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 29, 2009

Stock Market Fundamentals -- Indicators

Looking at 2010, most projections I have seen fall in a range of 1150
to 1350 for year's end. My SP 500 Market Tracker has the "500"
winding up next year somewhere between 1235 - 1300, depending
upon how strong recovering earnings may be. I do not a have major
issue with the Tracker projection as of now.

Core indicators -- monetary liquidity measures, market short rates,
confidence measures and the trend of lower quality investment
bond yields remain positive. So, I am still on a fundamental buy
signal. As the economy recovers, I doubt all the measures will
remain positive over the course of the year, so I look for a time
when the market will transition from an "easy money" buy signal
to a market more suitable for traders with time horizons that may
run out to a year.

My earnings indicators remain strongly positive as we move into
2010. The market tends to do well when earnings are accelerating
on a 12 month basis relative to the long run trend. Companies have
taken out enormous sums of cost, so earnings operating leverage
should remain strong, even if top line growth is moderate.

I am less confident about two key secondary indicators. One is
the oil price. The real oil price rose sharply over 2009, and petrol
prices rose accordingly. The impact of such on inflation was clearly
muted by a large decline in natural gas cost for heating, processing
and cooking. Pricing in the energy complex represents a key area
of uncertainty for the stock market in 2010. The other measure is
the degree of excess liquidity in the system. The economy is
expanding now and the broad measure of credit driven liquidity is
still in decline. Excess liquidity is winding down and could disappear
by spring 2010 unless private sector credit begins growing again.
The stock market rarely progresses strongly for long without a
liquidity tailwind, as the real economy normally outbids the market
for liquidity. We saw a situation like this in 2004 when real growth
outpaced liquidity in the early phase of expansion. Situations of this
sort are far more common in the latter stages of economic expansion
when inflation pressures arise and the Fed starts trimming credit.

Saturday, December 26, 2009

Stock Market Fundamentals -- Valuation

S&P 500 Market Tracker
This method of valuing the market rests on very long term ties
between earnings, inflation and the market's p/e ratio. The Tracker
has the SP 500 valued at 950 - 960 to wind up 2009 and at 1235 -
1300 to wind up 2010. With the SP at 1126, it is clear the market
is looking well into 2010 and is discounting continuing sharp eps
recovery. As I will discuss in the next post, the earnings indicators
do support handsome recovery next year. Readers should know that
the market will often trade at a premium to the Tracker in the
early stages of earnings recovery / expansion and that intervals of
this sort with the market at a premium can last two or so years.
The current premium over the Tracker value is nearly 18%. That
represents a sizable spread and points to significant price risk if
there is a conservative turn in investor psychology. For the record,
the Tracker did hit a cycle low of 655 for the "500" last spring
as earnings were bottoming. It matched the lows.

Valuation -- Digging Deeper
The market is discounting a return of earnings back from extremely
low levels to the very long term trend.

Investors are pricing in a sharp improvement in $ dividend payout
and expect solid earnings and dividend growth over the next 5 - 7

Investors are aware that the SP 500 has been moving over the
years to a much higher earnings plowback rate as corporate
managers have acted agrressively to accelerate profit growth. But
the p/e ratio implied by a high 65% earnings plowback rate is well
above what investors are willing to pay. Earnings growth has
accelerated since the latter 1980s, but earnings have become far
more volatile. Moreover, CEO interest in maximizing short term
earnings results has greatly fattened executive pay, but has
penalized the incomes of the rank and file and has done nothing
to add to shareholder value for over ten years. Sloppy returns on
assets deployed has led to heavy intermittent cuts in headcount
and wages to boost productivity and profit margins. True, the
development and growth of low wage emerging economies has
hurt US corporate pricing power and return on assets. Even so,
concentration on cost cutting in preference to wiser asset
management has left too many companies writing off too much
asset value and disgourging too much headcount when business
turns down. Finances within the market tell me that wiser business
asset management and higher and more stable dividend payout
would provide a less volatile and more satisfactory earnings and
market performance.

Cost cutting in the area of 25% plus moderate growth next year
could lead to a 15% return on equity for The Sp 500. A high
earnings plowback rate of 65% would imply sustainable growth of
nearly 10% in earnings over the long term. The global economy
will not support such ambition and continued CEO focus on labor
productivity to the exclusion of wise asset management will lead
to further squandering of resources that would best be dividended
out to shareholders.

In summary, investors are pricing in a standard economic recovery,
but are not now willing to pay a premium for aggressive asset
and resource management going forward and for good reason.

Wednesday, December 23, 2009

Stock Market Quickie

Volume has been light for a good several weeks now, and with the
year end holidays upon us, has dropped off about 50% save for
the recent options expiration. The light move up reflects year's
end window dressing by institutional and funds managers, with the
full panopoly of tricks on display (you own 100k shares of smaller
cap XYZ corp and you play in another 1k shares bid higher so you
get an extra 1/8 on your full position etc.).

I plan to do full profile fundamental and technicals on the market to
benchmark us before year's end and will post shortly.

Friday, December 18, 2009

US Dollar ($USD) -- Technical Note

The recent rally in the dollar continues on. The buck has come
up through its 10 and 25 day m/a's and both averages have turned
up to confirm the trend. MACD is positive and I like the ADX
reading which shows a positive turn and rising momentum. Chart.

However, do note that the dollar is now approaching overbought
levels on the RSI measure. I think that soon we'll see how sincere
this contra-seasonal move up in $USD is.

Financial System Liquidity

The Fed continues to make sure that narrow measures of monetary
liquidity grow. This remains essential to underwrite the early phase
of economic recovery. Since I think the Fed ought to maintain higher
levels of monetary liquidity in the system through time, I remain a
cheerleader here. The broader measure of credit-driven liquidity
(about $13.8 tril.) has yet to sustain growth from month-to-month
and is about 0.7% above year ago levels. This performance reflects
the continued roll-off of private sector credit demand and the
spectacular collapse of the shadow banking system and hence the
commercial paper market.

Flat funding for credit is not a major issue in the early stage of an
economic recovery, because businesses can fund operations via
internal cash flow. Moreover, in the current situation, mortgage
demand in the residential market is only beginning to show a little
improvement. However, as 2010 progresses, it will become
more important for the credit markets to loosen up to provide
more funding of a rising level of economic activity. This will not
be as easy a process as in most past cycles, since there are a
number of banks still posting higher loss reserves from loans
made over 2005 - 08, and this constrains both capital and

When bank credit is damaged as badly as it has been, the chief
credit officer at banks has the CEO's ear and can hold the
loan officers at bay and under control. He rules the roost. But,
as an economy expands and inquiries rise from decent credits, the
commercial side of the bank gradually regains power and $ finally
flow. Smart CEOs keep the chief credit person in play as a
consigliere once the commercial guys swing into action.

There has been a sizable amount of excess liquidity in the system
relative to the needs of the real economy. With recovery and
with no discernible growth trend in system liquidity, excess
liquidity is receding and could disappear for a spell by late
winter, 2010. That would remove a substantial support factor
for the stock market and could leave it vulnerable to a price
correction, especially if investment portfolio cash levels are low
(they are). So this is something for stock investors to watch
for early next year.

Wednesday, December 16, 2009

Monetary Policy & Short Term Rates

It was steady as she goes today from FOMC. No surprise. The
economy is recovering and the deterioration of the job market is
ebbing, but my key benchmark policy indicators do not suggest it
is time to raise rates. In fact, two of the indicators -- capacity use
rate and my short term business credit supply / demand gauge
remain well in the red. The latter, the pressure gauge, can turn on a
dime, but for now it is still showing weakening demand.

My cyclical model for where the 91-day T-bill should be, based
on super long term historical data, puts the rate in a range of 1.0 -
1.5%. As we move into 2010, the model will lift the value to 1.5%.
So, The Fed's ZIRP is behind the curve and points to the Fed's
conviction that inflation poses no problem in the early stage of the
recovery. Just so you know how accomodative the Fed is being,
consider that the long term model for the bill rate with capacity use
"neutral" at 80% is 4.5% (US operating rate now just 71.3%).

You should remember that even though the CPI is 1.7% below its
mid-2008 historic peak (still deflation), we now have the CPI up
1.8% yr/yr, and the inflation thrust indicators remain in a positive

Monday, December 14, 2009

The Banks & Their Fat Cats

System capital has improved over the past year, although most
of the increase reflects the net addition of TARP funds to the
system. On a "quick" basis, banking system liquidity is also
improving, as commercial loans roll-off rapidly against Treasury
holdings. This is a normal development after a deep recession
and primarily reflects weaker business loan demand. It is no
exaggeration to say that US based businesses have lost up to
$2 trillion in gross sales globally during the recession, and that
means a large reduction in working capital financing needs.

The banks' loan / lease book expanded in November after months
of decline. There was an uptick in the residential mortgage
portfolio to reflect higher home sales in the US. Still, loan / lease
footings are down 6.5% yr/yr, as C&I loans to business have
dropped by nearly 17.5% yr/yr. Bank loan loss reserving is still
growing, albeit at a more modest pace. The system loss reserve
account has topped $200 bil., or 16.5% of gross capital.

The system is repairing slowly. Bankers are no longer friendly
and it is understandable that credit standards have tightened
further when you consider that loan losses are still rising. With
business sales only beginning to recover, and with excess housing
inventories still being worked off, the economy does not yet
need robust development lending by the banks.

Relative to a sensible long term trend to include 3% inflation,
the loan / lease book of the banks was $1.5 tril. on the high
side in 2008. It is now half that amount.

The Fat Cats
Attacking commercial and investment bank compensation
programs has been a fine, populist sport for nearly two years
now. The programs that were volume or production based were
exquisitely dumb as they gave bankers the green light to put
their firms capital at risk in pursuit of higher comp. Plans will be
subject to regulatory review going forward.

Their are a lot fewer bankers around these days upon which to
lavish bonus money. If you are into attack mode on the comp.
issues, you might keep that in mind.

Even so, when one gazes at the shrinkage of the asset base of the
system, the still rising loan and securities losses books, and the
fact that TARP money has underwritten cash flows for many
banks and IBs, you have to admire the insouciance of a number
of the guys who are still standing. This issue is not going away
soon, and it will be interesting to see just how the Fed and other
regulators will treat bonus plans going forward.

Friday, December 11, 2009

Stock Market -- Be Careful With The Ho-hum

The market has been in a period of substantial price compression
for a month now. It has grown so tight that bull vs bear efforts are
perfectly balanced. Easy to go to sleep on the job. What's worse,
price compression can easily last another month or so, although the
bull vs bear balance may grow more imperfect. But, price com-
pression periods usually lead to major price action when they
break. I think it is very difficult to call the direction of these breaks,
and I know from experience that you can get head faked when the
break comes, because there can be occasions when the first few
days belie the eventual direction. In short, if you are trading, it
can be a frustrating period. But, know that there is action ahead.
SP 500 chart shows the compression.

Thursday, December 10, 2009

Inflation Potential

The broad CPI made an historic peak of 220.0 in 7/08. Then,
deflation set in and the CPI made an interim cyclical low of 210.2
in 12/08. Since then, prices have risen. The CPI hit 216.2 in 10/09.
Still, this latest reading is below the all - time high by 1.7%. So,
even though the economy is inflating here in 2009, we are still
in a deflationary period, and will not be out of it until the CPI takes
out the 220.0 all-time high.

Now, the markets closely observe inflation momentum on a trend
basis. Inflation often restarts even after a severe recession period,
and for now, the shorter term trend is for more inflation when
measured yr/yr. My inflation thrust indicator, which fell the
most steeply in many years from mid- 2008 through mid- 2009,
is now rising quickly and suggests the inflation rate is going positive
yr/yr now and that it will reach around 3.0% on a 12-month basis
through 1/10. A broader cyclical measure I follow from the
Economic Cycle Research Institute turned up early in 2009 on the
first signs an economic recovery may develop. It has moved up
rapidly and is also signalling a crossover in the CPI% yr/yr from
0.0% to a plus reading.

Looked at month to month, my pressure gauge is losing positive
momentum, reflecting a slowing in the progress of recovery in
commodities prices (chart). In fact, the CRB composite shown in
the chart is now "stuck" in long term resistance zones of 265 - 280.
Now without a fresh surge in commodities, any advance in the CPI
through mid - 2010 is likely to be tepid, and the old 220 high would
stay safe for a good several months. There is too much slack in
the US economy to expect a more rapid rise of inflation pressure
without another strong surge in fuels and other major commodities
sub-groups. It would be easy to question whether inflation would
be more than very mild except that there are two newer forces
to contend with: The growing importance of China and its satellites
as an industrial power, and the much heavier influence of pure
financial speculation in the commodities markets (viz. the oil price
bubble of 2007 - 08).

So, commodities will remain the key variable in the inflation
outlook. For now, it looks like expectations in these market sectors
have grown more subdued. But, let's not kid ourselves. Speculative
interest in fuels and other commodities loops back into the
economy just as readings of the economic indicators can feed into
speculative interest in commodities. So, you have to watch both
processes carefully in assessing the inflation outlook.

Tuesday, December 08, 2009

Oil Price

A bump up in the weighted exchange value of the US$ has helped
nudge the oil price into a more normal seasonally weak interval.
AT $80 bl., the price was fabulously overbought. Then it was
trading at a 33% premium to its 40 wk. m/a, when a good rule of
thumb for traders is to be wary of any commodity that trades at
a 20% or more premium.

My view has been that autumn seasonal weakness could take oil
down to $65. Its decline so far has been so tortuously mild that
one is hard pressed to say with confidence that it could slide
another $8-10, especially since the bulk of the big overbought
has been relieved. But I would also note that the 12-26 wk MACD,
which does not whipsaw often, has turned down. Chart.

In my view, it is difficult for the US economy to expand at its
potential when the real price of oil is rising rapidly. Advances in
oil of this sort are short-term inflationary, push the Fed to tighten
credit and punish the real wage, as wages are far less elastic than
the price of oil currently. Unstable oil and petrol prices also
create uncertainty for businesses and households facing capital
investment decisions. Now, it is true that the oil demand to GDP
ratio has come down over the years, but that salient factor can
be outweighed over the shorter run by booms in the oil price.

Interestingly, my longer term log scale chart (weekly) has oil on
a fast track to $150 bl. by the end of 2010. That, or anything
within hailing distance of it, would be disastrous for the broader
economy. At present, basic supply / demand for oil hardly
warrants a $75. price. So I am expecting oil to break down from
the current upsweep and settle into a far more modest path, lest
chances for a continued path of economic recovery are imperiled.

Friday, December 04, 2009

Economic Indicators

Weekly Leading
Both sets of weeklies resumed advancing in Nov. following brief
respites. They remain strong, continue to signal a "V" recovery
and point to growth out through Q1 2010.

Monthly Leading
the momentum of the breadth of new orders for businesses has
leveled off. The indicator did make a slight cyclical high for Nov.
It is solidly positive but is well below boom levels. "V" pattern
is still indicated.

Business Strength Index
This indicator is well off its lows. Now in the 123 - 125 area, it is
still below the 130 - 140 threshold that normally marks a turn
toward tightening by the Fed. The weakness here is in capacity
utilization %.

Economic Power Index
This index declined sharply in Nov. as the yr / yr rate of inflation
cut into a declining rate of salary growth. Real wage growth could
flatten or turn slightly negative through early 2010. The
employment momentum part of the index improved markedly
last month as there was a mild gain in total civilian employment
after months of deep decline. The bottom line here is that basic
consumer purchasing power remains increasingly dependent on
automatic fiscal stabilizers and fiscal policy initiatives. The
favorable change in employment momentum is a good sign that
needs to carry through further in the months ahead. The rise in
oil and petrol prices through 2009 has undercut the recovery.

Economic Slack / Pent-up Demand both remain sizable
and form the base for a lengthy period of recovery.

Other Current
The depth and persistence of inventory liquidation did catch me by
surprise. A normal cyclical swing off current levels could alone add
1.5% to GDP over the next year.

The home purchase tax credit is helping to clear excess inventory
in the housing market. Mortgage purchase applications dropped
recently, so the inventory clearing process could slow in early 2010.

Long lead Indicator --US
This composite hit historically high levels in late 2008. It remains
strongly positive, although there has been some slippage in the
wage vs. inflation component recently.

The global indicators are consistent with modest economic
expansion. The readings are far above the low levels seen back in
the depths of the recession, but are not especially strong. The flow
of new orders in foreign economies has lagged the US and I
would rate it as a little disappointing to date.

For a look at a real-time measure of economic activity by the
Phila. Fed, (ADS / BCI) go here. Open the PDFs. The index
does not include the positive employment data for early Dec.
We need to see a reading above 1.0 soon here to confirm that
a decent recovery is underway.

Thursday, December 03, 2009

Economy -- I'm Out On The End Of The Positive Limb

The US has experienced near depression conditions and severe
demand privation over the past two years. There is more economic
or capital slack in the system than at any time since the 1930's.

My reading of US economic history suggests to me that with
powerful monetary and fiscal tailwinds, the US should experience
a strong and sustained economic recovery that can run out at
least 5 - 6 years. Now, naturally it is not like days of yore when
US growth potential was quite a bit higher. I peg that potential at
2.8% growth per annum, but I do expect at least a couple of years
ahead where production grows at 5 - 6% and where employment
gains are strong. I also expect to see the US move from modest
deflation to inflation that could approach 5% on the CPI. Further,
I expect an eventual sharp climb in short term interest rates, with
the 91 day T-bill yield eventually returning toward 5%, and with
that could come a rise in longer dated Treasury bond yields back
toward 6%. That kind of inflation / interest rate framework will
crimp the stock market p/e ratio, but the offset there will be
likely substantially higher earnings.

I expect a return to more stable monetary policy, and I expect a
combination of higher tax revenues and a more aggressive trade-off
posture toward spending priorities will lead to substantial
improvement in fiscal budget balance. If anything, the risk now
is toward premature tightening and creation of fiscal drag. The
struggle in the years ahead to regain better fiscal and monetary
policy balance will increase economic volatility for short intervals.

I think we will remain in an elevated financial risk mode through
mid - 2011, as not even a stronger than expected US and global
economic recovery may be good enough to save any number of
marginal household, business and sovereign credits. For some,
the negative hit to cash inflows relative to debt service already
sustained may be too much to overcome (like Dubai).

I did not expect I would be doing a longer term overview again.
After all, I am no spring chicken. But, we are looking at extreme
low levels of economic activity, and history says that when such
is addressed, the economy eventually regains substantial verve.

The web is overloaded with points of view that would challenge
my simplistic outlook and I have to say part of the reason I
wanted to establish a stronger position was that it would better
enable me to grasp and profit from deviations to plan as I go along.

There, I said it and I am glad.