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 !!!

Wednesday, March 31, 2010

Stock Market -- Short Term Technical

This post is an exercise in due diligence. Short term consolidation in
the stock market has taken it off the uptrend line in place since the
2/5/10 interim low and left it just a smidge above the 10 day m/a.
So far, what we are seeing is a work off of a sizable short term
overbought condition which can be rescued easily enough. Even so,
I pay homage to the break of trend and the market's proximity to
the short term m/a's. I also note that the 9 month cycle rolls around
in mid-April and that a shorter cycle also has a low around the same
time. As always, remember that cycles shift and fail, but deserve
respect nonetheless.

There's a three day weekend ahead for the market, and with
employment data due out on this Fri., there may be position
squaring underway currently, as only the SP 500 mini will be open
and that only until 9 am. As well, with tomorrow being April 1,
the quarterly window dressing is done. Thus, I would be looking
toward next week to see if the rally may be rescued or not.


Monday, March 29, 2010

Gold Price

I last discussed the gold price back on 11/20/09. I claimed it was
very overbought but could have a blow-off spike up into the
high 1200s before settling back to $950 in the spring of this year.
Gold did get up toward $1240 oz. in late '09 and did settle back to
$1050 in early Feb., but it has moved up some from there in recent

Gold is now struggling to hold its uptrend rolling back to late 2008.
It has broken the trend twice this year, but the breaks have been
modest and you have to give a volatile medium like gold some "over
and back" chances around a trendline before you can say with
authority that a downside break has occured.

My gold macro-directional indicator has been rising pretty steadily
and strongly since the latter part of 2008. The monetary
component rose sharply over the past 15 months, but is very likely
to settle in to a much more modest trend as major central banks
rein in quantitative easing and special lending programs . Thus,
for its strength, the gauge will be more reliant on the pricing of oil
and a basket of industrial commodities as we move forward through

Updated fundamental research on gold mining now pegs the all in
cost of extraction at $700 oz. for new mines. I have used the new
data to reset my micro indicator for the value of gold up to $650 oz.
and may adjust it higher if the global economy continues to expand.

I continue to regard gold as very expensive and will likely only
play it on the short side from time to time. CHART.

Wednesday, March 24, 2010

Stock Market -- Valuation Benchmarks

Last of a three part post on market fundamentals.

The SP 500 Market Tracker based on 12 months eps through

3/10 sits at 1060. The market is currently trading at a 10%

premium to the Tracker. The spread is not onerous.

With rebounding earnings and rising estimates, the market is

discounting continuing strong net per share performance into the

third Q of 2010. Again, not unusual.

The Tracker, based on a full year consensus estimate of a touch

over $78 per share, would fetch a value 1290 for the SP 500 by

late in 2010. Since advance indicators point to sharply rising

recovery eps into Q 3, this is probably a reasonable enough


So far, investors are showing no concern about the issues of

exiting accomodative monetary policy and strong fiscal stimulus.

Both issues could arise as concerns later in the year.

The Market Tracker based on super long term trend earnings

gives a "500"value of 1155 for 2010 and 1230 for 2011. So, for

investors with a longer term time horizon, the market is now

fairly valued. This means that the chances for sizable excess

returns depends entirely on continued strong earnings gains and

a moderate level of inflation (not in excess of 3.5% per).

I also use a simple dividend discount valuation model and a

kindred p/e assessment model based earnings plowback. The

dividend discount model reveals that investors are expecting a

cyclical recovery of the dividend and that players are also

factoring in earnings / dividend growth of between 7.5 -8.0%

long term. From an economic perspective, this would imply

top line growth of 6.0 - 6.5% plus further profit margin

improvement. That would represent a tall order if the USA was

the exclusive focus. So, implicit in investor's minds are continued

aggressive balance sheet management such as share buy-backs,

and the benefits of increasing SP 500 exposure to faster growing

emerging and developing economies with lower cost structures.

Clearly, investors do not have humble expectations.

Over the past 20 years, companies have allowed dividend

payout ratios to decline and have increased the ratio of earnings

plowed back into the business. Return on Equity % x earns.

plowback rate = implied internal growth. Excluding the recent

recession years the formula would run as follows: 15% x 65% =

9.75%. That would imply a p/e ratio over 20x trend eps.

Investors, seeing that few companies can grow by over 10%

a year, have not bought into the corporate strategy since the

bubble days of 1996 - 2000. And, they have been correct to be

more conservative. In fact, I suspect that earnings and market

performance for the SP 500 would have been more stable had

companies payed out more in dividends than they have.

Tuesday, March 23, 2010

Stk Market Fundamentals -- Indicators

Second of a three part post on market fundamentals.

Core market directional fundamentals have been positive since
late Dec. 2008. This group includes measures of monetary
liquidity, market short and long term interest rates and
confidence indicators. These are my "easy money" measures,
both in terms of betting with an accomodative Fed at your back
and the opportunity for a high return / low risk long side play.

Core indicators turn decisively negative when restrictive Fed
policy chases up short rates and corporate yields, curtails
basic monetary liquidity growth and starts to bite into my
favorite confidence measures. That process has yet to start.

When the "easy money" period ends and a more restrictive
policy is adopted by the Fed, the market may sell off some, but
can recover and go right on up. But this type of situation offers
moderate return for steadily increasing risk. It is a time to play
with a substantial and rising liquid reserve kept aside. I am
developing a couple of indicators for increasing business cycle
risk keyed on the 91 day T-bill and measures I use to determine
when corporate earnings are nearing a peak. More on this at
another time.

True to form, the 3/09 - 9/09 period was an "easy money" run.
I played it full out, but have been in on the long side more
sparingly since, simply because the advance was so strong and
I was concerned players would be far more nervous than they
have been.

Secondary indicators remain negative. the real price of oil has
found a less ominous upward trajectory, but a continuing
advance forms a headwind for economic growth. Also, with
the broad economy advancing and the broad measure of credit
driven money growth declining, liquidity available for the
stock market is shrinking.

The market has done somewhat better over the past 6 months
than I thought it would. The trajectory of the advance has been
unimposing, but it has been strong enough so far to raise a
doubt whether the negative secondary indicator readings have
created much of a headwind.

Monday, March 22, 2010

Stock Market Fundamentals -- Earnings

First of a three part post on market fundamentals.

The recovery of profits began when expected, and has been strong
to date, also as expected. The initial surge of the recovery was
heavily influenced by cost cutting and the lower weight given to
failed major companies in the SP 500. Net per share just topped
$57 in '09 and about $10 of that reflects a much lower cost
structure going forward.

The lead indicators for profits suggest a strong recovery trend
well into Q3 '09. There is good potential for further improvement
in profit margins as higher sales and operating rates generate
efficiencies via rising productivity and even betters spreads over
fixed costs.

Analysts are raising earnings estimates as the ecoonomy progresses.
This is a normal development. So far, estimates for 2010 have been
increased by $3 per share or 4% for the SP 500.

The $ cost of production, a decent proxy for business sales, is in
an upswing and was up 3.8% yr/yr through Feb. Measured yr/yr,
profit margins tend to expand cyclically when the $ cost of output
exceeds 5%. The volume of recovery in goods and services this year
should exceed 5% over 2009, even without taking pricing into
account. Right now, pricing power remains narrow and limited

Analysts project SP500 net per share to top $78 this year, but that
number could well be bumped up to $80 over the next month or
two. The $80 figure compares to the revised record for 12 month
eps of $91.47 set in mid-2007. Sp 500 net per share on a 12 mo.
basis first topped $80 back in 2005.

At this stage, one should take 2011 earnings estimates as they come
out with double the normal grains of salt. This is because the US
and other major economies have been supported by the largest
fiscal and monetary stimulus programs ever, and because the
authorities will feel increasing pressure to exit these programs as
recovery progresses. Numerous program exits starting in late
2010 and running through 2011 will prove a drag on global growth
even if economic recovery is fully self sustaining.

Corporate earnings growth has accelerated over the past 20 years.
Companies manage balance sheets far more aggressively than
ever before. Strong pressures to boost performance have led to
higher profit margins and return on equity %, but have led to
ever greater volatility of cyclical performance as companies shed
losers and mistakes during downturns. As a consequence, ROE % is
up, but growth of book value has been stunted. Moreover, faster
growth is less appealing when growth visibility is reduced.

Friday, March 19, 2010

Financial System Liquidity

The banking system continues to contract as banks let loans roll off
the books and boost Treasury and other investment holdings. Thus,
banking system liquidity has improved sharply. The banks are still
recording a high level of loan loss reserves, although the momentum
in the system account is slowing. Businesses -- flush with cash --
have been steering clear of the banks and are using internal resources
to finance recovering sales. Businesses in desperate need of cash are
simply out of luck. Top quality borrowers with direct access to the
nonfinancial commercial paper markets do not seem to be paring back

Over 90% of the increase in banking system primary funding levels
reflects growth in currency and checkables and this is directly
attibutable to Fed quantitative easing. The Fed is looking forward to
cutting back on this policy, but wisdom suggests that the situation
with bank private sector credit creation stabilizes first. (Keep in mind
that the basic money supply accounts for only 15% of primary bank
funding and that the Fed, rather than being profligate, has been
battling to curtail a deflationary contraction in private sector credit.)

Money market funds, both retail and institutional , are used to finance
capital markets transactions as well as purchases of goods and
services within the real economy. These balances built up sharply over
2005 -07, but have since been in substantial drawdown mode. Thus
liquidity from this sector although remaining substantial, has been
pared back.

The real economy is growing and the very broad measures of financial
liquidity have been declining modestly. Thus, by my approach, the
capital markets now face a headwind from reduced liquidity as the
real economy takes precedence.

The economy does tend to lead the broad measures of credit driven
liquidity in the system. As the economy continues to recover, it is
likely to become more credit dependent, which can, in turn, lead to
more liquidity on hand to finance the capital markets as well.

Wednesday, March 17, 2010

Monetary Policy -- Observations

The Fed left rates unchanged yesterday as expected and continues
to wind down its special liquidity provision programs.

About 70% of of key rate setting indicators suggest that the FOMC
not raise rates. The Fed is putting added emphasis on the large
degree of economic slack still extant in the system. Capacity
utilization is rising, but remains a low 72.7%. Historically, the Fed
has often waited until CU % rises above 80% to raise rates in earnest.
On occasion, the Fed has started the rate adjustment process sooner,
but the continuing large slack in resource utilization gives you a
sense of Their concern.

Note as well that the supply vs demand for short term business
credit remains rather depressed. Measured yr/yr, the growth of
primary funding (supply) has increased by a paltry 1.6%. But
shorter term business credit demand has declined by a large 18.6%.
The commercial paper market may finally be stabilizing as signs
of recovery in top quality paper issuance are being offset by
continuing weakness in the asset backed paper sector. It would be
inelegant to say the least to raise short rates while credit demand is
still falling. Note well though that as economic recovery proceeds, the
credit supply / demand situation can turn on a dime.

Massive inventory liquidation has led to a reduction in the all-
business inventory to sales ratio to a more normal 1.25 months
supply. Shrunken receivables will also recover with business sales.
Thus working capital may be bottoming finally. Business' cash on
hand has surged so a number of companies are now financing
recovering working capital needs out of internal funds.

The Fed has waved off the action in the commodities markets over
the past 2 years, believing that inflation is not likely to regenerate
on a sustainable basis in a depressed economy. Super low short rates
encourage commodities speculation, so the Fed continues to gamble
some here.

Tuesday, March 16, 2010

Stock Market -- More On The Technicals

After the market broke down in mid-Jan., I argued we would get
ourselves a tradeable rally. We got it. I also argued that a quick
breakout to a new cyclical high was an against-the-house bet. I
figured we would see a good several months of go-no-where action.
But, the long odds bet came through nonetheless. From a technical
perspective, I find this strong a rally to be odd from a timing
perspective. Odd doings are hardly bad or dangerous doings in the
market, but, for a guy like me, they are not comforting doings.

So, I am observing now not with skepticism but with wariness.
In cases like this I go strictly by the book. Right now, the book says
the market is overbought based on indicators of up to six weeks
duration and that the trend of momentum is starting to flag. The
market calls the next move.
Chris E. of Red Dirt Trader inquired about ways to capture the
action of the Value Line Arithmetic equal weighted index other than
playing the KC future contract. The main problems with offering
equal dollar weighted index funds are cost and lack of consistent
interest. Value Line itself offers only actively managed funds that
do not have the breadth of their indices. There are SP 500 EW
ETFs and index funds and there might be a Russell 2000 offering.

Valuing small / mid caps against the large cap stocks is not an
easy proposition because of data accessibility regarding earnings
especially. But, I am due to look at this issue and will post on it

Friday, March 12, 2010

Stock Market Comment

Mid and smaller cap. stocks have been the way to play the US
market for a good decade now. Recently, the NYSE adv. / dec.
line hit a new all time high. With over 3,000 issues on the big
board, the NYSE is primarily a small / midcap exchange. So too
the 1700+ issues Value Line index. The equal dollar weighted
version of the index is now trading only about 4% below the
2007 all time high.

The Value Line Arithmetic or equal weighted index has been my
favorite for over 20 years now, and the Value Line research has
provided me with more stock ideas than just about any other
product. The Value Line Arithmetic is found as either $VLE or

The $VLE has been the market leader in this cyclical advance.
In the last couple of weeks, there has been something of a mini
blow-off in the smaller guys, and the $VLE is now getting
overbought on a relative strength basis to the SP 500.

Interesting relative strength chart here.

Thursday, March 11, 2010

Longer Term Economic Indicators

I have developed a diverse set of longer lead time economic
indicators over the years. As a group, the indicators provided the
strongest positive reading late last autumn for the past 90 - 100
years. It was an arresting moment that underscored the potential
for the economy to recover. That reading was not sustainable, and
with some decay here and there, the indicators are now moderately
positive. There has been some slippage in the growth of measures of
monetary liquidity. The oil price has rebounded to a level that is
close to turning negative, and inflation and a weaker job market has
eroded the real hourly wage. On the plus side, a positive yield curve
has steepened, and banking system liquidity is repairing in good
fashion. The improvement in banking liquidity is essential to lay the
base for a new round of private sector credit expansion.

My measure of capital slack, which is helpful in assessing prospects
for the duration of an economic expansion, remains quite low and
suggests there is sufficient idle plant, labor and lending power to
sustain a lengthy expansion.

I think it is still early to tell how conservative consumers and
business will be regarding consumption and investment in this
cycle. Various measures of sales and production fell 10 -15% in
the recession. We came very close to depression readings. In a
rapid economic decline, folks move to get liquid by saving and
deferring use of credit. When a decline gets as steep as 2008 -
early 2009 was, getting liquid covers the paydown of debt where
possible as well.

We are seeing rebounds in key economic output data, but with
confidence having been shredded in recent years, some patience is
required to see how folks all let themselves back into the game.

I still support the idea of a lengthy moderate economic expansion.

Tuesday, March 09, 2010

Junk Bonds

In my view, if you are interested in junk bonds as an investment,
you have every right to demand a 10% annual return on your
money as a minimum for your trouble. It helps when yield to
first call is equal to or exceeds 10%, as then you do not have to rely
so much on shorter term price appreciation. Junk funds are best
for those who do not possess professional credit analysis skills and

In the early autumn of 2008, as the financial panic got into full
swing, junk bond composites topped 15% in yield. I mentioned back
then that this was an attractive deal because you could basically use
the current income to fund your outlay within 5 years. Of course,
the market got much worse for a brief period, but you do not often
get opportunities to earn out your capital in a short period of time
with the issuer's own money.

Now, the Bloomberg 'high yield" composite yield just broke under
9%, so I would rate the market as less interesting and see this
sector as mildly overpriced for players with something of a longer
term horizon.

There is of course a momentum element to the junk market.
Investors tend to chase yield in post-recession periods when short
term rates are low, and may well pursue the junk sector well after
short rates have turned up. A major vehicle of pursuit here would be
the sector swap, where players sell Treasuries and top quality
corporates to rotate into junk and hedge funds short the Treasury
and go long the junk. There's enough hedge fund money in play to
have sector swapping as described bring the Bloomberg composite
down to 8%. Should such occur, I would add the junk sector to my
list of prospective short sales.

If you are more comfortable thinking price with bonds, view the
iShares "high yield" corporate fund chart here.

Saturday, March 06, 2010

Economic Indicators

Coincident Indicators
There are different sets of coincident indicators available, but I
prefer a stripped down version: real retail sales, production, civilian
employment and measures of the real wage. With two straight
months of gains in total civialian employment on the board, this
set of indicators is finally positive in all categories. Since the
household employment survey is more timely than payroll data, it
appears that payroll numbers will soon turn positive as well.

Inventory Accounts
GDP data show that inventories have been liquidated for 7 straight
quarters and massively so. With sales now rising. production is
following more rapidly, and we should expect to see a positive turn
to inventory restocking which should have a significant plus effect
on GDP growth over the first couple of quarters of 2010.

Longer Term Fixed Investment
The capital stock is shrinking modestly, and as you would expect,
spending for new facilities is still falling. On the plus side, businesses
have turned to heavier investment in equipment and systems to
upgrade productivity of existing plant.

Residential construction remains depressed and is bottoming at best
and with idle space available after such a deep downturn, commercial
construction should remain subdued.

To summarise, the recovery is regaining balance, but a large
stock of unsold homes and slack in business operating rates will slow
progress in longer term fixed investment.

Leading Indicators
The leading indicator sets I follow have been in exceptionally strong
uptrends from very depressed levels for a year now. By my reading,
this suggests above average gains in real GDP out through the middle
of 2010. Since the uptrend in the indicators appears to be set to
moderate, it may well be that the progress of the economy will also
be more moderate over Half 2 '10 (not an unusual development).

The global indicators have not exhibited the strength seen in the US.
For example, there has been no increase in the % of companies with
a rising order book since 10/09, and the % of companies with
rising new orders has been quite moderate (53.6% global vs. 57.3%
US in Feb.).

The lack of a stronger rebound in many foreign economies has
been a cornerstone of the increase in investor concern re: sovereign
credit risk in that rising counter-recession fiscal spending has
exceeded the recovery of the revenue take.

Thursday, March 04, 2010

Downgrading China

I am putting the China stock market on furlough for a while. My
primary concern is that with wages rising at a far faster rate than
the inflation measures, and with pressure continuing to find new
hires on the policy front, the "safety valve" for containment is
likely business profit margins, which are sure to contract in such an
environment. The broad macro data clearly point to a price/cost
squeeze for companies. Continuation of this process over a period
of several years will prove debilitating for corporate China.
Rectification of the squeeze will involve some combination of wage
growth restraints and stronger pricing. Such would help out the
business sector, but would also put pressure on social and state
economic policies.

I am well aware that China's economic statistics lack transparency
and that its stock market does not always conform to custom when it
comes to economic fundamentals. But, if China wants my money,
then they can play the game my way. Such is the freedom a
discretionary player like myself enjoys.

I like the volatility of the China stock market and with new funds and
ETFs available, the market presents a high growth, high beta profile
that has its uses. I know I will return to it.

Shanghai Composite Chart.

Wednesday, March 03, 2010

Stock Market -- Technical Quickie

The market is in a confirmed short term uptrend. Ditto breadth,
which looks even better because of a rotation back into mid and
smaller cap. stocks. Volume continues unimpressive. The bulls
are pushing the envelope in a tentative fashion. The SP 500 has
moved up this week from neutral to modestly overbought and
has yet to evidence the strong push on good volume that would
signify a new upleg as opposed to a bounceback rally from a nicely
tradable oversold.

The market has spent 2010 so far working off a massive longer term
overbought condition and this "work off" has proceeded far enough
where the odds of further consolidation have dropped from 90%
down to 50/50.

The market did correct earlier this year during the 13-15 week
cycle low and we are moving up out of that. The 80+ day daily
cycle I have been tracking is running out of time to see a low.
So, mixed bag here so far.