At Least It Closed Off The Lows...

Back in the turbulent 1970s when I commuted to and fro from
Wall St., I would catch the 5:39 home from Grand Central. I
would frequently stop in the bar car for a smoke and a Dewars
on-the-rocks. The bar car would be raucous after another of
the many down days for the stock market, and the joke was to
have one of the many brokers hop aboard and proclaim "At least
it closed off the lows!"

At last week's close, both bulls and bears seemed fatigued. I
was looking for a quiet week ahead. Instead we got a strong
rally up to important resistance, a day of top action, and then
a sharp sell off that broke the suspiciously mild uptrend
underway since the Jan. '08 low. What can one say but that it
was a typical bear market action. The field is open for the
bears in the week ahead. We'll see what they can muster.

A word about sentiment. My e-in box is cluttered with sentiment
charts showing there are many more bears than bulls. The
contrarian implication is that a buy point is near. But I
remember talking with fabled technician Joe Granville years ago
and Joe reiterated a favorite of his: "In a bear market, the
bears are right." That stuck with me over the years. I have always
taken it to mean that heavy bearish sentiment will ultimately
point to a rally, but that a hefty, tradable rally need not come
right as the bears get heavily bearish. It can take a couple of
months.

With obvious increased inflation pressure, my SP 500 Tracker has
dropped to 1300 fair value.

I am hoping for a more solid bottom for this market at some point
over the March - April interval. I think we are going to need
some help from a cool off in the mania for commodities to get it.

Inflation

The inflation thrust indicator is spiking to one of its
highest levels in over 25 years. This is consistent with a
continuation of inflation above 4% measured yr/yr. The
broader measures of inflation such as the CPI remain
highly sensitive to the indicator, signaling that commodities
continue to drive inflation. Non-commodity measures of retail
inflation have yet to incorporate costs and expectations that
are evident when retail inflation is more mature and less
sensitive to shorter term pressures in commodities prices.
The pass through of commodity price momentum has been moderate
so far. All of this is consistent with the early stage
development of deeper and more persistent inflation.

The Fed has been easing the FFR% aggressively despite the
upward pressure on commodities because it believes that a
deeper and more pervasive inflation psychology has yet to start
to blossom. The Fed has also so far opted not to provide the
monetary liquidity needed to support a materially stronger
economy. This is a "thread the needle" policy. The Fed cuts
rates in a weak short term credit environment but does not
liquify, thereby gambling that the commodities markets will
give way to deteriorating economic momentum before a broader
and more serious economic downturn develops. Old Fed hands
would be impressed with the cleverness of the scheme but would
also caution that it could well be folly to try such fancy
fine tuning.

So far the Fed's gambit has not worked, and without development
of a commodities downturn / correction real soon, the Fed could
face a more daunting time and get itself into hot water
politically.

Gold Price ($941 0z.)

My macroeconomic indicator supports an uptrend in the gold
price, primarily reflecting the powerful run up in the oil
price over the last 13 months. The strong price action in
the grain and edible oil pits is a supplemental plus.

The gold price was weak today as the US Treasury put its
support behind the IMF plan to sell 400 tons of gold this
April to raise capital. There have been some hints Congress
might go along with the proposal this time.

The gold price is at a critical juncture. There is a mania
developing, and I see gold just at the point where the action
could become increasingly raucous and more volatile if the
sharp uptrend continues. I think the same can be said for the
oil price, where speculative interest remains quite vibrant.

I have linked to a gold price chart below. Note that although
the MACD trend remains positive, it is very elevated. That
sort of MACD pattern signifies increasing downside price risk
as the price moves ahead.

Here is the link to the chart.

Stock Market -- Short Technical Note

The price triangles that show up on the charts of most of
the market composites were not decisively eradicated this
week as I thought they might be. The bears are tired and so
are the bulls. Now since the triangles are running out of
real estate on the charts, some directional would seem finally
at hand. Most discussions revolve around a positive breakout
vs. a breakdown (The breakdown argument looked to be set to
carry the day until Friday's last 30 minutes of trade, when
bigger players bid on baskets and creamed the shorts). The
other possibility is that the market simply remains in a
frustrating period of price compression that drags on. Folks
are so used to wrenching volatility that such an eventuality
seems remote to most. But, it could happen, and confirm the
old adage about the market following the path of maximal
frustration in the short run. We shall all see soon enough.

Stock Market -- Fundamental

My SP500 Market Tracker has dropped from the 1340-1350 area
down to 1325. This is entirely a reflection of the acceleration
of inflation, which now stands at 4.3% yr/yr. Short term
earnings expectations have steadied, and the consensus forecast
for '08 SP500 eps has been raised ever so slightly. That tiny bump
is the first positive one following months of cuts.

Economic data for January show a flattish economy and do not
confirm a recession is underway. The weekly leading economic
indicators have shown more stability as well. However, since the
indicators have fallen hard enough since last July to be
consistent with the development of a recession, the jury is still
out.

Last year's financial crisis blew a $600 billion hole in liquidity.
The yr/yr change in credit driven liquidity has dropped sharply to
5.2%. This compares to a yr/yr change of 6.7% for the $ cost of
production, which has been strongly influenced by a higher inflation
rate. Net, net, the real economy is draining liquidity via higher
inflation, leaving the capital markets primarily dependent on
portfolio and money fund cash for support.

At the current 1360 level, the SP500 is treading water relative to
recent earnings and inflation readings.

Commodities And..........

Trade in broad swaths of the commodities markets this week
is extending recent gains. Raw industrials have also re-
joined the party. As many an old hand in these markets can
tell you, trader discipline is starting to break down as
the folks chase after rising prices. Broad composites such
as the CRB were cheap in relative terms for many years
following the bust in the 1980s. Now, these composites are
getting expensive on a relative basis although they are not
yet at extremes. It is clear that the strong industrial
economies of Asia are playing a major role in fostering the
boom, but it is equally clear that there is a horde of
speculators on board as well.

Commodities booms carry the seeds of their own destruction,
not just because they coax out more supply, but because central
banks are eventually forced to contract liquidity to stem the
inevitable inflation surge. In full, such enforcement actions
have been tepid so far, leaving the field still open.

As discussed previously, in larger, more stable economies where
wage rates are more settled, a commodities driven acceleration of
inflation punishes real incomes and can result in deteriorating
economic growth. This corrective process is not fast moving,
but should not be ignored.

The yields on longer dated Treasuries are ratcheting up now as
markets adjust to faster inflation. The increased inflation
pressure also tends to suppress the market's p/e multiple even
as commodities producers may experience outsized earnings gains.

The global economy is slowing, and some economies such as China's
where inflation has topped 7%, may have to tighten more aggressively
at some point.

For now, There is not a strong fundamental case to say the broad
commodities market is headed for a fall. There may be seasonal
weakness in the spring, and there may also be greater volatility
reflecting the risks of inventory hoarding. The main factor to
watch short term may well be trader sentiment, especially given
the growing intensity of speculative activity, and the fact that
many of the sub-sectors are very overbought.

Strange Stuff, Sentiment

I have listened to the bearish and the downcast in the
final stages of major negative market/episodes such as 1974
and 1982. That's when the depression and collapse talk rises
to a feverish din. Perhaps it is all the negative vibe on the
web, but the fear stories are bordering on hysteria now, even
though the bottom has yet to fall out of the economy. Strange
stuff indeed. As all know, the economic situation has been
deteriorating here in the US, and uncertainty shrouds the
outlook. Yet sentiment seems either over the top negative or
grossly cynical. Not what you would expect until after the
spit has hit the fan big time. I am hoping that the black
cloud blows over during the next six weeks, since it would be
unfortunate if folks stampeded when it is not clear they should.

Comments on Commodities & The Stock Market

COMMODITIES

Difficult inflation periods are invariably initiated by surges
in commodities prices for such elementals as fuels, raw materials
and basic foodstuffs such as cereals and oils. Today, the CRB
commodities index made a new high near 385 on strength in
fuels and agriculturals. Commodities are up over 20% yr/yr,
and this continuing rise has fostered an acceleration of US
inflation as well as boosts in the price level for a number of
other economies. With US wages rising more slowly than the
general price level, take home pay is falling in real terms --
a clear recession threat.

The slowing of global economic activity has led to a mild
contraction of industrial materials prices since this past autumn
but the more general range of basic prices has continued to
surge. I have included a chart of the CRB. Have a look.

From a traders perspective, this is a bullish chart, but it shows
a powerful overbought on price momentum and relative to the
40 wk M/A. Now some seasonal weakness can be expected by spring,
but this index needs to lose substantial momentum if slower growing
economies like the US are to have a shot at a growth pick-up this
year and next.

STOCK MARKET

Today was a little wicked. It was set up yesterday when the broad
market could not break through the downtrend line in place since
12/07. In typical bear fashion, players came in to sell the rally of
recent days. There is still money on the table, so the directional
test I wrote about on Tuesday has not been resolved yet.

Notes On Liquidity & The Stock Market

Liquidity

As the Fed expands its TAF, the FOMC dumps Treasuries and
cuts REPOs. The net result is negligible growth in basic
monetary liquidity measures such as Fed Bank Credit and the
Adjusted Monetary Base. The broader measure of credit driven
liquidity (in which I include commercial paper) did expand
a bit more quickly in January. However, both monetary
and the broader measure of liquidity are not growing fast
enough to sustain economic expansion. Thus the Fed continues
to run a high risk policy regarding prospects for the real
economy.

Stock Market

For the SP500, there is shorter term trend resistance in the
1360 - 1370 area. Earlier in the day, as the market pushed over
1360, the sellers came in, driving the "500" back down near
yesterday's 1339 close. But, with a late afternoon rally, the
market managed to close up decently on the day, thus setting
up a prospective directional test for the final days of this week.

Uh Oh -- Liquid Gold (Alkylate)

The longer term trend has the retail price of gasoline in
the US going to $3.50 a gallon at some point in 2008. Some
industry experts speculate that such will happen this spring
during the seasonal bump in gasoline prices and reflecting the
need to add a costly additive called alkylate. The conversion from
MTBE to alkylate for summer driving was ordered in 2005, and
observers argue that the sharp spring spikes in the gasoline
price over the past three years relect the new additive which
spot trades 15 - 20% above gasoline. Refiners have added capacity
to crack out alkylate, but the spot market remains fairly large.

Industry gurus often are not any better than most in forecasting
fuels prices, so there's hardly any assurance this story will
hold up. But it is worth noting nonetheless, as another gasoline
price spike would be most unwelcome in an economy already being
suppressed by the rapid run-ups in petrol products over the past
year.

Stock Market & The Valley

The old adage is: "The market never looks across the valley."
The bear market underway is in the process of trying to
assess how deep the economic valley will be and also how wide.
Meanwhile, I am experiencing personal alarm bells. First, I
am spending a much larger than normal amount of time trying
to break down the uncertainty in the outlook. Secondly, I am
pushing numbers and find myself gilding the lillies, another
bad sign. All of this tells me that if I catch the bottom, it
will be a miraculous event.

My leading economic indicators have pitched downward, signaling
a downturn in the near term. My inflation thrust indicator is
still accelerating on a yr/yr basis. Liquidity measures are
tight. longer term economic indicators are improving but still
have a negative bias. My SP500 Market Tracker still stands at
1340 - 1360 fair value and implies that The Market's earnings
expectations for 2008 are quite subdued and that a quick and
positive turnaround in earnings is not expected now.

The monster oversold I discussed through much of January was
largely eradicated by last week's bumptious rally. This week's
downdraft is a bear market move -- sell the rally -- and it
leaves the market heading into moderate oversold territory.

Could the market slip down to the 1260 - 1270 low test zone
for a temperature check? Sure could. In the meantime, since I
remain comfortable that the market's fate may not clarify until
the end of March, I am going to try and not be too fidgety.

Economic & Profits Indicators

The broad economy has flattened out over the past 3-4
months as measured by consumer spending, production,
employment and real wages. Inventories have been tightly
managed, but even so, the US is vulnerable to a downturn.
Housing development activity remains in a steep downtrend
and starts are likely to drop below the 1 mill. mark on
an annual rate basis -- typical for a housing recession.
As I have discussed, inflation has sapped consumer spending
power and since companies have been too tightfisted in
adjusting pay levels, recovery of purchasing power likely
awaits an easing of inflation pressure. Individual company
managements may be prideful of maintaining wage discipline, but
collectively, the discipline is working to bring down the
economy.

Federal Reserve Bank Credit and the broader measure of credit
driven liquidity are not growing fast enough to support
sustainable growth. Fast falling short rates is a positive
for the future as is the recent weakening of the oil price. On
balance, however, the Fed is running a risky policy short term
when it comes to growth, and if the economy falls into a downturn
in this a national election year, there will be all hell to pay
at the Fed.

The proposed minimal $150 billion stimulus program to provide
rebates to household taxpayers is essentially a fuels subsidy, but
it will help folks with their budgets.

Profits, excluding the financial sector, are coming in better than
expected. The average US commercial or industrial enterprise is
struggling to maintain margins in a slow environment, but tech
companies have had a very strong year and oil producers are
experiencing dramatically higher crude lifting margins. Financials
are in the red collectively. Earnings for nonfinancials from
overseas operations remain fairly strong. Looking ahead, the first
half of '08 will reflect the weaker US economy and slower growth
abroad.