Eurozone Status Check

The EZ continues to operate with too little monetary / financial liquidity to support economic
recovery. There had been a moderate bounceback in output from the deep recession of 2008 -
09, but the Euro area is down again this year, with declining production reflecting how even
a modest acceleration of inflation absorbed the very low rate of liquidity growth. Euro Produc

Euro stocks initially reached bear market levels at summer's end 2011, and have rallied a few
times since as the key EZ political players have tried to fashion programs to stabilize the market
for weaker sovereign credits as well as shore up a seriously overleveraged banking system.
Even though output has declined, the broad stock market has been able to hold support at or
around the 2011 lows as investors have looked forward to a period of renewed economic
recovery over the second half of this year. IEV / EURO 350

Modest fiscal stimulus is on tap ahead, and it appears the ECB will be better enabled to
re-capitalize area banks as needed on a more timely basis. This new development should
reduce a reasonable portion of the stress on the area's financial markets as it will allow more
direct intervention on behalf of banks experiencing well above normal withdrawals. The
EZ economy is subject to being lifted, if only temporarily, by confidence building measures
from the authorities. With "fiscal union" still on the drawing boards, The ECB and local
central banks must pressure the Bundesbank to allow the central banking facilities to
provide more money to the now credit starved system. With area unemployment at 11% and
inflation decelerating on a cyclical basis, success here -- still doubtful -- may be critical
to providing a stronger framework for recovery.

As a US guy, I have had no need to play in Europe's markets since the early 1970s. But
as the bottom panel on the chart shows, Euro stocks have been seriously underpreforming the
US market and some value may be developing. But, first, the ECB needs to collect more
power, even if on the fly, to help the zone get back on its feet.

Stock Mkt. -- Fundamentals & Strategy

Fundamentals
Longer term readers will recall that I turned bullish on the stock market at the end of 2008. It
has been quite a ride. The very best time to own stocks is when interest rates are low and the
Fed is adding liquidity to the system (QE) to push the economy forward. During these periods,
you are trading high return for the assumption of low risk. With no QE in the system now, and
with very low private sector credit growth and grossly uneven distribution of income both in
evidence, the US economy and stock market are both skating on thin ice. The continuing low
visibility for further economic recovery is reflected in a major suppression of the stock market's
p/e ratio and unusually large credit yield spreads in the corporate bond market for this point in
the cycle. The economy can continue to expand if the credit markets thaw further and if the real
wage can continue to improve without a weakening of employment that may come with lower
inflation but less economic demand. The risk to the economy is now elevated and as I have said
recently, the Fed is gambling with the recovery.

I see the Euro zone ticketed for a deflationary recession ahead in the absence of a substantial
easing of monetary policy and perhaps large local stimulus plans as well. In addition, although
I agree that Euro bank leverage is far too high, the regulatory order to deleverage substantially
in the years just ahead is imprudent and carries large risks well beyond the EZ to Asia where
businessess have been highly dependent on EZ banks for trade finance. On to China. When I
started the blog in 2005 I referred to Hu and Wen as the new running dogs of capitalism. I
regard these guys as political hacks who further championed China's mercantilism, and the
acceleration of gross imbalances within the economy. The 2008 stimulus program, although
impressively grand, was largely a monetary and credit affair. With China broad money
supply reaching 30% yr/yr and with loan growth far above output potential, Hu / Wen
produced "banana boat" economics which left the PBOC with one of the largest monetary
excess mop up jobs ever. They are still struggling to get the ship properly righted. The US
cannot escape being affected by these difficult problems.

Stock Market Strategy
You can make money in the stock market without QE by the Fed. But you are taking on more risk,
risk which intensifies the longer the Fed stays on the sidelines or reduces its balance sheet in
real terms. If private sector credit is flowing freely, the market can do fine. I use very little
capital to go long the market during these periods because all of the big bear markets have come
when monetary liquidity, as opposed to credit, is flat or shrinking. Nice credit flow can ward
off the day for a while, but the bear will catch up with you sooner or later.

So, I'll do some long trades with light capital and some short trades with heavier capital and
I'll also watch the Fed carefully to see if : a) They have a positive change of heart; or b) They
are pushed to extend large currency swaps abroad. If circumstances are not too dire, the
latter could prove rewarding since the Fed is injecting liquidity into the mix.

Oil Price

I remain interested in a possible long position in oil. This is an oversold market which is still
trending down in price. It is at significant discount to its 200 day m/a, shows as oversold on an
extended 40 day RSI and sports an attractive below 10 + DI on the short term ADX measure.
Oil normally winds up a period of seasonal weakness over the mid-jun. / mid-jul. interval.
But I plan to buy on an upturn in price with some short term support behind it. No clear entry
yet, and I may have to give it a few more weeks especially since Fed QE 3 is presently only a
sideline option. WTIC Chart

The $80 -100 bl. range shown on the chart reflects my expectation of the likely range over the
remainder of 2012.

Gold Price -- Bugz To Be Tested Again

A graceful bear market is developing with gold. The bugz, however, have made repeated stands
down around the pivotal $1560 oz. area and are about to have that bullish resolve tested again.
Gold Price Chart

The downtrend in the gold price since late summer 2011 reflects the deceleration of global
economic growth momentum and the absence of further QE by the Fed with exception of the
$100 bil. currency swap line the Fed put in place over the early months of 2012 and which has
been largely unwound. The late 2011 - early 2012 surge in the gold price may have also
reflected the ECB LTRO liquidity injection program od 12/11.

So the gold price is moving down toward an oversold on RSI, a move that has brough the bugz
out each time since gold started its cyclical advance in late 2008. the positive trendline of that
advance has been broken. The 200 day m/a has rolled over and the gold price has not even
tested it for a couple of months. So, it has come down to the pivot at $1560. Note, too, that
the rallies off that line have been weakening and that prior support in the $1640 - 60 area
has turned into resistance.

With the Fed now on the sideline with QE, the bugz have a stern test just ahead.

Stock Market -- Daily Chart

The Jun. rally off the 6/1 interim low did start with some classical features: The 6/1 level of
SPX 1272 was more than 5% below the 25 day m/a. The market was also "sold out" on breadth
and selling pressure measures, although not on volume. The rally has been strong enough to
reverse the downtrend in place since late Apr., and has been confirmed by rising 10 and 25 day
m/a ' s plus a positive cross of the 10 over the 25 day. SPX chart Note as well the positive turn
to the time-extended MACD I use. The light volume in evidence over the spring has been
extended during the rally.

On a price momentum basis, the rally is at an important short run juncture in that the SPX, at 2.9%
above the 25 day m/a is at a point where many of the up moves in the market since the early 2009
cyclical lows have been temporarily clipped. Thus, there may be some short term traders who
would be happy to book some profits. I would also note that since 2010, extended moves up in the
SPX to 5% above the 25 day m/a have turned out to be "sucker plays" that preceded price
corrections. This observation may have no relevance for the near term future, but is worth
keeping in mind if the bulls push the SPX up further in the days straight ahead.

Monetary Policy & Lady Luck

Federal Reserve Bank Credit is about where it was on 6/30/11 when QE 2 ended. There was a
nice positive jolt to liquidity during the winter when the Fed did currency swaps which added
$100 bil. or 3.5% to the Fed's balance sheet, but that has largely run off. The economy is now
running on what I think is inadequate credit driven liquidity, which when viewed generously is
running at a little over 3% yr/yr. Now the private sector credit situation is improving but it is
thawing out so slowly, that to rely on it to support further economic expansion, puts you in the
position of counting on a sustained warm smile in your face from Lady Luck. I am in the small
minority camp which thinks the Fed is gambling with the US economic recovery and that in the
absence of a speedy, broad based and sizable acceleration of credit demand, the Fed needs to
step in and provide a more open ended QE program until the credit markets come into better
balance. I'll be happy to take a large currency swap program in the interim, but foreign central
banks have to request it, and they'll do that more out of desperation than not.

The economy is not only dysfunctional with regard to private sector lending, it is also
dysfunctional with regard to the real wage and the distribution of profits. Thus, with continuing
low wage growth and no indication this policy is about to change, even a robust new QE
program will have limited success as rising commodity prices will ultimately push up the
inflation rate and further punish the real wage. But, more QE should help business confidence
and provide for some further progress in unlocking lending.

I think the US needs much larger fiscal stimulus to support the economy, but at present, official
Washington is at powerful loggerheads with interest tilted more toward cutting spending than
increasing it. This leaves the Fed as the main game in town, and unless Lady Luck smiles down
brilliantly and sustainably we could be the worse for it without a hefty new QE.

Economic Analysis -- US

My primary gauge for economic momentum -- the yr/yr % change of the dollar cost of industrial
production -- Was +6.5% through May. It has understandably decelerated from the strong initial
recovery "bounce" of nearly 10% seen in mid-2010. Monthly yr/yr readings so far in 2012 have
been in a range of +6.0 - +7.5%. Modest improvement in US output has been offset by weaker
export sales. A swing below +5% would signify possible downturn trouble. This measure has
supported expectations for profit margin expansion until very recently as a decleration of inflation
has led to reduced pricing power. Price vs. cost work for business now suggests the development
of slight downward pressure on profit margins.

This year started strongly, but my weekly and monthly shorter term leading indicators are pointing
to a further slowing of recovery momentum ahead.

My economic coincident indicator combines the yr/yr % change of four key factors -- real retail
sales, industrial production, civilian employment and the real wage. I equal weight them in
the calculation. The economy is strong at +4.0%, and is expanding normally at 3.0%. The latest
reading through May was a subpar +2.6%, and this reflects still low but improving employment
growth of 1.8% plus a 0.0% change in the real wage. The combination of a flat real wage and
sluggish employment growth does not support the idea of faster economic growth on a more
sustained basis.

My longest lead time cyclical indicator is Federal Reserve bank credit (FBC). It is down yr/yr
on an inflation adjusted basis. This signals to me that the economy must grow more credit
dependent to expand, often a normal development. With fiscal policy more constrained and with
my proxy for private sector credit demand rising only in range of 2 - 3%, I am not encouraged
by the credit situation, which is indeed recovering too slowly.

Stock Market -- Daily Chart

The recent bounce in the stock market remains unconvincing. The SPX has been unable to take out even minor resistance at 1325 and then again at 1332 and has failed at the 25 day m/a. On balance, a
downtrend remains in place -- lower highs and lower lows as well as a receding 25 day m/a. $SPX

The psyschology of trade is difficult here, too. Numerous reports in the financial media suggest
further monetary accomodation and stimulus in key quarters to complement the recent easing action
in China, but nothing concrete has yet been forthcoming. Moreover, with a big EU summit slated
for late June and with Italy's reform programs hitting snags in Its legislature, the bond guys have
put Italy's gov. bond into play, perhaps as a way of forcing the EU's hand. In this kind of
evironment the risk on trade can be very tricky business in the absence of solid news that
players can jump on with gusto.

Stock Market -- Weekly

Fundamentals
T'was a nice bounce last week which ran counter to the weekly cyclical fundamental indicator.
The WCFI declined yet again last week on continuing weakness in sensitive materials prices.
Investors and traders adopted the assumptions of more monetary / fiscal support through key areas
of the global economy and a settling down of Spain's private sector financial system (bailout
funds were offered). The Fed's balance sheet shrunk slightly further last week, signalling no
easing immediately at hand. Players wound up the week taking good news as "on the come" or
out ahead -- China monetary easing, G 20 worries about growth, the upcoming FOMC meeting
and yet another Euro summit with the US and the rest of non-Euro G20 breathing down Merkel's
neck. Positive breezes, but breezes nonetheless.

Technical
Last week's rally came off "sold out" readings for breadth and for selling pressure per share, but
there was no strong "give up" volume to mark the end of the downturn as there was in the late
stages of the 2010 and 2011 price corrections. My weekly chart remains negative and the
intermediate term sell signal of early May remains in effect. The chart indicators have not
turned positive and show further room to the downside. The weekly SPX chart has been very
helpful over the past couple of years, so it has my respect. $SPX weekly

I did not post the SPX daily chart. It looks a little better, but price failed to take out the 25 day
m/a, leaving me with the same uncertainty as the weekly. I will probably watch the shorter
term action carefully this week to see if the rally does have any legs beyond last week's pop.

US Economy & Stock Market

Economy
The US economy continues to recover, but remains fragile. I am concerned about three factors.

1. When seen in the aggregate, or collectively, US business continues to behave stupidly. Yes,
corporate profits have recovered dramatically, with earnings moving into new high ground. But,
managements are not rewarding most employees for a substantial improvement in productivity.
Handing out wage increases of 1-2% adds to profit margins, but with inflation topping 2%, the
real wage remains negative, forcing most householders to dip into savings to boost consumption.
Retail sales have improved very nicely, but should consumers take a few months off to boost
the now low savings cushion, the economy will become vulnerable in a hurry. It is my belief
that corporate greed re: profit margins is a major reason why the market's p/e ratio is well
below normal for a low inflation environment with rising net per share.

2. The media has spotted a trend among US manufacturers to bring more production home and
is also smitten with the new growth of US hydrocarbons production . All well and good.
However, over the first years of recovery through mid - 2011, US export sales increased by
roughly 25% per annum, and contributed very substantially to economic recovery. Over the past
year through Apr., such sales increased by only 3.5%. So, there has been a dramatic deceleration
of export sales growth owing to sharply lower global growth.

3. When banker behavoir is viewed collectively, they are behaving as stupidly as they were
over 2003 - 2007, when they threw money at folks coming in for home loans in an overheated
housing market. Now, bankers are freezing out even well qualified borrowers because of a
preoccupation with collateral value. Naturally, if lenders remain dumbly conservative, the
collateral values have little chance to recover much. Since the wealth of most Americans is
tied up in residential real estate, super conservative bankers are contributing to the pressure
on household wealth and are greatly inhibiting prospects for a recovery of housing and
consumer confidence. As well, Tea party adherents who freaked out over the prospect of
US Gov't aid to the distressed real estate market now see the fruits of such behavoir : deeply
depressed home values, including their own. Vibrant real estate activity contributes to the
liquidity in the financial system and in that regard is a positive for the stock market.

Stock Market
The fragility of the US economic recovery and the slowing of growth momentum of the global
economy suppress the capitalization of earnings (p/e ratio).  But there is another important
reason why stocks have only drifted modestly higher over the past two years. There is not an
abundance of liquidity in the system. Money market fund cash reserves have been drawn down
sharply over the past two years, and my measure of broad based, credit - driven financial
liquidity is up but 3% over the past year, far less than total US business sales. There is
precious little loose change around for stocks. Now, there is a very large trove of money in
the US Treasury market. Viewed long term, Trasury notes and bonds are hyper- inflated. But,
to shake that excess money out of Treasuries for more than a trade is going to require a
far more balanced US economic recovery / expansion than what we have seen to date.

And this brings us to the Fed. Should inflation continue to decelerate and veer toward deflation,
the Fed would have an eminently justifiable pretext to step in with a sizable new QE program.
Inflation which goes south of 2% and an unemployment rate of over 8% would leave the Fed
little choice.

Fiscal policy? It has been too conservative in my view, and it is too early in this election
year to tell whether official Wash. DC will make things worse.

Euro Area -- My Bottom Line Case

In terms of critical measures such as monetary liquidity and broader, credit driven liquidity Euro
area monetary policy has been too tight over the past four or so years. It is not replicating the
 liquidity tightening in the US evident over the 2004 - 2008 period, but the results could be
very hazardous noetheless. In recent years, the EZ has experienced sizable deposit withdrawals and
bank dis-intermediation, and, by imposing new capitalization rules on its banks, the EZ is
inviting banks to reduce admittedly high leverage via cutting asset holdings. Thus, the Euro area
is experiencing both inadequate liquidity growth in real terms and a developing credit deflation
in real terms. These squeezes do not just invite economic weakness, they invite more serious
deflationary recession. ECB money / credit  Money, adjusted for inflation, is starting to disappear
from the system.

US history shows there is a decent relationship between the duration of a liquidity squeeze and
the severity of the subsequent economic downturn. The Euro area is now cruising along toward progressively more treacherous waters, which when reached, could produce a broadscale economic emergency. The longer the EU waits to commit to reliquifying its economy, the worse the losses
in output, jobs and social stability are likely to be.

Now, the Euro area recession does show signs of deepening and broadening. So, EZ officials
are likely going to have to provide fiscal as well as the critical monetary support to avoid far
deeper problems down the road.

Diverse politics and the cumbersome structure of the EZ power centers have made this process
very frustrating for investors and traders. If I was a younger guy, I suspect I would be quite
fascinated with this very important piece of history playing out in front of us. But, as an
emerging geezer, I think I'll stick with the monetary tools I've learned watching the Fed for
nearly 50 years and keep my eye on what the ECB does and shows datawise.

Hopes have taken an upswing with another EU summit out ahead for late June. Note on the
accompanying chart of Euro Stoxx 50 how key indicators are trying to bottom and note as well
the large surge of volume that went with the recent sell down. Euro Stoxx 50

Commodities Market

As the momentum of global economic growth has slowed further this spring, the commodities market
has suffered substantially. It has broken important support as traders have become progressively more
concerned about the global economy and the outlook for China in particular. The China economy
has slowed precipitously and so far, monetary policy accomodation and proposals for new fiscal
stimulus have been muted as China policymakers look at more modest support for the economy in
preference to a large scale program like 2008 - 2010, when sizable "fat tail" risk arose in the
form of more inflation and an unsustainable real estate boom.

Well, I have not given up on the global economy for this cycle yet. With business confidence easily
shaken both here in the states and abroad, it would seem that G 20 may want to look at the potential
for more stimulus at its mid-year confab, and as announced today, G 7 may want to look at how it
and the EU can provide greater assurances of available liquidity for a stressed southern tier EU
banking system.

So, with commodities under pressure but substantially oversold, I am happy to look for trades
here, particularly broad baskets. I would also look first for a positive turn in the broad market
like the CRB composite. Here is the CRB chart.

I also link to my Apr. 24 discussion of the commodities market here.

Stock Market -- Short Term

Technical
Following a suspect and uninspiring bump up over the 5/19 - 5/29 period, the market has resumed
the downtrend. It remains moderately oversold on a price momentum basis and is approaching a
short term "sold out" position, with only a very short interval of acute selling pressure on elevated
volume needed to signal a more durable low zone. The SPX has entered a pivotal area of 1275 -
1250. A decline through this area would throw open the question of a break away downer. SPX

Fundamentals
The weekly fundamental cyclical indicator (WCFI) has accelerated mildly to the downside
over the past two weeks reflecting further weakness in sensitive materials prices and a slight
edging down of the weekly coincident indicator (10 discrete data series).

The Fed continues to hold the line on expanding its balance sheet and is actually running about
$25 bil. below the level of 6/30/11 when QE 2 was completed. The time is approaching when
this extended flatness in Fed Credit will force me to downgrade my core stock fundamentals
indicator as well as the longer term outlook for the economy (More later this week).

Demand for currency swap lines from abroad remains quiet despite the Euro area hub bub.

Risk Off vs. Risk On
The global economic expansion is at greater risk than it was in the spring / summer seasons of
2010 and 2011, when preference also swung from risk on -- stocks, commodities, oil etc. to
risk off -- Treasuries, German Bund, USD Global PMI - Mfg. However, many of the risk on
assets are oversold while a big risk off favorite -- Treasuries -- are extravagently overpriced
on a longer term basis. I strongly prefer simply to be in cash and equivalent than the risk off
choices and I also think concern about the US economic position is currently overblown ( the
household survey portion of the employment report which, although volatile, does lead the
payroll portion showed 422k new jobs in May, and the US PMI for mfg. gave a strong 60.1
reading for new orders). Finally, there is another formal EU summit on tap for late June, and
officials who want to see the EU accelerate the process toward fiscal union are coming out of
the woodwork with dire messages to hold a torch to Mrs. Merkel's ample butt to move
forward with a plan to keep the EU together. Even guys like George Soros and other economists
and pundits are getting into the act. Not easy to stand tough when the world is laying its troubles
at your doorstep.

Oil Price Postscript

Tack this one on to the 5/29 post on oil (which links to the weekly WTIC chart).

The WTIC oil price has weakened further, down to $83 and change. A significant oversold is
developing for the oil price. It is headed down to the bottom of a range of $80 - 100 bl. which I
have felt is reasonable out through 2012. On a linear chart, oil, like the SPX, has broken down
from a 3+ year uptrend as worries about the global economic expansion's staying power have
again risen sharply.

I am watching it closely. The downside trading volume for the contract is approaching exhaustion
levels, and RSI and MACD are deeply down on the daily chart. WTIC daily

Since it is rarely smart to try to "catch a falling knife", I am going to watch for a little stability
in the price first. The chart includes  the exchange traded USO (bottom panel).