Bank Credit & System Liquidity

Bank Credit
Excluding the Fed, banking system interest earning assets (loans, investments) have
shrunk slightly over the past several months reflecting low economic growth and still
relatively stringent lending standards. The Fed is now the lone provider of incremental bank
credit to the system. Earnings wise, the banks in the aggregate are getting by on fees and trading
profits. The banks are also slowly losing market share to other consumer credit facilities.

In their own way, the banks do mirror the economy and collectively they are starting to
offer a bleak picture once more. Moreover, since the Fed is now the primary lender, it
is curious that the Fed seems keen to begin to curtail this service. System data on credit
suggests strongly the Fed is simply bluffing here in the short run with all the talk about
tapering.

Here's a graphic look at another important component of private sector funding:
Commercial Paper Outstandings

Financial Liquidity
With banks operating a flat asset book, they are not out there chasing deposits. So, my broad
 measure of credit driven liquidity has slowed down to a meager 2.8% annual rate based on
six month data. This compares to a 9.2% annualized rate of growth for the six months ended
Jan., 2013 and shows just how slow the system is now running. The liquidity side of the
economy is now functioning just ever so slightly faster than stall speed and points to how badly
a significant pick up in US economic demand is needed.

The Fed should be pressuring bank CEOs to get their asses out into the community to
find and assist the many good business and household credits out there. The banks, having
sinned as profligate lenders, are now sinning almost as seriously by playing scrooge to
the public.

The Gold Rally

The gold price made a fast double bottom down at $1200 oz. just as the seasonally strong
period for gold demand got underway in early July. Gold started to rally in a favorable
pro-inflation context. There has been a moderate acceleration of the US CPI from very
depressed levels, the oil price is in a favorable seasonal mode, the US dollar has been
under sudden pressure and commodities prices generally have been faring better since the
beginning of July Gold Price With Panels For $USD, Oil and $CRB

The timing for a turn in the seriously distressed gold price could not have been better. There
has also been help from a mild positive turn in sensitive materials prices and the accelerated
weakening of several emerging economy currencies such as India and Indonesia.

Gold is rapidly getting overbought in the short run but this is not so on a more extended
six month basis. Moreover, oil and gold can run strong seasonally into the autumn.

Now the rally has been a very fast one and it is difficult to project whether all the afore-
mentioned factors will remain in supportive roles. If you are riding this rise in the gold
price, you need to watch the constellation of supporting players and you should also note
that you are competing with very fast, large money coming over from bonds and just
recently, from stocks.

As readers know, I inadvertently called the recent bottom in gold at near $1200 when I
shelved the shorting of gold because it had fallen down to levels near or at production costs
(6/27). I am not at all ready to proclaim a new bull market for gold. I would note that when
a financial asset , commodity or precious metal comes off a perfect, long term parabolic
pattern such as gold recently has, the odds favor an extended period of price weakness
along with occasional, sharp rallies. Gold Price - Long Term History lays the burden of
proof at the hooves of the bulls.

Global Economic Supply & Demand

Global economic demand has remained positive yr/yr for the duration of the economic
recovery, but momentum has decelerated rather steadily over the past three years and
for the past year has been running at a decidedly subpar 2%. Global capacity growth has
exceeded that of demand for well more than a year, leading to declining operating rates,
falling commodities prices, decelerating rates of inflation and very importantly as well,
a sharp decline in the momentum of world trade. With banks globally still in repair
mode, credit to support trade finance and cross border investment has become more
limited, so that even prior rapid growth emerging economies are suffering a deterioration
of internal fundamentals as exports have slowed to a crawl and aspiring middle class
consumers  have drawn in more imports. To add insult to injury, an apparent commitment
by the Fed to curtail its very large QE program, has worked to force long term interest
rates up around the world.

Interesting then global PMI manufacturing data for Jul. and Aug. to date show an upturn in
output and new order rates. This is very good news even after acknowledging that PMI data
can be volatile. A re-acceleration in production and trade growth from the recent dreary
and socially risky 2% would be very welcome globally and for the US as well, since our
exports were a strong driver of recovery in the initial stage and have been quite subdued
since the spring of 2012.

Naturally, faster global output growth would eventually lead to higher inflation. However,
an acceleration of global capital flows needed to underwrite the kind of speculative
expansion witnessed over 2003 - 08 now seems remote as banks have more leverage
restrictions and are still unwinding remaining excesses from the last boom. As well,
business will take its time to gear up after experiencing the dramatic loss of sales
momentum seen over the past three years.

Note the recent improvement in the commodities market: CRB Weekly

Stock Market -- Shorter Term

As discussed in the 8/4 post on the weekly chart, the SPX at 1710 was once again fully
extended on a price basis just as it was in May. Since then, the market has fallen into a
short term downtrend that was recently confirmed by negative rollovers in the 10 and 25
day m/a's. Viewed strictly short term, the SPX has moved from a mild overbought up at
1710 down to a mild but deepening oversold. SPX Daily There is short term trend support
for the SPX down in the 1630 - 1640 area.

From a purely technical perspective, I do not have a strong point of view regarding the
direction of the stock market in the weeks just ahead.

I am surely not the best guy to listen to this year on the stock market as I have thought
that SPX 1550 represented a decent top for the year on both fundamental and technical
grounds. I have been concerned however, that the guys would use the QE elixir to drive
the market higher even though the underlying business sales and earnings fundamentals
did not warrant the drive. They have done so.

Presently there are concerns in the market about the future of QE and the widely discussed
eventual cut back in the growth of this program. And this is now coupled with questions and
debate about the current strength of the economy. So, players see more risk in equities for
the time being and we are witnessing profit taking and some effort to replenish cash kitties.
For my part, the weekly leading economic indicators have turned more positive but are not
showing anywhere near the zip needed yet to support rosy earnings estimates for the final
quarter of this year and especially for 2014. Moreover, I flat do not think there is a case
for curtailing the Fed's QE program in the months ahead without a switchover to a sizable
fiscal stimulus program to backstop a sluggish economy, and for what it is worth, I doubt
Bernanke does either.

Right now there is a swirl of competing forecasts, predictions and expectations about the
likely courses for the economy that is too rife with varied assumptions to capture my interest.
Ditto the bond market where there has been a case for a very gentle upturn in yields but
nothing in support for the strong reaction well underway.

August on the sidelines has been very pleasant for me.

Economic Indicators, Company Comments Whipsaw

Purchasing manager data released in early August suggested a firming US economy
with clear suggestions of further strength ahead. The weekly leading economic data
sets I follow also suggested a better pace for the economy, especially with initial jobless
claims dropping down. This info strengthened the hand of those folks who have been
claiming the Fed is set to cut the pace of QE soon. Thence comes the whipsaw. Cisco
Systems is battling a soft patch and is adding to layoffs. Macy's sees softness in sales
and today, Walmart -- the largest US retailer -- reports lighter traffic as a combination of
higher payroll taxes and mildly accelerating inflation cuts into consumer spending
power. Today, the Fed reported flat industrial production for July, and retail sales,
although up 5.4% yr/yr, barely budged forward in July. The past month was sluggish
indeed for the economy and company and Fed regional data suggest the opening weeks
of August were slow as well.

Should the economy pick up going forward, then there will be no discrepancy between
the leading indicator data and recent reports on sales and output. We will just have to
wait several weeks to see if the recent upturn in the leading data, including strong new
order numbers from the PMI reports, were one shot wonders or not.

My coincident economic indicator, which measures the very basic economy on a yr/yr
basis, came in at +1% for July. It shows a continuing sluggish economy with a down-
trend in momentum still very much intact. Hopefully, readings for Aug. and Sep. will
confirm the recent pick up in leading indicator data via a positive turn in the
coincident indicator.

Stock Market -- Daily Chart

On a seasonal basis, the market is behaving perfectly -- flattish, with low volatility and light
volume. SPX Daily Chart It's August in the Hamptons and the living has been easy.

The sharp advance underway since mid - Nov. '12 is still underway, although the SPX is
failing to sustain the momentum or speed line of the original impulse that ran into May.
The market is not overbought in the short run, but it does remain relatively strongly
overbought against its 200 day m/a. So far, investors have waived off this significant
intermediate term caution. Attached short term RSI and MACD are trending down,
but the market does not show breakdowns of the 10 and 25 day m/a's which would signal
a likely, more noteworthy move down. The VIX remains very subdued and indicates a
strongly confident tone to the market. On balance, it has been very hard to scare players
off the market so far this year.

Seasonally, the stock market does tend to give up some ground ahead in Sep. and Oct.
There is already a surfeit of "crash talk" out there on the Web as guys try to make the
big call via capitalization on the 1929 and 1987 Oct. crashes. There are also folks who
have moved into crash debunk mode. Some of it on both sides makes for interesting
idle time beach reading on vacation.

There is a serious element here, however. Historically market panics such as the US
experienced in 2008 - 2009  can beget an add -  on panic / recession a few years out
provided that the steep loss of confidence the initial panic caused hasn't been broadly rebuilt
and providing that near concerns develop regarding liquidity in the system. Post 2008,
the Fed's QE programs and ZIRP policy have been in place to keep the wolf away from
the door, and system liquidity levels are probably adequate to keep the wolf at bay so
long as the Fed does not behave foolishly and cavalierly in the months ahead regarding
any prospective firming up of monetary policy. In a like manner, the administration
and the Congress will be squaring off on the budget and the debt ceiling later in the
year and we can hope but not genuinely expect that no further damage to this modest
economic recovery will be done via foolish fiscal policy choices.

Stock Market -- Take A Deep Breath

It is August. More folks are on holiday. Volume is light. The stock market has quieted
down. However, more Fed governors are speaking up in favor of curtailing the growth
of the large QE program which has been the major driver of the market's strong advance
since late 2012. Normally when the Fed wishes to curb the growth of Fed Bank Credit,
it simply freezes it in inflation adjusted terms and uses tighter liquidity conditions to raise
short term interest rates.The stock market can shudder briefly but usually bounces back
so long as credit growth is brisk enough to fund continued economic progress.

Both the monetary base and M-1 monetary liquidity are very sensitive to changes in Fed
Bank Credit. In fact, I use real M-1 as a sort of ultimate longer term leading economic
indicator. Presently, the growth of real M-1 is running about 10% yr/yr . It has been
decelerating, but has been way too fast to create concern about the economy. A gradual
tapering in the growth of Fed Credit would push the issue whether real M-1 might be
slowing too fast well out into 2014. Even then, there might not be a problem for the
economy if credit growth is fast enough to fund both real output and cyclical inflation.
Moreover, if the Fed can trim its credit account without raising short rates, there would
even be less pressure for the economy. Finally, and if necessary, a new QE program
could be put in place to backstop a faltering economy.

Market players have loved the QE programs even as earnings improvement momentum
has slowed to a crawl. The QE programs, in underwriting a strong bull market, have
worked to allow confidence in the economy to recover from the depths. Straight line
reasoning implies that a reduction in and subsequent elimination of QE would damage
the stock market, undermine confidence and, in the end, punish the economy.

The history of this economic recovery suggests the Fed, if it goes through with its heavily
leaked new program could top the market for quite some time unless investors and
traders see enough in the progress of the economy to waive off QE as a concern. My
reading of the evidence since 2009 says that if this transition is to occur, it may not do so
quickly unless the economy surprises to the upside for a good several months as QE
subsides.

I would dearly like to see the economy recover a faster stride and failing that, I would
prefer the Fed, if it concludes it must curtail the QE, go ahead in a very cautious manner.

QE curtailment, tapering etc. could well introduce a sizable element of perceived risk
into the market "equation" even though from a strictly monetary economics point of view,
no such worry should surface for another year or so.

Take a deep breath and think through carefully what I have outlined. I happen to like the
idea that the market could be close to where it is now a year further out in time before
the QE reduction issues are resolved and a new bull leg can begin. It is not a prediction,
just a thought. In the meantime, I will stick with my indicator disciplines.

SPX Daily Chart

Eurozone Status Check

Here in the US, there is stronger interest in the Eurozone stock market than that seen
for a good several years. The view gaining in popularity is that the EZ will very soon
be coming out of recession and that EZ stocks may offer more appeal than US stocks
in view of a possible strong leg up in EZ stocks as an early-in-the-recovery play. Since
EZ policies have many critics here, this perspective is far from unanimous.

I have followed a very simplistic approach with the EZ over the past couple of years
with my focus on Euro monetary liquidity. The growth of such liquidity has been
strong enough over the past year to have entered an area of sufficient magnitude to support
a mild economic recovery. I would like to see Euro M-1 up 10% or more yr/yr, but that
is well within reach this year. Euro M-3 is growing very slowly as EZ credit is still
shrinking, but it is monetary liquidity that usually leads the way in re-inflation start ups.

The EZ PMI has been in a base mode of a downturn-indicated  level of just above 45 for
most of the past 18 mos. and has just risen above the 50 level into expansion mode.
This sharp turnaround may well signal an end to recession conditions for the EZ in the
aggregate. Yes. it could be a fluke, but it is a hopeful sign after such an extended basing
period. 8/5 EZ PMI

Euro land  stocks have been trending higher over the past two years as players have mostly
blown off attention to the recession for the EZ as a whole. Plenty of investors here in the
US have ignored the market because it has seriously underperformed  the SP 500 and have
taken little notice of the strong recovery of the Euro currency. Europe 600 Stocks

The charm for US players despite already rising Euro share prices is the economic recovery
may finally just be starting with Euro stock composites 25 - 30% below the prior 2008 all
time high. The "600" index chart above shows its relative strength against the SP 500 ETF.
Traders are eyeing the recent basing of this RS measure against a longer term downtrend
and may well like the idea of a stronger Euro which is coming out of an extended down-
trend against the dollar.

There is risk in the trade since a scale down of US Fed QE could bother some foreign
markets even more than it may jostle US equities.

Trading Russia -- Better Lucky Than Smart

I have done alright trading the Russian stock market via the ETF route and as a higher
beta proxy for the oil price. There was a nice long side trade in early Dec. 2012 on a
stronger oil price and with better late autumn industrial output (See 12/5/12 post in
archive if you're interested).

I have stayed away form Russia this year because of the sharp divergence between the
price action of oil and the RTSI and passed up the recent opportunity to go long with
the exchange's value having dropped down to important support. RTSI Weekly Chart

Russia's industrial economy held up reasonably well in 2012, but the domestic side has
clearly weakened in recent months. The poor price action of the stock market after Jan.
of this year tells me the smarter money surely had the edge as it has been discounting
slippage of the industrial sector into negative territory. Russia Mfg. PMI

Moscow has been having good fun with the Snowden affair, but it is time for Putin and
his boys to tackle a deteriorating domestic economic situation which has damaged the
market after a solid 2012 economic performance in the face of the Eurozone recession.

Relative to the oil price, the RTSI should probably be trading up around the 1600 - 1700
area. But, being half a world away, I plan to stay on the sidelines for now to see how
the domestic economy performs in the shorter run. In the meantime, there is the great
music to enjoy -- No, not Pussy Riot --  but Shostakovich and Prokofiev, two of my
favorites.

Stock Market -- Weekly

Fundamental
The key driver for the continuing advance is the Fed's ongoing large QE program. It has
fostered broad liquidity growth in excess of the needs of a muted real economy, and with
slight progress in corporate earnings, provides a strong tailwind for investor confidence.
Some investors believe the economy is set to accelerate and some are very happy with
very slow economic growth and low inflation and interest rates. Weekly cyclical data
I follow show some recent firming for the economy, but this index has been flat since Feb.
and must strengthen considerably to support the economic growth acceleration case.

The SPX is up about 54% from the 3Q 2011 when this latest extended up leg began.
Over the same period, SPX quarterly net per share earning power has expanded but 7%.
The p/e ratio has risen by nearly 50% leaving the SPX fully valued for now. Few wish to
fight the Fed.

Technical
The SPX remains in a strong uptrend. It is again getting extended in price as it was just
back in May. The RSI and MACD show rising trends from the 2011 low with the MACD
now very overbought on the weekly chart. Notice the recent and not often seen whipsaw
in the MACD, signaling strong player desire to add to positions on dips. The market
remains at a hefty premium to its 40 wk. m/a as well. SPX Weekly

The VIX volatility index -- a barometer of fear vs. confidence -- has dropped down to a
level just a hair above the 10 line which demarcates strong confidence and supreme
complacency (bottom panel).

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The continuing expansion of the p/e ratio marks the passage of the SPX from value driven
to price momentum speculation. Keep your quote device nearby as the fast action guys are
arriving in trucks.

Market Breadth Has Yet To Confirm Recent Advance

Recent strong equities performance to new highs has yet to be confirmed by a run to
a new all time high for market breadth. Hardly fatal, but this non-confirmation is worth
your continued attention anyway as it could signal a more narrowly focused advance
for the market even if it does not necessarily presage a topping stage. Obviously, the
non-confirmation from the adv / dec line is small enough now that it could overcome it
easily enough during further positive price action. Breadth Vs. Price

Monetary Policy -- Setting The Clock For Confrontation

As expected, pushback on the QE program is on the rise: It is inflationary; it will create
asset bubbles; it is not proving effective . The economy has shown some signs of improve-
ment in Jul., but Bernanke chose first half 2013 performance -- 1.4% annualized GDP
growth and below target inflation -- to press the case for continuing the program.

My weekly leading economic indicator sets are turning up and that is welcome. But, we
probably need 4 -6 months of stronger indicator performance to make the case that the
economy is entering acceleration mode sufficient enough to have a worthwhile discussion
of sustainability. Outward appearances suggest strongly Bernanke will give up his
chairman role by 1/31/14 if not sooner and there could be substantial pressure on the new
chair to begin to wind down the QE program even if it is far from clear that it is ok
from an economic perspective to do so. Moreover, if the economy is set to do better as
many now think, QE liquidity could continue to funnel into the oil price, thereby setting
off higher inflation which, over time, could pressure real incomes. Put up more points
for the anti - QE hawks.

I figure the fight over curtailing QE is likely to be settled within the next 6 months. The
issue is a big deal because broad measures of financial liquidity are barely adequate to
sustain decent growth. I realize that a still very depressed construction market is holding
down private sector credit growth and that bank lending and funding would likely improve
sharply on stronger construction demand. Yes, there is idle developed real estate, but this is
also symptomatic of the business and banking caution the Fed has had to confront and
could well be indicative of a more general and shallow confidence at work in the system
which could be undermined by a premature reduction of the QE program.