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 !!!

Sunday, January 30, 2011

The Fed Is Falling Behind On QE 2

The Fed started off a bit slowly in providing its promised $600 bil. of additional funds to the
financial system. It added only $11 bil. in the month of Jan. and is now well behind a sensible
straight line funding approach to meeting the $600 bil. target by 6/30/11. The Fed may simply
have followed a traditional pattern of either freezing or draining liquidity after the holiday
season, but if they are not planning to welch on the deal, I doubt there is a good reason for
holding off on stepping up the funding process straightaway. Otherwise, further delay could
add unnecessary volatility to the commodities, forex and capital markets. For example, further
delay in program execution could invite the major dealers to buy bonds and short stocks etc.,
only to reverse these trades when the Fed steps up to the plate again. With the global markets
now nervous about Egypt and oil transport security, it would be wise for the Fed to step in
this week with a significant round of Treasuries purchases.

Friday, January 28, 2011

Stock Market, Oil Price, Arab Unrest

Stock Market
I have argued unsuccessfully for several weeks that the market was due for a sharp, short
term pullback. It took the hit today as traders used weaker than expected economic news and
a spike in the oil price to take some profits. The SP 500 has broken below its 10 and 25 day
m/a's, thus signaling a possible and negative change of direction. At this point, it is wise
to pay attention to see how much, if any negative follow through takes place. SP 500 chart.

Oil Price
The oil price started the week with a contra-seasonal price decline, but the shorts moved
quickly today to cover and sent the price up around $4.00 bl. The Arab region is seeing
increasing turmoil and with a weekend ahead, the boyz, fearful of a contagion of turbulence,
decided to even up and await developments. Oil price.

Arab Unrest
It is a region of bad governments and has been for years. Global recession shook sizable
parts of the area, and now rising food prices are straining household budgets. A number
of Arab countries have watched former struggling LDCs like China, India and Brazil
arise and flourish economically, while they have chafed under corrupt regimes which have
shown little interest in providing programs to develop their own economies. Arabs in
countries like Egypt, Tunisia, Algeria and Yemen to name several have realized ever more
clearly that being backwater states need not be their lot in life. So, with Ben Ali having
been chased and people out on the streets to challenge in Egypt and Yemen as well, there
could be revolution in the making, and the capital markets are taking note. As of today, there
are far more questions than answers, and investors and traders need to be careful not to
leap too far forward of the emerging narrative.

Wednesday, January 26, 2011

Monetary Policy

My policy indicators may have all turned the corner in favor of having the Federal Reserve
raise interest rates, but the upward direction of several of them may have to continue on
for months before the evidence becomes more nearly conclusive. Specifically, producer
operating rates have recovered sharply, but are still on the low side, while short term
business credit demand, although perhaps coming off a cyclical low, is still very depressed.
If the economic recovery proceeds a little faster this year and more steadily, the traditional
case for raising short rates would be in place by very late this year.

My shorter term business credit supply / demand pressure gauge is very weak when it falls
below a reading of -7.0. In the wake of the 2000 - 2001 economic downturn, the gauge dropped
to a -9.5 in 2003 as the credit excesses of the telecom / tech / dot.com bubble were washed
out. The gauge fell to a staggering -18.5 in early 2010 following the near economic depression.
The gauge has recovered to a still very weak -8.9 and could rise to equilibrium at 0.0 by
the middle of this year. It is not for nothing that the Fed cut the FF target rate to between 0.0 -

One factor you can monitor here is the relationship between banking system holdings
of Treasuries and Agencies and the level of commercial and industrial loans. When recession
strikes, banks build liquidity by buying short Treasuries and letting C&I loans run off. On the
eve of the onset of economic free fall in mid 2008, the banks held $1.2 tril. in Treasuries
against $1.6 tril. in C&I loans. Now, they hold over $1.6 tril. in Treasuries and a little over
$1.2 tril in C&I. The Fed watches this balance carefully, and when the economy is
recovering and the banks are taking on new C&I and letting Treasuries run off, They will take
careful note of that (banking system data).

You should also keep an eye on certain market shorter term interest rates as the year progresses
to see if market players are anticipating the Fed will be raising rates. You can watch 270 day
commercial paper, 1 and 2 year Treasury yields and 12 month Libor. These indicators are
far from infallible as guides to policy, but are well worth watching.

Monday, January 24, 2011

Stock Market Valuation

My SP 500 Market Tracker is an entirely empirically based way to value the market. The
"500" kept up nicely with the Tracker in the current cyclical bull until May, 2010. The
Tracker kept on rising, but the market corrected sharply on concerns about the sustainability
of the economic recovery. The Tracker now stands with fair value at 1400. So, even with the
strong market recovery of the past five months, the SP 500 stands at an 8% discount to Tracker
value. Investors have recovered some of the confidence lost over the spring / early summer,
but remain wary.

From a fundamental point of view, the market is now trading at a reasonable 13.6x consensus
earnings for 2011, and a still reasonable 14.5x my more conservative estimate. Whether
investor confidence recovers enough to catch up with the Tracker over the rest of this year
remains to be seen.

Investors are now not worried about accelerating inflation or rising short term interest rates.
Instead the focus is on whether the economy can develop enough internal balance to sustain
positive direction so that stimulus programs are not integral to growth. Regaining that balance
is still a matter that is "on the come". The more proximate focus of investor attention is on
the continuing positive trend of earnings.

If I was a long term investor with a minimum five year time horizon, I would be cautious
about adding to long term holdings at this level as I believe true long distance positions
should be purchased cheaply. There were nice windows of opportunity through 2009 and
during the sharp correction of May - Aug. 2010, but I would not be interested in taking
on more true long unless and until the SP 500 drops to 1240 or lower. Cyclical players who
are looking out 1-3 years should find their own comfort levels by applying their own

I continue to be unhappy with the corporate world. The dividend yield on the SP 500 is
a paltry 1.8%. This means that if you are long the market you need to count on earnings
growth of 8.2% and /or an upward revaluation of the p/e ratio to earn a 10% annual return
which is reasonable for capital at risk. High earnings plowback by the SP 500 companies
over the past 10-15 years has not resulted in earnings growth faster than the long term
average. In my view, investors should demand much higher dividends.

Saturday, January 22, 2011

Stock Mkt. Fundamentals -- Directional

My primary indicators have returned to 100% positive. The basic money supply indicators
have experienced a re-acceleration of growth since autumn, 2010 on the heels of Fed
implementation of its $600 bil. quantitative easing program and intermediate grade bond prices
have ralled in Jan. For now, the Fed seems reasonably determined to complete its easing program,
with 6/30/11 set as the wind-up date. It is very likely that by Apr. /May, market players and
economists will be speculating freely about Fed. intent beyond 6/30. In the present though,
we have a classic "easy money" environment where the longs are betting with the Fed.

The economy has been growing more rapidly than has my broad credit driven measure of system
liquidity, which normally creates at least a headwind for the market. However, I would note that
retail money funds were drawn down heavily over Half '2 2010. Much of this money may have
gone into retail sales, but some of it may well have found itself into the market. I also note
that institutional money market funds, which rose over the 3rd quarter of 2010 when the market
struggled, were drawn down sharply in Q4. This development helped the market rally
as did a rotation from Treasuries into lesser quality corporates and stocks. So, there were some
broader liquidity and rotational factors which helped the market rally strongly over the latter
part of the year, but continuation of these trends cannot simply be counted on going forward.

I do expect earnings growth momentum to slow markedly relative to the longer term trend
line by late 2011, but not by enough to significantly bother market players who are usually
willing to stay positive on the market so long as earnings do not look likely to trend negative (I
often do not share investor generosity on this score).

My weekly fundamentals coincident market indicator has been rising strongly since late Aug. '10,
right along with the market. This indicator jumped very strongly in Dec. and has lost positive
momentum so far in Jan., but the main trend continues up.  (Note: this indicator is not so useful
for shorter term timing as data availability only becomes available toward the end of each
trading week. But it has its uses in the shorter run. For example, the indicator was unusually
strong in Dec. '10. Loss of positive thrust so far in Jan. could make some players more wary in
the near term.)

Wednesday, January 19, 2011

The US & China....

Today's State visit by Pres. Hu of China to the White House played to a light and fidgety crowd.
Top GOP members of Congress are passing on attending this evening's State dinner. China has
lost in the court of American public opinion, and this will make dealings between the two countries
far more difficult going forward. Now that most Americans are leery and distrustful of China, the
way will be open here for politicians to scapegoat and demagogue on China. China public
opinion has been adverserial to the US for years, and now that sense of a formidable adversary
will be reciprocated. Focus is strengthening in the US on the issues of jobs seen lost to China,
an ever rising level of subpar quality goods from China (toys, pharma, construction materials)
and questions over just how tightly the civilian side of China's gov. controls its military.

Although it is doubtful that a broader deterioration in the foundation of the US - China relation-
ship will have consequences for the capital markets in the year ahead, we are starting a new
and more tense chapter.

Tuesday, January 18, 2011

Small Vs. Big Cap Stocks

Small and mid-cap stocks have left the big caps in the dust over the past 15 years here in the
US. On a risk / reward basis, smaller caps are supposed to outperform the large, established
companies over the longer term, because the small fry aggregates contain those companies
destined to grow into much bigger companies. The preference of investors for small and mid-cap
US companies coupled with increasing diversification into foreign stock markets have played
an important role in turning  big cap measures such as the Dow 30 and SP 500 into sources
of funds over the past decade.

This year, as in the past five or so, many strategists are proclaiming that now is the time to move
out of the little guys into the bigs. Now there are some structural reasons for this optimism
centered around the poor performance over the years of many of the big cap techs like Intel and
Microsoft along with the more recent collapse of a number big cap financials such as Citi et al.
This is a good point, because there have been an unusually high number of big cap tank jobs over
the past decade.

Strategists also point to a good sized p/e ratio discount of the bigs when compared to the smalls.
This is a more challenging issue. Looking out through 2011, the SP 500 is trading at near 14x
earnings compared to near 17x earnings for the Russell 2000 ($RUT). But you have to be very
careful here. Realistically, you could project longer run earnings growth of 6.6% for the "500".
However, analysts have the Russell 2000 clocking out at 12.7% aggregate eps growth longer
term. It is proper to question whether the small / mid-caps can grow so much faster than the
major caps for years to come, and the issue would be critical if the p/e premium for the smaller
caps was much larger.

The best time to own the larger caps is when the p/e against the smalls is comparable to
that of the smaller guys, while the growth potential for the major companies is equal to
or greater than the smaller cap stocks. This does happen from time to time, and it occurs
most notably when there are big cap sectors with strong new product / services growth
such as occured with big techs and pharma some years back.

Now I also believe that the current US recovery could take a number of years to run, so
I am less skeptical of the projected earnings growth for the smaller caps than I normally
would be.

If I was running large pools of equity capital now as in the old days, I probably would be
reluctant to screen candidates on the basis of capitalization size at this juncture. I would be
inclined to let the economy run for a good couple of years before putting up  cap size screens.
I plan to return to this interesting but difficult issue in a few months.

View chart for a look at the relative strength of the Russell 2000 small cap vs the SP 500.
Note that there is currently rotation in favor of the big caps following strong end of year
2010 by the "2000."

Saturday, January 15, 2011

Earnings Indicators & Comment

Profits indicators were positive through the year and ended 2010 on a strong note as business
sales recovery accelerated in Q' 4. SP 500 profits are expected to come in at around $84, up
about 48% from a depressed 2009. S&P sales rose around 6% and margins expanded on a
reduced cost structure, with a nice portion of incremental sales falling to the bottom line.
Net revenue from the large financial services sector contracted by 11%, so non-financial
business sales were materially stronger than total sales. In addition, financials' earnings
benefited over Half '2 on a sizable decline in loan loss reserves.

The S&P estimate for "500" profits in 2011 is nearly $95 -- which would be a new record.
Many analysts, myself included, are more comfortable with a range of $90 - 93 for next year
based on reservations about continued profit margin improvement. As of now, two keys in
the outlook concern how fast oil revenues may grow and how rapidly the banks may allow
the loan loss reserve to contract as the economy improves.

The analysts have earnings progress through 2011 "back loaded", meaning the stronger gains
are seen coming over the second half of the year. Now, since the economy is entering 2011
with faster momentum, there could be upward revisions in the near term outlook for SP 500
net per share.

Looking at the longer term trend, quarterly earnings is seen as rising up to the mid-point of
the trend range. This is dramatic progress considering that the final quarter of 2008 saw
an operating loss -- the first since S&P started keeping data in the 1930's. Earnings in 2011
will come in well below trend peak levels, which would tend to reaffirm that the economy
will still be operating with considerable slack and that the potential should be there for
further significant progress provided the economy develops better internal balance as it
progresses further out of deep recession.

The dividend is projected to rise by another 8% in 2011 to over $25.50. I am not impressed.
The major corporations have a large and growing cash hoard which is earning them little.
The policy of a super high earnings plowback ratio has not boosted sustainable growth for
the SP 500. This and other aggressive balance sheet practices have only served to make
earnings more volatile on a cyclical basis. Jot me down for saying that "500" earning
power of $90+ calls for a $32 -35 dividend.

Friday, January 14, 2011

Coincident Economic Indicators

Paced by gains in retail sales, production and export sales, the US economy finished up 2010
on a stronger note than seemed likely at mid year in the midst of a brief but sudden, sharp

Measured yr/yr, output only indicators were up by around 4%. Gains in business sales and
production were strong at about 7% in real terms. The big offset continued to be the construction
markets, with new building activity down 20% from a depressed 2009 level despite some
improvement as 2010 progressed.

When the indicators are broadened out to include income and employment measures, then the
various coincidental activity composites drop to a +3% for the year on slow wage and real
earnings growth.

Monthly and weekly economic data do highlight an imbalance between the output and income
sides of the economy. The cut in the payroll tax and more stimulus goodies for businesses are
designed to boost the income side of the economy in 2011 with the expectation by policymakers
that stronger income growth will sustain moderate output growth.

Political Note: 'Tis true voters harbor deep anger and distrust of government after the economic /
financial disasters of 2008 - early 2009. But even more, there is anxiety about the future, and
most specifically about whether the jobs market will improve enough to support continued
economic recovery and further increments in home values. Since the campaigns for the Presidency
and the Congress in 2012 are already underway, politics in Washington will be judged strongly
by whether actions taken add to or diminish jobs growth prospects. The smarter course for the
Dems and the GOP would be to take bi-partisan steps as needed to better the employment
situation and let the battles for office be fought over other issues. I would not be surprised to
see grudging cooperation about growing employment and addressing the risks to the economy
from a still rising home forclosure rate. After all, the elections of 2006, 08 and 10 show that
loyalty is zilch for many voters. Since the states and municipalities are boxed in to greater
austerity by statute, it is the feds who will have to carry the ball.

Thursday, January 13, 2011

Gold Price

My view on gold remains unchanged since the early Oct. '10 post. I see the metal in a bubble
with an empirically warranted top of $1,500 oz. based on  studies of a wide range of capital
markets bubbles over the years. This view is clearly well in the minority.

The gold price has lost its positive momentum in recent weeks after rallying strongly over the
autumn to overbought levels. It has recently fallen back through the top of its primary trend
band as it did in both early 2009 and 2010. Right now this looks like a normal pullback from
a shorter term extended position. Based on my weekly chart, I would have to say that gold, which
closed today at $1,373, could fall to $1,300 in the weeks ahead and still not violate the uptrend in
price in place since late 2008. A sharp break below $1,300, should it occur, could well be a
more serious matter.

I link to the weekly gold chart below, and I would note that the 12 wk. RSI is in a downtrend
which has rarely fallen much below 50% in recent years before the bulls have moved in to
support and rally the price (gold chart). So, sometime in the next few weeks we can look to
see if the bulls do jump in again to reverse the deterioration.

I have been using the leveraged short ETN, symbol DZZ, to trade against the gold price. I
am using a small portion of trading capital to do this and have made two round trips with
a total gain of 13%. As they say, do not try this at home.

Wednesday, January 12, 2011

US Stock Market

I had been expecting the market to have a short but sharp sell off over the past ten odd trading
days because key indicators pointed to intense and seldom rewarded speculative short term
activity. There has been some easing in these measures, but not in others such as RSI and
the CBOE weekly equities only put / call ratio.

The market remains in a firm uptrend. It has been continuously but modestly overbought on my
short term price oscillator and ditto my short run market breadth measures. The SP 500 is now
running 11.7% over its 200 day m/a. That represents a moderate overbought viewed a bit longer
term. The extended view 40 day RSI is now overbought at 60+%.

Obviously, there is a correction due before long, but it is hard to be more than wary with
trending factors so solidly positive for now. SP 500 chart.

I will be brief here as a longer post on the fundamentals is coming soon. Core measures
remain positive, but there is still a headwind coming from inadequate growth of broader,
credit driven measures of liquidity. The market probably got a little extra lift in recent
months from rotation out of Treasuries into stocks, a move that does not require sharp
incremental liquidity (See chart below). My weekly coincident fundamental indicator
continues to rise, powered by a fast rise in sensitive materials prices and a hefty recent
decline of unemployment insurance claims. The coincident indicator turned up sharply
with stocks in early Sept., 2010.

Here is a chart which compares the SP 500 Spyder with the long Treasury price. Chart.

Friday, January 07, 2011

Economic Indicators / Analysis

Economic Power Index
The EPI -- yr/yr % change in real wage + yr/yr % change in civilian employment -- jumped to a
strong 4.5 in Dec., its highest reading in several years. The basic EPI was only a paltry 1.3.
Extra hours worked and overtime added 1.2, and the temporary cut in the FICA payroll tax
added  about 2.0%. With further employment gains indicated in the months ahead, the EPI is
sufficient to underwrite a significantly stronger economy in 2011. However, the current EPI is
hardly as healthy as it looks viewed longer term. The payroll tax cut is only a 12 month deal, and
one cannot count on strong extra time hours each month along the way. What is still needed, is a
much stronger basic EPI, with healthier real wage growth and an acceleration in jobs growth.

Civilian employment rose modestly in Dec., but was only slightly higher than at the 2010 mid
point and is down from the Apr. '10 level. The leading economic indicators suggest the higher
payroll numbers are in the cards, but for the last 8 months, businesses have talked the talk about
hiring, but have not followed through. with the labor market weak, companies have also slashed
wage growth to buttress profits. If this does not change for the better, do not blame consumers if
they tighten budgets some. And, if you were wondering, well you can bet your ass that senior
managers did not walk away with 1.9% compensation gains on the year. Paid like rock stars.

Capital Slack Measure
High unemployment, low capacity utilization % and near zero short term interest rates all attest
to large idle resources in the US., and underscore the Fed's concern about slipping into a
deflationary period if the economy fails to respond more vigorously. The high amount of slack
also suggests the economy can expand for a good 4-5 years easily if there is further improvement
in the balance of supply and demand for goods and services including especially credit and


Investors face challenging strategy issues in 2011. The Fed's QE 2 program expires at mid year.
The payroll tax benefit expires at the end of this year. Businesses need to step up hiring, and
the banks have to re-enter the credit market with sensible, expansive loan programs. Last year
was a poor recovery period, and the stock market p/e multiple was suppressed despite strong
profits on cost cutting. Bondholders saw handsome gains dissipate over Half 2 '10, and savers
were screwed yet again. Looking forward, my advice would be that you minimize the assumptions
you make (especially the grand ones) and srutinize your basic premises about the economic /
financial environment frequently. I am not calling for a turbulent, volatile year, but you will
need to get the basics right to do well. No coasting I think.

Thursday, January 06, 2011

Global Economy Snapshot

Paced by the US, the growth of the global economy likely did pick up in Dec. '10.
So did the breadth of inflation pressures, with the number of companies reporting higher
input prices rising to a 27 month high. JP Morgan, Chase / Markit report.

Leading Economic Indicators

The weekly leading indicators re-entered a firm uptrend at the end of Aug. 2010. The positive trend remains intact. The indicators portend continuing economic recovery through Q1 '11. These
indicators were not entirely helpful over Half 2 '10, especially as retail sales -- a coincident
economic indicator -- turned up in Jul. and has been trending positive since. Moreover, the weekly
leading data badly overstated the pace of recovery from 2009 - early 2010, and then badly over-
stated the spring/summer slowdown of this year. The data has its uses, but one has to adjust for
the substantial lack of linearity between the indicators and implied economic performance.

the monthly US Conference Board leading data is trending positive and has painted a less misleading
picture of the path of economic of economic recovery in 2010 than did the weeklies. The monthly
new orders diffusion index turn positive again in Sep. after several months of decline. It has turned
sharply higher and the reading for Dec. matched the cyclical high points seen over Apr. / May.
This indicator has also indicated the prospect of continuous recovery since 03/09.

My longer term leading economic indicator has remained postive since late 2008. Readings
through most of 2010 have been more modest than at the end of 2008, when the indicator was
exceptionally strong. The partial loss of momentum in the trend of the indicator reflects a
rising real oil price, a moderation of the real wage and the error by the Fed of tightening
monetary liquidity earlier in 2010 even as the broader measure of credit driven liquidity
struggled to stay flat. The QE '2 easing program started this past autumn will rectify that mistake
of judgment by the Fed and strengthens the indicator.

My inflation pressure gauges turned up again around mid 2010, and are in firm uptrends.
Capacitiy utilization % is once more recovering, but the real action has been from sharply
rising commodities prices. Clearly, higher inflation readings are ahead as the upturn in the
commodities baskets passes through the system.

In sum, the indicators suggest an acceleration of both the pace of economic recovery and
that of inflation as we move into 2011. In turn, the longer term indicators point to another
year of economic recovery ahead.
The long Treasury yield is an ok economic indicator on its own as it encapsulates the collective
view of investors and traders regarding the outlook for economic growth and for inflation.
$TYX chart.

Monday, January 03, 2011

Stock Market -- Technical

The cyclical bull market remains intact. The current leg up off the early 07/10 low represents
the second major up leg, with the real action not getting started until the end of Aug.'10.

The current move up is very strong off the late Aug. low and has the potential to carry the
SP 500 up to longer term resistance at 1300 by the end of Jan. 2011.

The market is not strongly overbought on my shorter term price oscillator, but internal trend
measure (ADX), 13 week momentum and intense speculative interest via heavy call buying
all signal to me that a fast, sharp sell-off is close at hand. In addition, the TRIN measure
(relative strength of down volume vs up volume), which helped me identify the Jul. '10 low
as an exceptionally sold out period, is now flashing a very strong overbought. So, I am cautious
in the very short term.

Looking a little further out in time, I am conjecturing that we could see a more pronounced
correction in the market sometime over the mid Feb. / mid Mar. time frame. I am simply
guessing that such a correction would be about 7% off a cyclical high of 1350 on the SP500.

From a technical perspective, the first step for me in 2011 is to see if a quick sell down
may be at hand in the days just ahead.

SP500 chart with ADX in bottom panel.