Stock Market -- Short Term Technical

The broad market has entered a period of price compression, and
it is neither overbought or oversold. I find it very difficult to get
any sort of edge in a market like this and almost always allow the
compression period to resolve before taking a trade. Ahead in
September we have a period of seasonal weakness to traverse,
and that is likely keeping some money on the sidelines. From
my perspective, it is still an up market based on its position
relative to the 10 and 25 day m/a's. Obviously though, there
is clear short term overhead resistance, so the powder shall
remain dry.

The daily SP 500 chart is here.

US Economic Outlook

First off, I think it is going to take a year or so to straighten out the
statistical mess building in the GDP accounts. Measured yr / yr,
the GDP price inflator advanced a paltry 1.9% through Q2 '08.
That compares to a 5.6% advance for the CPI. The use of the
modest deflator enables the BEA to show real growth over the
past year, which is unlikely with the CPI over 5%. So, at some
point, the Gov. will have to come cleaner on the data. This all
might await the departure of GWB and his crew.

So, we have a weak economy with housing development and
retail sales -- durables particularly -- the main culprits. Total
Gov. spending has been a slight positive offset. A bigger plus has
been good inventory management, with retail running an especially
tight ship. The biggest offset to a weak consumption / housing
picture has been the strong performance of export sales, which
has helped keep production and employment levels from falling
more sharply.

The shorter term lead indicators remain in firm, strong downtrends.
The longer term indicators have turned progressively more positive.
We have lower short rates, a positively sloped yield curve, a sharp
downward break in fuels prices and a Fed that is moving to add
monetary liquidity to the system, however gingerly. The longer lead
indicators are mediocre when it comes to timing, but my guess is
that a return to sustainable 3% real growth could be a good year out
in time. If commodities prices were to fall significantly further, this
would likely allow the Fed to speed up reliquifying the economy, and
would shorten the time frame for recovery worth the name.

The economy is deriving some benefit currently from the tax rebates.
The bulk of this program will have passed before very long, leaving
some vulnerability in its wake. In addition, with global growth
decelerating, the US export book will eventually reflect the global
trend.

The two vital elements I see are inflation and Federal Reserve
flexibility. The surge of inflation over the past year has punished the
economy. Wage growth has actually been slowing, so real take home
pay has been hit hard. A slow global economy needs to work to
suppress the commodities speculation party to relieve inflation
pressure on wages and profit margins. A hefty deceleration of the
inflation rate would allow for a recovery of real purchasing power, and
would further allow the Fed to operate more freely to open the spigot
further.

I would have to say that the earnings estimates I see for late 2008
running through 2009 do look too high at present. But I suspect that
the big players in the stock market are making some allowance for
that.

I rarely us the GDP accounts for macro analysis because of the wide
lattitude the White House uses in playing around with the price
deflators. These accounts can be helpful in looking over sector
comparative performance. I prefer the Fed's production series and
a host of monthly series, especially those that are privately sourced.

Ok. Enough of the big picture. Back to the grind for a spell.

Stock Market -- Fundamentals

The liquidity cycle is edging a little more positive for stocks in that
inflation may have peaked for a spell. However, the growth of
monetary liquidity, which the Fed controls, is improving too slowly
to underwrite a new cyclical advance for stocks. As well, credit
quality spreads remain wide across the yield spectrum, indicating
low confidence in the US economy's prospects. Confidence readings
of this sort differ from measures of market sentiment in that the
former reflect the attitudes of people playing with real money while
the latter indicate opinion. When confidence in the riskier segments
of the capital markets is low, you are betting heavily against the
weight of the tape when you maintain sizable exposures. Better to
have some more risk takers out there with you.

The SP 500 is trading near 1270 as I write this. My SP 500 Market
Tracker hit a low 0f 1050 in July and is now around 1100 reflecting
the deceleration of inflation pressure underway. So, the market is
continuing to trade well above the Tracker as it has done in recent
months. Players continue to discount an earnings rebound to
start as 2008 wears down, and are also looking for the inflation rate
to moderate significantly.

The market has a 15.5% premium to the Tracker. The value of the
Tracker may well rise more in the months ahead if the inflation
readings turn more subdued, but fundamental risk will remain
elevated in the absence of a stronger liquidity push by the Fed
and some improvement in the very low level of investor
confidence. I harp on the issue of money liquidity because a
strong positive turn in growth is very important to an eventual
rebound of earnings.

Election 2008 -- 1

This year the national conventions are coming up back to back.
After these shows close, the candidates will be on the road to
sell their programs to the voters. Give 'em a week or so after
that, and the campaign will be back down in the gutter with new
and even uglier messaging. So the convention weeks offer a
brief period to glean what each party officially has in mind.
These stories often have some rationale behind them as well
and give the public a sense of what priorities are and what the
candidates are for. It does not mean you can take any of it to
the bank, but these moments can be helpful. Once we are past
the conventions and the program roll outs, it will be back to the
food fight. The GOP convention may be the less informative
since Sen. McCain may well plan to stab the rightie faithful
square between the shoulder blades should he get elected. He
has an option on his current Faustian bargain.

Inflation To Ease

By now, all know that the CPI for the US reached a multi year
peak of 5.6% measured yr /yr through July. As a result, take home
pay in real terms was slashed, profit margins contracted and all
of the incremental liquidity in the financial system was sucked up
by a rising price level. All this did come to pass from hefty
speculation in commodities even as global growth momentum was
declining.

As discussed, my inflation thrust indicator surged sharply starting
in early 2007. Commodities prices, particularly fuels, did the trick.
Other components, such as capacity and labor utilization rates,
ticked down over the interval. The thrust indicator is now coming
down reflecting the negative reversal in the broad commodities
market. Even so, there will be drag effects. Commodites will have
to weaken further in the months ahead just to get the twelve month
CPI back a little below 4.5% by year end '08.

Looking back over the past twenty odd years, there have been five
surges in the thrust indicator, with the last one being the swiftest and
the steepest. After each surge, the indicator has dropped steeply,
and the CPI has followed suit, with the yr / yr CPI % falling by 50%
on average. If the historical behavoir pattern holds, we could look to
a twelve month CPI of 2.8% out there in 2009 at some point. There
is no doubt that at the peak in 2007, global operating rates hit very
high levels. But the speculative run in commodities was so strong,
that a blow out could occur which would take these price indices
down sharply further as weaker demand and modest capacity growth
bring supply and demand into better balance across much of the
spectrum. History does favor the rapid downward adjustment once
demand growth gives out.

Be Careful This Week...

As detailed in the 8/15 piece "Be Careful Next Week", we have
seen changes in the momentum or direction of markets of
interest. As expected, the US dollar has backed off from key
resistance at 78, oil is trying to bounce and gold is as well.
I also pointed out the vulnerability of the stock market, which
failed to take out minor resistance last week and which broke
down today in a minor way. Of all these trades, I am most
interested in the US$ at this point. The dollar experienced a near
vertical liftoff in recent weeks and needs to find a trend.

I owe some more substantive posts, but have been sneaking out
with grandson for some fishing and swimming. I should be back
on track soon.

Be Careful Next Week...

The price of oil is getting sticky a bit above support at $110 and
is short term oversold. The $USD is set to test important
resistance at 78 on the index. Gold is hovering above major
trend support at $770. The SP 500 is mildy overbought short
term but should have taken out minor resistance this week.
All of this says to me that players are set to have a look around
to see what others are up to. Traders know that the USD is
overbought short term and want to see if it will back and fill
a little. They also want to see how well the oil market holds up.
The failure of the SP 500 to take out minor resistance this week
is a sell signal to some traders and at the least shows the reticence
to proceed with extended levels for the USD (up) and oil (down).
The gold bugs were creamed on the first attempt to rally the
metal from $810, but since gold did not collapse through $770 oz.
on Friday, hopes may rebound. Tread lightly in all markets on
Monday.

Gold Price ($833 oz.)

Gold remains in a long term bull trend. My macroeconomic trend
directional indicator confirmed it by hitting a new all time high a
few weeks back. Both the trend indicator and the price of gold
remain extended to the upside reflecting the strong rise in the
oil price and in industrial commodites over the past year.

The gold price shifted to a high return / high risk profile in early
2006 and remains in that mode despite the recent price correction.
The macroeconomic directional has declined sharply since 7/11/08
on oil and industrials pricing weakness and the gold price has
followed suit.

Gold is now in a steep short term price downtrend and recently
broke important pivotal support at $850. It touched $810 oz.
earlier in the week and is rebounding from a steep oversold,
helped no doubt by a bounce in the oil price. Gold needs to
take out $850 on the rebound to arrest the short run sell -off.

Gold remains in mania mode and needs to stay above the $770
oz. level to hold the high return / high risk profile. If I push the
macro indicator hard to produce a high value, I can come up with
a price of $760 oz. So, gold is still priced out of my league.

The metal has entered a strong seasonal period in an oversold
state, so expect the bugs and bulls to push hard to get you into
a long position. If my guess that oil may sell down to $90 bl.
by late this year is correct, my macro indicator is likely to
weaken further, which suggests to me that a powerful
seasonal rally in gold would be a highly speculative affair lacking
much fundamental substance.

I would like to see gold trade down in the $600 - 650 oz. area
before it would get me interested on the long side, but I do not
have a case for that now.

Interestingly, when gold did trade above $1000 oz. late this
winter, dealers and larger commercial jewelers saw a goodly
amount of supply come across their counters. I continue to
see a gold price above $1000. as bubble territory and have
been surprised there was no bandwagon effect when the
metal crossed that threshold. Gold chart here.

Oil Price

The oil price has continued to sink in recent weeks, closing today
around $113 bl. Strong indications of a global slowdown that is
still in the intensification phase have aroused concerns that the
oil market may come back into more equitable balance reflecting
slower demand and conservation efforts. Oil is moving into a
seasonally weak period now, and without surprise supply or
demand developments, it is reasonable to guess that the oil price
could decline to $90 bl. by late this year.

The fabulous overbought that we saw earlier this summer has
been eliminated, and the market is neutral intermediate term as it
approaches its 200 day m/a. Oil is getting oversold on a short term
basis and that has traders looking for a bounce off support at
$110 (chart link below). The $100 level is very much a pivotal
one for oil, but there may be a short covering rally before that
level is tested. Click for chart.

Stock Market -- Fundamental Profile

Right now, the SP 500 is priced for sustainable earning power of
20.00 per quarter, or 80.00 annually at a 16.1 p/e multiple. That
multiple translates roughly to an assumption of a 4.0% inflation
rate. Investors have wearied of earnings estimates which have
proven too high consistently over the past year. On the plus side,
they are not buying into a continuation of the acceleration of the
inflation rate witnessed over the past year, and which could see
an interim peak of 5.2% yr / yr. for July. Inflation has been
dominated by a large run up of commodities, particularly oil,
gasoline, natural gas and raw foods. Since the broader commodites
composites have fallen by nearly 16% in recent weeks, one can
see the rationale for reduced concern over inflation.

The market is looking forward in conservative fashion, not yet
willing to buy into a rapid recovery in earnings over the next
6-9 months. Quarterly earning power had reached about 24.00
for the SP 500 by mid-2007. Net per share for Q 2 '08 may come
in around 19.40. The roughly 20% decline in quarterly net
primarily reflects a 95% hit to the financial sector income account,
which constituted nearly 25% of SP 500 eps at its peak. The
earnings forecasting errors by analysts following the financials have
been huge, as the industry has struggled to come to grips with
estimating its loan and securities losses during the recent debacle.
Overall, it would appear investors are not now factoringin a rapid
recovery of financial sector profitability, and are viewing
prospects for non -financial earnings conservatively in view of
concerns about when the economy may regain momentum seen as
sustainable.

the weakness in the stock market this year has been severe enough
to raise the question of whether investors are reducing longer term
expectations for earnings growth. It is hard to do much with this
issue so far, because the damage to earnings over the past year has
been heavily confined to one sector -- the financials.

The Fed has opted to keep short term interest rates low and to allow
monetary liquidity -- a key building block for economic and profits
recovery --to grow a little faster. These are encouraging early stage
developments that have to be seen in tandem with the temporary
benefits to the economy from the recent round of tax rebates, as
the latter may confuse the issue of the extent of Fed ease of liquidity
for a few more months.

Leading economic indicators that have started to soften again
coupled with still large credit quality spreads signify continuing
economic risk and low investor and trader confidence in the
environment. If the Fed continues to re-liquify the economy and
we see those credit quality spreads start to come in, we may have
something good to work with.

Monetary Policy / Trades To Watch

Monetary Policy

Fed's FOMC met today and left the FFR% at 2.0% as all expected.
The statement carried no significant surprises, either. Key
economic variables supported a "no change" stance. However,
recent economic indicator readings show renewed economic
weakness in industrial and commercial order rates. If fresh data
on these series to come in early September show further erosion
in order rates as we move into the 2008 election homestretch,
figure FOMC members will receive phone calls from Power
suggesting a further ease might be in order.

Trades To Watch

The price of oil has broken sharply again this week and, at $119 bl.
or so, is right down on trend support for the powerful up-channel
in evidence since early 2007. Nat. gas has already broken down, and
further weakness in oil below $120. would signify a change of
direction not just for trader sentiment but for supply / demand
perceptions as well. Weak oil is helping the stock market and is
providing support for the US dollar, which is on the cusp of an
intermediate term breakout (see chart). The combo of a firmer
dollar and the drop in the oil price is also pressuring the gold price
as well.

The next couple of weeks will be important for traders and maybe
investors, too. Weak oil / stronger dollar is a major change in the
environment, likely reflecting concern that the global economy is
cooling fast and leading players to look over fresh horses. Just
remember that markets like oil, gold and the US$ can be fickle or
volatile or both.

Economic Indicators

The weekly leading indicator sets hit new cyclical lows and are
consistent with: a) development of a recession; and b) further
deterioration within a downturn.

The purchasing managers' index for new orders dropped sharply
in July and is now much closer to recession levels. The same is
true for the global PM composite. Even China's overall mfg. PM
reading fell below 50 in July (Olympics clean up?).

Underlying purchasing power within the US economy declined
to -1.8% yr/yr reflecting a falling real wage and lower total
civilian employment. When the tax rebates are added in, the
purchasing power measure improves markedly.

A strong export book plus rising public expenditures is continuing
to help the economy stay afloat. Momentum of global trade would
appear to be set to slow soon reflecting sharpened slowdowns in
domestic economies.

US manufacturers used the period of weaker order inflows to
work down backlogs and inventories and maintain high shipment
levels. Heavy inventory liquidation suppressed GDP. Backlogs
still remain elevated. Attention to working them down will
help shipments, but suppress capacity growth.

Clearly, the tax rebates are helping to sustain the economy
presently, and if these rebates do not spark more sustainable
growth, an extension may well be on the table for 2009.

The longer term leading indicators improved markedly as
July rolled on, reflecting a weakening in oil and gas prices. The
critical advance money liquidity indicators also improved, but
remain very modest.