Financial System Liquidity

The Fed's balance sheet and the monetary base both have been flat for a year now, but there is
still solid residual growth in the M-1 measure which lightens the stress from the shutdown of QE.
The US economy and the stock market have held up decently. Private sector liquidity growth has
been adequate to fund a modestly expanding real economy and low short term interest rates and
non-existent current inflation have kept equities players from abandoning stocks where they can
earn 2.2% to hang around and see how 2016 shapes up.

The banks have been expanding the loan book with more categories seeing rising outstandings.
The system is not aggressively chasing deposits but has been content to ease up on balance sheet
liquidity constraints to meet higher credit demand. Overall, the banking system and consumers
are maintaining sufficient confidence to underwrite modest economic growth in the absence of
further quantitative easing by the Fed.

Private sector funding has been growing at around a 5% annual rate for a number of months and
with  low real output growth and zippo inflation, the system has been generating more liquidity than
the economy actually requires. However, the capital markets have not benefited as investor
confidence in both the stock and bond markets has deteriorated as measured by widening credit
quality spreads and the progressive loss of positive price momentum in stocks overall. In fact,
institutional money market holdings in the US have increased by over $100 billion or nearly 9%
over the past 18 months and the guys appear ready to see the new year ushered in before
getting off their hands.                                                                                                                                                                                          

Oil Price Quickie

Historically, the oil price tends to  experience seasonal weakness from early October through late
February of the following year. Interestingly, during this interval, there is a brief period when oil
tends to rally, and this occurs over the second half of December into very early January. I bring
this issue up to caution longer term players who have an interest in getting long oil and related
stocks that price weakness often re-asserts itself after the new year begins. In an ideal seasonal
pattern, the oil price tends to make its low in late February when it is time to build the gasoline
stocks up for the driving season ahead in the northern hemisphere. Seasonal patterns suggest
seeing what January holds in store for the oil price except for shorter term traders. WTIC Weekly

Changing Stock Market Fundamentals

With the decision by the Fed to raise short term rates by 25 basis points, the "easy money buy"
rating I have had in effect since very late 2008 has ended. With primary fundamentals now
negative I have a "tight money sell" now in place. The stock market can rise from here, but it
is no longer rated attractive as an investment but only as an occasional trade. This is only my
preference and others will surely disagree. Primary liquidity measures, the direction of interest
rates and measures of financial market confidence are all negative. I also flag the Fed view
expressed today that as short rates reach 'normal' levels, the Fed will consider selling or allowing
securities held on its balance sheet to run off. That possibility, although may be sound in theory,
has proven disastrous in practice.

Whatever the return potential for stocks may be going forward, stock market risk is now substantial
and rising.

I do follow a group of indicators I regard as secondary and it is a mixed bag at present. The positives
represented are no evolving liquidity squeeze in place, ample private sector credit driven liquidity
relative to the present needs of the real economy, and modest levels of 'sideline' cash reserves. The
negatives are obvious -- an ongoing earnings recession and the high level of valuation.

The upshot here is that the future direction of the stock market is now much more difficult to
predict.

There are a couple of more important factors here.  One is 'career risk'. It has been a lengthy
bull market, the economy is just muddling along, and stocks are expensive. There may be
a number of players out there who have all manner of reservations about the market outlook.
However, if positive price momentum develops and seems like it may have staying power,
many players will hang in there because they do not want to lose clients and their jobs.
Also, in a rising interest rate environment, investors may be inclined to move a portion of
assets out of bonds and into stocks. Finally, we will have to keep an eye on the oil price,
as extreme developments there can challenge the market.

Stock Market -- Quick Weekly Profile

The charts and text below are meant to benchmark the stock market ahead of the Fed's policy
meeting this week. 

Value Line Arithmetic Index (Unweighted)
$VLE is a 1700 stock composite that captures universe of US stocks that are most popular. $VLE 
The powerful uptrend dating from late 2011 ended earlier in the year and the index has been
flat although volatile since mid -2014 reflecting ending of huge QE 3 program, and peaking of
economic growth momentum which has ushered in a mild but persistent decline in profits that
does not yet show signs of a positive reversal. Note persistent decay of indicators since late '13
but with no sustainable price break yet.

Cumulative Advance / Decline Line ($NYAD)
Longer term but cyclical uptrend ended earlier in year and moderate breakdown is underway
as breadth is shrinking with investors becoming more quality and liquidity conscious. Recent
failure of A /D line to take out its 40 wk. m/a on rallies is a shorter term warning sign for the
market.

Buying Vs. Selling Pressure
My preferred indicator is the NYSE measure, or $TRIN. Readings on this measure above 1.5
for the weekly TRIN on the basis of a 6 wk. m/a suggest a strongly oversold market which was
evident in Q 3 '15. Following the recent rally in stocks the TRIN has moved into more neutral
territory but continues to show milder net selling pressure.

SPX -- Daily

With the variety of fundamental crosscurrents in play over the past couple of months, I have been
letting the technicals serve as the guide to the market short term. I cashed out of stocks on Nov. 2
and in posts on 11/9 and 11/20 I cautioned about the failure of the SPX at resistance at 2100. I even
conjectured that with failure to breakthrough resistance, the SPX could fall into the high 1900's. We
are getting close to that area now. SPX Daily

The SPX has been trending down since early Nov. from a powerful short term overbought and is
now heading into oversold territory and could well have further to go. Now, market fundamentals
are set to return to the fore right ahead as the Fed's FOMC decides whether to raise short term
rates at its meeting over next Tues. - Wed. as it has been almost unambiguously hinting. If They
go ahead and do it, the increase will come with the strong suggestion that an eventuating uptrend
will be mild and gradual and that short rates could be allowed to fall subsequently if circumstances
warrant. If this is the correct scenario, players will have the next week or so to sort out further
how much risk each feels is appropriate in a tighter monetary environment which features rates still
at historically low levels. If the Fed decides at this meeting that It does not want to push up short
rates, then investors will have to sort out the Fed's 'take' on the outlook. Certainly, the Fed would
look silly if It postpones the decision and implies "well, may at the end of Jan. '16 we'll look at
it again".

I have never seen much value in trying to psyche out the Fed. I do not see a good case for raising
short rates, but all of us will have to play it as it lays next week. 

Oil Price

The recent decline in WTI crude below $40 bl. beckons the imagination to wonder if the world is
going retro to the decade ending in 2004, when crude ranged from $20 - 40. WTI Monthly Back
in that period, spare production capacity at the wellhead averaged near 4 million bd., a tidy amount
on a much lower base of oil supply / demand. Oil production surged in recent months at what may
well be an unsustainable pace, and if demand grows moderately in 2016, spare capacity may be at
only a little over 1.5 million bls. a day, even factoring in expected larger output from Iran. Cover
stocks are currently put at 3 billion bls. which is triple the size of inventory held a decade ago and
represents a dramatic increase in cover stock investment, no doubt.

Even with the large increase in stocks on hand, eventual tightening in the balance of production
capacity and demand may eventually lead to stabilization of the oil price, followed by a modicum
of recovery.

There has been a dramatic bust in the price of oil on expanded relative supply, but not a bust
in the global industry. In the 40 odd years there have been price busts in oil where excess capacity
at the wellhead ranged between 4 - 11 million bd. Seen historically, the supply / demand balance
currently is fairly tight. However, financial speculation in this industry has at the least quintupled
over the past ten odd years, which I strongly suspect has added greatly to the volatility of the
oil price relative to the fundamentals of the industry.

It is clear the oil price remains in a bear market with periodic moments of panic, and now that
the price of WTI crude has broken major support around the $40 area, the tensions among players
are palpable. The market is once again moving toward an intermediate term oversold condition,
but since OPEC timed the elimination of production constraints for the current seasonally weak
period, one cannot rule out a fast spike down in price. But, as importantly, folks need to recognize
that given what a high stakes game this has become, any perceived improvement  in fundamentals
could trigger a surprisingly positive response in the price of crude. $WTIC Weekly

Monetary Policy

Back on Sep. 15, I argued that a review of the cyclical indicators that have held sway in the Fed's
decisions for setting interest rate policy since the end of WW 2 suggested that if anything,
the Fed should be easing policy. In view of the continued weakening of economic momentum and the
further development of economic slack via falling facilities operating rates, that opinion remains
warranted in my view. In Its apparent desire to raise short rates as 2016 fast approaches, the FOMC
has resorted to spin to make its case. Perhaps a couple of bumps up to short rates will do no economic
damage, but it is costing the Fed credibility and the twists and turns of Fed communications  are
adding needless volatility to the markets (Draghi over at the ECB is faring no better in this regard).

To compensate for an obvious indiscretion, the Fed promises to be sparing and gentle in raising
rates so as not to be too disruptive to the economy and the markets. This is good to know since the
US economy and stock market have yet to prove they can transition away successfully from a
strong dependence on large scale quantitative easing toward dependence on customary internally
generated resources.

With falling net per share and an elevated stock market, the S&P 500 is now trading just slightly
below 20 x latest 12 months earnings as the Fed prepares the next round of monetary tightening.
I have the market as significantly but not yet outrageously overvalued.