SPX Monthly And The Rule Of 20

Starting in the 1960s, capital asset pricing began to shift focus, tying prospective asset returns to
the levels of the risk free rate (91 day T-Bill yield) and the rate of inflation. In broad terms,
equity strategists started tying the rate of earnings capitalization (the market p/e ratio) to the Bill
yield and inflation, with the market p/e ratio set to vary inversely with the levels of short term
interest rates and of inflation. With some empirical foundation, strategists came up with the 'the
rule of 20' which lays out that the market p/e ratio = 20 - the inflation rate. Thus if underlying
inflation is 2%, the SPX should trade for around 18x net per share. There are different sorts of
issues and problems with the formulation, but it has retained significant popularity.

Using a long term trend line, SPX net should be around $135. out through mid - 2018 and the
market should trade around 2430 (18 x $135.). Under this method, the SPX is reasonable or
fairly valued. There is an issue that investors have not fully broached yet. How reasonable is it
to assume that SPX net per share will grow at 6.5% in the years ahead when the top line or sales
growth may struggle to reach 5% and companies have been squeezing cost structures for years
to boost profit margins? This is why a number of well seasoned  strategists are warning that in an
era of real growth below the long term average, investors must brace for lower returns.

For a good while this year, investors were not troubled because they saw the Trump / GOP nexus
pushing stimulus plans that would boost top line growth somewhat and lower the corporate
income tax. But Trump's troubles and a GOP that lacks the unity to push stimulus programs
through raises questions about whether SPX earning power will be strong enough to sustain
the 6.5% growth trend for the next several years.

Whatever your strategic approach to the market may be, the preceding three paragraphs offers
good insight into how the Big Money plays the game most of the time.

Attached is the SPX Monthly Chart. Pay careful attention to the continuing positive reading
of the monthly MACD indicator -- It does not whipsaw often.

Stock Market

The week before last, the boyz were hollering for a break above SPX 2400 as they feared having
to deal with a double top. And they got one! The market loves to punish the vocally demanding,
but not this time. Last week's advance keeps the post election rally alive, at least for the large cap
sector of the market. The trend up from the Nov. low remains sharp, but there remains little room
to avoid a break in the weeks ahead. The SPX remains moderately overbought on a momentum
basis. It was allowed last week that it could break above 2400 in the short term and there is still
a little bit of room to push it higher. However, the SPX remains heavily overbought looking out
3 - 6 months. SPX Weekly

The weekly cyclical fundamental directional indicator has been flat since the end of Jan. this year,
but it has improved nicely over the past couple weeks reflecting the remarkable performance of
the new jobless claims indicator which has dropped sharply to a 44 year low. Total civilian
employment is up only 1.0% y/y, but it is the jobless claims data that wags the dog here. I would
like to see more positive breadth among the weekly data, but initial claims has been a trader
favorite for years. Among the indicators, sensitive materials prices have turned weak since early
in the year. This development has been a nice positive for the bond market and it may also account
partly for investor preference for large cap stocks.

From a fundamental indicator perspective, the cyclical case was very strong for equities for most
of 2016, but has weakened appreciably since earlier in this year. the SPX is holding its uptrend
nicely in 2017, but without strong and comforting cyclical support.

SPX -- Weekly

My e-inbox is stuffed this week with indications of growing pundit / strategist impatience. This
is the first such suggestion in 2017, although it should not be a surprise given the continuing
flat market and a volatile week. I am not receiving  much bearish commentary, but rather
intimations that its high time for more upside or, maybe it will be wise to think about reducing
exposure.

My forward looking cyclical economic indicators have continued on the flat side since the end
of January, and, like the market, have not evidenced much in the way of volatility. The Congress
has taken up tax reform with emphasis on revenue take neutrality, and it is possible traders are
starting to miss Trump team leadership on a more stimulative set of guidelines with a clear focus
on significant deficit financing.

The weekly SPX chart shows the market is still working off a serious intermediate term over-
bought situation including now double top resistance at 2400. The market's range over the past
few months has been tight and there has not been the sort of sustained corrective action to
provoke thinking that a fresh buying opportunity might be at hand.  Similarly, there has not been
a test of the 40 wk. m/a since last autumn. I do not have a strong view on market direction near
term, but my discipline says not to trade extended overbought situations on the long side. The
chart does suggest there is upside through 2400 but maybe not very much.  SPX Weekly

SPX -- Daily

I plan to do a weekly update before the end of the weekend, so this piece is intended to focus
on the short term as revealed by the SPX Daily

There was a sharp and overdue dip this week as the Trump farrago captured The Street's focus
for a day, but news that the Congress is taking up a large tax reform program led to some cheer as
the week ended. The price gap alluded to a couple of weeks ago with the announcement of the
Trump tax proposal was closed by the sharp sell off on Wed. The partial rebound toward week's
end closed half the distance after the big downer on Wed. The market is still laboring under the
SPX double top at 2400, which marks clear short term resistance. There is short term support for
the SPX a little above the 2320 level.

The MACD looks a little nasty, but the SPX is now in relatively neutral territory.

Gold Price

In early 2016, economic fortune turned positive for the gold price in the form of faster economic
growth and accelerating inflation. It prompted a dramatic cyclical run for gold off its low in the
$1050 oz. area up to an unsustainable peak of $1375 in Aug. of last year when speculative froth
in the futures market bubbled up to dramatic new highs.  As expected then, the gold price corrected
to a deeper than expected low near $1125 late last year. That translated into a 7% price gain for the
2016, which seems appropriate to me, after all the dust settled. My shorter run economic and
inflation indicators have both lost substantial positive momentum so far this year, so the typically
volatile rally in gold in 2017 has been too strong on the inflation front in my view. Now there are
a bevy of potential geopolitical risk factors still ahead for 2017 ranging from North Korea on to
elections in Iran through to the Brexit saga, more elections in Europe and unsettled global
diplomacy reflecting The Donald in his role as wrecking ball of the old world order. On top,
with the US expected to be less dominant in the growth of the world economy this year, the
US dollar has been weakening so far in 2017 (which is fine by me).  So, gold has been getting
some support from both geopolitical uncertainty and a weaker USD, which has lost some haven
status.

With a correction underway in the USD, the gold price has some traditional appeal even though the
recent rally in anticipation of trouble after the French election has not materialized.  Gold Daily 

SPX -- Weekly

Fundamentals
Measured y/y, business sales and profits remain quite strong. Forward looking economic indicators
still suggest growth deceleration out ahead, but even this case is not closed yet. The future inflation
pressure gauge has weakened after a strong period of recovery starting in early 2016. Inflation may
also be set to moderate out ahead. Thus, the faster economic growth / inflation thesis which was
the bedrock for the strong up leg in the stock market since early 2016 hasn't yet collapsed, but has
dissipated considerably since earlier in the year. The market rally over the past couple of weeks
primarily reflects Trump talk of 'massive' tax cuts later in the year and hopes that he will keep
the infrastructure and offshore and dollar repatriation programs alive. If you are in it to win it
with The Donald, simply be prepared to continue to wade through the Trumpian horse shit that
will flow steadily our way.

Technical
Basically, the market remains overbought for the intermediate term with mild corrective action
quickly remediated in recent weeks. The market has now formed a 'secondary top'. This may
merely be incidental, but it could also be the prelude to something nastier as happened in mid-
2015. The SPX is also trading at the top of its 20 week Keltner channel, a development that
commands extra attention.  SPX Weekly

Trump And The Russians
There is plenty of smoke here, but how big the fire is is far from clear. In making FBI Director
Comey walk the plank this week, he has alienated the FBI to its core. Regardless of how the
investigation proceeds, figure that at some point in his tenure, the boys with the short hair cuts
and dark suits will take a large bite out of Trump's ass. Even a Trump built dyke will spring
serious leaks if it comes to that. 

Oil Price

Wicked isn't it? Confidence built strongly over the course of last year that the oil price had made a
decisive bear market low just under $27 bl. in Feb. 16. What followed was a powerful seasonal
rally into Oct. There was seasonal weakness afterward, but since Nov. of last year the market's
trading pattern has been somewhat off - kilter seasonally as debate has focused on whether
OPEC / Russia production cuts would allow rising demand to balance off supply such that, by
later this year, we could see crude rise to $60. By early 2017, speculative long positions in the
oil futures market had reached record levels. That intense speculation plus already dramatic yr/yr
% price momentum produced a dramatic overbought in the market as I suggested in posts earlier
this year. I argued that there would be at least a price "hiccup", and we have seen such over the
past couple of months after the normal or seasonal round of price strength over the Feb. - Apr.
failed to pan out. WTIC Daily

Indicators reveal a marked improvement in global economic demand over the past year. However,
the rate of progress may have peaked, at least temporarily. On the supply side of the oil equation,
US output recovery has exceeded earlier expectations, with the  NA rig count having more than
doubled since last May and capacity utilization at the well head now having risen to over 93%.
Even Libyan crude output is topping expectations. So, the story of supply / demand balance this
year is less sturdy now than it was. Moreover, speculative long positions in the oil future have
been sharply reduced, but are now in a gray area where further liquidation cannot be discounted
even if the pace of redress slackens. Seasonals have not been that important, but it should be noted
that Jun. ahead is normally a weak month.

The upshot here is the game of guessing on the direction of the oil price is now more tenuous
 in the near term. The technicals here are mixed. The oil price is in a volatile short term down-
trend and is behaving poorly against its 200 day m/a for the first time in quite a while. On
the plus side, the market is oversold and even though timing measured in days is not sure,
there is a rally out there before too long.

The VIX Volatilty Index

I make limited use of the VIX index. However, when the weekly index falls into the 10 -12 range,
there is a clear suggestion to expect volatility in the stock market to rise out ahead. This means
that it would be normal to expect some corrective action, but it certainly does not imply that it
will be major. Even so, the current nearly historically low VIX does suggest that when the market
moves into a more volatile period, it can certainly last a while and be a little spooky.  VIX Weekly