Economic Momentum Expectation Measure

The relative strength of the MSCI Cyclicals index vs. the broader
SP 500 gives a good insight into investor expectations for the pace
of economic growth ahead. Chart.

$CYC relative strength turned up with the market last spring and
has vaulted back up to the historic long term high range. So, we
are seeing technical resistance and the possible beginning of a
cooling in growth expectations. The $CYC RS line does fit well
with the weekly leading economic indicator sets in that they are
flatlining in the short run as well.

The chart shows a slight break of short term support for $CYC RS
and it thus raises the question of whether portfolio managers are
at the early stage of thinking through whether rotation into more
stable earnings prospects companies might be appropriate. Keep
this yellow flag in mind re: cyclicals.

Back on 9/20, I turned cautious on the shorter term outlook for
the stock market and decided to take a trading holiday for 6 weeks
or so. I mentioned then that positve earnings surprise for Q3 ' 09
might lift stocks higher in the interim but that a period of either
consolidation or correction probably lay ahead. We got the bounce
from earnings as expected and we are now seeing some weakness.
I'll pick up more intensive coverage of the broad market again next
week.

Gold Price

As discussed in the last gold post on 9/10, I pointed out that the
gold price needed to take out key resistance at $1000 oz. to hold
the uptrend in place since 10/08. This it has done.

The gold price was rambunctiously up over Q1 '09, but it could not
hold that action and has since settled into a more stable uptrend.
The negative price action of the past few days has taken some of the
froth off the market, but gold has not been dizzyingly overbought
now since a brief stretch in 3/09. I would rate it mildly overbought
at this time.

My gold price macroeconomic directional indicator entered a new
uptrend starting last December. It has been rising with relative
consistency and reached a new all-time high on 10/23, slightly
exceeding the previous high set in 8/08. The primary factor
behind the setting of a new high has been the strong growth of
monetary liquidity via the Fed's easing actions, but oil and industrial
commodities prices have also contributed significantly since the
early part of this year.

It is encouraging that gold and the indicator made new highs close
in time to one another, but I continue to see gold as carrying a large
price premium that I cannot account for through various techniques
of economic analysis. That premium is now close to $350 an oz.
It is clear that there is no shortage of folks who worry about the
stability of the financial system. But, I would also point out that
2009 has seen sharp advances for the other precious metals, so
there could be as much a cyclical element in gold's recent trend as
anything else.

At any rate, gold remains too rich for my blood, and I have been
happy to trade away from this market and will continue to do so
until gold finds a range closer to my idea of its economic value (now
a paltry $500 -550 oz.). Gold chart is here.

More On SP 500 Profits

This entry builds from the 10/21 post on earnings. With
earnings in recovery mode, analysts now see quarterly
operating net improving serially straight through the
final quarter of 2010, and they expect full year SP 500
eps for 2010 to be up by 31% to about $73.50. Now, this
represents a fairly strong takeoff, and as discussed in the
10/21 post, suggests that profit margins will benefit from
a positive turn in top - line or sales growth. Looking out
to Q 4 ' 10, the consensus is for quarterly net of about
$20.20. This is hardly a stretch with modest real growth
in sales of 3% and a pricing gain of 2%. So, I do not think
the numbers needed to produce much stronger earnings
in 2010 are heroic by any stretch.

For perspective, should Q 4 ' 10 eps come in at $20.20, we
can compare that number to a mid - range $25. based on
the SP 500 earnings channel for the past 20 years. The
projection represents good recovery from severely
depressed levels, but would fall far short of the indicated
norm of the past 20 years.

You should know that earnings projections through 2010
are somewhat backloaded in that no big lift is expected
until mid - 2010. So, as analysts now see it, the big test
of their projections is still 9 months out.

I think the above fairly presents the earnings
fundamentals game plan out through 2010. It looks
daunting, but really represents a "lay up" with a modest
modicum of economic recovery.

I think investors are clearly looking well into 2010 with
the SP 500 at current levels. And that is an important
takeaway for you as you assess the economic outlook for
yourself from week to week and month to month.

Corporate Profits

Reality Check: Yes profits are coming in better than expected and
that is a good thing. But the companies that have crashed and
burned or are doing so now, get deleted from earnings when their
market capitalizations shrink enough to be supplanted by stronger
companies. So, earnings are better than they would be if the SP 500
were static. Over time this imparts an upward bias to index eps
and its price value.

That caveat aside, corporate profits are coming in better than
expected and estimates are being raised for Q 4 ' 09 and for 2010.
Q4 '08 eps were so awful that comparisons will be easy. Ditto for a
match with Q1 '09. So the game now is to watch earnings progress
Q to Q through time. S&P estimates that yr / yr sales through Q3
' 09 were down by an astounding $1.52 tril. or more than 15%. Since
companies cannot cost cut their way to prosperity, analysts are
going to focus heavily on a prospective recovery in sales. The profit
margin on extant 500 company operating eps is way off the high
levels of 2007, but is higher than most imagined it would be
nonetheless. The positive leverage to earnings from a recovery of
sales looks awfully good now.

My earnings indicators save for the finance services sector have
been in sharp uptrends since the spring of ' 09. They have been so
strong, some degree of moderation would be normal in the months
ahead. Financial service company net revenues before fees and
trading profits are down reflecting lower private sector credit
demand and low returns on liquid holdings. On the plus side, the
pace of loan and securities loss reserving has moderated. Now,
oil and gas producers face tough comparisons for Q 4 ' 09, but
rising product price realizations suggest some recovery in 2010.

My SP 500 Market Tracker has net per share for 2009 of around
$56. By my calculations, the market is currently pricing in earning
power of $66. per share. So, investors are looking positively well
into 2010 -- a reminder of why a positive turn in sales is going to
be so critical.

Stock Market -- Some Thoughts

Back on 9/20, in an identically titled post, I decided to take a
more cautious view of the stock market. I thought the 60%
run - up off the 3/09 low represented a tidy downpayment on
economic recovery. I pointed out that forthcoming Q 3 '09 earns.
reports would come in better than expected and that a decision
not to play in the market could prove early. Right about that.

My core fundamentals remain ok. The market is in a firm uptrend.
Looking out past the short run, the market is strongly overbought,
but, that is a hallmark of a powerful market. Even so, there are a
couple of issues that bother me, issues that might even be
antithetical in the short run. First, I believe the market has derived
much of its power from one of the strongest surges ever in the leading
economic indicators. Since the redundancy here is so mild, I think it
is fair to wonder how stocks hold up once the leading indicator spurt
moderates and flattens out for a spell as it inevitably will. So, I am
calling into question the staying power of market psychology.
Secondly, my inflation thrust indicator, which quieted some over the
summer, has started to surge again, with even natural gas joining the
petrol complex to lead the way. Oil, which is now closing in on $80 bl.,
is now high relative to what most consumers can afford without
looking again at their budgets. In short, a fast rising oil price dims
the longer term economic outlook.

Now, it may well turn out that if the leading economic indicators
moderate over the next several months, the stock market will correct
and the oil price -- nearly 32% above its 40 wk. m/a and wildly
overbought -- will drop down sharply in price. I'll happily sign up
for another long side tour in stocks if that all happens and the core
fundamentals hold up.

I am all in cash now and will likely just monitor the economic indicators
and the markets for another 3 weeks or so. But, I'll be posting even so.

Financial System Liquidity

My broad measure of credit driven liquidity is down 1.5% yr / yr,
and has decreased at a 4.0% annual rate over the past 6 mos. With
deep recession and its immediate aftermath, private sector credit
demand has been declining. The weakness shows not just with
shadow banking, which has collapsed, but with the banking system's
loan book as well. The big roll-off on the banks' book is business or
C&I loans. Readers will recall I have discussed this probability for
months, and also that the C&I loan book could decline significantly
for another year or so. The banks are charging off the loans that
some businesses cannot service, and viable companies are
reducing exposure because with business depressed, working capital
needs have shrunk. Moreover, as the economy recovers, many
companies will generate cash flow well above spending needs, at
least in the early stages.

Monetary liquidity -- the narrow money supply -- is up about 15%
yr / yr, and this has been, as always, the platform to turn the
economy positive. Monetary liquidity represents only 10 -15% of
the broader measures of financial liquidity and cannot sustain an
economic expansion for very long without a positive turn in private
sector borrowing, but it is the kick starter. The Fed, for seasonal
reasons, is presently allowing monetary liquidity growth to
accelerate via its open market activities.

Despite a reduction in the broader credit driven composite, the
velocity of money has declined sharply, as the cyclical economy is
down much more yr / yr. The excess liquidity thus created has
supported the cyclical recovery in stocks, although it should be noted
that velocity has started to recover and that excess liquidity is
easing. A "V" shaped recovery, suggested by the leading indicators,
would likely bring down excess liquidity rather rapidly and give stocks
much less of a tailwind.

The world's major central banks are keeping large currency swap lines
to cushion the decline in global capital flows fostered by the 2007-08
credit crunch and a collapse in global trade. The outflow of US dollars
through the trade window is down 50% over the past 2 years.

Banking system loan loss reserves have increased only modestly in
recent months following a large leap from late 2007. Even so, bank
capital remains flat as cash flow is moderating on a declining loan
book. Thus, as the economy recovers, and with it private sector loan
demand, more than a few banks will need to raise additional primary
equity capital.

Oil Price

Oil has been playing peek a boo in the $70 -75bl. range for several
months now. We are into a period of serious seasonal weakness for
oil, so it is noteworthy the price is holding up. The strength in the
price in recent days has boosted the relative stock price performance
for the producer group.

One concern I have here, which is not tangential to the interests of
oil price players is that if oil does break above $75 a bl., it will have
the effect of reducing the longer term performance potential for
the economy. A rising fuels bill could well put some pressure on the
real wage, and it would force consumers to borrow more to maintain
discretionary spending. Down the road this little series of
connected dots could work not only to moderate economic demand,
but demand for petrol as well. Suggest you keep this in mind.

Oil chart.

Stock Market Quickie

The rally off of the mildest of short term oversolds plus the failure
today of the SP 500 to take out resistance at the 1072 level will
not go unnoticed by a good sized group of traders. Some of the
boyz may see this little failure as a mechanical sell signal. Well, it
sets up a couple of interesting days...CHART.

Economic Indicators

Weekly & Monthly Leading
Both weekly and monthly lead indicators continued to improve in
9/09, and both continue to point to a "V" shaped economic recovery.
The weeklies did lose some momentum over the month, so we will
have to keep an eye on that.

Coincident Indicators
Data is available through August. With real retail sales and industrial
production rising over the first 2 months of the quarter, it is likely
the coincident sets have stabilized. Measured yr / yr, momentum
has improved from -6% readings to -3%.

Corporate Profits indicators
My profits indicators have improved dramatically since early ' 09.
The number of companies reporting rising output has risen sharply
over Q 3 ' 08, but actual output levels, although rising in recent
months still trail prior year levels. Pricing power has remained
weak, but operating costs have been slashed. Viewed sequentially,
quarterly profits are rising from low levels as earnings power
recovers, and this positive trend is the more critical factor. The
"buzz" on The Street has it that Q 3 profits will top estimates.
Right now, annualized SP 500 net per share is probably running $60.

Economic Power Index
This simple index has turned negative. Yr / yr real individual wage
growth has decelerated, but remains historically strong. But,
this crucial positive has now been eclipsed by the deterioration of
total civilian employment when measured yr/ yr. Thus for now,
tax cuts, automatic policy stabilizers and a growing flow of fiscal
spending $ have to carry the day. The key here will be how quickly
negative job loss momentum reverses in the wake of improved
spending and production. This transition period is anxiety provoking
not only because of the weak job market, but also because the
consumer has been adding to liquidity by boosting savings and
paying down revolving credit. The plus side here is that the
underlying demand for consumers is strong following nearly 2
years of marked retrenchment.

Most economists are not sanguine on the employment outlook. And
it is tempting to just go along with this view. But, since business
slashed costs so sharply as the recession took hold, I think it only
prudent to see if higher demand might bring people back on to
payrolls at a faster clip than expected. Companies do not like to
blow orders because they are short handed. Good way to lose
market share, that.

Global Indicators
Output on a global basis appears to have turned positive over the
summer and might be slighly ahead of the US, except for new
orders where the breadth of companies with a rising book has been
quite strong. Employment and pricing power remain subdued on a
global basis, in tandem with the US.

Long Treasury Bond

As readers will recall, I have thought the long Treasury was a
decent countertrend trade on the long side over the past 3-4
months. This was not easy work, but it was an ok call. Now the
bond is trading around the 40 week m/a after posting up 10 points
in recent months. So, it is no longer an oversold entity, and, given
my admittedly indiosyncratic way of trading the bond, is now less
interesting as a trade, even though it is trending positively and has
decent fundamental support, now that industrial commodities
prices have been softening.

I have no quarrel with the bond bulls in the very short run. Trading
on the long side may still be ok, but I am less sure footed now in my
method, so I plan to sideline it for a while. Treasury price chart.

Stock Market -- Technical

As discussed back on 9/20, this large advance was in need of a
vacation or correction after such a powerful run. Today's sharp
decline fractured the uptrend leg running from early July.
Moreover, further weakness would fracture the uptrend line
running from early Mar. At today's close of 1030, the SP500 is but
10 points above the longer running trend line and a break there
would be a bit more serious. the market is slightly oversold now
and is not yet in a confirmed shorter term downtrend. Now since
July, the boyz have been quick to go long on the little dips, so the
next trading day or so will be interesting. A more respectable
oversold would come at around SP 500 990.

A look at the chart linked in below shows that SP 500 is in a
pivotal area. Chart.