undercut the near term economic outlook. That
fast surge of inflation no doubt influenced the Federal Reserve
to maintain inflation pressure as its primary target
through July. The Fed is concerned not only that inflation
will raise the cost of capital, but that real household income
can be threatened as well, since wage rates change far more
slowly than does inflation that is heavily influenced by
volatile commodities prices.

Now as autumn approaches, oil and petrol prices are expected to
ease as driving conditions fall off the seasonal peaks in the
northern hemisphere. Shorter term inflation pressures may subside.
On balance, the longer term inflation indicator, although rising,
is still in benign territory.

Traditional bedrock indicators of monetary policy certainly do
not yet support a cut in the Fed Funds Rate, but if the Fed
remains concerned about financial market liquidity and its effect
on the economy, there is a "window" of seasonal weakness ahead
in key petroleum price composites that might offer "cover", as
headline inflation could remain modest. Naturally, the Fed also
knows that strong upward pressures on the petroleum complex
can develope over the first half of the new year reflecting
continuing demand for heating oil and the start of accelerated
gasoline production. the Fed must also contend with commodities
speculation, should the FOMC vote for rate cuts. The pit bulls
could well reason that monetary stimulus would eventually lead
to a stronger economy and higher demand for a variety of crude
materials.

There are a couple of other points worth remembering. Modest
inflation through year's end will lead to faster real household
income growth, providing the economy remains stable. Also, note
that the Fed has a little "breathing room" on the FFR at 5.25%.
With inflation running at 2.5% measured yr/yr, the Fed could
take the FFR% down to 4.75% and still leave savers with some
protection.

Don't Be No Hero

New Yorkers of a certain age will recognize the expression
above. Translated into ordinary English it means "Do not
take unnecessary chances".

The stock market has turned up for the short run, but there
is precious little to confirm the upturn. Moreover, although
Friday was a strong up day, the market failed to take out
short term resistance set the prior Friday, after having
it clearly in its grasp. For some traders, the weakness
before the close was a sell signal.

The ambivalence seen in the market reflects a wider sense of
uncertainty. Investors do not know whether they have seen all
of the fallout from the subprime mortgage fiasco, nor are
they so confident that the economy and corporate profits will
escape this financial debacle relatively unscathed. In his
speech yesterday to economist conferees in Jackson Hole, WY
Fed Chair Bernanke cautioned that only the "timeliest"
incoming economic data warrants strong attention and further
stated "the uncertainty surrounding the outlook will be
greater than normal, presenting a challenge to policymakers
to manage the risks to their growth and price stability
objectives." That statement made clear that the Fed would
take steps to ease policy quickly if the economy seems to be
faltering or on the verge of doing so.

So, let's see what the freshest data tells us over the next
week or two...