Stock Market -- I Am Still On The Sideline

One rule I follow is when I foresee twists and turns ahead in a piece that I am about to write, I
lack a clear, definite point of view. So  rather than belabor the outlook for the market with a
lengthy discourse, suffice it to say that I remain cautious and happy to sit on my hands.

When I look at the technical work, the "perfect" path would be for the market to sell down sharply
this week, then rally reasonably quickly to a minor cyclical high with this to be followed by a
couple of weeks of consolidation before prospects for a more substantial correction take shape
sometime in June.

However, since tthe market very seldom rewards one with exactly what one thinks should
happen, I am going to continue to take it easy, not argue with anyone, and see if the action gives
me some better clues.

Monetary Policy

The Fed issued its FOMC policy statement today. Its intent is to keep short rates low all
the way out to late 2014 and to be on standby to provide increased monetary liquidity if
the economic recovery falters.

Post WW 2 indicators are now 75% in favor of the Fed raising short rates. Only capacity
utilization is below the threshold, and that by a scant 1.5 percentage points. But, the Fed has
fears. My broad credit driven measure of funding liquidity is up only 4.3% yr / yr. and about
80% of that increase is attributable to the prior QE 2 program of liquidity injection. In turn,
even with much improved housing affordability, banks and mortgage financiers are heavily
shading lending decisions in favor of collateral value rather than cash flow adequacy and
stability. Raising short rates would trigger long rate increases in the short run. That
would make mortgages more expensive, reduce housing affordability and could scare the
banks into even more conservative lending practice. This all would increase the supply of
housing on the market and introduce more intense deflationary pressure.

With a platform of low interest rates, the Fed is banking on an eventual recovery of the
housing market as well as a continuation of a non-residential construction upturn. Stronger
housing and real estate financing needs would expand credit driven liquidity in the economy
and reduce the need by the Fed to resort to quantitative easing. It would ultimately force
lenders to compete more aggressively for funding and begin to put upward pressure on
market short rates. As of now, the Fed thinks this process could take another two years before
private sector credit demand is robust enough to warrant more constrictive monetary policy.

Of course, if the housing / construction markets stage a stronger than expected recovery and
if it comes sooner than the Fed anticipates, well then you can kiss ZIRP to late 2014 good bye.

Commodities Market

With 1932 as a base, commodities price composites have trended moderately higher. Given the
extraordinary volatility of commodites, the top part of the historic price channel has tended to
run at 2x the bottom or base trend line. The last two huge spikes up in price took place in 1980
and 2008. For the CRB index ($CRB), The base trend line up to the historic mid - point describes
a range of 290 - 445. At 301 presently, the CRB broad commodities index is trading only slightly
above the longer term trend. Now I also use an economic model based on what I think is a
sensible production cost curve + mark - up, and that has the CRB "fairly valued" at 325 - 330.

The CRB did experience a crash over the mid - 2008 to early 2009 interval when it fell 57%.
Since then, the market has staged a cyclical bull advance until Mar. of this year, when the
market started to break below trend. $CRB Chart

The weakness in the market since May, 2011 reflects decelerating economic growth in China --
a prime commodities buyer in the world market, a downturn within the EU and not least, the
end of large scale QE by the Fed, which, no doubt, prompted plenty of speculative interest
over the early 2009 - mid - 2011 period. 

Since mid - 2011, global production growth has decelerated further and has been moderate
enough not to chew up excess capacity in rapid fashion. This has cooled speculative trading
and inventory stocking in the commodities markets.

It is noteworthy that China has begun the process of loosening the monetary reins. This could
help the commodities market going forward, but players still need to be careful as China is likely
to move cautiously in the wake of a troublesome real estate price boom triggered by the
monetary excesses seen over 2009 - 2010 when it put on a huge credit driven stimulus program.

The CRB is trading down near both long and intermediate term support in the 290 - 295 area. the
market is oversold and is reasonably valued at the current level. On the flip side, a sharp break
below support could be an alarming development as it would suggest players are growing
more concerned about a fizzling out of global real growth going forward.

Stock Market -- Daily Chart

The caution light has been on for a couple of weeks now. The daily chart of the SPX shows a
breakdown is underway following the powerful rally from late Nov. '11. SPX Chart

The market is 1.9% below its 25 day m/a. In bull runs, going long at -2% to -3% the 25 day m/a
is an ok deal, so that would be the first test here. The safer bets have been at 5% or more below
the 25 day m/a. My cycle work, which has been less reliable over the last 6 - 9 months, suggests
a cycle low should be chalked up over the next 10 odd trading days (Grab a grain of salt). A
"normal" correction following an interim strong bull run of several months duration would run
5 - 7% and would take the SPX down into the 1320 - 1350 range. Unfortunately, since 2010, the
market has been in more of a feast or famine mode (risk on vs. risk off), and price corrections
off of nice run ups have approximated -15% to -20%.

It would be lovely to rally decisively from the current modest oversold, but no one should be
surprised to have to come to grips with a 5% move below the 25 day m/a given the volatility
seen in the market over the past two years.

Note that the bottom panel of the chart shows the long Treasury which has been catching bids
recently. Long side interest in the 30 yr. bond has been a good measure of risk off trading in
the capital markets.

At this point, I plan to wait and watch for a couple of weeks as I have not yet abandoned the
idea that the market could re-start up again by then following a period of mild correction or
consolidation.

US Economic Indicators

Sales
In current $ terms, US business sales are running about 7.0 - 7.5% yr/yr through Q1 '12. This is
down from the very strong +10% we saw through much of 2011. Deceleration reflects essentially
flat export sales since last summer, lower CPI price momentum yr/yr, and a large decline in
power generation, which reflects a very seasonably warm 2012 to date. Inventories and sales have
remained in good balance. It is important to note that export sales make up about 15% of total
sales and that sales continue to be hampered by a weak EU and slower growth in China.

Input Costs
Over the past year, the pricing vs. costs spread has improved modestly. Labor costs are still
low relative to business pricing despite faster hiring as the real wage remains negative. Businesses
also continue to benefit from large net interest savings on very low credit costs. Potential for
further profit margin improvement in the shorter run is growing more constrained as pricing
momentum has been weakening relative to wage costs particularly.

Quick Output vs. Income Measure
US business output in real terms is up about 4% yr/yr. My economic power index ( yr/yr %
change in the real wage plus yr/yr % change in total civilian employment) is up a scant 0.9%.
The burden of this unfavorable spread has fallen hardest on household savings, with the
savings rate being drawn well down to finance higher consumption. Measured yr/yr, total
employment has been ranging around +1.7% so far in 2012. These have been the strongest
totals since early 2007, or right before the economy started to hit the skids. the progress in
total employment measured month  to month has been the strongest since early 2010, and
given the very uneven progress of employment growth so far in this recovery, it would not be a
surprise to see slower jobs growth ahead, although I hope I am wrong and that jobs progress
will chug along at a healthy rate.

Inflation Potential
My inflation thrust indicator made a cyclical peak in Apr. 2011. By Sep. of last year the CPI
had accelerated to 3.9% yr/yr. The inflation thrust indicator dropped sharply over the Apr. -
Dec. 2011 time frame and has remained suppressed. The CPI has decelerated to 2.7% yr/yr
in the meantime, and must continue decelerating if business holds wage increases at 2%
going forward. Otherwise, the income side of the economy could remain sluggish and leave
the economy vulnerable. It is not healthy to have to continue to count on the draw down of
savings and the use of the credit card to finance higher consumption.

Stock Market -- Weekly

Fundamentals
As discussed back on 3/23, my Weekly Cyclical Fundamental Indicator (WCFI) began to lose
positive momentum in March after rallying steadily since late 2011. This trend continued into
early April to be followed by a decline this week on an unexpectedly large increase in initial
unemployment insurance claims. So the WCFI uptrend has been broken. The coincident economic
component of the indicator has held up alright, but the forward looking elements -- industrial
commodities prices and unemployment insurance claims --  have run out of gas. Since I smooth the
claims data as do most folks who use it, The WCFI may remain suppressed for a few weeks.

Fed Bank Credit and the adjusted monetary base remain at or near levels seen at mid - year
2011. Monetary Base

The short run flat / weakish WCFI and the absence of QE may prove challenging to market
players who have relished strong positive momentum in both short run fundamentals and
monetary accomodation since the cyclical bull market began. The modest but progressive
improvement in private sector credit demand has yet to capture investor favor whose sense
of confidence has been rooted in Fed QE and positive cycle pressure gauge readings.

Technical
The strong uptrend evident in the weekly SPX price chart and in related indicators was
fractured this week. It had been "hit or miss" whether the SPX could squeeze out a bit more
upside here in April, and this week's sell off did damage. There are few saving graces on
the chart. The SPX did not break below its 13 wk. m/a, MACD although teetering did not
reverse and my 40 wk. price oscillator (not shown) fell to support. The chart has not reversed,
but it is getting ugly. SPX Weekly

Conclusion
Advanced cyclical bull markets run on credit driven and not monetary liquidity and can also
excuse a week or two of sloppy economic data. This behavoir marks confidence. We have
yet to see that in this cycle. Ditto Europe.

Stock Market -- Daily Chart

My view over the past two weeks has been that I did not see a top in view but that caution was
warranted because the market was overbought on an intermediate term basis. So, let's look at the
damage in recent days.

The very strong uptrend from the late Nov. '11 low was fractured with a sharp downside break to
a powerful uptrend line. My view has been that extended run ups at that level of trajectory rarely
last for more than 3 - 4 months without a break. This one extended just a touch beyond 4 months.
Since powerful uptrends like the one just witnessed can resume after a break and consolidation
of several weeks, the break this week is not necessarily a death knell. But, you have to be prepared
to give a situation like this a month or so to resolve even though the overbought condition has been
reduced.

The SPX chart will also show trend breaks for the 40 day RSI and a special intermediate term
MACD. Obviously further downside in these measures cannot be ruled out. $SPX

In the short run we need to watch the movements of the SPX's 10 and 25 day m/a's. A dip in the 10
below the 25 followed by a dip in the 25 can signal more downside. As of today, the market has
not dropped far enough below the 25 day m/a to signal more trouble ahead.

Note as well that SPX 1350 is pivotal as it has offered both short term support and resistance.

To muddy the waters further, you can draw a trendline up from the Oct. '11 low of SPX 1100.
This line now implies downside for the SPX to near the 1300 level and would if tested confirm
the high volatility mode in which the advance originated.

Finally, the cycle work indicates the market should move into a bottoming process over the
next 2 weeks. There was an approx. 84 day cycle in operation for the SPX from 2007 through
the early part of 2011. The cycling has since shortened to 70 -75 trading days. You should note
that the run in the market over the past 4 months blew right through these cycle measures if
only to remind us never to bet the farm on such work.

US Economy -- Analysis

If this was a normal economic recovery which came in the wake of a moderate recession, it would
probably be ok to posit that economic expansion will end around mid-2013 to be followed by an
economic recession of six months' duration. This idea would fit with the old, well established
presidential cycle as well. But what we have is a rather mild recovery coming in the wake of a
mild depression or severe recession, take your pick. My measure of capital slack, which
incorporates excess production capacity, proximity to full employment, short term business credit
supply and demand and short term interest rates has, in the aggregate, only recovered about 50%
of the slack between the cyclical low point and full, effective capacity and employment. In short,
there is substantial slack or idle resources in the system which in my view is sufficient to underwrite
another 3-5 years of continuous economic expansion.

Historically, to generate an economic downturn prior to when the economy's resources are maxed
out in the shorter run, conditions are required which generate a liquidity squeeze in the system
either because the Fed drains monetary support or because the banks remain overly wary in
providing financing to an otherwise viable period of growth. And, I guess, you can have some of
both with banks following the Fed's lead.

Now, I am of the view that the economy can keep right on expanding as long as there is enough
slack and the system can maintain reasonable balance especially between money and credit and
output and income. The Fed has maintained the money / credit balance with QE programs to
underwrite the economy while the private sector credit situation repaired. Ditto the US Gov't
stimulus and bail out programs just prior to the outset of recovery. The balance between output
and income has been far less favorable as business has opted not to reward worker productivity
but to hand out 1 - 2% wage increases instead and ultimately force consumers to draw on savings.

Except for real estate, private sector credit demand is recovering decently enough and the need
for Fed QE intervention has been slackening. To secure an economic recovery which can extend
in lengthy fashion, business must step back from the trough, pay its work force substantially better
and make sure it is adequately resourced to handle higher levels of business. Failing that, there
is no compelling reason to expect consumers to keep up their end of the bargain -- and keep it
up they have -- if you look at the critical real retail sales chart.

A final and important point. With the private sector credit situation repairing decently after the
financial blowout of 2008, it would be unfortunate for investors to throw a tantrum now because
of no apparent new QE, and trash the stock market again as happened in 2010 and 2011. This
would only serve to undermine business and consumer confidence and set back the time when
the economy can be self sustaining.

Stock Market -- Short Term Fundamentals

Weekly Cyclical Fundamental Indicator (WCFI)
The WCFI did tick up in the past week, but is exactly even with the Mar. 2 reading. Since that
point, the SPX has advanced 2%. The main reason the WCFI did not advance over the past month
is moderate weakness in cyclically sensitive materials prices (see 3/23 post for more). WCFI
flatness over the past four weeks challenges the uptrend underway since late 2011 and also
may reflect the pattern of stronger cyclical economic momentum seen over the 4Q / 1Q intervals
in recent years (see 4/6 post just below). The moral here is to watch industrial commodities
prices like copper in the period just ahead.

Quantitative Easing And Two Track Credit Results
The Fed has been cutting back the currency swap line to foreign CBs and its balance sheet has
retreated to levels seen at the end of QE2 on 6/30/11. Those players who have only wanted to
trade long with QE at their backs must now confront the recent retreat of Fed Bank Credit.

The banking system's real estate loan book has not grown over the past year, but lending
excluding real estate has advanced by 10.3 %, powered primarily by a sharp recovery in
shorter term business loans to fund rising working capital needs. The construction market is
turning around, so bank mortgage, lease and real estate development financing should eventually
improve, although the process is obviously still being impeded by writeoffs and foreclosures
in the still troubled housing sector.

When there is no QE, investors must satisfy themselves that private sector credit growth is
adequate to fund continuing progress for the real economy. That time is at hand now as well.

The Fed, The Economy & Stocks

The Fed -- Uneven Accomodation
In recent years, the Fed has provided roughly $2 tril. of liquidity to an economy that was sorely
in need of it. The process  has been uneven to say the least. The first surge of more than $1 tril.
came during the latter part of 2008. The Fed then withdrew $400 bil. at the begininning of 2009,
which resulted in the final tanking of the bear market in stocks in early 2009. Then, the Fed went
on another tear, adding nearly $550 bil. to the system through mid - May 2010 (QE1). the next
program -- QE2 -- injected nearly $600 bil. into the system over the 11/10 - 6/11 time frame.
The Fed then added another $100 bil. dollop in currency swaps in late 2011.

Economy -- Surges & Stalls
The economic recovery has roughly followed the path of the Fed's liquidity addition programs.
Over late 2009 - present, my cyclical pressure gauges have been strongest over the Q4 / Q1
intervals and weaker over the Q2 / Q3 periods when quantitative easing has been on hold. We
are now in an interval when QE is on hold.

Stock Market -- Deep Corrections In A Cyclical Bull
The steep market corrections came during Q2 / Q3 in both 2010 and 2011 as leading economic measures and cycle pressure gauges faltered. Fresh QE rescued the market in both latter 2010
and 2011 with positive carryovers into the new year.

Bonus Times For The Bears
In both 2010 and last year, flare ups over weak sovereign credits in the EU periphery became
acute over the Q2 / Q3 intervals. It's Q2 2012, and Spain, with its addled banking system and
generally weak private sector credit situation is steaming into view.

Looking Forward
My cycle pressure gauges and forward looking indicators have eased some after a strong start
to the year. QE is in abeyance and the EU's economic discontents can resurface in warmer spring
weather when folks find it more congenial to take to the streets. Private sector credit demand in
the US is continuing to recover but may not be quite strong enough yet to fully underwrite further
economic recovery.  Given how economic and investor confidence seem to reflect the status
of QE activity, another Q2 / Q3 stock market swoon cannot be discounted. The market is now
overbought, so a 5-7% decline could come along and be normal. When I say "swoon", I have in
mind the much deeper corrections experienced over the past two years.

Crystal ball gazing is not my forte. I would not argue with anyone who foresees a normal,
moderate price correction ahead, and I hope we do not get another large corrective dip. In the meanwhile, I may well be stuck for another six months with having my core fundamental
indicators still positive and with a continuing cyclical bull market call still on the table even
if the "risk off" siren calls get loud.

How about more QE? Fed chair Bernanke would take a lot of political heat and criticism if
he went ahead with further QE if the economic recovery started to flounder. But, if I read him
right, I doubt he would hesitate and I think he could get the votes from the board. I also think
the Fed would dearly like to avoid another splashy program if It possibly can. By the way, if
another QE round becomes an issue soon, you know Obama will be in Ben's corner.

Stock Market -- Weekly Chart

The weekly chart for the SPX continues positive both trend and indicator - wise, although there is
some wear from the recent loss of price momentum. The market remains moderately overbought for
the intermediate term (out to 3 - 6 months), but the indicators continue to show some leeway for
more positive price action through month's end, although the thrust of this move is rather well along.
SPX

I have also linked to the SPX against its 200 day price oscillator. The oscillator measure also
remains positive, but is close to one standard deviation above the mean. There is room for the
market and the oscillator to carry higher, but I should caution that oscillator movements above
one SD happen rather infrequently (the last one being in 2009, when there was tremendous thrust).
SPX & 200 day osc.

I plan to look at the economic fundamentals for stocks in the days ahead. There are elements
of transition to a more normal environment, but the bigger picture still shows the US is far
from fully normal on a cyclical basis.

Gold Price

Despite the downtrend underway, the gold bugz might sustain a rescue effort if they can keep the price
above the $1620 - 1630 area. Gold took another hit today when the Fed's FOMC minutes indicated
that further QE is on the back burner. This should not be a surprise, but it knocked the wind out of
the market anyway, with gold trading down again at very short term support of around $1645 oz.
For more, scroll down a couple of days. Gold Price

Oil Price -- Taking Care

Oil has experienced a mild break in the uptrend started at the end of Sep. '11. On top, both the 10
and 25 day m/a's have rolled over with oil struggling to get back above them near term. I have
argued that geopolitics involving Iran make it tough to have a trading edge here, and I have recently
reminded that we are in a strongly positive seasonal period for oil. Even so, keep an eye out
because there is short term technical damage underway. $WTIC