Stock Market -- Fundamentals

In yesterday's post on the market's technicals I described the stocks as "bubble eligible".
Since the autumn 2011 low, the SPX is up over 67%. This reflects modest economic and
earnings growth coupled with a sharp deceleration of inflation which has reduced the discount
rate for stocks and sharply boosted the p/e ratio. On top, the Fed has kept short rates negligible
and has flooded the system with liquidity through its aggressive QE 3 program. Logic would
suggest further modest economic growth, continued very low inflation, ZIRP and ongoing QE
could well keep the market on a bubble trajectory, other things held equal. However, if the
US and the large remainder of the global economy can maintain or even increase the recent
faster pace of real growth, then inflation pressure may be elevated and the Fed and perhaps
other central banks would curtail and, perhaps, ultimately eliminate the large liquidity
infusions. In this case, earnings performance should improve markedly, but there could well
be downward adjustments to the market's price / earnings multiple to reflect faster inflation
as well as a diminishing speculative interest as the QE tailwind for  the market fizzles.

Looking at 2014, there will be less fiscal restraint both regarding spending and taxes and this
development should strengthen basic US economic potential. The trend of the momentum of
my coincident economic indicators has recently turned up, and it is good to see that the
weekly leading economic indicators have continued to move higher since Q 3 '12. So, as we
move into 2014, there is enough economic promise to look for somewhat higher inflation
and to expect the Fed may maintain a QE taper program, at least for a while. The implication
here is that investors may need to prepare to see some p/e ratio erosion as well as a bit of
leakage away from US equities to offshore stock markets and, perhaps, commodities and PMs.

Looking out through mid - 2015, the critical issue is to have determined whether the US
economic expansion can sustain itself without QE and the promise of negligible short rates
for years to come. If not, a sharply elevated market based on more QE and ZIRP will
eventually be seen as a Potemkin Village on Wall Street.

Stock Market 2014 -- Technical Stuff

Seen in long term perspective, the current cyclical bull market is exhibiting early characteristics
of an emerging secular bull. It started in 2009 from a historically very depressed base and
has maintained a trajectory over the past four years that is consistent with the early phases of
a secular bull. The SP 500 is also hyper-extended compared to very long term price channels
and given its continuing trajectory, is now bubble-eligible. This is a very unusual development
for the US stock market.

The SP 500 (SPX) has experienced 20% annual gains in price compounded off the 2009 low
and has maintained this powerful rate of ascent since the autumn of 2011 as increasing
investor confidence allowed the p/e ratio to continue to expand. This sort of consistent strong
price progress above the very long term channel top is unusual but is not without precedent
(viz. 1995 - 2000).

It is now simply too early to tell whether this is a price bubble of some considerable magnitude
or whether corrective events will alter the trajectory of the market sufficiently to eliminate
the bubble as a probable outcome.

The SPX will roll into 2014 on zippy momentum with a weekly MACD measure near +50.
Powerful annual finishes usually set the stage for market corrections of consequence in the
following year, although stocks may not get dumped until the May - Aug. interval as positive
momentum can continue for several months into the new year. The SPX is extended and
overbought on an intermediate term basis and could correct  to the low 1700s in the early going
without cracking the +20% annual price trend. SPX Weekly

Confidence and sentiment measures are running very high.

Oil Price

Whether long or short (See Nov.25 Oil Price), oil was my baby to trade in 2013. With
this post, I attempt to put the oil price into a broader context.

Despite its usual volatility, the oil price has been in a nice cyclical uptrend since the first
half of 2009, and has been trading in a $18 per bl. channel since then. The channel markers
for the current month are $97 - 115 bl. Oil is set to turn seasonally weak again from the
second week or so of Jan. 2014 through the end of Feb.. I had been thinking for quite a
while that oil could well fall to $85 by the end of Feb. 2014, but with a firmer tone to the
global economy, I am now not so sure. Perhaps a dip to the high $80s would be a better bet.
At any rate, the oil price has been compounding at a 10% annual clip since the middle
of 2009. This compares to a 15% pace over the 2000 -2008 period when global growth,
with China in particular, was faster. If the global economy is nearing a faster velocity for
the next couple of years as many expect, we ought to see the oil price accelerate out of the
current $18 bl. channel even before consideration of any supply disruptions. WTIC Crude

The oil and gas group has underperformed the broad SP 500 by a fairly wide margin over
the past five years despite the superior performance of the oil price to the CPI. Yes, it is
true that natural gas has been a drag on oil company earnings over this same period, but the
gas price has improved rather sharply since early 2012. Right now, investors are smitten
with rotating into the cyclicals and technology but the oil / gas complex might not be too
far behind in a firmer global economy. ^XOI vs. SP 500

Final Checkpoint Ahead -- Economy, Stocks

Longer term readers will recall I have been using the 1932 - 37 period as an analogue
for the current recovery. Not only did the decline of US industrial output clearly reach
depression levels, but the recovery was supported by powerful quantitative easing and
a nearly zero T-bill rate. The stock market rebound from the lows in 1932 was very
strong, and by early 1937 at an interim peak, the SP 500 commanded a p/e multiple of
18X. Then the roof fell in as the Fed ended QE, the economy went into recession and
the market dropped 55%. As a bow to 1937, Bernanke has opted for a QE taper rather
than cold turkey in the hope that a transition to more normal open market activity will
avoid a bust. This is a pure experiment as there is no evidence it will work. Even now,
the private credit system, which must pick up the liquidity slack as the Fed winds down
QE, shows scant signs of life.

Investors have put their faith in the idea it will work and that the economy will self -
sustain expansion as confidence in the markets and with households, businesses
and banks rises to make it happen. That's what stock players are paying 17x current
earnings to see and that's what you read in most of the market commentary presently.

For me, this is a momentous time. I hope the Fed is correct and a taper period is just the
right medicine to move the economy to self sustainability rather than a deflationary and
highly risky period. As we enter 2014, we see that there is current strong liquidity
support, slightly improved momentum in final demand and continuing jobs growth.
We will also be five years out from the deep trauma of near financial and economic
collapse, and so one hopes the post trauma stress syndrome will have eased sufficiently
to allow the US to get on with its business on a firmer footing.

If the Fed's plan works, there will be a battery of new issues to concern ourselves with.
However, recovery from individual / group trauma is a psychological / sociological
affair and not a primarily econometric one, so if I seem to be running a little behind the
herd, it is because I am going to continue to study how well the US can get past this
final, emotional checkpoint.

Economic & Profits Indicators

Coincident Activity Indicator
Measured yr/yr, my coincident economic indicator has moved from 1.0% in Jul. to 1.6%
through Nov. That says the economy is now operating a little better than one half speed before
inventory investment. A review of the indicators that make up the composite shows that
low wage and employment growth have retarded sales and production growth and have
increased the volatility of both of the latter. Thus, faster sales and production growth
may prove sporadic without faster employment and real wage growth. Businesses, prideful
of cost cutting to raise profit margins, are thus contributing to a suppression of future sales
and production growth via the steady hammering of a still weak labor market. Smart on a
company by company level, but damaging in the aggregate.

Profits Indicators
As the year has progressed, my measure of US business sales growth has moved up to 4.3%
yr/yr compared to a low 3.0% level seen this spring. Pricing power has been eroding,
so the price / cost ratio has been tilting in favor of costs at the expense of profitability.
Productivity has started to edge higher again on faster volume gains and operating rates
have been moving up with both helping to at least partially offset the effects of rising
costs. Looking top down, capacity utilization is not quite yet high enough to trigger a
round of more aggressive capacity expansion. Thus even though business cash flow growth
has been modest, there have been plenty of funds on hand to buy back shares.

Forward indicators suggest profits should continue rising going into next year, but the US
will need faster household income growth to underwrite moderate sales and production
growth through the year.

Inflation -- A Quick Way To Look Forward

For well over 100 years, inflation has tended to start up first in the commodities sector.
Moreover, since the processing of commodities can often be energy intensive, it is no
less important to keep an eye on the fuels sector when watching for inflation (or deflation
for that matter).

The chart link ahead looks at the CRB commodities composite with special focus on the
52 week rate of change and also includes in the bottom panel the behavior of the wholesale
gasoline price in recent years. CRB With 52 Wk. ROC + Gasoline

The inflation rate has decelerated sharply since Sept. 2011. The chart shows an ongoing
downtrend in the CRB since the spring of that year and also shows that the gasoline price
although volatile has been range bound. Inflation pressure starts to build when the 52 wk.
ROC% accelerates up and can move sharply higher in the wake of the development of a
strong uptrend in the CRB's ROC%.

Various leading economic indicators are pointing to faster global economic growth ahead.
Thus, even though the balance of economic supply  / demand has remained tilted in favor of
supply, you can use this chart to monitor if there are stronger developments for the leading
edge of inflation pressure, which, as you can see, remains pretty quiet for now.

The horizontal line on the chart for the CRB stands at 325 and reflects my macro based
estimate of when commodities supply / demand will come into balance. Note how far the
index is now running below equilibrium. With the world still deeply in debt, it is easy to
see by observing the chart why central bankers have been so concerned about trying to
keep the deflationary wolf away from the door and why fiscal austerity policies are so very
risky.

Stock Market Breadth

Market breadth continues to rise to confirm an ongoing cyclical bull market. Breadth
continues to make new highs, but note how the uptrend in the cumulative A/D line has
been fading since the Fed raised the issue of tapering its QE 3 program in May and since
there has been a sharp upswing in the long Treasury yield as well. The more interest rate
sensitive sectors and funds have lost considerable momentum since the spring of this year,
leaving the A/D line with a much milder trajectory. NYSE Cumulative A/D

Breadth has been edging a little closer to trouble, but it has not reached it yet even though
the A/D line has broken the normally important 30 day m/a on several recent occasions. A
break below the 145K line just ahead could signify something more serious as that would
would herald more downside after a period of just slightly higher highs since May. Note as
well that the RSI for the A/D line is trending down, but note too that touches of RSI
down around the 30 level in recent years have proven to be decent 'buy' markers.

SPX -- Weekly

Fundamentals
The Fed's QE 3 liquidity program has been the major force behind the market's powerful
rise over the past year. The SPX has lost momentum since this spring when Bernanke
first introduced the idea of curtailing the growth of securities purchases within the program.

The market's p/e ratio has powered higher this year, but it is interesting to note that corporate
bond quality yield spreads have not narrowed nearly as one should expect in an ongoing and
solid economic expansion. Naturally, this divergence reflects the far keener interest in equities
over bonds on display through 2013.

Market players have become very mildly defensive ahead of next week's FOMC meeting set
for Dec. 17 - 18. There is increasing brave talk among investors that the economic recovery
is fast becoming self - sustaining and that QE is fast becoming redundant, but short term
price action since this spring when tapering the program was first broached suggests ongoing
very keen interest in what the Fed may have to say next week.

Technical
The current leg of this cyclical bull dates back to Aug. - Sep. of 2011. The market has followed
a strong trajectory over this period with the band for the rising SPX set at about 150 basis
points. The market has not kissed the bottom of that band since late 2012, thus allowing a
strong overbought condition to develop. Here is the SPX Weekly Chart. The tops of the
trading band match up reasonably well with the tops in the Keltner channel shown in the chart
and you will note the drawdowns which have happened when the SPX has hit or slightly
exceeded the Keltner channel tops. Interesting that the market is just re-entering the channel
with the FOMC meeting dead ahead.

Stock Market -- Daily Chart

The SPX is edging away from consolidation toward correction. SPX Daily There has
been a small break below the little shelf of support at 1780 - 1782, the RSI and MACD
indicators are heading down and the VIX (bottom panel) is headed up while the SPX has
edged below the 10 and 25 day m/a s. Nothing nasty yet, but watch carefully.

Players would like a sugar plum ending to the year -- a graceful move up to close out a big
2013 on a high note. But, taper from the Fed worries notwithstanding, there are folks
who are cleaning out losers and others who are quietly rotating issues within their
portfolios to be ready on day one for 2014. So, you cannot count on the sugar plums.

Gold -- Entering Low Test Zone

Back on Nov. 1, I posted that gold had failed to take out trend resistance at $1350. It
fell sharply afterward. Yesterday, gold could not take out down trend resistance at $1260.
They hit it again today. Since it has been in a bear market from the summer of 2011, and
since another year's end is just ahead, it is a case of "gold be gone" for some players as
speculative interest has been wrung out. Others may be concerned that QE failed to
generate faster inflation, and some are likely worried that the expected tapering of QE by
the Fed will eventually boost the US$ and create another low growth / nominal inflation
period.

Now, history shows that  PMs can be in a long term bear market but still have nicely
profitable rallies when cyclical pressures pick up. The global economy does have a strong
liquidity tailwind, the US leading economic indicators have recently accelerated and my
inflation pressure gauges have stopped falling. Now the global economy has been plagued
by weak demand growth and excess capacity. Somewhat stronger real economic growth will
put a little upward pressure on operating rates, and so there could be modest upward pressure
on inflation rates. I do not think we know if curtailing quantitative easing over a twelve
month period will harm the economy or not, but there is surely a chance for faster growth
in the interim and perhaps a revival of a degree of inflation pressure. Such should help
PM prices, perhaps enough for a good rally.

However, with "give up" selling in gold maybe still underway, I say let's see if gold can hold
support again down around $1200 and see further if the metal can rally through the down
trend line. Gold Weekly

Liquidity Cycle

My broad measure of financial system liquidity, excluding direct QE from the Fed, rose by
6.3% over the past year. Thus, private sector funding topped total demand from the economy
by a modest margin, allowing a small amount of excess liquidity to flow into the capital and
real estate markets. When you add in the QE 3 program, the yr/yr change in liquidity provided
jumps to 11.9 %. Even though the QE securities purchases are primarily filtered through the
banking system, there has been heavy liquidity support for the markets with stocks and
housing prices being the notable beneficiaries.

Private sector loan demand did pick up just recently, but the banking system has been loafing
along for the past year, with total interest earning assets having risen by just 2.2% and the
system's loan book by 2.6%. This meager output from the banks is far below normal for an
economic recovery approaching a duration of around 4.5 years and shows the economy's
reliance on the QE programs from the Fed as the banking system continues to repair. Yet,
other sources of private credit such as shadow banking are taking share from the banks, and
so it is fair to wonder how bankers have been filling their time at the office.

Going forward, if the economy can sustain faster growth momentum, business and household
sector cash flows will improve, but the banks are going to need to step up lending activity if
the economy is to able to grow decently without the unprecedented QE support.

From a policy perspective, the Fed is officially following employment growth and the inflation
rate as primary policy parameters. However, it would indeed be very risky for the US economy
if the QE program is eliminated before private credit creation begins functioning more normally.

Business Indicators

I do have a measure that suggests the momentum of business sales and profits out six
months in time. The outlook for US business sales volumes looking out through mid - 2014
has been improving nicely in recent months, and physical sales volumes measured yr/yr
have been edging higher since Aug. of this year. The breadth of new orders receive by
business -- an admittedly volatile series -- has also improved by 11% over the past six
months compared to the prior six. All good news for volume.

However, the business pricing power measure has not improved over the past year and this
suggests that the ability of companies to raise prices on expected higher volume looks
rather limited going forward. It will not take much in the way of stronger business pricing
to overcome the growth of primary business costs such as labor, but potential for such a
development is not up on the radar screen presently. The poor environment for pricing
does reflect the modest volume growth US business has been experiencing and the fact that
capacity utilization still remains modestly below the 80% level when more sustainable
pricing power normally develops.

If volume growth accelerates further into 2014, businesses should find it easier to raise
price points. However, investors need to keep in mind that when inflation does pick up,
investment rate of return assumptions normally also rise with the result that p/e ratios can
decline. The erosion to the market formula can be offset to the extent business price
increases fall to the bottom line and are not absorbed by higher costs.

Stock Market -- Daily Chart

It has been a couple of weeks since I last posted on the SPX daily. As expected, traders
could not resist pushing the index up to a new round number all - time high of SPX 1800, but
upward thrust ended quickly as Nov. closed out. The sharp trend line up from the Oct. 8
interim low has been broken here in early Dec. and whatever else you might have in mind,
it is usually wise to observe the market more carefully once such happens. SPX Daily

The recent action is consistent with either a consolidation phase or the outset of a price
correction. Regarding the latter, we have yet to see the kind of breakaway price movement
that would herald something nastier.

As indicated in the post on the weekly chart just below, I expect more volatility in the
market between now and the end of the year as players appear very sensitive to whether
economic data is strong (bearish) or tepid (bullish), and also as to whether there will be
further bad behavior from official Washington. The handicapping of the prospect for how
long QE will be extended based on economic data flow may remain intense.

The next Fed policy meeting is set for Dec. 17 - 18. Since it would be un - sportsman like
conduct for the Fed to throw in a 'taper' plan a week ahead of Christmas, we may have to
keep our breath baited until the next meeting in late Jan. 2014, to get the whole enchilada
on Fed thinking.

I did add the VIX volatility measure in the bottom panel of the chart. Should there be a
move up toward the 20 level in the weeks ahead, it may suggest the betting is swinging
toward an early rather than a later curtailment of QE. I plan to discuss the QE issues in more
detail closer to year's end.

Stock Market Weekly -- 3 Year View

The market has basically been running up with the expansion of Fed Bank Credit via
the QE 3 program. The advance has "outdistanced" itself from a technical perspective,
and with official Washington again moving toward center stage in terms of both the
budget fight and monetary policy, there could be some volatility in the weeks ahead
as players try to handicap the interplay of oncoming economic data news and the doings
 in the Capitol. SPX Weekly

Stock Market Weekly -- 20 Year View

This week I link to a 20 year view of the SPX (1993 - 2013). SPX Weekly Over this period,
the SP 500 has returned about 7.2% annually before dividends.  Despite some extraordinary
interim volatility, the long term performance is pretty decent. SPX net per share also rose at
about a 7.2% annual rate over the 20 year interval, and that latter trend is moderately above
the long term average. It is also an interesting time slice because the p/e ratio back in the early
1990s was elevated on cyclical earnings as it is presently.

To maintain adequate return on both assets and capital, the SP500 companies managed their
business portfolios very aggressively, often preferring to buy rather than build, as well as
using a greater proportion of cash flow to buy in common stock. They have benefited very
substantially from refinancing borrowings at steadily lower interest rates and have cut their
pension contributions by raising actuarial rates of return and where possible freezing the
traditional defined benefit and contribution plans by substituting 401ks in their stead. To
maintain return on assets, most companies have struggled to boost asset turnover but have
been very successful in using technologies and in running very tight ships on labor costs
to boost profit margins. This has been strong performance in an increasingly globalized market
place where newer,  lower cost competition has been chipping away at pricing power.
Moreover, business failures are written off aggressively at the end of economic expansion
periods. Investors, who prize current operating earnings above all, have graciously overlooked
the mammoth write-offs that crop up over recession intervals. Some folks may think the top managements of big companies are pretty smart, but when you look at the huge write-downs
that have been taken, you cannot help but conclude that the boyz are not that smart. But, they
are smart enough to pay themselves kings' ransoms while leaving table scraps for the rank and
file.

Remember the old formula for return on equity %. It goes as follows: Profit margin x asset
turnover = return on assets x total financial leverage = ROE%. For many companies, the
focus has been on boosting profit margin and on maintaining leverage via share buybacks
and refinancing ever more cheaply via lower interest rates. I should also add that by
exhausting plant, some companies have been able to boost asset turns (sales divided
by total assets).

Looking forward, with interest rates around historic lows, the bulk of gains from lower
rates has been achieved, and aging plant will eventually have to be replaced. There will also
be a little pressure to fund pensions more heftily as the boomers retire and finally, it will
be increasingly more difficult to keep pushing profit margins higher via leaning on the
work force as the fat has largely been trimmed, leaving the bone and sinew. Before long many
companies will be looking at the need to re-work business strategies.

On the technical side, the indicators which accompany the chart  show a strongly overbought
 and extended position for the SPX.

Strategy & Chicago Fed National Activity Index

Each month, The Chicago Federal Reserve presents an index of 85 economic indicators
which can be very helpful in diagnosing economic growth momentum and inflation potential.
The 3 month average of the indicator is compared against a longer run measure of real
economic growth. Statistically, monthly data is detrended and shown as an oscillator around
the longer run measure. CFNAI

The recovery cycle has been weak because the index has had trouble staying above the trend
line. Moreover, moves in the index above trend have followed after QE programs from the Fed.
Note how close the economy came to dipping into recession in 2012 before the Fed came to the
rescue with QE3 and notice the struggle the index has experienced staying above trend in 2013
reflecting fiscal austerity measures on both taxes and spending. The combination of QE 3 and
slow economic progress has triggered excess liquidity which market players have poured into
the stock market to ramp up the p/e ratio on faint progress in earnings.

There have been upward flutters of cyclical inflation, but the index has yet to approach the
levels of strength typical of a period when more sustained inflation pressure can develop.
The inflation situation has been very tame in recent years because  modest economic growth
momentum has not taxed a global supply base which grew sharply over the 2004 - 2012
period. with an economic supply / demand balance favorable to lower inflation, commodities
including fuels as well as PMs like gold and silver have fared poorly compared to equities.

Now, looking out to 2014, it would seem that with the liquidity support under the economy
and likely less fiscal stress, depressed asset categories such as commodities and PMs ought
to do better relative to stocks as economic expansion could be strong enough to push up
operating rates enough to generate more positive interest in these depressed groups. If QE 3
without the countervailing fiscal stress is worth its salt, the CFNAI should be able to hit
readings of +0.4 - +0.6 for several months as 2014 rolls along.

Interest in run of the mill inflation hedge plays such as oil, gold and commodities as a class
has been insufficient to turn the tide this year as economic demand vs. supply has yet to
firm up enough to move the needles positively.

Corporate Profits & Capital Spending

Profits drive business cash flows and those flows plus the raising of additional funds help
drive capital spending. S&P 500 profits momentum has been very sluggish over the
past two years on modest physical volume growth and the erosion of pricing power.
With more sharply limited cash flow growth, managements have become more reluctant
to upgrade extant facilities and start new ones. Instead, there has been greater executive
suite interest in buying in stock to bolster earnings. The order book for civilian capital
goods excluding aircraft has turned down again. New Orders

Following a lengthy period of capacity growth in the 1990s, the bookend recessions for
the prior decade have left the monthly order book for basic capital goods no higher than
it was in the year 2000. Normal life depreciation measures tell you that companies are
managing more and more with aging facilities and are squeezing the labor force hard to
extract efficiencies and force workers to accept slight compensation gains in a still slack
labor market.

The recent developments of a selling / price cost squeeze and reduced productivity have
darkened the outlook for capital goods.

Oil Price

I closed out a handsomely profitable oil market short position today. The traditionally weak
late autumn seasonal period may well give way to a bounce over the next month and the
market itself has been stabilizing at a technically oversold position. The internal structure
of the futures market indicates to me that there are still way too many financial players who
are long this market, but from a contrarian viewpoint, that does not preclude a rally. I have
not factored the Iran deal on Their nuclear enrichment programs into the decision as more
detail is needed. There still could be another nice shorting opportunity on the oil price come
mid - Jan. 2014 that could see WTI crude drop down to about $85, but that is still a way's off.
WTI Crude Chart

Economic & Profits Indicators

Leading Economic Indicators
The weekly measures I follow accelerated up from mid - 2012 through mid - 2013. There
were dips around Hurricane Sandy (It destroyed over $40 bil. of the US capital stock) and
the timetable to see an acceleration of economic growth may also have been disrupted by
the put - back of the 2% of the payroll tax and US gov't. sequestration programs, but we
did finally see much stronger PMI data in recent months plus mild pick-ups in retail sales,
payroll employment and industrial production. More lately though, the weekly leading
data have flattened out disappointingly and thus suggest a slower period for the economy
not too far down the road.

Coincident Economic Indicator
Measured yr/yr, my coincident indicator has improved slightly, but at +1.5% is still only half
the +3.0% yr/yr reading that would signal solid, balanced expansion. The slow pace for this
indicator continues to reflect sluggish employment growth and a - 0.9% reading for real take
home pay. Looking ahead, the effects of the payroll tax increase of Jan. this year should
continue to dissipate and the real wage before taxes may creep a bit higher with very low
inflation pressure.

Corporate Profits Monitors
My macro measure for US business sales has picked up modestly in recent months to about
4.3% yr/yr. Volume growth has accelerated, but pricing power remains very subdued not just
in the US but globally. The pricing / cost measure remains mildly unfavorable which
suggests continuing pressure on operating profit margins. As well, productivity has dipped
slightly in recent months. The large US export sales sector is up but 2.7% over the past 18
months and this remains a major factor behind slower earnings growth momentum in recent
years. Large share buy back programs continue to inflate reported SP 500 profits.

The current strong liquidity cycle, buttressed by the Fed's QE 3 program, should be good
enough to see my top line growth measure for business sales accelerate to about 6.5% on
a 12 months basis. The business sector has done a little better recently, but is still well
under the pace needed to restore stronger operating earnings growth.

Figuring China's Shares

Following the destruction of China's stock market bubble after 2007, investing and
speculating in the local real estate markets has been the big game in town. The Shanghai
Composite never recovered the bubble sheen after the crash and is still trading nearly 65%
below its peak. Since then, only fools have rushed in where Chinamen have feared to tread.
Even in its heyday, the Shanghai was primarily a vehicle to build cash kittys to play the
real estate market. There have been some good stock market trades over the past five years,
but it has been evident that those mercantilist goldbrickers Hu and Wen were not interested
in establishing bona fide capital markets. As you have been reading, mr. Xi , the new
president, is starting to fashion a long term plan to legitimize China's capital markets and
to determine the role of the yuan in the global currency markets.

So, I have been re-benchmarking the Value of China's shares by admittedly top down
western techniques. I have dropped the Shanghai index and am currently using the S&P
China SPDR tick: GXC. This ETF represents a very broad composite of established and
tradable shares and has been up and running since 2007 GXC Chart

By its own admission, China does not revere the accuracy of its macro data and reams of
micro data as well. This lack of precision suits my back of the envelope style of model
building anyway and the results are I think, reasonable enough. With 7% GDP growth
as the principal assumption, I rate the GXC as fairly priced at a value of 80, a level it has
struggled to reach in recent years. I also see the GXC as offering some significant longer
term value down around 65 (Check the chart link).

The recent quick run - up to near the 80 mark on the GXC reflects a positive reception to
the new Xi / Li reform program which is bigger, broader and more liberal than many were
expecting. It does not reflect the acceptance by investors that China can indeed grow at
7% or better in real terms going forward. Indeed, China has threatened its own economic
future by allowing far too rapid liquidity and credit growth since 2000. Messrs. Hu and Wen
and their deputies have put the country in harm's way well before such formidable issues
had to arise.

The chart shows the market has gone from a deep oversold as I highlighted back on Jun.25
and has now moved into short term overbought territory. With a new regime now starting out
to mold a "better" China, some volatility and economic sector vulnerability would be normal.
I am very keen on seeing what if any reform will come to the PBOC, China's central bank.

China is making previously restricted "A" shares available through new ETFs (See tick ASHR).
Let's let these babies season up for awhile before adding any to the potential shopping list.

Silver

Yes, I have been guilty of calling the silver price "the great American crash dummy" from
time to time, and for those who know the history of the metal's price going back to the
latter 1800s, well then you know that the appellation has been well deserved. But, the
silver buffs are a colorful  and interesting lot and do not share the turgid sanctimony of the
gold bugs. There may be nothing interesting here immediately, but if continued efforts by
the major monetary policy chieftains to re-inflate their economies ever bear fruit, silver
could be interesting, as its ups and downs in price nicely mirror the cycle pressure gauges
I have used profitably over the years. What silver needs to get some positive interest going
is evidence of faster industrial output growth coupled with upturns in sensitive materials
prices, and rising commodities and inflation. Cooler economic activity and a decline in
the US CPI from 3.9% in Q '3 2011 down to 1.2% yr/yr recently have been killers for
the silver price. Silver Weekly Chart

I need to say straightaway my cycle pressure gauges have been quiet by and large this year
save for the purchasing manager business strength measures in recent months. The chart
link above does reveal that this pocket of strength has not gone unnoticed by the PM players.

I do have an industry pricing model for silver which I have upgraded recently to reflect
the higher costs of retrieving ores in general, and I put a price of about $18.25 per oz. as
representing a reasonable value for silver. So, at $20.77 oz. silver is hardly bloated in
price as it was when it traded near $50 in the spring of 2011.

From a technical perspective, a little caution is in order with silver. The price is still
trending down and the summer lows under $20 may still be subject to a retest. Even so,
I'll keep an eye on it. I have done no more than a handful of silver trades over the years,
but have been treated very well.

Stock Market -- Daily Chart

The cyclical bull market broke out of a consolidation phase this past week as presumptive
new Fed chair Janet Yellen gave a vigorous defense of Fed policy including maintaining
the QE program until the economy firms up and appears self-sustaining. In her confirmation
hearing on Thurs. 11/14, she poured it on with the full knowledge that the production data to be
released on Fri. would be sloppy, and in the current giddy logic of stock players, the weak
data only re-enforced the conviction that QE would stick around for longer to support stocks.
She was outspoken in favor of Fed accommodation for the economy even as The Street paints
the Fed into a corner on QE.

Looking ahead, SPX 1800 and DJIA 16K are within easy reach and traders might enjoy
racking up these milestones. The SPX is not more than mildly overbought viewed in the
short run, but remains strongly overbought with a six month horizon as the average is again
approaching a 10% premium to the 200 day m/a.

The action still seems innocently speculative and not cynically so as was observable as the
late 1990s bubble inflated. I think we all know that sentiment remains very bullish and that
confidence is high. The trade is quite crowded now but the desire to stay long with the
big QE program in force has proven hard to resist.

Here's the daily chart: SPX  The horizontal line at 1700 SPX denotes the top of the long
term price channel dating back to the end of WW 2. So, the market is now getting into
hyper-extended territory for the first time since 2007 and this recent surge above super long
term trend resistance is what is triggering the talk around the web about a new market bubble.

Coincidentally, the 1700 level is now trend support for the current run.

Investor Expectations For Growth, Inflation

Output & Profits Growth
A fast, efficient way to gauge what investors are looking toward regarding output and
profits growth is the relative strength of cyclical stocks. That's because the main swing
factor for both output and profits growth is how well cyclical companies will fare in the
environment ahead. The RS of the cyclicals sector reflects the collective expectation of
how strong or weak investors think the economy will be. $CYC Relative Strength

Market players have favored cyclical stocks since the summer of 2012 as they accepted
the idea that the Fed's new and large QE effort would lead to faster growth for the economy
and profits. There was noticeable hesitation over the first half of the current year on slower
economic progress and then initial concern about whether the Fed would cut back on QE.
But stronger economic data in recent months plus increased confidence that no cutback of
QE is imminent has returned the cyclicals to favor. The group is overbought now on an RS
basis but that condition can sometimes run on for awhile.

It is interesting to note that in a more mature economic recovery, cyclicals tend to be more
reliant on pricing power for positive earnings leverage than earlier in the cycle when rising
volume and a return of operational efficiency can carry the day. Keep this idea in mind since
the chart below also shows many investors see inflation and pricing power for business as
being rather tame ahead.

Inflation 
When inflation accelerates up, it generally starts in the commodities pits. As well, longer
duration bond prices can be very sensitive to rising inflation. Thus, a quick and easy way to
gather the wisdom of the markets regarding inflation potential is to look at the relative
strength of a commodities price index to a bond price measure, such as the 30 yr . Treasury.
CRB RS To 30 yr Treas.

The chart shows how this ratio anticipated the sharp deceleration of cyclical inflation pressure
from Sep. 2011 at 3.9% yr/yr down to 1.2% recently. The chart also indicates that QE from
the Fed has so far led to a conviction that only a very mild recovery of cyclical inflation
may lie ahead. So, the CRB / Treas. chart is less bullish on stronger pricing power for
business than is the $CYC / SPX chart. Interesting, as I say.

Normally, an acceleration of real output growth in the business sector comes with a decent
size uptick in pricing power. Let's see if commodities start to firm before long or if the
recent pick up in output is but transitory.

Stock Market -- Weekly

Fundamentals
The economic recovery appears to have picked up some speed recently, but the apple of
the investor eye remains the ongoing powerful round of QE from the Fed. Fed Bank Credit
has now expanded by more than $1 tril. over the past year. That's an increase of nearly 36%.
Perhaps coincidentally, the SPX has risen by nearly 42% since mid-2012 when the Fed
opened the the door to new QE. Since the economy has tended to struggle without the QE
during the recovery period, the issue of when the Fed may begin to curtail the growth of its
balance sheet remains a topic of intense interest. The market remains driven by speculation
and not value with players assuming there are still a goodly number of greater fools out there.

Technical
The SPX remains in a cyclical bull market dating from 3/09. SPX Weekly Longer term
trend support is now around the 1700 level SPX. The chart shows the market is
overbought on RSI, MACD and the 52 wk. rate of change measure as well. The old rule
of thumb going back many years is to be careful when the yr/yr momentum gets up near
30%. The market is also getting extended on a 20 wk. price channel (Keltner).

Scroll down to the 11/3 post on the equities only put to call ratio ($CPCE). Sentiment is
very strongly bullish and confidence remains high (low $VIX). This chart shows that
bullish regard is getting a little intense for comfort.

Beijing And The Big Red Liquidity Machine

The market for established, tradeable equities is coming up to important price resistance
just as the Party Bigs are gathering to look at reform issues. S&P China SPDR (GXC)

Back on 6/25 I posted that the Shanghai was deeply oversold just after the PBOC was
punishing its big banks and dealers by intervening in the overnight markets. My view
then as now is that the PBOC must begin to operate with greater discipline if more serious
problems are not to follow upon a five year period of extraordinary liquidity and debt growth.
China M-2 money has compounded 22% annually since 2008. China Dragon Flu 6/25

Most analysts agree that China needs to reset economic priorities away from reliance on
industrial investment / mercantilism toward building a larger and more stable consumer
economy. All well and good. My concern is with run - away real estate markets which can
only be sensibly controlled by more restrictive monetary and credit policies that have to be
reset to align with China's self professed goals of 7.5% real growth and controlled price
inflation. I'll judge the Plenum at hand by whether the Boys are up to slowing down the
Big Red Liquidity Machine.

Commodities Market

From 2001 through mid-2008 the CRB commodities index sailed from a low of 170 to a
new all-time high of 475. The rapid rise reflects the effects of strong global demand coupled
with a long lag in productive capacity investment. After the deep global recession, the CRB
recovered substantially from a downturn low of 210 up to the 370 level on a sizable bounce
in final demand and re-inventorying led especially by China. Over the 2001 - 2011 interval,
a new investment cycle began to support rising commodities output. With a build up in
capacity and much lower global economic growth (2% per annum) over the past two years,
capacity excesses have developed and the CRB has been languishing. CRB Chart

The negative demand / supply imbalance has left the market teetering upon entering a long
term downtrend. The chart for the CRB is admittedly bearish as it stands with suggestion of
greater weakness ahead if the CRB breaks decisively below important support at the 270 level.

Interestingly perhaps is recent evidence that global industrial and commercial output may be
setting up to enter a period of faster growth with a move from 2% up 3%. Global PMI Comp.
This observation is not without some reservations. First, remember that purchasing manager
data is volatile and not so predictable short term. As well, it is far from clear that a shift from
low global growth to a more moderate level will be sufficient to lead to a period of recovery for
the commodities market.

Still it is an interesting time as demand may be picking up just as the CRB is about to test support.
Moreover, financial players have likely been flushed out of this market as they rotate into stocks,
which has been the big game in town for the past two years.

Sentiment -- CBOE Equities Only Put / Call Ratio

I like to watch the $CPCE as a sentiment indicator because it reflects real money put to
work in the options market and not just opinion. A downtrend in the $CPCE shows that players
are becoming increasingly bullish. There is clutter even on a weekly chart, so I have included
6 and 13 week m/a's.  $CPCE Weekly

Sentiment is not just strongly bullish on a shorter term basis, but from a longer term perspective
as well since the $CPCE moving averages have been rolling down trend wise since the major
intermediate market low back in 2011. Note as well that the $CPCE weekly trends match up
well with the $VIX or volatility index in the bottom panel of the chart.

The chart also shows the wisdom of being more careful with stocks in the shorter term when
you spot clustering of low p/c ratios over a short duration and when the m/a's move down
toward that .60 level.

Players are becoming increasingly bullish and complacent.

Noteworthy Short Term Fails For Gold and Oil

Gold
The gold price has been in a quiet, almost 'under the radar' rally since early summer.
Down trending indicators have bottomed and show modest positive action. A big test
came this week when gold confronted trend resistance at the $1350 oz. level. It failed
to take it out and quickly lost $37 on the lack of success. It thus remains in the 'dead
cat bounce' category until it can push up through the down line and rise above short
term resistance at $1350. Gold Price The bear has yet to be upended in the short run.

Oil
The oil price remains in a robust period of seasonal weakness, and broke trend support off
the 2012 level of $80 bl. this week. I expected a little tougher battle, but news of rising
supply trumped that. My hope has been that continuing seasonal weakness would carry oil
down to $85 in early 2013. That might provide a terrific long side trade, and would also be
a nice plus for the consumer who is already enjoying a weaker gasoline price. Oil Price
Oil is coming off very quickly and you will note the weekly RSI is moving smartly to an
oversold position. This does not dim my hope, but it is time to be more watchful now for a
bounce in the weeks ahead.

Probable Big Challenge For The Fed

In the absence of strongly stimulative fiscal policy to create economic demand and
employment, I have been a supporter of a large QE program from the Fed to promote
some growth and keep us from a deflationary recession. As we move in to 2014, the
latest QE program will have added about $1 tril. in liquidity support to the financial
system. Fed Bank Credit Chart The latest very large QE program has been heavily
offset by restrictive, anti - growth fiscal policy with the latter undercutting potential
demand growth. With more scrapping to come on fiscal policy as 2013 wears down,
QE may have to be extended into next year. I do not think the Fed thought such would
be necessary when it kicked off the latest initiative. Moreover, I also believe that
continuing the program for more than another few months will find the Fed in a position
where it will become increasingly difficult to conduct a well balanced monetary policy
where liquidity excesses can be trimmed without rather painful results for the economy
as well as for the markets. Because it may well be necessary to provide additional direct
liquidity support over the next five or so years, the wiser course for the Fed may be to trim
the very large current program in favor of a dramatically milder one and to aggressively
pursue pushing the President and the Congress to adopt growth fiscal policies if and as
needed. The Fed needs to get this message out there so the media can develop pro - growth
storylines to challenge the rest of official Washington. Such lobbying by the Fed will
create ire in DC and threats of retribution, but this necessary challenge by the central bank
will leave them in a better managerial position long-term.

The Congress has ignored the economic realities to play to their respective constituencies
while counting on the Fed to bail them out on growth. It has not worked very well and it
is high time for the Fed to call the Congress out on it by fostering challenges from the public
on the eve of an off year election. Since Bernanke is the short timer, it would be best for him
to step up and warn emphatically that the Fed can no longer shoulder this burden alone.

Stock Market -- Daily Chart

As expected, the post debt ceiling fracas rally did take the SPX up to a new all time high.
The rally has brought the market into a moderately overbought position on a short term
basis and once again has the SPX up near a substantial overbought position with a six month
perspective in view. SPX Daily

Investor psychology is very positive now. Players know the market is entering a seasonally
strong period and few expect the Fed to begin a regimen of reducing the large QE program
just ahead. The rally leading up to the FOMC meeting anticipates no dicey equivocation
by the FOMC and no bluffing as well. The Fed might like to introduce some sort of temporal 
note regarding the tapering of the program in view of how the market has called its bluff,
but the earlier comments about rolling down the program hurt the bond and housing markets.
Since the Fed does not like to be boxed in like this, It will be looking for avenues to gain more
leeway before long.

Liquidity Cycle-- Looking Ahead #3 The Stock Market

The broad measure of financial liquidity from the private sector is growing about 6%. This
is faster than the real economy is growing, so there would be some modest excess liquidity
available to dabble in stocks and other select markets. But, when you add the current large QE program from the Fed, you get a turbocharged 11% growth in liquidity. With substantial fiscal
drag in place from austerity measures, and still suppressed confidence among households,
businesses and the banks in place, the economy has been very, very slow to respond positively.
In fact, SP 500 net per share for the 12 mos. through 9/30 looks to be only about $102. That
puts the "500" up at a p/e of 17.3x and above the longer run norm. The powerful run -up in
stocks since mid - 2012 reflects two factors: 1) The economy and profits have been advancing
at a snail's pace, but this performance and the expectation for eventual improvement have been
good enough to sustain positive investor confidence ("Prosperity is just around the corner").
2) The 1 $trillion annual rate of QE from the Fed has been overwhelming enough to drive
both the optimistic and the cynical into stocks.

The year ahead will probably be the last one where investors believe in the stimulative power
of QE unless the economy responds in a more forcefully positive manner. It would be another
grievous mistake for the President and the Congress to add more austerity to fiscal policy
and it could also be fatal if business again suppresses take home pay to push up profit margins.
We can only sit back and see.

The issue of the status of the QE program is now a very big deal since there is no clear evidence
the economy will avoid lapsing into a deflationary recession without it. With such a momentous
and challenging year ahead, a p/e ratio of 10x earns. and a dividend yield of 3.6% would seem
more appropriate, but that would be to fail to grasp the current power of investor confidence.

I must confess now that I am much more interested in seeing the economy perform much
better than I am in how the stock market does. The market has performed admirably since
early 2009, but the economy has not. We are approaching a point where we desperately need
a better America. The market will take care of itself if we get one.

SPX Daily Chart

Oil Price

As anticipated in the 9/11 post on the oil price, a period of normal seasonal weakness is
underway. Without a surprise disruption, oil can remain in a seasonal downtrend right on
through the end of Feb. 2014 that could, under normal seasonal conditions, take the price
down to the $85 - 90 bl. area. Despite sluggish global economic demand over the past two
years, oil had a very strong surge over the 15 month period starting in mid -2012 and
recently ended with crude topping out over $112 bl. I think the main reason was the very
large QE program from the Fed aided by easy money from other quarters. Relative to basic
supply / demand conditions, this was a speculative but profitable run. WTIC Crude Chart

The price did fall to cyclical trend support this week and is around the 200 day m/a support
level as well. It is headed to an oversold on RSI, so may be there can be a little bounce, but
oil is far from the sorts of deep oversold readings evident in recent years.

The internals of the futures market are not bullish now. The big petro industry hedgers have
deep short positions while the large traders -- who are often wrong when positions are
outsized -- continue to maintain very large long positions. My interpretation here is that
commercial guys are looking at supply vs. demand while the big financial players are
using the global easy money background to speculate on eventual and substantially faster
economic growth. Crude Contract When the crude supply / demand picture stabilizes and
actually begins to firm, you can expect the petro guys to begin slashing the short side of the
trade.

30 Yr. Treasury Bond

Back in a post on 9/15, I argued that the long T- bond was deeply oversold with the
sharp rise in yield % (and consequent price weakness) reflecting the development of a
weak market brought on by concern that an accelerating economy would lead the Fed to
curtail its large bond buying program and remove a large bid under the market.

The yield on the long T has retreated since then and there has been a modest price rally.
There is further potential for the yield % to fall short term because the recent Gov. shutdown
and surprisingly weak employment growth have removed the prospect of a quick end to
the current sizable QE program.

The long side trade since mid - Sep. in the bond has been fairly tame so far. From a yield
perspective, I was thinking the T-bond could fall to about 3.3% and that the price could rise
above the $140 level for a decent profit.  30 Year T-Bond With Price In Top Panel

The key shorter term yield directional fundamental gauge I use is the combined momentum
of industrial production + industrial materials prices. This indicator has actually been on
the weak side since late 2012, and strictly speaking, the yield on the long guy should still
be sitting maybe in the 3.1 - 3.2% range. So, there is still a large premium in the yield to
reflect the consensus expectations that the economy will be growing more rapidly and that
the Fed will eventually have to begin to moderate its bond purchasing programs.

Tricky business. The bond yield can trend strongly for extended periods up or down, but
it is highly unusual for the long T to get so far out ahead of on-the-ground fundamentals.
Treasury players rarely exhibit such longer range confidence. 'End of the nose' is usually
good enough.

Stock Market -- Weekly

Here is the weekly chart through 10/18/13: SPX Weekly

Technical
The "dip" buying has whipsawed the market again to the upside this time with good breadth
and decent volume behind it. Short term, the SPX is getting near overbought at channel tops,
but there are no other extremes. I do have an intermediate sell signal in place as of early Aug.,
but the price momentum internals on which the signal is based have merely decayed modestly
instead dropping off sharply as normally happens. The large intermediate term overbought
in the SPX since May of this year has also simply been working off slowly with no damage
 to the market.

Fundamental
Returning to the chart, the green horizontal line represents fair value for the SPX based on a
p/e of 16.5X normalized 2014 trend earnings of $91 per share for the index. The line is set at
1486 and the market, at 1744, is trading 17.4% above it. The premium primarily reflects the
fact that reported earnings are cyclically elevated and are coming in above the long term trend.
Investors are thus paying up now to play the cycle although the premium is hardly onerous
yet and is no doubt troubling few players at the moment.

The blue horizontal is set at 1700 with the SPX now above it. We have entered a period when
the market is trading above the top of its long term trend channel going back to the end of
WW 2. So, from the point of long term history, the SPX is starting to develop a small bit
of froth. We are not talking bubble here. Far from it. But, by the same token, it is wise to
realize that the SPX has crossed over into a high risk zone viewed over the long term.

(There is also arcane technical work which suggests the run from the 1125 area in 2011 is
complete at 1700 both price and time wise and that a period of either correction or
extended consolidation would provide the attractive symmetry to say that the first two legs
up for this cyclical bull market which started in early 2009 are in the books. This a very
interesting historical point but I would be the first to say that the market is at liberty to
override such neatness and precision.)

Liquidity Cycle -- Looking Ahead #2

Here are a couple of economic follow-ups to the overview outlined yesterday (just below).

Economic Power Index (EPI)
This index is expressed as a yr/yr % change and combines the 12 month momentum of
both the real or inflation adjusted take home wage and the change in total civilian emp-
loyment. A reading of +4.0% or higher suggests a robust, balanced economy with labor
as well as capital  being rewarded by decent productivity growth. 

The last time the EPI was up at the 4.0% level was in early 2007. Since then, no monthly
yr/yr observations have exceeded 2.0% and there have been some negative readings at
times in each of the past five years. The poor performance reflects both the very slow
pace of jobs growth and a real wage that has increased by a bit less than 1.0% per year.
Moreover, if one tosses out 2009 when the real wage was strong on a collapse of inflation,
the real wage has been eroding over 2010 - 2013. There have been strong increases in
productivity over this period, but business chieftains have disenfranchised the rank and file
in favor of rewarding shareholders and top management.

The EPI may do better in 2014 on modestly stronger jobs growth and the better take home
pay compared to this year when workers had to absorb a 2.0% increase in the payroll tax
back up to the old norm of 6.0%.

The EPI has been running about -0.5% this year and will remain a drag factor on the economy
until rising output finally pushes business to accelerate jobs and pay growth. To get this
sort of change, we may need to see capacity utilization, now around 78%, rise up and through
the 80% level. If this happens, count on higher inflation, too.

The sharp rise in business profit margin has come heavily at the expense of a sizable decline
in the real wage when it is adjusted for strong productivity growth. This a nice recipe for
the stock market in the shorter run, but will prove catastrophic longer term if sustained
as aggregate buying power weakens.

Global Economic Supply & Demand
Strong global growth through much of the past decade triggered tight supply / demand
conditions for basic materials, fuels and other commodities. This set off a large investment
cycle outside the US which substantially increased supply availability. The deep global
recession of 2008 - 09 created substantial slack which has been only partly taken up
over the past couple of years. Thus, going forward price boosts for commodities and
materials will be temporary to reflect inventory restocking with firmer trends to await
possible stronger growth in the out years of the cycle.

To get a flavor for the past 15 years for basic materials, check out the long term price
chart for copper. Comex Copper

 

Liquidity Cycle -- Looking Ahead #1

The liquidity cycle is currently the strongest it has been during the economic recovery which
began in 2009. Normally when financial liquidity in the economic system accelerates, the
real economy and business profits will follow in positive fashion. With a short time lag,
stronger economic demand brings along faster inflation.

Presently, my broadest measure of financial liquidity to include Federal Reserve Bank credit
is growing a rapid 11% yr/yr. Now, looking back over the past nearly 50 years, the 11%
growth number is right up there with past periods of accelerating liquidity growth. However,
with the Fed's balance sheet at a high base, the growth rate of liquidity is set to slow
markedly over the next year even if the present QE program is maintained.

Since there are questions about how rapidly Fed only liquidity may be absorbed into the
real economy, I suspect the velocity of the liquidity will continue to decline because
confidence in the economy by consumers, banks and businesses still remains well below
normal. Looking conservatively, it is reasonable to expect that business sales in the months ahead have the potential to move up from the 3 - 4% area yr/yr  to about 6.0 -6.5%. This development would lead to faster profits growth and ultimately to a pick up of inflation from the recent
1.5 - 2.0% level to 3.0 - 3.5%. If the banks turn more aggressive and dip into excess reserves,
output and inflation could be stronger. So far, however, the banks have been very passive.

Believe me, the Fed's current $85 bil. per month securities purchase program has increased
its balance sheet to levels that are above what the Fed, including likely Bernanke, is
comfortable with. In fact, the pace of QE is now running faster than the expansion of the
monetary base did over the long 1932 - 46 stretch. Policy is thus moving the Fed into
unchartered waters, even compared to the long pull from the economic bottom of 1932. Thus
the pushback from some Fed board members and economists.

Prior to the latest cat fight over fiscal policy and the debt ceiling in DC, the leading economic
indicators I follow were flashing stronger as was new order data from purchasing managers'
surveys. The battle in DC may have rattled confidence in the very near term, but the liquidity
cycle still points to moderately faster economic growth ahead.

The Fed would dearly like to rein in the growth of its balance sheet and it also dearly wants
to avoid a 1937 scenario when a sudden extended period of "cold turkey" flattening of the
monetary base led to debacles for the economy and the stock market (The latter went down
about 45%).  Hence the "taper caper" -- the idea of slowly weaning the economy and the
markets off the big QE push. The idea of curtailing the QE program likely will present no
substantive economic growth issue if, and this is the big "if", private sector credit demand
finally responds more vigorously. Since banking system data show that the banks have
basically taken 2013 as a long holiday at the loan window, there are no assurances going
forward.

I'll use the little framework above up until the time is at hand for the Fed to put its QE
taper plan into effect.

The secret to successful use of an economic outlook framework is to look for data and
info that tends to disconfirm the base view and not just collect items that confirm it.

I plan to put up a few more posts shortly on the topic with focus on the capital and
commodities markets as well as factors that can undercut the view such as real household
incomes and the magnitude of excess physical capacity in the global system (There's a fair
amount).

Stock Market -- Short Term

The market has rewarded the dip buyers once again this year with a 4% SPX rally over the
past week or so as it has moved up toward the recent all-time closing high. The 10 and 25
day m/a's have turned up and the SPX shows only a modest 1.8% premium to its 25 day m/a.
Traders like the idea of the Janet Yellen selection to head the Fed and think they will have a
new friend in a very high place. Concerns about damage to confidence from the Gov't.
shutdown and nasty debate about the debt limit have been shelved and worries about a
Fed decision to curtail its QE program were set on a back burner. Players rightly concluded
the political fight in DC would not end with the worst outcome and are even speculating that
with new shutdown and debt ceiling deadlines in place for early in 2014, the Fed may have no
choice but to hold off the taper even longer.

It would be strange if the guys did not press the SPX up to a new high to celebrate the reprieve
on the present shutdown, debt ceiling worry but take care to remember the old phenomenon
of "buy the rumor, sell the fact".

One item of interest on the attached chart: Note the downtrend in the MACD. No break here
would suggest limited upside, indeed.

SPX Daily

GOP Right Wing Lands On Its Feet

The intransigence of the GOP righties pushed Obama to accept an increase in the debt
ceiling that runs only into Feb. 2014, and a re-opening of the Gov. for but a limited time.
This partial cave-in by Obama will be a drawback for him going forward with fiscal policy
and will be duly noted by foreign powers the US is currently engaging. For the GOP, they
retain their nasty options for possible use after both houses go to conference and set spending
bill appropriations.

It reminds me of GOP 1964 presidential candidate Goldwater's comment that "Extremism
in defense of virtue is no vice". The Goldwaterites got creamed back then because the
economy was growing fast, inflation and unemployment were low and liberalism was in its
hey day. Political conservatives make up about 25% of voters now, and are increasingly reaction-
ary in the classic French sense of the term -- hold back the future and bring back the past era.
As pundit Andrew Sullivan (The Dish) recently said "They (conservatives) want their president
white and the budget balanced now". The newer righties are both more militant and sharp at
building a power base.

The weak economic recovery in the wake of a deep recession has stolen US household
confidence, increased impatience with the status quo and is fertile ground for the growth of
both righty reactionary and lefty radical movements. The righties are way ahead now, but
continued subpar economic performance will bring on more interest in the left as well.

The bottom line now is the GOP's rightwing obsession with austerity to slam down gov't.
spending and reduce the budget deficit. Policies of this sort may well backfire in a slow
moving and still well leveraged economy and certainly could punish capital at risk.
That's why capital market players need to be very mindful of the power of the right.

Show Me The Deal

The economic stakes are high concerning both the spending bill and a raising of the US
debt ceiling. But the political stakes are also very high, both in terms of the Obama
presidency vs. the GOP right wing and the clear intent of the US Constitution. Rebuffed
at the end of last week, the GOP right has slipped into demagoguery and rabble rousing to
increase the political pressure and is in near breach of the Constitution regarding the
directive that the proper servicing of US sovereign debt be held sacrosanct.

It is now difficult to envision the House meekly voting out even semi - clean bills on
spending and the debt ceiling. So, I am anticipating more drama in the next couple of
days from the GOP right wing of the House to try and break the president's resolve and
I have to wonder for example whether the stock market is now too sanguine in the near
term relative to the very ugly storm which could still billow up as righties and tea partiers
are faced with having to come away virtually empty if Obama holds his ground.

And, Obama must hold his ground because he is being threatened with extortion.

So, show me the deal that will resolve the serious political dangers the US faces.

SPX Vs. 200 Day M/A Oscillator

Most of time, when the SP 500 gets more than 10% above its 200 day moving average,
it gets tougher to make good money on the long side in the months out ahead. That is
because history shows that 10% or higher premiums represent big time overboughts .The
last time the SPX exceeded the 10% m/a premium was in May of this year, and here we are
with the market no higher than back in May when the 200 day m/a oscillator hit its most
recent peak. SPX vs  200 Osc.

Most of the time, when the SPX does get to a big premium to its 200 day m/a, it subsequently
loses all of the premium and, when the corrective process is sharp, can go to a discount.

The SPX has so far worked off most of the recent major overbought situation without a
substantial price correction. The chart I linked to shows a downtrend in the oscillator which
has yet to make a clear bottom, so even though the large overbought has mostly disappeared,
there is still some vulnerability evident.

There are market pundits who are calling for a washout to scare the folks in Washington to
end the circus and produce a compromise that will end the gov. shutdown and resolve the
debt ceiling debate in a way favorable to the economy. Since the "drop dead" date to raise
the debt ceiling is still more than a week away there is clearly time for more brinksmanship
before the denouement or before the cans get kicked down the road for a few weeks. The
GOP is doing one of its scorch the earth routines and is also previewing its campaign for 2014
off-year elections. Obama has a more serious issue -- the very credibility of his presidency.
He needs to stand as firm as he can. Few market players want to sell way down only to have
to reverse the strategy if a "positive" deal is struck. There can be more volatility ahead.

Gov. Shut Down / Debt Ceiling Issues Seen Differently

I have no trades on the books now and am 100% in cash. Partly it is just laziness. Partly
it is that there are no trades that suit my interests. Shorting oil and going long the T-bond
are prospects but have yet to show the volatility I would like to see.

I am in the black for the year but it has been a quiet one, especially since late spring when
the SPX became strongly overbought.

So, it would be nice to see some good opportunities open up between now and the holidays.

My view on politics is that the GOP right wing continues at war with Obama personally and
is using the shutdown and debt ceiling issues to scorch the earth for as long as it can. For now,
I am assuming  that speaker Boehner will simply not vote out a clean bill on the debt ceiling
regardless of whether the votes are there or not. Since Obama can hardly compromise on a
fully extra - legal move by Boehner without damaging the spirit if not the rules of the US
Constitution and further, since giving into clearly extortionate demands would destroy the
credibility of his presidency, he has little choice but to stand back from the Boehner group.
Obama can explore raising the debt ceiling by executive fiat, but any method he might choose
could be challenged in court and would for sure get the House Of Reps. to commence
impeachment proceedings.

I suppose Boehner could have an epiphany, whip his charges into submission, and vote out
clean bills. Devoutly to be wished for...

I must add that the GOP righties do not hold Mrs. Clinton in warm regard either and see a
knock down drag fight ahead for years if necessary. It is the worst hostility coming from the
right that I have seen since the last couple of years of the Truman administration (1950 - 52),
and the Democrats very much need to start breathing fire and really go after these dangerous
people.

Stock Market -- Short Term

The market is threatening to roll over into correction mode for the third time since May.
As the daily chart shows, key short run indicators are trending down and the $SPX has
broken below both its 10 and 25 day m/a's. SPX Daily

You will note from the chart that breaks below the 25 day m/a over the past year have
engendered further weakness, and note too that the 10 m/a has rolled while the 25 day is
flattening and perhaps preparing to turn lower.

The increased volatility in the market since Jun. would allow the SPX to drop down to
the 1660 area before there is a threat of a shorter run trend reversal.

The SPX drew up to a major intermediate term overbought against its 200 day m/a when
the premium rose to a high +10% this spring. Since mid - May, the market has gone on
to new all - time highs, but it has been difficult to hold the gains as the SPX has moved
off a zippy tight speed line up into a lazier and more volatile pattern.

Traditional liquidity, inflation, short rate and economic indicator fundamentals remain
positive. However, the market grew fully valued over the Apr. -Sep. period and has been
vulnerable to bouts of profit taking. First, it has been the developing ambivalence by the
Fed over continuing the big QE program and now, we have the fiscal policy / debt ceiling
bullshit from official Washington to work through. Although the turkeys that comprise
the far - right in the House might ultimately relent on the debt ceiling, the group remains
nasty, destructive and cynical enough to damage the economy for as much as they can get
away with. This ensemble remains apoplectic that a man of color continues as president.

The price dips in recent months have rewarded aggressive buyers who trade. In this
emotionally charged environment, I am inclined to let the current dip play out more.

Gold Price

The gold price has been traveling with some old pals in recent months, namely the oil
price and the $USD (gold behaves inversely to the buck). The yellow metal did latch on to
the  seasonal rise in the price of oil this summer, and it derived benefit from the Syrian crisis
and labor unrest at the shipping point in Libya. Now, however, the US and Russia are
teaming up to remove Syria's chemical weapons and Iran's new president, Mr. Rouhani ,
is talking nice to the US in an effort to get out from underneath tough sanctions which have
hurt Iran's economy. Moreover, oil is poised for a period of seasonal weakness and with the
Syrian and Iranian threats off the table in the short run, we'll soon see if oil supply / demand
fundamentals are in tight enough alignment to mitigate a seasonal run down in the oil price
to the $85 - 90 bl. area by late Jan. of 2014. Thus the gold bulls may have to shift more
focus on to the $USD and the US debt limit fight which is just starting to roll out. Gold Chart

Gold did fail to break the downtrend in price running from Sep. 2012's $1800 level when it
recently rolled over at around the $1400 point after a strong rally in summer's months. That is
a bad sign, but since the oil price has yet to break sharply lower, gold may get to test the
downtrend line again in coming weeks. Even so, gold is drawing price action impetus from
other markets and has yet to show a supportive fundamental base in what must still be
counted as a bear market. To hold technically, gold does need to take out and rally above
the $1360 level in the weeks just ahead.

SPX -- Monthly Chart

Today closes out Sep. 2013, so I thought I would take a look at the monthly chart.

Technical
This is a cyclical bull market which has carried the SPX to a new all time high recently. The
market is extended on a cyclical basis off the 3/09 low and is also very extended within a
long term band that carries back to the end of WW 2. It can definitely go higher but once the
SPX rises above the 1700 - 1750 into hyper - extended territory, history strongly suggests the
market could be bought considerably more cheaply within the next five years. SPX Monthly

Note also how extended the monthly readings for MACD, RSI and Williams %R are getting.
Note as well how far above these indicators are from excellent possible buy points. From a
technical perspective, this is a well advanced bull market, which if it continues to move
higher without a substantial breather, is going to force participating investors to accept sharply
higher long run risk.

Fundamentals
Now we get to the fascinating part. Tops in the market coincide with economic expansions
with elevated cycle pressure measures and high rates of resource utilization. At these points,
broad money / credit growth is normally at +10% yr/yr or higher and short term interest rates
are at least 5% and in uptrend mode to counter a credit supply / demand pressure gauge that
is running at strong positive levels in favor of demand. Finally, inflation is in cyclical
acceleration mode. The current US economy still has ample resources to grow, moderate
cycle pressure gauge readings, only 6% funding growth, a low credit supply / demand
pressure gauge of a mere +1.4, a ZIRP on short term interest rates and very low inflation.

So, the stock market is rather fully extended, but the economy is not. There is slack to
support economic expansion for a good several more years.

What we do not know is whether the economy can realize its expansion potential without
continued substantial quantitative easing from the Fed. This epoch is not like any time
since WW 2. Stocks wise, it matches up with 1932 - 36. The market crashed in 1937 when
the Fed removed QE and allowed a slight rise of interest rates. the analogy has 2014 match-
ing up with 1937 and there could be trouble if the Fed tapers down QE to zero next year
and consumers, businesses and bankers lack the confidence to transition the economy to
self - sustaining expansion.

Stock Market -- Daily Chart

The latest leg of the bull advance has been underway since latter Nov. 2012. SPX Daily
The market could not hold the 11/12 - 6/13 speed line and a fairly tight up channel has
given way to a milder and more volatile advance, but the broad trend is intact. The
current, still minor corrective action of the SPX is from a short term overbought position
and if the more volatile price action remains in force, the SPX could drop further into the
low 1650s area without wrecking the new up leg underway since later in Jun.

The moderation in basic trend and the step up in volatility plainly reflect the introduction
of sterner talk from the Fed about eventually curtailing the large QE3 program. The FOMC
did extend the QE thrust at its Sep. meeting, but some Board members continue the rounds
of harping about its eventual curtailment before many moons have passed.

The US fiscal policy / debt ceiling circus is well underway and there is an obvious stronger
level of mutual contempt between Obama and his allies in the Congress and the GOP right
wing. The ugliness on display is welling up fast and it now seems like there may be a
stunning crescendo of invective yet to come. I do not think investors have taken the show at all
seriously so far, as more zigs and zags in debate and tactics likely remain ahead. If there is
a battle over the debt ceiling which seems headed straight for the eleventh hour, there could
be nasty reactions in the bond and stock markets that come suddenly and late in the game.

Junk Bonds

The junk market has been struggling since earlier in the year as yields have been buffeted
by rising Treasury rates. Junk price indices have rallied recently on signs of a stronger
economy and hoped for better fixed charge coverage and could get some further play if
traders grow more confident that the Fed will resist curtailing its large QE program for
a while longer. However,the Bloomberg high yield index is sitting down around 6.50%
and is carrying a small premium to an array of investment grade bonds which can be had
to yield between 5 - 6%. That now smaller quality differential spread does not present junk
players with a favorable comparable risk / return profile for now. Bloomberg High Yield

US Stock Market

Fundamentals
The more critical directional fundamentals -- growth of monetary liquidity, near zero short
rates and confidence -- remain positive for the market (Confidence is reflected in the trends
of narrowing credit quality spreads and a rising p/e ratio). My broad measure of money +
credit funding growth has exceeded the demands of the real economy, thus leaving excess
system liquidity to flow into the current favorites of equities and housing. A substantial loss
of earnings growth momentum has yet to significantly inhibit the market's advance and a
rising oil price has so far been well accommodated.

My weekly cyclical fundamental indicator has regained positive traction in both forward
looking and coincident categories, but a degree of caution is still advisable given the scant
growth of consumer and business incomes.

The Fed is keeping its large QE 3 program in place for now, but It is harassing the market
with threats of curtailing and eventually zeroing out this effort if the economy can show
sustainably faster growth. The specter of winding down QE does seem aimed at inhibiting
speculation in stocks.

Below par cyclical inflation does provide theoretical support to the market's p/e ratio of
16x+, but the market is tending toward full value as earnings progress remains subdued.

The President and the Congress have another circus planned for just ahead with the
rebellious right wing of the GOP so far unwilling to vote out clean budget and debt ceiling
bills and with Obama prepared to veto what is on the table now. Because the major players
are more coldly angry now, it would not be a surprise to see stocks become more volatile
in the weeks coming up. However, since the players may put more cards on the table by
the end of the forthcoming week, it is still early for strong pessimism. This is ugly stuff
with a heavy undercurrent of race coming from the right.

Technical
The strong advance in the stock market throughout 2013 to date has so far been a winning
hand in an against-the-house bet on technical grounds and the heavily overbought nature
of the market since May has yet to produce the odds-on deeper correction that big time
overboughts generally set up. SPX Weekly Chart

Monetary Policy -- Going The Fed One Better

I have argued over the course of most of this year that there was no economic case to end
or curtail the Fed's major QE program. I also discussed earlier in the year how pressure
to reduce the QE program would rise by mid - 2013 as the Fed's balance sheet rose to the
top of the range for QE programs dating back to late 2008. There is no doubt in my mind
that a number of Fed staffers got very nervous about that, leading to "hall talk", babbling
over lunch, and leaks to The Street and the media which in turn precipitated the "taper talk".
The "taper" stuff was a dumb and costly idea and it is a shame that key board members such
as Bernanke, Bullard, Dudley, Evans and Yellen put up with it. Dumber still that so many
Wall Streeters ran with it and spun it.

I think the truth is that not only does the economy have to perform a lot better to warrant the
reduction of monetary stimulus but that a decision to curb stimulus will prove a risky bet
until well after the economy is functioning normally with income and credit flows that are
well recognized as adequate to sustain the economy in the absence of highly accommodative
monetary policy.

The risk to the stock market and the economy of a premature curtailment of QE remains
very large in my view. QE has been there to keep confidence up and the deflationary
wolf away from the door.

I am sure Bernanke would like to eat out in Wash. DC on others' tabs but, as he completes
his valedictory lap, it would be nice if he called out the Congress again for their recklessness
in mishandling fiscal policy and, nice as well, if Obama got behind him.

Corporate Profits Indicators

Sales
Over the past few months, my sales growth indicator has moved up to around 4% yr/yr
from 3%. The very long term average for yr/yr  sales growth is about 6.5% and the current
measure is running lower both in terms of volume growth and pricing. My expectation for
the current year, set at the outset of 2013, was for a 6% yr/yr gain through Dec. So far,
both volume and pricing have fallen below the estimate. Historically, it has been hard
to maintain profit margins when 12 month growth comes in below the 5% level. On the
plus side, the leading indicator sets I follow suggest at least a mild acceleration of volume
growth ahead.

Profit Margin
The work continues to suggest mild pressure on the operating profit margin through Aug.
Facilities operating rates have been down ever so slightly over much of 2013 and this has
worked as a modest drag on profit margins. My sales vs. cost ratio has been running about
-0.4% which means that pricing has not been recouping operating cost. My productivity
measure has been flat this year, too. Productivity growth has naturally slowed appreciably
over the past two years following the dramatic improvement seen over 2009 - 10. If sales
do pick up in the final quarter of the year as now suggested, companies can recover some
of the modest pressure on margins seen so far in 2013.

S&P 500 Net Per Share
I have been hoping that SP500 eps would rise 6.5% to about $103 per share this year. Net
per share could actually do a little better owing to factors such as lower cost of capital and
share buybacks, but $103 of pure operating profits would be fine given drags on sales
growth and operating margins seen over most of 2013.

The stock market often heads for trouble when SP 500 net per share rises above the top of
the very long term range of trend earnings such as happened in 2000 and 2007. The top of
the long range trend channel is now running about $120. The economic recovery is now
over four years in duration, but profits are running well below the top of the long term
range owing to how deeply depressed eps was at the bottom of the recession and the fact
sales growth has moderated markedly since mid - 2012.

30 Yr. Treasury Bond -- Deep Oversold

My weekly fundamental indicator for the Treasury bond suggests mild price weakness
for the year to date. The bond has been swept lower in price since late last year with the
heftiest part of the decline coming since the late spring when the Fed began to talk about
curtailing the growth of the large QE program. Market players fear the loss of a large
bid the under the market if the Fed tapers, and have been buying into the idea that the
economy should accelerate ahead. The 91 day Bill has stayed near zero and inflation
pressure has been mild, but the yield curve has steepened sharply as investors prepare
for the return to a faster growth environment.

From a technical perspective the bond is deeply oversold relative to its 40 wk. m/a and
bond advisory bullish sentiment has been evaporating rapidly  $USB Chart With the next
Fed policy meeting due up in but a few days, and bearish bond sentiment as high as its been
since early 2011, there could be a quick long side trade here if the Fed skips the taper and
focuses on an economy which has yet to exhibit the sort of balanced growth envisioned in
their forecast. Moreover, if the Fed, under political pressure, decides to curb the QE program
and investors  review the Fed's comments and decide the action is premature, the bond price
could benefit anyway. Keep an eye out.