Liquidity Cycle

Reflecting the supportive power of the Fed's QE 3 program, business sales measured yr/yr
have advanced from a recovery low point of  3.0% up to 7.0% through Jul. 2014. this strong
acceleration is currently underwriting faster profits growth for the SP 500 companies of over
$30. per share per quarter from the $25. level.

However, a negative reversal is now underway in total liquidity growth (including the Fed's
balance sheet). So far yr/yr growth in liquidity has declined from a cyclical peak of 11.6%
earlier this year to 8.9% yr/yr through early Aug. Thus, it is likely that at some point in
late 2014, business sales momentum will have made at least an interim peak and be set to
decelerate. The ramp up of liquidity growth starting with the onset of QE 3 has led to a
muted acceleration of inflation.

The bond market, save for the junk sector, is enjoying the run down of QE, with players
figuring that the expected lower growth of liquidity will lead to an easing of economic growth,
reduced inflation stimulus, and a postponement of the day when the Fed ends its ZIRP and
begins to raise short term interest rates. Sluggish retail sales data for July also helped the stock
market this week as traders, who were concerned about an economy which could overheat,
welcomed the sign of a more leisurely pace to economic expansion.

Although I am concerned about how the US economy will perform as QE is zeroed out, the
slower pace of retail sales was a little surprising and also suggests that there maybe a minor
round of lower inventory investment ahead as the pace of sales at the wholesale level has
been quite a bit faster than retail. It may well be too early to buy off on a slowdown story
this soon, but it is worthwhile to keep it mind.

Relative Strength of the SPDR 500 vs. the long Treasury price: SPY: $USB