About Me

Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!

Tuesday, July 30, 2013

Inflation Potential -- Long Term

To come up with longer term potential, I use a "back of the envelope" model that has
worked very well for a number of years. In brief, I subtract a real economic growth
assumption from the 10 year annual rate of gain for money M-2, the most stable of
the aggregates. Over the past decade, M-2 has gained by 5.8% per year. My growth
factor combines reasonable projections for annual increases in both productivity and
for the labor force. This assumption works out to about 2.8%. Thus, I peg longer run
inflation potential at 3.0% per year. M-2 has been decelerating in the long run as has
real growth potential for the US based on a downturn in the growth of the labor force
(Productivity has been improving as a partial offset to lower labor force growth).

The yr/yr CPI has averaged 2.1% over the past six years on a 60 month smoothed basis.
The period encompasses 6 / 2007 through 6 / 2013 and includes a very deep recession
and below average economic recovery. The excess output capacity and weak labor
market over this interval primarily accounts for the shortfall of inflation compared to
the 3% projection and extremely sparse credit growth has played a roll as well.

Supported heavily by the Fed's QE programs, M-2 has begun to accelerate since 2010
and has been growing about 7.5%. This progress has been undercut by weakness in
other important measures of bank funding such as "jumbo deposits" ($100K+) and
financial sector commercial paper. The inflation rate since 2010 has averaged 2.2%
when measured on a smoothed yr/yr basis.

In the US, business capacity utilization should average about 80 - 82% in a stable
growth environment and the unemployment rate should run lower than currently. But,
the nation's operating rate has not topped the 80% level since 2008, and the economy
has not run near full or effective capacity for almost 20 years. Moreover, wage growth
over the past 10 years has barely been strong enough to support 3% inflation.

When we look out over time, it will become increasingly difficult to hold inflation
at or below 3% if some mixture of monetary easing plus faster credit growth puts new
upward pressure on that 10 year M-2 growth rate.

looking in the shorter run, inflation has been running 100 basis points below where it
should be and since fails in monetary and / or fiscal policy can punish output in an
economy with still substantial idle resources and relatively high debt levels, you should
realize the latent deflation potential in the outlook until there is a more sustainable
strengthening of real output, wages and pricing power. The US is not out of the woods
yet and I would happily trade a brisker economy with 3% inflation over what we have
been experiencing.

Many people scoff at the CPI and substitute their own measures to suit their convictions.
Do not be a fool. The CPI is a good approximation of inflation in the US system.

Monday, July 29, 2013

Stock Market -- Daily Chart

The SPX has come off a spike QE re-affirmation rally as the market awaits the next
chapter on monetary policy this week and seeks to glean if there may be new hints
about the continuation of this program. Of particular interest would be whether the
Fed believes the economic outlook is solid enough to commence a program of curtailed
QE wherein the Fed say only buys between  $60 - 70 bil. per month of securities instead
of the current $85 bil. program and, if so, when the curtailment might begin. There is an
apparent consensus that a moderate "taper" program could begin this autumn. The weekly
leading economic indicator sets I follow have started to show some slight improvement
but do not at all yet suggest that such speculation about monetary policy is appropriate.

Regardless, the run up in the SPX off the 6/24 closing low was fast enough that that no
one can blame traders for wanting to take "a breather". The SPX just broke below its 10
day m/a and the short term indicators are showing some deterioration. So, despite the
idea that some consolidation is reasonable, more damage in the indicators in the days
ahead would signal a pullback. SPX Daily Chart

Viewed long term, the SPX horizontal line of 1700 on the daily chart would confirm
a turn to a more speculative market on technical grounds if the SPX takes it out soon
and would fall in line with my fundamental work that puts a new speculative era in play
above 1650.

Wednesday, July 24, 2013

The Pro Inflation Trades

The fairly standard block of trades to capitalize on an acceleration of inflation are: short
the US dollar and go long commodities, oil and a PM of your choice such as gold. This
type of trade was magic starting early in the past decade and running through mid - 2008,
and then again from early 2009  into 2011 on a hefty global re-inflation to bring the
world's principal economies out of the Great Recession.

I bring this up at this glum, slow time for the global economy because my inflation pressure
gauge may be set to rise and because there are preliminary signs of economic demand
improvement in big economies -- The US, Euroland, and Japan (China, the most voracious
user commodities and fuels, is still decelerating in growth). I also know there are lots of
players out there who favor this trade and would like to see it run strong again. For now,
this trade is working on a thin reed, awaiting more robust economic performance.

The chart I link to has panels for the US$, commodities, oil and gold. Inflation Trade Chart

US $
Graceful uptrend in place since latter 2011...Failure to take out 2012 - 13 resistance in 84 - 85
area and failure to take out 88 level resistance seen over 2008 -2010 keeps it suspect and the
hopes of inflationistas alive... The dollar's natural appeal in the wake of the deep global
recession of 2008 -09 has been undercut by the QE programs despite the very slow growth of
money + credit...Stronger US inflation pressure needed here to hurt $ in still risky global

Strong downtrend from 2011 reflects unwinding of China's mercantilist engine, slower
global growth and larger spare capacity...Note downtrend is now being challenged...
I still see the CRB as undervalued on production cost basis and see 325 easily achievable
on stronger growth...CRB responding cautiously now.

Oil has been benefiting from spillover of QE into selected risk assets (see 7/19 post below)
...Took profits above $108 bl. on overbought...Note the $80 -110 approx. range of recent
years and that $110 should be broken to deliver the pro inflation trade.

The bounce here looks mostly like a response to stronger oil and commodities which have
put players of this oversold metal  in mind that there has been a small pick up of inflation
 pressure born by the fuels sector.

Sunday, July 21, 2013

Stock Market -- Weekly

The forward looking economic indicators remain both sluggish and range bound and do not
signal an acceleration of sales and profits growth. Such has been the case since early in
the year. The QE program from the Fed has been surging along and this has been the prime
underwriter of the strong advance for US stocks this year. The p/e ratio on 12 months net
per share is approaching 17X, thus just lifting stocks up from value to the start of a more
speculative phase. The current bull  now represents the third liquidity driven speculative
advance since the mid - 1990s. The excess liquidity which is fueling this advance is not
credit driven as have been most prior heavily momentum driven runs which have been
eventually negated by rising short term rates and credit tightening. The current run has
been fired up by a combination of exceptionally strong money liquidity growth coupled
with both low output growth and inflation thus allowing surplus liquidity to flow into
stocks. The 1935 - 36 period when stocks soared on QE is the closest analog.

Like the 1930s, the curbing and / or shut down of QE would represent a powerful
tightening of monetary policy and leave both the economy and the market vulnerable
unless we see private sector credit demand return to more normal levels.

The weekly chart is now showing a positive whipsaw which has lifted my intermediate
term indicators from negative up to neutral. The sell signal generated a short time back has
been swept away by easy money policies continuation reassurances from none other than
BB of the Fed himself. The market remains overbought for the six month window and is
now getting overbought on a very long term basis as well as the SPX is once again at the top
of its post WW 2 channel. It can blow through the channel top and money can still be made,
but the risk of eventual large losses heads progressively skyward. (The SPX has only gone
above its channel top twice since 1945 -- It happened 1995 - 2002 and 2003 - 07).

SPX Weekly Chart

Friday, July 19, 2013

Gold -- Keep The Down Staircase In Mind

My e-mail inbox is filling up with recommendations to buy gold or securitized gold in
the wake of gold's thrilling downturn since last Autumn. Since I receive precious few
missives from the Bugz, this is interesting.

I do have a caution and draw your attention to the stair case down for gold which started
last Oct. with gold at $1800 oz. Each step down since then has followed when a step was
put in following a rally which ended in resistance that could not be successfully breached.
As the chart shows, the latest step is set at $1300 resistance. The chart cries out for heavy
diligence here. Gold Price Chart

Oil Price

Trade / Invest
The oil price has advanced nicely this year so far. Longer term players have had the easier
time of it. The leg up in price in Jan. was a tough one for traders because it came at a time
when oil was supposed to be seriously seasonally weak. The positive jog up since Apr. has
been easier what with a flare up in Egypt and concerns over transport safety around Suez
and the Sinai. WTI has stayed within my projected $85 - 115 bl. range for 2013 and has
stayed within a subtle uptrend in place following the initial spike up off the 2009 recession

The fundamental supply / demand picture for oil does not warrant the kind of advance seen
so far this year and, to be realistic, neither does Middle East / North Africa (MENA) tensions.
There is no short run bull case from the usual suspects, but as fate would have it, it appears
oil traders are enamored with the Fed's QE programs and have welcomed the arrival of Japan's punchbowl as well. The oil price, like the stock market, is front - running the fundamentals.
As of now then, oil players are also stuck with the machinations of the QE programs and very
much need to watch along carefully with equities players.

Perhaps $110 per bl. is in view for WTI, but oil is overbought in the short run, and for less
greedy traders like me, there are profits to be booked. $WTIC Daily Chart

The way I read the long term chart circa 1999 to the present is that oil is still in a bull
market, the $148 bubble top in 2008 notwithstanding. The bull remains in effect because
as supply has risen with demand, excess capacity at the wellhead has remained in a down-
trend, making supply security a more prominent feature in the environment. There are
rivals to oil coming, but the oil market still has the scale dominance. Longer term players
might well look at oil in a continuing $20 per bl. central range which is now set at $90 -
110 WTI. At this point, a sharp break below $90 bl. should trigger a careful review.

Macro Implications
There is a tough issue with petroleum products in the US. As oil has advanced in price,
folks have been conserving. However, with wage growth on average of only 1.5 - 2.0%
in a still weak labor market, sudden advances in gasoline and heating oil  prices can
wreak havoc with real household incomes and confidence. At this point, an oil price
above $110 bl. which sustains would be a source of concern.

Wednesday, July 17, 2013

Inflation Potential -- Cyclical

The inflation rate experienced a more or less normal cyclical acceleration coming out of
the Great Recession in 2009. The 12 month CPI swung from a mildly deflationary reading
on up to a cyclical peak of 3.9% for Sep. 2011. Then things changed both in the US and
globally. Output growth lost substantial momentum over 2011 - early 2013 and US
and global operating rates declined mildly. The starch went right out of inflation, with the
US 12 month CPI declining to an extraordinary 1.1% by Apr. this year.

The yr/yr CPI has accelerated since then and is at a point where there could be a positive
reversal to the trend. Capacity utilization has ticked up slightly and commodities and fuel
prices have starting moving up. $CRB Composite & Wholesale Gasoline Price Chart
Fuels pricing, including long quiescent natural gas billings, have been the main culprits.

My inflation pressure gauge made a yr/yr % change bottom in mid - 2012, and the index
from which I derive it has put in a recent double bottom. The US, at least, is at a cyclical
inflection point, but it is too early to say the index itself has reversed. I do use a couple of
other economic measures that are considerably less attuned to the commodities markets.
Here the suggestion is that inflation should begin to accelerate on a cyclical basis starting
in the second half of this year and run higher through 2014 (These measures are based off
leading economic indicator trends and are not that sensitive to short term developments).

Since my work is more indicator driven than reliant on forecasts, I am posting this warning
on inflation even though I do not yet have evidence the economy is about to break positive
from the dreary, low growth mode it has been in.

There is a way to look at long term inflation potential based particularly on monetary and
productivity trends. Sometime over the next week or so I will post on this view. For now,
suffice it to say that longer term inflation potential is mild and that a period of deflation
cannot be ruled out.

Tuesday, July 16, 2013

US Economic & Profits Indicators

The monthly coincident economic indicator is measured on a yr/yr % basis. It came in
at +1.3% for June for a slight improvement over May ( A CEI reading of +3.0% represents
solid, moderate growth). The sales and production side of the indicator was pretty fair,
but the income side -- real take home pay and 12 month % change in civilian jobs --
was negative reflecting higher taxes on wages plus the effect of somewhat faster inflation.
My weekly CEI, a conservative measure, was up by about 1% yr/yr. To maintain a moderate
level of consumer spending, householders are having to borrow more and dip into savings
because wage rates remain rather low. Retail sales have held up reasonably well despite
the income pressures on households.

Consumer discretionary spending stocks are now overbought relative to the broader
market, but continue in a leadership role. XLY Relative Strength

My primary top line or sales growth indicator for business improved in Jun., but averaged
only 3.3% for the second quarter. With sluggish growth overseas and a stronger US $, it
would be fortunate if corporate sales growth came in at 3.0% overall for the quarter. My
price / cost ratio has been improving in recent months, but there is still mild pressure on
profit margins. Business sector output growth and pricing power remain subpar in this
challenging economic environment.

Sunday, July 14, 2013

Financial System Liqudity

Broad financial system liquidity growth has continued to decelerate over the first half
of 2013 despite the Fed's large QE program as the banking system's loan book growth
has slowed leaving banks less interested in bidding for deposits. Ditto the growth of
the system's key liquidity asset -- Treasuries. The activity mirrors a sluggish domestic
economy and modest progress in the need for trade financing. Mortgage run off and
defaults top new originations despite a decent pick up in housing and broader building
activity. It is worth noting that part of the slowdown evident in credit and the broad
measures of liquidity is a reflection of a loss of inflation momentum since last autumn
on lower capacity utilization not just in the US but globally as well. The world has yet
to shake the deflationary bias introduced by the "Great Recession."

Thursday, July 11, 2013

Thoughts On Bernanke & Selected Markets

Well, as suggested on 7/8 (below), Bernanke did round on the monetary policy hawks
with a defense of his views. By my hard nose standards, it was a wimpy riposte, but the
markets loved it, with stocks jumping to a new high and gold in strengthening rebound
mode. QE remains in place for now, but remains in play politically as the Board is
strongly divided over its future. Gentleman Ben battles the sharks.

The SPX has made a new high. The short term indicators are positive, but the market
is again heftily overbought on a 6+ months basis and is subject to the possibility of
a "secondary" or rebound top as seen back in the Spring of 2011. SPX Daily Chart

The bull leg in place since Half 2'  2011 remains in place and is once again getting
very extended, enough so that more shorts will be invited in if the SPX can move up
closer to the 1700 level.

The fundamental environment is far from ideal. Monetary liquidity is strongly positive,
short term interest rates are negligible, and inflation pressure is low. All to the good. But,
the progress of business sales and operating internal cash flows and earnings remains
scant in a slow growth global economy. With liquidity carrying the day, the SPX is
gliding into overvalued territory, leaving stock price momentum to pull even extra duty.
Some players are comfortable with this and some are not, like me.

By sheer luck, on 6/27 (below) I switched from a negative view of the gold price to a
more balanced view. The future was down around the $1200 oz. level then, and after
a retest, there has been a nice rebound. Assets have powerful occasional bounces in deep
bear markets, and maybe I'll catch the gold train on the long side when the indicators
turn trend positive. Gold Daily Chart

The long Treasury is back on the radar, but like gold, it would be nice to see some repair
in the indicators. $USB Bond Price

Tuesday, July 09, 2013

Stock Market -- Back To The Daily Chart

The SPX, although rallying in recent weeks, is finding some resistance up around record
ground of 1650. The market has spent nearly two months trying to break and hold above
this level. SPX Daily Chart The new move up has taken the SPX through short term
trend resistance, but has deposited it at the same level seen on 6/18 before a stumble.
This is the fourth impulse up to regain the 5/17 closing high of 1669, and perhaps that
magic moment is at hand. Even so, you need to keep a critical eye out as there has clearly
been overhead resistance which could prove nettlesome.

For my money, SPX 1650 is the very upper border of value in this market currently. A
strong move above this level in the short run will begin to take the market into more
speculative territory and will add more downside price risk.

Monday, July 08, 2013

The Fed: Quantitative Easing Queasiness

With this latest round of QE, Fed Bank Credit has expanded up to the top of the range
in place since the programs started in 2008. FBC Chart (pdf) In turn, the longer term
trend of QE is actually running mildly ahead of the pace that was set over the 1932 - 46
period when the Fed let the monetary base expand very dramatically to counter the Great
Depression and to provide liquidity support for WW 2. So, although the current QE
program is not without precedent, it is still very large compared to the 1932 - 46 program
when the US economy was more deeply depressed. However, unlike the Great Depression
years, total financial leverage in the system, especially longer term debt, is now very much
larger on a relative basis. In short, economic demand is less suppressed, but leverage is
larger and of much longer duration.

If you pull up the FBC chart again, you will see that the Fed curtailed QE both in 2008
and 2011 after large spikes in the credit balance. And, as I have discussed, it is mid -
2013, and there is another spike up in place. there are many critics of the QE program,
and it is especially hard for Fed board members to keep up their nerve when FBC is
rising up to the top of the trend going back to 2008. The heavy pushback to QE has
arrived and it has been difficult for the Fed to be steely about it even though
unemployment is well above target and inflation is well below the Fed's goal.

The Fed's job has been made more difficult by the large back-up in bond yields which
increases the cost of longer term funding both for business operations and for construction,
naturally including housing. Bond investors, now concerned about all the pundit talk
regarding curtailing the QE program, have dumped bond holdings heavily. In fact, by
ingenuously reminding investors that a firm economy will bring an end to the QE effort,
the Fed has undercut its position and is watching matters backfire in the credit markets.

I think the curtailment of QE through much of 2012 damaged the momentum of the
economic recovery. The current "taper talk" is not helping now either. Moreover, the
Fed and the Gov. in DC may again need to be reminded how risky it is to pressure
economic demand in an economy that is still well leveraged and deflation prone.

Most have concluded that the Bernanke era at the Fed is about over. If so, it would be
nice for Ben to stand up soon and say "Nope, the economy is still too sluggish and
the risk of a deflation event is still too high....We need the liquidity and we need to
see our federal government take steps to get people back to work."


Sunday, July 07, 2013

Stock Market -- Daily Chart

The SPX has rallied above its 10 and 25 day moving averages. The short term indicators
are also turning up. Curious then that the SPX did not breach a modest downtrend line
on Fri. 7/5 when it rallied up nicely. For some trend traders, that failure is an automatic
sell signal. SPX Daily Chart

That failure does leave the market in an interesting technical position, for it is exquisitely
poised to move in either direction in the week ahead. Bernanke will speak on 7/10 and
may have a comment about current monetary policy, but the pause in the rally may also
have much to do with the opening of the earnings reporting season for Q2 '13 and especially
the forward guidance that various companies may provide. My forward indicators suggest
that such guidance may be both reserved and muted as rather slow growth in sales, both
in terms of volume and pricing, seems on the menu. No shocker there, but we still have to
see how investors may tilt their collective interpretation (Do not forget the QE program in
this regard).

However, the technicals suggest not to be prejudicial but to be open minded in the short

Wednesday, July 03, 2013

Leading Economic Indicators

The US weekly indicator sets have been volatile but were basically flat over the first half of
2013. There was substantial improvement so far this year over the second half of 2012,
but the indicators leveled off after Jan. of this year. The stimulative effect of the big QE
program was offset by the effects of the 2% payroll tax increase, fiscal drag from the
sequestration budget trims and more conservative turns by banking and the business
sectors. Many economy watchers highlighted better housing and auto sales data, but total
US production was held nearly flat by the large export sales business which has yet to
progress this year in a marketplace of very sluggish global trade.

I like to watch new order rates from the manufacturing and services PMI reports. There
was nice improvement here from 6/12 through 2/13, with Feb. being a very strong month.
Since then, there has been a substantial downturn in new order rates for both the service
and manufacturing sectors on both domestic and exports categories.

Looking Ahead
From an indicator perspective, the evidence does not point to an acceleration of economic
or profits growth for the current third quarter. There are expectations the economy should
gradually improve as the negative effects of the payroll tax increase and fiscal spending
cuts abate over the next 12 - 18 months, and some folks see "trickle down" benefits from
the strong stock market and the recent sharp recovery of home prices. These are reasonable
expectations. However, because the economy responded so positively to the mere
announcement of the QE program after June of last year, it might be wise not to get too
far ahead of the narrative now that the Fed has surfaced the idea of curtailing QE not too
far down the road. This recent discussion of the issue has affected the capital markets and
it could have an impact on business planning as well.

Tuesday, July 02, 2013

Adding The Long Treasury Back To My Trading List

With the long Treasury now back up around 3.5%, I am returning it to my list of trade
candidates (long or short). Way back in late 1980, when I first started buying bonds I took
on but survived several bouts of career risk as a result. Since 1982, trading the long bond
has been a  cakewalk as we have seen a phenomenal bull market. Many think the low 2.55%
readings seen in 2012 mark the final bottom for yields (and top for prices). Could be, but
viewed long term, the 30 yr. Treas. yield needs to rise above the 4.20%  level and stay there
for a while before such talk would gain some credence.

For years, I have used a long term inflation assumption for the US of 3% per annum. Thus
for now, I am using a 3.5% cut off rule to buy the bond as purchasing the Treasury at or
above 3.5% gives you a shot at earning a minimum premium over inflation for the long
term. There have been many years since the early 1980s when the market has priced in
a much higher premium than 50 basis points over the long range inflation rate and when you
are trading you have to study to see at what premium over inflation the market may derive

Take a look at the 30 yr. Treasury on a weekly basis from a yield perspective: Long Treasury
Viewed against the 40 wk. moving average, players have taken the Treas. yield up to a
large premium. So, I see the market as substantially too high on a yield basis and nicely
oversold on a price basis. Note that the technical indicators also suggest that the yield is
presently on the high side. In addition, some trader advisory services are now perhaps a
little too bearish on the market (Consensus Inc. principally).

Surprisingly, trading bonds can be a fairly simple matter often enough. This is not one
of those times despite the bearish sentiment and the deep oversold in the market. I even
think the yield on the long guy is too high relative the mopey, draggy performance of the
economy. But, players have begun to re-price risk in this market to account for the time
when the Fed may curtail or end QE and begin pulling the large bids now under the
range of fixed incomes. The stark response to the "taper talk" serves notice about the
nervousness of investors even though the recent adjustment could turn out premature.

Whatever, there has been enough damage done in the market to move me to consider
getting back into the game to look over possible opportunities.