Stocks, Inflation & Liquidity

With the latest inflation readings, the fair value estimate
for the SP500 Market Tracker has been reduced from a range
of 1600 - 1625 to 1575 - 1600 to reflect downward pressure
on the p/e multiple from an acceleration of inflation.
Looking forward, the p/e may be downshifted further, as this
year's surge in the oil price works its way through to the
retail level. The oil price has moved well above parameters
long seasoned traders would be comfortable with, but
speculative interest has been bubbly in recent weeks.

The broad measure of liquidity I favor has been flat since
May, '07, due entirely to the sizable contraction of the
market for financial org. commercial paper. Measured yr/yr,
broad liquidity has dropped from the 9+% level to just 6.3%
through Sep. In turn, the yr/yr % change in the $ cost of US
production has inched up to 4.8%(also through Sep.) Thus,
excess liquidity in the system has dropped from over 5% earlier
in the year to just 1.5%. Much of the rally in stocks since
mid-August then likely reflects the put back of cash raised
during the immediately preceding sell-off. The liquidity
tailwind for the capital markets has thus moderated in
dramatic fashion.

My longer term inflation indicator has turned sharply upward.
Sustainability of trend remains a question as the indicator
is being powered by the oil price which is heavily overbought
and which could turn volatile at any time.