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 !!!

Friday, December 31, 2010

Picking Up Russia Stock Market

A goodly number of readers of the blog are from Russia. Since the view on Russia of an old
US pro might be of interest over there, I am adding Russia to my list of foreign stock markets
of interest. Russia is a resource based economy. Their market tracks well with my global basic
industry indicator, the oil price and the US stock market. The Russian market trades at a huge
p/e discount to the global average, but features well above average volatility. So, despite all
the qualms one might have about Russia's financial, legal and political systems, there is value in
the market and the kind of "beta" or volatility that would warm the hearts of most traders.

The Russian market fell around 90% in the financial panic / global recession of Half 2 '08 -
early 2009. This compares to a 77% drop in the oil price and a 32% decline in my global
basic industry indicator over the same period. Since the bottom in early 2009, the Russian
market has recouped much of the loss, but still stands about 32% below the previous high.
The oil price has made a similar recovery, and the global basic industry index has rebounded
strongly on rising production and sharply higher industrial commodities prices.

The oil market is crucial to Russian fiscal policy and broader economic strategy, and with a
global economic recovery underway, elemental risk should be only moderate for the economy 
over the next couple of years.

So, Russia looks to be interesting for traders and investors in 2011 and beyond. The market
is presently overbought in the short run, having rallied nicely along with the oil price and
the SP 500. Time for me to watch it carefully going forward as there could be some nice
tradeable opportunities next year.

See chart for comparison of Russian, US stock markets and the oil price.

Tuesday, December 28, 2010

S&P 500 Profits

With a recent strengthening of the economic indicators, profits estimates are again being
revised up, but in typical modest fashion. SP 500 profits are expected to rise 47% in 2010
to around the $83.70 level reflecting about 8% sales growth and higher profit margins from
dramatic cost cutting. The bulk of the sales increase reflects higher unit volume, with pricing
power remaining modest. Higher profit margin is somewhat overstated by a rising level of
share buy ins as cash flow rises and companies gently increase underlying leverage and ROE%.

Analysts in sum now look for 2011 profits to rise to a record $94.80 per share, for a gain of
13.3%. Confidence in this good an increase is on the rise, in line with the recent improvement
in the economic indicators and further liberalization of fiscal and monetary policy. To do this
well in a continuing environment of modest pricing power, companies will again need to show
good volume gains and further operating efficiencies.

I am using a number around $90 a share for SP 500 eps in 2011. That would represent a 7.5%
increase over the current estimate for 2010. I am using the more conservative figure because
I am not as yet willing to make more generous growth assumptions beyond mid 2011, when
the Fed must again make another decision regarding quantitative easing. Moreover, I want
time to assess to what extent companies are willing to increase hiring and whether the
markets for private sector shorter term credit will begin to loosen up.

I continue to think there is ample slack in the US economy and that recovery / expansion
can easily proceed for another 4-5 years before the system would become well and truly
overheated. This view strongly suggests further significant progress in earnings and
dividends in the years ahead.

Sunday, December 26, 2010

Stock Market -- Caution Light

The bull run in place since late Aug. remains intact. But, it is getting overbought on  an
intermediate term basis against the 13 week m/a and the 12 week RSI. Moreover, it is
extended on the 14 week stochastic momentum measure. SP 500 chart. As well, the CBOE
weekly individual stock put to call ratio is at a low 50.5 average for the past four weeks.
That is not just very bullish sentiment, it is heavy betting on a rising market that is usually not
rewarded at such aggressive levels of short term speculation.

These warnings suggest the market is likely to pull back some over the next 10 trading days
and hardly signal a major turn of events on their own. But the market has put in a solid 17
weeks without major upset and it only seems fitting that it would stiff the optimists at some
point over the next couple of weeks.

Friday, December 24, 2010

Natural Gas Price

Last autumn, when natural gas fell below $3.00 mcf, I posted that it my might be worth more
work to get up to speed on it. There was a rally, but I did little in the way of follow-up. Since
the autumn rally, gas has fallen into another bearish funk. I still think gas is interesting, as it
is now trading just above $4.00, which is a pennies premium over all-in production costs.

Natural gas was in a powerful bull market over much of the first half of this decade, as solid
fundamentals allowed it to piggy back on the strong upswing in the oil price. With hurricanes
Katrina and Rita hitting the La. - Tx  gas hubs in 2005, gas surged to a crazy $14.+ momentum
driven peak in 2005. It made a secondary top of around $13.60 in the commodities blow off
of 2008 before crashing down to $2.90 during Sep. 2009.

Natural gas demand was on the flat side over the past decade, while production rose about
10%. With a rising price trend, exploration increased and proven reserves surged 67% and
is closing in on the old record set years ago. The 2007-09 recession punished demand as new
supplies came on, leading to a large 12% increase in carry stock or stored supply. With this
new and upward trending inventory overhang, the price has remained suppressed over the
past two years. The adjustment process has been extended because shutting in gas wells
is a costly, time consuming and tedious process.

With an economy that is continuing to recover and normal weather, consumption should
rise and the inventory overhang should dissipate over the next two to three years, although
inventory will remain near  historically high levels.

With gas having a strong reserve position and with new technologies at work to produce
greater supply such as shale gas, there is no explosive pricing story here. But, smart
companies like Exxon are bypassing oil properties to develop gas reserves, and that also
means the industry will be pressing to find ways to boost gas consumption through fluids
conversion and other technologies. Gas is cheap relative to oil, but the key here is to find
practical ways to boost its utility.

Gas players who have bought contracts around $4.00 over the past decade have had the
opportunity to profit each time out. Holding gas above $8.00 mcf has not worked out well
save for the Katrina and commodities price spikes of 2005 and 2008, respectively.

Continuing economic recovery and better inventory control would support a central $4.00 -
$8.00 range over the next couple of years. Moreover, if smart guys like Exxon want to own
more gas, it may be worth thinking about.

Ahead, I want to look at UNG, the direct ETF type participation in gas.

$NATGAS chart.

Tuesday, December 21, 2010

Oil Price

Over the period from mid 2002 through mid 2008, global oil consumption rose steadily and
excess production capacity fell sharply. The oil price accelerated dramatically up as excess
production capacity was drawn down to extremely low levels. So, the world wound up with
an oil  price bubble and subsequent crash as global oil consumption fell sharply once worldwide
recession developed. The demand contraction drove a growing legion of financial "round trip"
players out of the market.

Oil demand stabilized in latter 2009 and rose this year. It should rise again in 2011, but perhaps
more moderately as inventories have remained at high levels after the desperate scramble for
crude in 2008. There is now a substantial cushion of excess or shut in capacity at the well head.

The cost of oil extraction has risen substantially on new production during the past decade, and
this has raised the equilibrium price of crude substantially. My number for the equilibrium price
is $58. bl. Most industry specialists would peg the price at around $70.

The oil price, which fell to a little above $30. bl. in the 2008 price crash, rose to the accepted
equilibrium price of $70. by mid 2009 on speculation demand would recover in succeeding
periods. The upward price momentum of the oil price has cooled substantially since it recovered
to $70. After all, there is now a much larger spare capacity cushion and supplies in storage
are very much higher now than in early 2008 when the accumulation scramble started.

The volatility of the oil price has toned down substantially over the past 18 months. It is
currently enjoying a counter-seasonal run up as players have jumped in to position ahead
of the normal seasonal rise in price over the winter months as gasoline stocks are built.

With oil consumption set to rise further through 2011, I am merely guessing a range for the
year of $75. - $110. bl. The current price of $89. is slightly overbought. One thing to
watch for next year is whether  the oil price uptrend is passed quickly through to gasoline
prices as has been happening recently. Such a development could lead consumers to
re-allocate budget commitments away from other consumer items.

Oil $ chart.

Sunday, December 19, 2010

CRB Commodity Price Composite

The CRB - Jefferies commodites composite will enter 2011 with a cycle bull market intact.
It could even receive an extra kick in Q1 '11 if winter weather in the northern hemisphere
continues cold and snowy and if China does not accelerate credit tightening, which would
allow for normal seasonal stocking there.

However, the market is overbought, and as the linked-to chart shows, has exhibited fairly
strong discipline when it gets at a sharp premium to the 40 week m/a, as it is now. It will
be instructive to see how well the discipline holds up near term. $CRB chart.

Saturday, December 18, 2010

Stock Market -- 2011

My primary fundamentals are positive and improving as we approach 2011. However, I am
more curious than bullish about the year ahead. My SP 500 Market Tracker -- based on a
long term model that derives a p/e ratio based on inflation -- indicates the market should close
out 2010 around 1370. The "500" closed on Fri. 12/17 at 1244, so even if there is a "Santa
Claus" rally, the market is likely to finish the year well below the indicated fair value. So, for
me, this represents a big miss as I had no argument with the 1370 number at the outset of the

When the model fails, it is often because the earnings expectation is wrong. A failure of this
sort is easy to adjust as a year wears on, because the earnings indicators start suggesting that the
estimate is too high or too low. It is much tougher to analyze a miss well when it is the p/e
ratio implied by the model that goes wrong. Such is what happened in 2010. I used a multiple
of 16.5x, when it looks like 15.0x would have been the better number.

Having too high a p/e in this case did reflect the very weak growth in my broader measure
of financial liquidity as well as an underlying sense of investor caution about the poor
balance the economy showed between business sales growth, which was good, and the
growth of employment which was very lacklustre over the second half of the year. In my
view, the decision by so many companies to max out profit margin in preference to adding
more staff and conducting normal working capital financing may have resulted in
the punched up earnings being accorded a lower multiple as investors were left to wonder
who would buy the higher output if employment is stagnating.

The Market Tracker has the SP 500 going to 1470 by the end of 2011. However, rather
than make a specific projection for 2011, I am going to be content to see how cautious
investors remain next year, and adjust my thinking as the year goes along. Ditto liquidity
growth, which, as of today is only visible through mid 2011 on the strength of the Fed's
current round of quantitative easing.

Thursday, December 16, 2010

Stock Market & Financial Liquidity

Measured in 12 month intervals the US economic recovery has been at a far faster pace than
has the growth of my broad financial liquidity composite since late 2009. The resulting liquidity
"deficit" primarily reflects the shrinkage of private sector credit demand which has reduced the
need for funds in the system. This has created a headwind for stocks. This headwind has eased
substantially since the spring of this year, but it remains appreciable. Looking forward, the
decision by the Fed to buy an additional $600 bil. of Treasuries through mid 2011 will ease
the strain on the broad measure of financial liquidity, which increased by a tiny 1.2 % yr/yr
through 11/10 (and was essentially flat adjusted for inflation). But that $600 bil. pool will
be subject to claims by the real economy as well as the capital markets, so contrary to what
a number of commentators have said, it's not all gravy for the capital markets or the inflation
rate, for that matter.

The leading economic indicators point to a continuing acceleration of the pace of economic
recovery in the months ahead. Moreover, inventory investment by business, which badly
lagged the economy during most of the current recovery, has been catching up. Now, the
recovery of business sales and continued cost cutting has provided a sizable surge of
business sector cash flow which has been more than sufficient to fund expanding working
capital requirements, and, we will have to see whether rising new order books can
continue to be funded internally or whether business will need to increase shorter term
borrowing for working capital and to invest more in adding new workers.

Increased business borrowing would add credit based liquidity to the system, and that
would, other things held equal, diminish further the headwind the stock market faces.
Naturally, this more normal funding activity would come at a cost down the road in the
form of higher short term interest rates. But since rates are so low, the stock market
can accomodate the early phase of rising rates.

Investor caution and the liquidity headwind the stock market faces have trimmed 1.5
points off the p/e multiple based on 2010 earnings by my reckoning. We shall have the
headwind in place as we move into 2011.

Tuesday, December 14, 2010

1) Stock Market Quickie 2) Monetary Policy Quickie

Stock Market
The SP 500 made a new cyclical high near 1242 today, but NYSE breadth and my buying
pressure gauge are not confirming this high. The  NYSE TRIN index did show strong
buying pressure over the past two weeks, but the non-confirmation of breadth suggests
there are sectors and issues that are overbought and are holding back the broad market.
Watch carefully in the days just ahead.

Monetary Policy
I'll skip doing a FOMC wrap since such will be all over the web. But I did want to note that
my interest rate policy gauge has slipped from a 50% chance the Fed will raise rates soon down
to 25% on a weakening of non financial commercial paper activity. Now, although both short
term business credit demand gauges are now negative, they are in basing and bottoming patterns.
Thus, if the economy broadens in recovery momentum beyond stronger retail sales in the
months ahead, we'll need to see if  business credit demand reverses to the upside. Make a note,
as such developments would likely wind up giving me a reading of 75% in favor of raising
short rates and set off  Street chatter that the Fed is falling behind the curve.

Sunday, December 12, 2010

Financial System Liquidity

We are now nearly 18 months into a US economic recovery, and the loan book of the banknig
system continues to contract. By post WW2 standards, this is a truly extraordinary story,
although it is an understandable one given the depth and duration of the preceding recession.
At its peak in Half 2 '08, the system's loan book was about $1.5 tril. or 8.2% over the long term
growth trend. It is now only $220 bil. or 3% above the long term trend. The system is still
carrying loan loss reserves in excess of $200 bil., and there has been but modest improvement
in the ratio of nonperforming loans to total loans. There is ample liquidity on the system's
balance sheet and lending standards are starting to be relaxed. However, the banks are behaving
with great caution.

Consequently, the boad measure of system liquidity to include the basic money supply and
primary funding tools has incresed only slightly from it's recession trough and remains a bit
below the historic peak seen in late 2008. This is true despite the very large injections of
liquidity by the Fed ($1.5 tril.) to stabilize and grow the system since latter 2008.

From my perspective, the recovery has primarily been a "cash and carry" affair, with the
Fed's large liquidity infusions being the lifeline for the recovery.

With system cash and checkables accounting for only 16% of the broad measure of cash plus
the broader array of deposits and funding vehicles like commercial paper, the burden on the
Fed to supply supporting liquidity is enormous.

We are very much in the kind of situation the Fed and the economy faced in the years
after the Great Depression trough, when private sector credit availability was contracting.
Then as now, there is pent up demand for goods and services, but the very narrow base
of liquidity expansion reduces the visibility of growth nonetheless, and, with the Fed serving
as the main game in town, confidence stays restrained.

The consumer has begun to loosen up and spend more here in the closing months of 2010,
and now time is at hand for business and the banks to respond more positively with jobs,
investment and credit.

Friday, December 10, 2010

Stock Market Comment

The weekly cyclical fundamental market indicator remains in a firm uptrend off the 8/30/10
interim low and has been moving up faster than the SP 500. This result is partly a consequence
of investor preference for mid and smaller cap stocks as well as for selected foreign markets.
As well, investor confidence is lagging some, reflecting, I think, concerns about the weaker
credits in the EU and continued firming of China's monetary policy. On a weekly basis, the
correlation of the SP 500 to the cyclical indicator has dropped from +.7 down to +.64.

The market did break above resistance as the week wore on. We have new cyclical highs and
confirmation that the second upleg of this cyclical bull is intact. The shorter term uptrend has
been re-established, and I have the market as still mildly overbought.

SP 500 short term chart.

Thursday, December 09, 2010

Treasury Bond Strategy Factors

Today's post builds upon yesterday's entry on the Long Treasury bond. Here I want to look at
strategy factors and the difficulties involved in devising workable strategies.

Long term interest rates are sensitive to the trend and level of short term rates. There are
effective models one can use to get a fair bead on where bond yields should be when short
term rates are at moderate levels. Such is not the case when short rates are at extreme levels.
There is an extreme now with the 91 day T-bill rate at just around 0.15%. Moreover, since the
Fed has no intention to raise short rates in the near term, there is not a solid model application
here for the bond. My very long term model for the level of short rates based on inflation
factors implies the T-bill should now be yielding about 3.0%. My very long term model
for deriving the long bond yield from the short rate says I should multiply the bill rate by 1.5x.
The model implies that the long Treas. should now be yielding 4.5% (3.0 x 1.5), which is
close to the present yield for the bond and which also suggests bond players are assuming
that short rates will eventually rise moderately. This hypothetical run-through is interesting

To protect purchasing power, a bond needs to provide current return and re-investment of
interest received return  which exceeds inflation by a meaningful degree. With the current
CPI running about 1.2% yr/yr, the old rule of thumb is to add 300 basis points to the CPI
reading to get get a fair yield for the T-bond. This informal model puts the "proper"
yield for the bond at 4.2%.

Another approach I have used in recent years is to deduct a 3% inflation assumption from
the yield on the 30 yr. T-bond.  Experience shows the bond tends to rally in price when
there is nearly a 200 basis point premium over the 3% CPI assumption and to not do so
well when the premium is only 100 basis points or less. See chart. (Note too, the
sensitivity in yield to industrial commodities  prices such GS's industrial metals composite).

There have been few periods in US history when the inflation rate has sustained above 5%
for an appreciable period. Mostly, these inflation surges have come around war time when
resources are heavily in demand. However, if you wanted to look out past a few years and
were concerned that inflation could average 3% for a sustained period, then my work
suggests the T-bond yield would have to rise to 6% before it offered decent value. And, it
will do precisely that on evidence of a sustainable acceleration of inflation pressure from
the present low level.

With a rise in the Treasury's funding requirements, bondholders should expect a premium
to be built into the long bond yield to cover a much heavier supply of new debt and a
higher level of re-funding. I do not see that yet, but if confidence grows further in other
riskier markets, it may appear and could add up to 100 basis points to the bond yield.

In summary, the T-bond is reasonably valued now given the low levels of short rates and
inflation. Obviously if the recovery continues to advance, broaden out more and solidify,
then it would be no stretch to the see the long Treas. move up to 5.25 - 5.50%.

Wednesday, December 08, 2010

Long Treasury Bond

In posts dated 8/19/10 and 8/24/10, I argued that the long bond was strongly overbought and
that it was overdiscounting a presumably weaker economic environment. I stated that the $USB
which was trading around 135 could lose up to 20 price points in a correction, and warned that
with large pools of fast money such as hedge funds in the market, change could be fast and
dramatic when it came. Well, today the future is trading around 121.8 in a downtrending market.
The market is now oversold, but since major support lies down around 115, one needs to be
careful $USB.

The sharp reversal in the market reflects several factors. Shorter run leading economic
indicators turned positive in late Aug. and, consumer spending has strengthened. The Fed's
commitment to a quantitative easing of monetary policy gives concern to Treasury players
that economic growth potential may be enhanced. Inflation pressurge gauges have started to
rise here in the autumn, and finally, an outline of a "tax deal" between Pres. Obama and
congressional GOP leaders contains modest additional stimulus which would aid the
the economy but boost the budget deficit as well. 

the long Treasury yield has been anchored by a near zero 91-day T bill yield and a volatile
but low inflation rate. Seasoned bond players know that as an economic recovery progresses,
inflation pressures eventually build as does credit demand. The normal response of the Fed
is to cite inflation pressure and raise short term interest rates. There is little risk the Fed will
so respond in the months straight ahead, but a firming economy can bring more inflation
pressure and sour bond players on the bond even so.

The long Treasury has moved into oversold territory on both technical and fundamental
grounds. However, the long bond could easily fall to $115 support  and the yield could
easily rise to 4.85% resistance in an environment of firming production and rising
sensitive materials prices even as the Fed sits on its hands. There is not enough of an
extreme yet in the market level or in sentiment to warrant more than a long side trade
for an interval too short to suit my taste. I would also point out that bond players tend to
close their books for the year by mid-Dec., so liquidity in the market gets very thin.

I would suggest that should the long Treasury yield move up to and through the 4.80%
level, there would be a rather preliminary indication that the 30 year long bull market
in bonds could finally be winding up. Although such a development could trigger a torrent
of bearish commentary on investment sites, best to remember that a number of other
pieces of the puzzle would have to fall into place to legitimize the claim that the bull is

Long Treasury Yield.

Tuesday, December 07, 2010

Stock Market -- Short Term Technical

This one will be a quickie. The minor run-up in the market so far in Dec. has not yet
been strong enough to offer much to get excited about. The rally came off a mild oversold
and is encountering resistance at a mild short term overbought level. A continuation of the
upleg off the Aug. EOM lows should have more upside zip than has yet been exhibited.
The SP 500, which closed today at around 1224, should have no trouble moving right on
up to the 1250 level if this is going to be a solid upleg continuation and not a head fake.

I have linked to the "500" chart below and at the bottom of the chart is a panel showing the
% of stocks within the index that are trading above their respective 200 day moving averages.
When this index tops 80%, it normally signifies a higher degree of risk in the market, although
during powerful run-ups in stock prices, the % above the 200 day m/a can remain elevated
for extended periods. Even so, players should recognize that the market's risk level has moved
up since the summer.

SP 500 chart.

Friday, December 03, 2010

Economic Indicators

Both weekly and monthly leading indicators remain in uptrends which did restart in the
latter part of Aug. The linearity between most of these series and eventual economic
performance has declined primarily reflecting the increased volatility of sensitive materials
prices. In sum, though, a re-acceleration of both US and global economic recovery is

Weekly and monthly coincident indicators have also turned up since Oct. following an
extended flat period running back to Jul.

The slowdown of economic growth experienced over the late spring and summer of this
year lead initially to a flattening of total US civilian employment followed by weakness
in both Oct. and Nov. As a consequence, the unemployment rate has moved back up to the
9.8% level. The combination of nominal real wage growth and a weaker employment
picture over the past six months has substantially undercut the visibility for continued
economic recovery in the US. The recent decision by the Fed to accelerate the growth of
monetary liquidity and fresh life to the leading economic indicators are welcome
developments as is the faster growth of retail sales in recent months. However, if business
remains reluctant to hire and continues content simply to reap gains from a lower cost
structure, the odds that the economy will eventually sputter and cease recovering will
inevitably rise significantly as 2011 wears on. Ditto the banks, which are experiencing
a rising trend of earnings from a drop off in loan loss reserving as opposed to profits
gained from an expanding loan book.  

Thursday, December 02, 2010

Energy Sector

Back on 10/15, I mentioned that the energy sector stock group was starting to  reverse a decline
in relative strength in place since the bursting of the oil price bubble in mid 2008. I mentioned
several factors to account for the positive turn: The oil price has resumed a positive trend
following a sharp pullback over Apr. / May 2010. The natural gas price is building a base after
a huge price decline from mid 2008 through Aug. '09. These two factors in a recovering global
economy provide the basis for a positive turn in earnings for the industry. As well, continued
recovery will eventually return increased pricing power for oil especially as capacitiy
utilization at the wellhead rises. Thus, the sector may be expected to offer relative strength in
earnings, too.

When there is a sharply positive turn in relative strength for a sector against the broad stock
market following a significant period of decline, it is well worth notice especially if the
positive movement in relative strength is appreciable. This means investors are changing their
outlook quickly with some zeal and are doing re-positioning in favor of the group.

One caveat: The XLE energy sector is a market leader now but is coming up on a short term
overbought situation. XLE

Wednesday, December 01, 2010

Stock Market -- Short Term Technical

The recent sell off eliminated the overbought. I did not like the idea of calling for a correction
without a clear cut break of shorter term trend. The market bent down but did not break.
Today was akin to a do or die day to determine whether the market was set to break down
and head sharply lower. Lo, and behold, we get a dramatic 2% up day instead, which reverses
the nascent downtrend and leaves the market in neutral territory.

The chart link below shows a series of tests of support for the SP 500 around the 1180 area
followed by today's big bounce. This is an encouraging sign for the bulls, and if the market was
coming off a deep oversold, I would be even more encouraged. However, there was no
deep oversold, just some volatility around a very mild oversold.

I would then be looking for positive follow through. I would like to see the 10 day m/a, which
reversed up today, rise through the 25 day m/a and for the 25 day m/a to hold up as well.

Today was an impressive move up from well tested short term support, but since it may just
represent a sudden short squeeze, I think it's fair to ask for more upside here, especially
since the market is hardly overbought and could easily run another 4-5% if the upleg which
started at the end of Aug. is truly set to resume.