About Me

Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!

Tuesday, December 30, 2008

Stock Market & Economy

If this be but a nasty variant of an ordinary business cycle, I would
say the environment is an easy call from here. Specifically, my
indicators point to a steep further economic downturn through
mid-2009, followed by a moderate economic expansion that could
continue for several years. In this world, the stock market would
most likely bottom Mar. - Apr. of '09, followed by an upturn in
corporate profits by Sep. '09 and the first hike in the Fed Funds rate
at some point in half 1 '10. Commodities would turn up over half 2
'09 and inflation would re-accelerate from a very low level by late
'09. Piece of cake.

But, my range of indicators also suggests to me that the US is
flirting with economic disaster. The key word here is "flirting". It is
far from clear to me that consumers are going to behave as
positively and predictably as they have in prior downturns and
readily jump in and lead the charge to recovery. Consumer
hesitation to spend in the months ahead can lead to further
downcycling and subsequent considerable difficulty in turning
things around. Real incomes have been punished too long for most
and wealth has fallen rapidly, especially for the upscale folks. Debt
levels continue on a high plane and take up substantial income. So,
I think it is reasonable to wonder whether they are going to be so
eager to spend and borrow in 2009. Moreover, if they remain
reticent, I doubt monetary and fiscal policy will prove so
enticing to them. Realistically, and looking at the household sector
on an individual basis, it would be kind of dumb for folks to jump
into heavy spend and borrow mode.

It is easy enough to envisage recovery where consumers exhibit
much greater balance between spending and saving. On the
surface, that's one way to finesse the issue and maybe that's how
it will work out. But, it will need to happen soon, lest a weak
economy and job picture leads to further forbearance.

Production, trade and employment all seem primed to contract
in the months ahead, but the stock market can endure that if
consumers show some signs of putting spending on a more even
keel and if prospective homebuyers show more interest this
coming spring.

For now, I'll probably go along with the framework outlined in the
first paragraph of the post, but I will not stay with it long if we
continue to see folks shunning the shops as we have been.

Sunday, December 28, 2008

Economy & Liquidity

During periods of recession, it is right as rain for consumers, banks
and businesses to rebuild cash and cash equivalent liquidity. Since a
serious downturn can add more uncertainty to the outlook, the
rebuilding of liquidity can intensify during such times.

Real personal wages have rapidly turned positive in this quarter
as inflation has subsided quickly and dramatically. Normally, when
the real wage improves, spending quickly follows, and the desire to
build liquidity slowly wanes. So far, that has not happened, as
spending has remained weak and liquidity balances are rising. This
is partly attributable to the shock of a rapid decline in the economy
since late summer, but it may also reflect a desire by householders to
add to savings to offset sinking 401k and home values. If the latter is
so, then we might expect the period of liquidity enhancement to be
stronger and last longer than in prior recession periods, despite low
available rates on savings. The test of liquidity preference is
underway now, since the real wage has recovered quickly, with the
normal expectation of higher spending to follow now in the spotlight.
I would also say if consumers as a group plan to alter budgets to
accomodate more cash on hand to offset losses in asset values, that
stimulative monetary and fiscal programs may not be very
effective for a while until liquidity cushions are fattened further. I
would also point out since 2005, 2 million boomers cross the age 60
threshold annually, when liquidity preference naturally increases.

Banks are not liquid, and the natural process of improvement is to
allow loans to run off and liquid investments to rise. This process
has actually been slow to get underway. Banks are also taking
massive loan writedowns each quarter. This restains capital growth
and it is likely that the bulk of the rest of the TARP program will have
to be released to banks and other credit intermediaries to rebuild
capital. A big test for both consumers and the banks will come this
spring when more nearly affordable homes are prospected by
folks looking to buy (Improved affordabiltiy reflects both lower
prices and mortgage rates).

Business sector liquidity was well repaired after the 2001-02
downturn. However, my profits indicators have fallen dramatically,
and non-financials may want to further shore up liquidity if cash
flows sink as now expected.

As a recession winds down, the capital markets can rally nicely even
as sectors rebuild liquidity, as investors see such a process as normal
and healthy. The hitch comes in if consumers, banks and business
are seen as too zealous in propping liquidity, for that would mean
that recovery may be further afield then expected.

I take the dramatic weakness in the capital markets over the past 15
months as a sign that fundamental changes may be in store and that
one should treat the tried and true assumptions with more reserve.

A first stop for me vis a vis the economy is to watch consumer
spending now that the real wage has recovered sharply.

Tuesday, December 23, 2008

Stock Market -- Short Term Technical

The rally resembles a duck in flight which has evaded a full load
of buckshot, but which was clipped by a BB or two. There is another
load of buckshot en route, and the duck needs to gain altitude rather
quickly to avoid a nasty hit. Less prosaically, the market has
worked off a sizable short term overbought, and needs to move
ahead quickly to keep long side trader interest. Confirmation of
a rally of substance remains elusive, and the trajectory has flagged
to a critical level. Last Wed. it was mentioned that it was ok to
allow for the work -off of the heavy overbought but now we need
to see if this bird can gain some altitude before impatience brings it

Thursday, December 18, 2008

Financial System Liquidity

As prior discussed, the steep downturn in the global economy since
Sept. '08 shredded Federal Reserve efforts to resuscitate broad
liquidity in the financial system. The commercial paper market
resumed a steep drop, and banks lost large institutional deposits as
players moved to the safety of Treasuries. My broad measure of
credit driven liquidity is now down about $120 bil. below this past
summer and stands only +1.5% measured yr/yr. The Fed has been
buying top quality financial commercial paper to prop up the system,
but large deposits continue to roll off, curtailing the Fed's latest
efforts. 90 day a2/p2 commercial paper trades infrequently and at
a horrendous 6.25%+.

Monetary liquidity has been soaring -- +11.5% yr/yr -- as the Fed
primes the pump. The data is biased up as smaller banks leave
some excess reserves in sweep accounts, but the basic money supply
is moving in the right direction. From a cyclical perspective, the
narrow money supply typically leads the broader credit driven
aggregates in time, and when the economy is rather weak the
recovery of private credit can lag. This is particularly the case when
the residential market is in distress. We know we have the most
depressed residential market we have seen in many years.

In the residential area, there is also the likelihood that deflationary
psychology is growing -- why buy now when house prices are headed
lower and job security is a factor?

The new Obama admin. may well review how to increase already
improving housing affordability further.

At least the Fed is on the case with allowing money to grow in the
system. that's where you have to start to repair the tatters. It is
genuinely too bad that Bernanke was so slow to turn to growing
monetary liquidity.

Even though the broad measure of liquidity is up but 1.5% yr/yr,
there is excess liquidity in the economy overall. The $ value of
production is down 4.5% yr/yr through Nov. That leaves my
excess economic liquidity index at +6.0. Such a reading is normally
very positive for stocks, but I now keep this as a secondary
indicator since it failed badly during the bear market period of
2001 - 2002. However, it has been a good support measure over
the long run so we need to keep it very much in mind.

Wednesday, December 17, 2008

Stock Market -- Short Term Technical

The short term uptrend is gaining firmer footing now as the
25 day m/a is set to join a rising 10 day m/a. However, the
SP 500 is strongly overbought in the very short run following
yesterday's ZIRP rally, courtesy of the Fed. Note also on the
chart link below that the "500" has not taken out two previous
interim peaks of recent weeks at 910-911, indicating resistance
and hesitancy. It is tempting to say that a healthier rally would
have easily blown through that level, but first we need to
see how well the market handles the short run overbought.

The ADX indicator is set to turn positive (+D1 to go through -D1),
but note the weakening momentum line in black. That is not a
confidence builder either. Chart.

Tuesday, December 16, 2008

Policy & The Economy

"Outlier" economic data have policymakers in "all hands on deck "
mode. A collapse in residential construction, weakening home
values, tumbling retail sales and an outright 3.5% decline in the
CPI in recent months are alarming because they are slipping
outside the boundaries of weakness seen in business downturns
over the past 50 years. This is risky business for a US economy
operating with record high debt leverage across most sectors.
Similar situations are playing out to varying degrees across the
globe. A sudden turn to thrift to offset a weak home value, a down
401k and worries over job security make great sense to most on
an individual basis, but policy makers fear the consequences should
the majority of folks get in on the act.

I think the hard reality is that as this massive 80 million strong "baby
boomer" generation matures, the momentum of consumer spending
growth in real terms has slowed and has been boosted by debt
accumulation. As the boomer generation greys, it is going to be
tougher to drive discretionary spending in the US. Were it not for
the current difficult circumstances, I think it would be true to say
that the task of promoting strong consumer spending will only get
tougher over the next decade. Heck, Gen X ,which is following the
boomers into prime spending years is only half its size.

So today the Fed went to ZIRP -- cutting the FFR% to between
0.0 - 0.25%, and promising to inject money into the system more
directly, as the banks have tighter credit policies, inadequate capital
and more substantial loan losses to book. The aim is to force people
to give up their liquidity and step up their spending. Savers are to
suffer and thrift is to be thwarted. On top of this the incoming Obama
admin. is planning massive fiscal stimulus to stabilize a deteriorating
economy. Again, these policy actions are being played out globally.

The fear policymakers share is that failure to act dramatically could
produce an uncontrolled, deflationary economic tailspin with the
end result being substantial economic damage and possible social and
political turmoil. Maybe so, maybe not.

Since consumers have endured very substantial and broadscale
shocks. I think it will be tougher to turn them around this time and
that people with newly revised budgets will resume a higher level
of spending as and when those budgets permit. It is going to take a
little time to rebuild confidence and even a modicum of trust.
Moreover, I am concerned about how well recovery / expansion can
be sustained. Freewheeling commodities markets could surge as
economies recover and again jeopardize confidence and real incomes.
Relatedly, The Fed and the Gov. will face a heavy challenge to manage
policy once inflation pressures resurface.

The message : Tougher to turn the economy...More modest results
whence it turns...Tougher to mange an orderly and durable expansion.

Friday, December 12, 2008

Stock Market -- Quick Comment

Well, the bears did come in on Tues. after the sharp rally to
overbought at Mon.'s close. But they really did not do enough
damage this week to upend the rally. Just a little back and fill.
So we carry the drama into next week with an eye to whether
the market could morph into a plus Santa finish for the year.
Uptrend not confirmed yet for the shorter run in my book.

Thursday, December 11, 2008

Inflation Hedge Trade

What I call the inflation hedge trade goes as follows: Be short the
US dollar and be long oil and perhaps a PM like gold or silver.
This has been a popular trade from time to time over the past
35 years, and was a dominant one in this decade so far. It is a
tricky business, more like a 3 cushion billiard shot than a straight
pop of the 8 ball into the corner pocket.

There is evidence over time that a weakening of the dollar goes
with a rise in the oil price, while a sronger dollar pairs up with a
weaker oil price. The US tends to be a cyclical leader and when it
cuts short rates to bolster growth, the trade deficit may widen
relatively, leading to a weaker US$. In turn, US oil import demand
picks up, and the price is shaded to the upside as a way to hedge
a weaker dollar. Timing is far from exact and markets psychology
plays a major role. This trade was a powerhouse over most of
the decade and was spectacular once it became evident that the
Fed would cut rates to ease a gathering financial crisis in 2007. It
came acropper this year when spreading global financial market
turmoil triggered a flight to the dollar and when oil subsequently
crashed on lower demand and a powerful US dollar rally.

One other fact, the pools of money in this game -- hedge funds,
pension funds with "alternative" investment authority and a
bevy of mutual funds and ETFs devoted to these sectors -- is
huge and far larger than anything seen in modern times. It's not
just primary dealers and old line speculators anymore.

The $USD has weakened so far in December (seasonally typical)
and sure enough oil is rebounding and gold and silver have come on
board. Importantly, oil refineries have run their heating oil and
are set to shut down for maintenance in Jan. to get ready to run
gasoline for the spring. So early in the year can be seasonally
strong for oil. Thus, the guyz have the trade going -- short the
dollar, long oil and maybe gold for good measure. Traders know
oil could rally to $60 + in Jan. without challenging the downtrend.
Moreover the $USD is at trend support and a break here during
the month will whip up the oil pit. This can be crazy stuff, since
there can be little change in bedrock fundamentals in the interim.

From a macro economic perspective, this inflation hedge trade is
harmless as long as it runs for a month or two more. But
development of another sustained strong run up in oil will not be
harmless and will eventually punish a weakened global economy

Monday, December 08, 2008

Stock Market -- Technical

Short Term
Well, here we are again. Another potent rebound from severely
distressed levels, although not quite a rocket. At 910, the SP 500
is overbought short term for just the second day in nearly 2
months at 3.8% above the 25 day m/a. Not only have such
overboughts been rare over the past 3 months, but have been
quickly crushed as well. Good rally durability test straight ahead.

I would like to see the market and its 10 day m/a above the 25 m/a
and see the 25 m/a turn up as well. I would also like to see the +D1
on the Wilder ADX rise above the -D1 as well. Chart here.

Intermediate Term
The NYSE breadth flame index -- runs back 12 weeks -- hit a deep
oversold at -154 on 10/24 and is now just a tad oversold at -20. The
14 week stochastic will need a strong close this week to turn positive.
It has been on a "sell" trend since 5/16/ 08. The smoothed 40 week
price oscillator has been on a "sell" since 7/4/08 and is now just
slightly below the last cyclical bear market low registered in late
2002. That's interesting in itself. When the market turns truly
bullish, the NYSE breadth flame mentioned above can run on
overbought for weeks -- a healthy sign indeed. We have not seen
that since late 2006.

Most contrarian measures I follow show bearish sentiment. It is
curious that Market Vane 's advisory sentiment is still at 40%
bulls compared to readings in the low to mid 20's during 2002
and early 2003. Market Vane's Treasury bond bullish sentiment
hit a rare 89% bullish last week. You see that only at market
tops. A sell-off in Treasuries might help the stock market as it
would suggest a flight from quality back toward riskier assets.

Bernanke, Paulson, W. and Obama have all been furiously
"painting" the tape green over the past two weeks. they have the
sheep and the dogies a' runnin' with a continuous stream of
supportive comments. I don't blame them and, as mentioned
last Friday, it would be nice for all players to take a time out to
think on whether the economy is truly headed off the cliff.

Friday, December 05, 2008

Stock Market Comment

Americans love irony and I am no exception. And so with the all
the seriously bad economic news of recent weeks, the stock
market is trying to steady if not rally. It is a discounting
mechanism and the crash that started over two months ago
has correctly foretold the bad news emanating forth. So, I have
been amused this week by the thought that since the economy
has moved to the cusp of peril (See comments in earlier post),
wouldn't it be something if the market decided to hold off on a
rapid pursuit lower to see if the US and the rest of the major
economies are actually going to go over the cliff into the abyss
or whether we have a deep but managble recession to contend
with. Look, it would be unusual if such a serious economic
situation did not start with a bear market that lasted a good
16 -17 months and which carried into 2009. Moreover, after all
the carnage, now might be a good time for investors to pause to
decide whether all economic hell is about to break loose or not.
This is especially so with a new president coming on board, a
strong congressional majority in hand and a thumbs up from
voters to try and forcibly stimulate the economy and perhaps
massively so. And of course there is the issue, prevalent in
recessions since WW2, that the system has its own self correcting
mechanisms. So why not spend the holidays mulling whether
the wolf is really at the door?

I have had many more good hunches than bad over the years.
But I have had enough bad ones not to trust them but to tend to
the trading and investing disciplines instead and save the hunches
for conversation over drinks. At any rate, I thought I would
pass this little piece of irony along...

Economic Indicators

Weekly Leading Indicators
Both data sets for the economy have been in free fall since June. The
declines -- measured peak to trough so far -- are the steepest since
the Great Depression days. Yes, the stock market influences the
declines, but weakness is broad based, with a collapse in sensitive
materials prices and a surge in initial unemployment claims very
notable. Global indicators are also now falling steeply.

My weekly and monthly inflation pressure gauges remain in free fall
as well and are now consistent with the development of modest
deflation measured yr. on yr.

Monthly Leading Indicators
Manufacturing and commercial new orders measures have simply
tanked since Aug. '08, including US export orders. The total index,
a diffusion measure, has fallen from a strong 142.0 in Jan. '04 to
the current paltry 63.3.

Economic Power Index
This measure is improving. The yr/yr real wage has turned positive
as wage growth has so far held up and inflation pressure is abating
rapidly. The change in yr/yr employment has accelerated to the
downside, however at -1.7%. The combined index is a -0.5% yr/yr
and is up from the cycle low to date of -2.5% set in Jul. '08. The
sharp deterioration of this index from the business cycle peak of
+3.9% set in Jan. '07 correctly foreshadowed the sharp pullback in
consumer spending we have seen. Now, spending and production
levels for the consumer market are very weak as householders
strive to build liquidity and control borrowing. A sharp rise in the
unemployment rate is underway, and that could undermine wage
growth going forward. But, if the damage remains slight, then
purchasing power will mend further. I would also note that
with mortgage rates lower and housing prices still trending down
that affordability is rising very quickly.

Capital Slack
A fast rising unemployment rate and falling operating rates in the
business sector reflect sharply growing slack. The low level
of short term rates overstates the case for slack in the financial
sector as bank business loan exposure is still high relative to
bank liquid investment levels. But liquidity will improve as the
downturn wears on.

Financial Stress
There is more to come here. Troubled home loans are still rising.
Commercial real estate loan losses and C&I loan write offs are
both to rise. On a global level, the bust in commodities prices is
going to add more pressure for countries and companies
dependent on resources, materials and cash crops. Governments
can be expected to inject more funds into the system.

We are on the cusp of danger here. The then neophyte Fed kept
the monetary base flat for a dozen years leading up to the 1929
crash and subsequent depression. It went after the inflation from
WW 1 with a vengeance. The current Fed kept the monetary
base flat in real terms for most of the 2004 - 2008 period to
correct the Greenspan profligacy. The collapse of credit driven
liquidity growth over the past 15 months and the belated turn
to adding monetary liquidity by the Fed leaves us vulnerable.

Maybe we can afford a few more months of deep economic
weakness, but those short term leading indicators for growth
and for inflation do need to begin improving well before winter
is out or else we could slide into a deeper, more pervasive
decline. We are now presuming heavily on the size, stability,
diversity and resiliency of the US economy. Do not underestimate
that power, but watch those short term indicators like hawks.

Tuesday, December 02, 2008

US Treasury Bond

Currently trading at 3.2%, the yield on the 30 yr. Treasury has
dropped at the fastest rate in history in recent weeks. This
decline reflects weakening global production and a collapse of
industrial commodity prices. More broadly, it bespeaks a fast
flight to quality across the Treasury yield spectrum as investors
and traders, concerned over fast gathering economic weakness
in a world of high debt leverage, scramble to safety and liquidity.

The Treasury market is now dramatically overbought. Moreover,
bullish sentiment on the market has reached dangerous levels,
registering 82% bullish on Marketvane. This is not just a short
term overbought, but a longer term overbought as well based on
my 12 month oscillator. Looking back over the past twenty odd
years, the yield on the 30 yr. could fall a bit further to the 2.8 -
3.0% area before it would signal a typical and major cyclical low.

Now, the recent action in the Treasury market has been no more
crazy than what other markets have exhibited. As well, the 30 yr.
carries a 300 -320 basis point premium to the 91 day bill in
yield, and at 3.2%, provides a suitable premium to inflation,
which is sinking fast. Even so, the market has become very
risky in that a turn of investor confidence in the prospect
of eventual economic recovery could badly punish long
Treasury holders should players move out of Treasuries to
more typically risky assets.

The measures I use to gauge confidence in the economy and in
the financial system are drawn from the actions within the
capital markets themselves. So there is no way except by a
guess that I could tell whether confidence is returning before
the markets move in the right direction (More on guesses and
hunches in the next post).

For a chart of the 30 yr. Treasury yield, click.