Stock Market

Back on 11/18, I posted that the stock market was deeply
oversold and that a rally might not be far off in time. Well,
in the interim, the market got even more oversold, and with
better news over the past 2 days, it rallied powerfully, to
the point of leaving only a slight short term oversold in its
wake. Hard to say how it will do in the days straight ahead
after a 4% 2 day pop, but there has been a positive break in
my shorter term momentum trend, and that's an attention getter.
So is the prospect for a positive turn in MACD (12/26/9 day).

At this point, I continue to see enough economic uncertainty
out there to feel a degree of comfort in plunking the SP500 into
a rough 1400 - 1550 trading range until matters sort out
further.

For the daily SP500, click.

Bond Markets

The long Treasury closed under 4.3% today. This market is
now getting seriously overbought. The Marketvane index of
bullish advisories on Treasuries has reached 77% and is
trending up. As a contrarian reading, 77% bulls is signaling
an eventual rebound in yields (and lower prices).

The strong rally in Treasuries since this summer reflects
prospects for a slowing economy and a strong flight to quality
from riskier assets, especially CDOs of varied stripes. But
yield spreads between top quality and medium quality corporates
are widening, and the high yield market is now once again the
junk market, with yields here jumping from under 8.0% a few
months back to 10.8% presently.

One indicator I watch closely is the industrial commodities price
composite. Broad measures of industrial commodities prices have
leveled off in recent months, a normally bullish development for
bond prices.

I had a nice trade earlier in the year when long Treasuries were
oversold, and now I am looking carefully at a short on the Treasury
price. I am also getting intrigued by the junk universe, which
is deeply oversold. Yields above 10% are attractive for risk capital
since you have a shot at a 10%+ annual return for the risk taken.
So maybe there is nice long / short trade coming up. (I rarely hold
positions in bond trades past 2-3 months.)

I regard Treasuries as fundamentally unattractive for investment.
Investors are not being adequately compensated for inflation and
interest rate risk, nor are they being compensated for the vagaries
of the offering calendar in the years ahead. Flip the coin and you
could make a good argument for offering long Treasuries to the
market to lock in these yields.

For the long Treasury price ($USB), click.

Holiday Season Sales

As all know, sales for the holiday season are avidly watched
by many. Business and investment people enjoy debating the
prospects for the season when it comes to hand, and this time
will be no different, especially since the Fed's FOMC is to
meet on monetary policy on 12/11.

The fundamentals are far more somber this year than last.
Yr/yr, employment is up only 0.5% and the real wage is up by
only 0.5% as well. That yields a base case for a 1.0% gain
in sales before inflation and maybe 4.0% in current $ terms.
But beyond that, it is hard to say how consumers will do at
the register. From my perspective, much depends upon whether
there's an interesting cross-section of newer stuff to buy and
also the weather will play an important role. A good cold snap
with some snow around the US can do wonders at the malls as
folks stock up on easy stuff -- hats, gloves, boots, coats etc.
Another interesting issue is how tough it is to stick to
a modest budget. That requires shoppers have a plan and that
they carry it through with ruthless precision. If you head out
to shop with a vague idea of cutting back, you may find yourself
in trouble when Christmas Eve comes, and the same old large
pile of goodies is under the tree. Debate the outlook if you
wish, but do not fail to miss the magic of the season, for
magic it is.

Short Term Rates & US Dollar

Short Rates

My 3 mo. T-bill yield indicator spans more than 90 years
of data. It is a diagnostic tool and not a forecasting
model. Based on recent inflation readings, the T-bill
should be trading in a range of 5.10 - 5.50%. The bill
is now around 3.50%. Part of the discount to the model's
value reflects the recent 75 bp. of cuts to the FFR%, but
most of it reflects investor flight to quality. Some
players are anticipating further FFR% rate cuts as the
economy slows, and some have moved into bills and notes
hurriedly as they dump or reduce positions in higher
risk assets.

A 3.50% T-bill yield is not attractive at all to the
average investor and saver. With inflation at 3.5% on a
yr/yr basis, the after tax return is negative and savings
are being confiscated. For higher net worth savers, 6
month CDs at 5.10% are even a bit below breakeven.

Holding taxes aside, the real or inflation adjusted rate
on the bill has fallen from a cyclical high of 3.8% down
to zero since late 2005. Retirement funds have been put
under increasing pressure to increase risk levels to
maintain beneficiary purchasing power.

My longer run measure of inflation has been running about
3.1% this year. On this measure, short rates and shorter
duration T-notes are just too low and unless inflation
pressures ease, savers are going to continue to take it
on the chin. With the economy slowing, consumers may
be pushed to increase savings anyway, especially with a
soft housing market.

US Dollar

The rapid decline in the real rate of interest since late
2005 has greatly reduced the appeal of holding dollars for
US householders and businesses. That alone is a good
reason for foreigners to avoid dollars in preference for
stronger currencies. The cost of doing business in and
with the US for Asian mercantilists like China is rising
sharply as US rates and the dollar decline. The weak dollar
is sharply increasing US competitiveness abroad and is
producing large currency translation gains for US multi-
nationals. Even smaller US companies are getting into the
act.

I genuinely like the fact that US exporters are doing very
well, and if it takes a low dollar for a goodly time to
put our exports out there successfully, fine. However,
The Fed owes savers as well and must move as quickly as is
prudent to restore short rate equilibrium for savers.

Stock Market

The market oversold has deepened. The SP500 remains at a
nice discount to its 25 day m/a, and my six week selling
pressure and buying pressure gauges are in deep oversold
territory. So, a tradable rally may not be far off. I would
also note that there are two distinct 20 week cycles and
one nine monther that point to lows within the next 30 days.

That's the good news. The bad news is that the SP500 Market
Tracker is coming down fast reflecting both earnings estimate
cuts and pressure on the p/e multiple from accelerating
inflation. The Tracker is undergoing its sharpest decline
since early 2001, falling from a July 'fair value" estimate
high of 1610 to just slightly below 1500. Analysts are cutting
Q4 '07 estimates and are just starting to trim Q1 '08 numbers
as well. The weekly leading economic indicators have stopped
falling however, but are flattish and suggest slow or "drag
ass" growth. The inflation thrust indicator remains in a
substantial uptrend, pushed hard by the oil price and, more
lately, a recovery in the retail gasoline price. The momentum
of inflation thrust has slowed a little bit over the past ten
days. You have to respect all of this, but not get carried
away with it as there are at least short term indications the
economy is stabilizing. There is no end of print about the
problems of the financials, but the banking sector is
functioning -- loans are ticking up and funding is not unduly
constrained. Loan losses are rising, but cash flow for this
sector has mushroomed to $150 billion annually in recent years.

Visibility to sustain the cyclical bull market is low now, but
my indicators do not yet suggest throwing in the towel.

I plan to give discussion of the stock market a rest for a couple
of weeks and look at some other topics. I include a link to the
weekly SP500 chart.

Quick Note On The Short, Short Term

As discussed on Sunday, we entered the week with a deep
short term oversold. As expected, traders jumped on it and
rallied the market strongly yesterday, right up to short
term downtrend lines. The market failed to break through
today and ended on a weak note. There is still a moderate
oversold in place, and players may have to watch the oil
price carefully because the strong bounce in oil today
following a steep, fast sell off, did not sit well with
the stock market in my view.

Stock Market Comments

The recent weakness in the market has brought it into a
deep short term oversold condition at about 4.5% below
the 25 day m/a. Oversolds at this level have proven very
attractive to aggressive traders in recent years. In turn,
my six week selling pressure gauge is heading into oversold
territory which is another positive.

Intermediate and longer run measures have turned negative.
Breaks of trend on market and breadth measures, weakening
momentum against the 40 wk m/a and a downturn in the 14 wk.
stochastic all signal caution. There have been no breaks
in any of these measures so decisive that a whipsaw move
in the market to the upside can be readily precluded.

Speaking more broadly, the volatility in the market since
mid-July suggests that players are re-appraising fundamentals
that guided the market sharply higher from mid-2006. Signs
of a slower economy, earnings estimate cuts and re-ignition
of inflation pressure have forced the re-appraisal.

The suggestion to me is that any forthcoming rally may be
more subdued and of shorter duration than we have seen in
recent months.

Stock Market Comments

My SP500 Market Tracker is weakening. It is now signaling
fair value at 1570, down from a range of 1600 - 1625 several
weeks back. Analysts are cutting earnings through 2008, and
with a fast rising retail gasoline price, headline inflation
is likely accelerating. The result is a lower market P/E on
lower earnings.

The subprime mortgage reset volume is peaking now, and that
assures more defaults and foreclosures going forward. One
difficulty here in trying to restructure these loans is that
law rquires you deal directly with the lender -- tough to do
with sliced and diced collateralized obligations. the larger
problem is that most of the delinquencies involve inadequate
collateral and fraud as to opposed macro-conditions. Not much to
work with even for sympathetic lenders. Net of foreclosure $
and tax writeoffs, I am thinking the total tab will be $145
billion. That figure could equal 10% of total underwriter
capital. The regulators will need to allow recognition of
these losses to be gradual or even amortizable so as not to
impair primary capital. A tough but not unmanagable situation.
The banking industry throws off about $150 billion a year in
gross cash flow.

So, there are more financial sector losses to come. On top,
leading economic indicators do not yet signal a recession but
are in a downtrend. Global indicators are still solid, but are
trending down as well. My inflation thrust indicator is moving
up sharply from a steep low set early in the year and is being
paced by the oil price, up 92% from the Jan. '07 low.

The Fed has so far taken 75 bps off the FFR%, and there are clear
signs that system liquidity is repairing. I'd advise the Fed to
maintain a stable policy course for the next few months to better
sort out economic and inflation potential and to glean how the
financial sector is coping with the mess it created.

The financial system is repairing and the problems, although
very large, are managable with deft regulatory handling. Also,
a little time is needed to take the measure of the oil price.
Yep, supplies are tight, but the action suggests a full scale
blow-off may be well underway.

Bottom line? Patience is needed here. I am not uncomfortable
with the idea that fundamental direction may remain elusive for
another four weeks or even longer.

Treasury Bonds -- Heads Up

I am strictly a contrarian when it comes to trading bonds.
I get very interested in bonds when the long Treasury yield
has drifted far from its 40 wk M/A and / or when trader
advisory sentiment moves to extremes. The Long T is a little
overbought relative to its M/A, but advisory sentiment,
specifically Marketvane, is moving into territory that is
starting to signal excess bullishness. In recent weeks, the
Marketvane compilation of sentiment has kissed 70% bullish
once or twice and most recently stood at 69%. These are the
highest bull readings since mid-2005. Bullish sentiment is
not yet flat out extreme, but the 70% area signals to me
I should starting to think about shorting the bond.

Quick Notes

1. Leading economic indicator set weakened slightly more
in Oct., but growth indication still posiitive, albeit
slow.

2. Yr/yr growth of employment through Oct. was a slim 0.5%.
Wage growth was 3.8%. Underlying consumer purchasing power
continues to erode.

3. Heating oil has broken out to the upside and on deck is the
wholesale price of gasoline, set to break out
above the 2.35 - 2.40 per gal. area. Retail gasoline price
continues to inch up, but now has potential to run up to the
$3.25 area again.

4. Support for SP500 has firmed at 1500. Let's see how they take it
out today.

The Fed "Zinger"

This past Monday, I opined that should the Fed choose to
blow off the speculators in the markets by standing pat
on Halloween, it would cause a ruckus. Well, the Fed did
cut the FFR and discount rates by 25 bp, but in its
statement it cited economic growth and inflation risk as
of equal concern, hoping folks would infer that it was
going to stand pat on rates going forward.

The message did not sink in right away, but today it did,
and with news of economic slowing and concerns about
Citibank's dividend in hand, market players took stocks
to the woodshed.

Since mid-August when the Fed addressed the fallout from the
subprime debacle more earnestly, oil prices have rocketed as
all know, and industrial commodity prices have surged at a
25% annualized rate. Inflation potential has been growing
quickly. The Fed's gambit here is to posture tough enough to
crack oil and materials prices in hopes of taking steam out
of the inflation thrust underway. The Fed knows that an
inflation surge domestically will punish consumer real incomes
and confidence down the road and damage the economy. So, they
hope to scare the commodities markets and the US dollar shorts
in the interim. The Fed knows only too well that capacity is
constrained in oil and industrials, but they also know there
is plenty of speculative interest as well.

Many market players appear to have all but dismissed inflation
in favor of tracking economic potential. Let's give it a week
or two to see if they can connect the dots, and whether an
apparently firmer stance by the Fed will shake out some of
the commodities speculators.