Gold Price

As discussed in the last gold post on 9/10, I pointed out that the
gold price needed to take out key resistance at $1000 oz. to hold
the uptrend in place since 10/08. This it has done.

The gold price was rambunctiously up over Q1 '09, but it could not
hold that action and has since settled into a more stable uptrend.
The negative price action of the past few days has taken some of the
froth off the market, but gold has not been dizzyingly overbought
now since a brief stretch in 3/09. I would rate it mildly overbought
at this time.

My gold price macroeconomic directional indicator entered a new
uptrend starting last December. It has been rising with relative
consistency and reached a new all-time high on 10/23, slightly
exceeding the previous high set in 8/08. The primary factor
behind the setting of a new high has been the strong growth of
monetary liquidity via the Fed's easing actions, but oil and industrial
commodities prices have also contributed significantly since the
early part of this year.

It is encouraging that gold and the indicator made new highs close
in time to one another, but I continue to see gold as carrying a large
price premium that I cannot account for through various techniques
of economic analysis. That premium is now close to $350 an oz.
It is clear that there is no shortage of folks who worry about the
stability of the financial system. But, I would also point out that
2009 has seen sharp advances for the other precious metals, so
there could be as much a cyclical element in gold's recent trend as
anything else.

At any rate, gold remains too rich for my blood, and I have been
happy to trade away from this market and will continue to do so
until gold finds a range closer to my idea of its economic value (now
a paltry $500 -550 oz.). Gold chart is here.

More On SP 500 Profits

This entry builds from the 10/21 post on earnings. With
earnings in recovery mode, analysts now see quarterly
operating net improving serially straight through the
final quarter of 2010, and they expect full year SP 500
eps for 2010 to be up by 31% to about $73.50. Now, this
represents a fairly strong takeoff, and as discussed in the
10/21 post, suggests that profit margins will benefit from
a positive turn in top - line or sales growth. Looking out
to Q 4 ' 10, the consensus is for quarterly net of about
$20.20. This is hardly a stretch with modest real growth
in sales of 3% and a pricing gain of 2%. So, I do not think
the numbers needed to produce much stronger earnings
in 2010 are heroic by any stretch.

For perspective, should Q 4 ' 10 eps come in at $20.20, we
can compare that number to a mid - range $25. based on
the SP 500 earnings channel for the past 20 years. The
projection represents good recovery from severely
depressed levels, but would fall far short of the indicated
norm of the past 20 years.

You should know that earnings projections through 2010
are somewhat backloaded in that no big lift is expected
until mid - 2010. So, as analysts now see it, the big test
of their projections is still 9 months out.

I think the above fairly presents the earnings
fundamentals game plan out through 2010. It looks
daunting, but really represents a "lay up" with a modest
modicum of economic recovery.

I think investors are clearly looking well into 2010 with
the SP 500 at current levels. And that is an important
takeaway for you as you assess the economic outlook for
yourself from week to week and month to month.

Corporate Profits

Reality Check: Yes profits are coming in better than expected and
that is a good thing. But the companies that have crashed and
burned or are doing so now, get deleted from earnings when their
market capitalizations shrink enough to be supplanted by stronger
companies. So, earnings are better than they would be if the SP 500
were static. Over time this imparts an upward bias to index eps
and its price value.

That caveat aside, corporate profits are coming in better than
expected and estimates are being raised for Q 4 ' 09 and for 2010.
Q4 '08 eps were so awful that comparisons will be easy. Ditto for a
match with Q1 '09. So the game now is to watch earnings progress
Q to Q through time. S&P estimates that yr / yr sales through Q3
' 09 were down by an astounding $1.52 tril. or more than 15%. Since
companies cannot cost cut their way to prosperity, analysts are
going to focus heavily on a prospective recovery in sales. The profit
margin on extant 500 company operating eps is way off the high
levels of 2007, but is higher than most imagined it would be
nonetheless. The positive leverage to earnings from a recovery of
sales looks awfully good now.

My earnings indicators save for the finance services sector have
been in sharp uptrends since the spring of ' 09. They have been so
strong, some degree of moderation would be normal in the months
ahead. Financial service company net revenues before fees and
trading profits are down reflecting lower private sector credit
demand and low returns on liquid holdings. On the plus side, the
pace of loan and securities loss reserving has moderated. Now,
oil and gas producers face tough comparisons for Q 4 ' 09, but
rising product price realizations suggest some recovery in 2010.

My SP 500 Market Tracker has net per share for 2009 of around
$56. By my calculations, the market is currently pricing in earning
power of $66. per share. So, investors are looking positively well
into 2010 -- a reminder of why a positive turn in sales is going to
be so critical.

Stock Market -- Some Thoughts

Back on 9/20, in an identically titled post, I decided to take a
more cautious view of the stock market. I thought the 60%
run - up off the 3/09 low represented a tidy downpayment on
economic recovery. I pointed out that forthcoming Q 3 '09 earns.
reports would come in better than expected and that a decision
not to play in the market could prove early. Right about that.

My core fundamentals remain ok. The market is in a firm uptrend.
Looking out past the short run, the market is strongly overbought,
but, that is a hallmark of a powerful market. Even so, there are a
couple of issues that bother me, issues that might even be
antithetical in the short run. First, I believe the market has derived
much of its power from one of the strongest surges ever in the leading
economic indicators. Since the redundancy here is so mild, I think it
is fair to wonder how stocks hold up once the leading indicator spurt
moderates and flattens out for a spell as it inevitably will. So, I am
calling into question the staying power of market psychology.
Secondly, my inflation thrust indicator, which quieted some over the
summer, has started to surge again, with even natural gas joining the
petrol complex to lead the way. Oil, which is now closing in on $80 bl.,
is now high relative to what most consumers can afford without
looking again at their budgets. In short, a fast rising oil price dims
the longer term economic outlook.

Now, it may well turn out that if the leading economic indicators
moderate over the next several months, the stock market will correct
and the oil price -- nearly 32% above its 40 wk. m/a and wildly
overbought -- will drop down sharply in price. I'll happily sign up
for another long side tour in stocks if that all happens and the core
fundamentals hold up.

I am all in cash now and will likely just monitor the economic indicators
and the markets for another 3 weeks or so. But, I'll be posting even so.

Financial System Liquidity

My broad measure of credit driven liquidity is down 1.5% yr / yr,
and has decreased at a 4.0% annual rate over the past 6 mos. With
deep recession and its immediate aftermath, private sector credit
demand has been declining. The weakness shows not just with
shadow banking, which has collapsed, but with the banking system's
loan book as well. The big roll-off on the banks' book is business or
C&I loans. Readers will recall I have discussed this probability for
months, and also that the C&I loan book could decline significantly
for another year or so. The banks are charging off the loans that
some businesses cannot service, and viable companies are
reducing exposure because with business depressed, working capital
needs have shrunk. Moreover, as the economy recovers, many
companies will generate cash flow well above spending needs, at
least in the early stages.

Monetary liquidity -- the narrow money supply -- is up about 15%
yr / yr, and this has been, as always, the platform to turn the
economy positive. Monetary liquidity represents only 10 -15% of
the broader measures of financial liquidity and cannot sustain an
economic expansion for very long without a positive turn in private
sector borrowing, but it is the kick starter. The Fed, for seasonal
reasons, is presently allowing monetary liquidity growth to
accelerate via its open market activities.

Despite a reduction in the broader credit driven composite, the
velocity of money has declined sharply, as the cyclical economy is
down much more yr / yr. The excess liquidity thus created has
supported the cyclical recovery in stocks, although it should be noted
that velocity has started to recover and that excess liquidity is
easing. A "V" shaped recovery, suggested by the leading indicators,
would likely bring down excess liquidity rather rapidly and give stocks
much less of a tailwind.

The world's major central banks are keeping large currency swap lines
to cushion the decline in global capital flows fostered by the 2007-08
credit crunch and a collapse in global trade. The outflow of US dollars
through the trade window is down 50% over the past 2 years.

Banking system loan loss reserves have increased only modestly in
recent months following a large leap from late 2007. Even so, bank
capital remains flat as cash flow is moderating on a declining loan
book. Thus, as the economy recovers, and with it private sector loan
demand, more than a few banks will need to raise additional primary
equity capital.

Oil Price

Oil has been playing peek a boo in the $70 -75bl. range for several
months now. We are into a period of serious seasonal weakness for
oil, so it is noteworthy the price is holding up. The strength in the
price in recent days has boosted the relative stock price performance
for the producer group.

One concern I have here, which is not tangential to the interests of
oil price players is that if oil does break above $75 a bl., it will have
the effect of reducing the longer term performance potential for
the economy. A rising fuels bill could well put some pressure on the
real wage, and it would force consumers to borrow more to maintain
discretionary spending. Down the road this little series of
connected dots could work not only to moderate economic demand,
but demand for petrol as well. Suggest you keep this in mind.

Oil chart.

Stock Market Quickie

The rally off of the mildest of short term oversolds plus the failure
today of the SP 500 to take out resistance at the 1072 level will
not go unnoticed by a good sized group of traders. Some of the
boyz may see this little failure as a mechanical sell signal. Well, it
sets up a couple of interesting days...CHART.

Economic Indicators

Weekly & Monthly Leading
Both weekly and monthly lead indicators continued to improve in
9/09, and both continue to point to a "V" shaped economic recovery.
The weeklies did lose some momentum over the month, so we will
have to keep an eye on that.

Coincident Indicators
Data is available through August. With real retail sales and industrial
production rising over the first 2 months of the quarter, it is likely
the coincident sets have stabilized. Measured yr / yr, momentum
has improved from -6% readings to -3%.

Corporate Profits indicators
My profits indicators have improved dramatically since early ' 09.
The number of companies reporting rising output has risen sharply
over Q 3 ' 08, but actual output levels, although rising in recent
months still trail prior year levels. Pricing power has remained
weak, but operating costs have been slashed. Viewed sequentially,
quarterly profits are rising from low levels as earnings power
recovers, and this positive trend is the more critical factor. The
"buzz" on The Street has it that Q 3 profits will top estimates.
Right now, annualized SP 500 net per share is probably running $60.

Economic Power Index
This simple index has turned negative. Yr / yr real individual wage
growth has decelerated, but remains historically strong. But,
this crucial positive has now been eclipsed by the deterioration of
total civilian employment when measured yr/ yr. Thus for now,
tax cuts, automatic policy stabilizers and a growing flow of fiscal
spending $ have to carry the day. The key here will be how quickly
negative job loss momentum reverses in the wake of improved
spending and production. This transition period is anxiety provoking
not only because of the weak job market, but also because the
consumer has been adding to liquidity by boosting savings and
paying down revolving credit. The plus side here is that the
underlying demand for consumers is strong following nearly 2
years of marked retrenchment.

Most economists are not sanguine on the employment outlook. And
it is tempting to just go along with this view. But, since business
slashed costs so sharply as the recession took hold, I think it only
prudent to see if higher demand might bring people back on to
payrolls at a faster clip than expected. Companies do not like to
blow orders because they are short handed. Good way to lose
market share, that.

Global Indicators
Output on a global basis appears to have turned positive over the
summer and might be slighly ahead of the US, except for new
orders where the breadth of companies with a rising book has been
quite strong. Employment and pricing power remain subdued on a
global basis, in tandem with the US.

Long Treasury Bond

As readers will recall, I have thought the long Treasury was a
decent countertrend trade on the long side over the past 3-4
months. This was not easy work, but it was an ok call. Now the
bond is trading around the 40 week m/a after posting up 10 points
in recent months. So, it is no longer an oversold entity, and, given
my admittedly indiosyncratic way of trading the bond, is now less
interesting as a trade, even though it is trending positively and has
decent fundamental support, now that industrial commodities
prices have been softening.

I have no quarrel with the bond bulls in the very short run. Trading
on the long side may still be ok, but I am less sure footed now in my
method, so I plan to sideline it for a while. Treasury price chart.

Stock Market -- Technical

As discussed back on 9/20, this large advance was in need of a
vacation or correction after such a powerful run. Today's sharp
decline fractured the uptrend leg running from early July.
Moreover, further weakness would fracture the uptrend line
running from early Mar. At today's close of 1030, the SP500 is but
10 points above the longer running trend line and a break there
would be a bit more serious. the market is slightly oversold now
and is not yet in a confirmed shorter term downtrend. Now since
July, the boyz have been quick to go long on the little dips, so the
next trading day or so will be interesting. A more respectable
oversold would come at around SP 500 990.

A look at the chart linked in below shows that SP 500 is in a
pivotal area. Chart.

Inflation Potential

My inflation pressure gauge rose at a good clip over the first half
of this year on the strength of a rally in the commodities market.
In tune, the CPI, not seasonally adjusted, increased by 2.7% for the
year through Aug. However, the pressure gauge has flattened out
in recent months as the rally in commodities has stalled. In fact,
the uptrend in the commodities market for ' 09 is being tested
presently (chart).

There could well be several reasons for the stall out in the upturn
in commodities. The obvious one is that with a global economic
recovery just starting from low levels, supplies are ample. But I
suspect players are also being influenced by the CFTC inquiry into
the trading structure of these markets as well as the recent weak-
ness of China's stock market and concerns about how strongly its
credit driven business recovery may proceed.

The quick moderation of inflation thrust has helped the bond
market in recent months, and it may also account for the more
stable US dollar seen in the last couple of weeks. Normally, the
prospect of a moderation of inflation pressure as economic
recovery commences would be cheered by stock players, and
we have seen that, although there could be some backlash
potential if players begin to worry again about deflation. that is
why some traders are concerned that a rising dollar would be
bad for stocks in that it would signify a flight to quality in
anticipation of a failed economic recovery. Fancy stuff, but
interesting nonetheless.

When inflation is commodities - driven as it has been so far in
this decade, you have to be prepared for volatility, and this
means keeping a careful eye on the the commodities composites.

Oil Price

Viewed historically, the oil price is about to enter a period of seasonal
weakness that can last well into Dec. The sharp 8.8% decline in the
crude price this past week is not without seasonal precedent. The
decline did fracture a sharp uptrend that began in Feb. '09 off a
another seasonal low point, a trend that essentially belied the broad
supply / demand fundamentals, and one which was fuelled by
speculation on eventual economic and oil demand recovery. I think
the run - up came early, but I guess one has to recognize that newer
long only and price - mimic ETF funds have brought more purely
financial players into the game. Some of these guys do take actual
bunker crude, but most have no intention of riding at home at night
on the train seated next to a barrel of oil.

As mentioned, there has been a break in trend line, and a break in
shorter term trend relative to the 10 and 25 day m/a 's. (Chart
below). The market is also approaching a mild oversold situation,
and there is more downside possible.

In days well gone by, one might have plausibly assumed that the
downward seasonal adjustment in the oil price into Dec. could be in
a range of $15 - 25. a bl., which could take crude as low as $50. But
with more financial players on board, that easy assumption is no
longer assured.

If, indeed, there is a period of seasonal weakness, then we might look
to a test of support at $60 as the first line of defense. A break below
this area might well signal that a more traditional seasonal swoon is
at hand. Chart is here.

A Twofer

Monetary Policy
FOMC left matters largely unchanged today. They acknowledged
an improving economic outlook, and expressed considerable
confidence inflation would remain very well contained. FOMC
normally raises rates on rising business strength, and does so
when my Business Strength Indicator (BSI) rises into the 130 - 140
range. This indicator -- capacity utilization % + ISM mfg. output --
now stands around 121.5. That is way up from the late '08 low
but remains under the monetary tightening threshold because of
a sharply depressed CU%. So, the Fed is continuing to count on
the large gap between capacity and production to anchor its view of
any inflation threat. Short term, they are counting on the CPI,
not seasonally adjusted, to flatten out or recede over the final 3
months of this year. This also implies the Fed thinks that oil and
gasoline prices are also set to flatten or drop on seasonal grounds.
The US has had inflation this year through Aug. ' 09, and this has
undermined the USD.

Cyclical Stocks -- Relative Strength
The relative strength of cyclical stocks is a good measure of economic
growth momentum potential. The MSCI index of cyclicals, $CYC,
divided by the SP 500, has historically peaked in a range of .65 - .75.
The cyclicals relative strength index is up in this historically high
ground now and shows some flattening after a very strong run-up.
Good time to monitor it closely. Chart here.

Stocks -- Tech Sector Leadership

The broad info. technology sector has exhibited relative strength
vs. the market (SP500) since the late spring of 2008. The
relationship has been a volatile one for sure, but the leadership
tech has shown makes it worth watching not only as a sector to
search out for candidates, but one which, because of its economic
sensitivity and substantial p/e ratios, could cave in early in a market
correction. You have to keep in mind that a loss in relative strength
by a particular sector may simply spell normal rotation in a
cyclical market and not be a precursor of a correction. But I say
attend to the tech sector vs. broad market closely for now for
the former has the bigger trading profits to be protected, and,
because individual sector rotation which comes after a lengthy
period ofrelative strength frequently indicates increased investor
concern about "the story" behind the market advance.

Tech sector relative strength chart is here.

Stock Market -- Some Thoughts

This cyclical bull market, unfolding since 3/09, has been one of the
most powerful seen over the past 100 years. The leading indicators
for the economy and for earnings recovery have surged, and
suggest that the early phase of an economic turnaround will be far
stronger than most folks expect. It may be the case that the
recovery is due entirely to massive easing of monetary policy and
a large fiscal stimulus, but that would be to deny that the economy
has self-recuperative powers inherent in deep pent up demand
and empty product pipelines. Not a wise denial.

A century of market history involving bona fide cyclical advances in
the wake of deep financial and / or economic crisis suggests cyclical
recovery averages nearly 50% over the first 12 months from market
trough and can hit nearly 120% as occured over 1932 - 33 in the
wake of the Great Depression. Since Mar. '09, the SP 500 has
advanced by roughly 60%, and so it stands only behind 1932 - 33
in a 12 months out context. Moreover, the big advance over the
1932 - 33 surge was interrupted by a deep and scary correction. So,
there is risk, especially when you consider that the p/e multiple is
now not at all low on early recovery stage earnings potential.

In my view, a 60% shot up over 6 months time has earned the
market a vacation if not a correction of consequence. As readers
know, I turned bullish on the market's potential in Dec. '08, did not
give up on it over Jan. / Feb. and wound up seeing the bottom as
coming over Mar. / May ' 09, which I judged to be about 6 months
ahead of the decisive positive turn of earnings. So, I have done ok
with this market. I also understand that there could be plenty of
positive earnings surprises ahead when Q3 reports come out in
October, and at least some players no doubt have this very idea in
mind as the market is pushed higher. But, being a conservative
fellow, I think a 60% move is a very healthy down payment on
recovery. Acknowledging that I could be early with a cautionary
approach, I leave the field to the bulls for the next 6 weeks. In the
meantime, I have continued to trade long Treasuries with leverage
in the interim and am not hurting for profits.

I plan to relax and enjoy the autumn weather.

Stock Market -- Short Term Technical

My 25 day oscillator broke a downtrend on 9/8, signaling another
run-up was in prospect. This oscillator now has the market at a
moderate overbought level at 1068 on the SP 500. To be precise,
the market stands 4.7% above the 25 day m/a. Over the course of
the advance since 3/09, heavier overboughts have been recorded
at 7 - 10% above the 25 m/a. Historically, however, a reading of
near 5% above the 25 day m/a has often been strong enough to
attract profit takers, so if you're a short term player, you need to
pay attention.

I have linked to the SP 500 chart below. Note that momentum is
overbought and that the 40 day RSI is near 63%. That is a high
reading for this measure.

SP 500 chart is here.

US Dollar -- $USD

I did make a good call on the dollar in early 2008 (saw it higher), but
Forex is not a game of interest to me. So currency posts are very few
and far between.

The dollar has lost ground since early in the year. The Fed has
provided strong money liquidity growth and is running an effective
ZIRP with Fed Funds %. Meanwhile, my inflation pressure gauges,
after bottoming early in the year, are moving up and the CPI without
seasonal adjustment is higher than at y/e 2008 on a lift in petrol
prices. So, the dollar supply has been increasing and money left on
deposit is earning a negative rate of return. The purchasing power of
the dollar is declining in the US, and with global economic recovery in
prospect, no need to blame traders for exiting the dollar, even though
the supply of dollars moving offshore has declined dramatically.

Internal or domestic fundamentals for the dollar will not improve
until basic money growth moderates and short term interest rates
turn positive in real terms. Economic recovery here will bring that
moment closer, but it is a ways off for now.

The $USD is moving toward an oversold position in the forex
market for the first time since early 2008, so a rebound in the next
several weeks cannot be ruled out despite the internal fundamentals.

Here is a link to the weekly $USD.

Gold -- Around $1,000oz.

Well, here we are at $1,000 again. And, here we are at resistance
again, as well. It is fair to say though that the market is not heftily
overbought as it was on its two prior trips to this historic level.

Gold is in an uptrend off 10/08 low, but to confirm from here, the
price needs to take out $1,000 oz. with some authority over the next
five odd weeks.

Gold remains in a mania price zone, and to get into full bubble
territory, we would need to see a sharp break above $1,100 in the
weeks ahead. The market is now mildly overbought.

My gold macroeconomic directional indicator made a low in 12/08
and has been in a relatively strong uptrend since. The fit of the
price of gold to the indicator is somewhat off over the past three
years reflecting price surges in gold within the first five months of
each year that were well out of proportion to the rising indicator
values. The "fit" over the longer run is much closer.

My work shows a basic economic value for gold in a range of $500 -
550 oz. If I push the data using the macro indicator or gold's
relationship to the dollar, I can wring out $700. So, I am unable to
account for about $300 oz. or 30% of the gold price. The "premium"
in the price may have something to do with fears of both inflation
and financial instability, but this concern is not felt with consistency.
I would also note that gold players have followed China's economy
and stock market with very focused interest since last autumn.

At any rate, I would have to say that unless gold can blow well
through the $1000 level before year's end 2009, it is going to look
vulnerable on the long term chart.

Stock Market -- Technical Observations

The stock market remains in a powerful cyclical uptrend in effect
since 3/09. Price momentum has eased measurably as the market
has advanced, but this is a normal dvelopment. My internal market
measure -- cumulative advance / decline plus unweighted prices
has run far stronger than the SP 500, a good sign.

The market exhibits a modest overbought short term and a stronger
one based on 6-13 week reads. An early bull market hallmark does
involve an extended price advance coupled with a substantial and
continuing intermediate term overbought. In a period such as this,
I find it difficult to pick interim tops and corrections when the short
term momentum of the market does not behave audaciously.

25-40 day measures of RSI are around 60% and do suggest the
recent loss of positive momentum may extend ahead. There are not
sufficient disconfirmations from other favored measures to signal
that a significant price correction may lay right ahead.

Because the SP 500 has lagged the broader, unweighted price
measures of the market, it could take another month or two
before the "500" confirms a major positive cyclical reversal.

My reading of the charts suggests that even if a 5-7% price pullback
does lie ahead in upcoming days and weeks, there could well be
another extended but more moderate upleg in price to follow. To
continue this conjecture, I would have to say I am more confident
another upleg lurks out there than I am that we would escape with
a mere 5-7% correction.

The two sentiment measures I follow most closely, the trader
advisories of Market Vane and Consensus Inc., are both a country
mile below levels that would signify "too many bulls".

SP 500 chart is here.

Economic Indicators

Leading Indicators
The two sets of weekly indicators remain in strong uptrends and are
close to turning up when measured yr/yr. They have lost some
momentum over the past 2 weeks as sensitive materials prices have
leveled off. The action of the indicators point to a "V" shaped bounce
for the economy in the early stages. The monthly indicators are
also strongly up, paced by a rapid surge in the index of new orders
for manufacturing. With 100 = to expansion, the combined index for
commercial / mfg. has moved up from a 12/08 low of 62.6 to 114.8
for August. This represents a substantial positive reversal of trend
from a downmove in order momentum that ran from early 2004
through mid-2008. Again, the pattern for now is a "V".

Also of note here is that the index of mortgage purchases has been
basing after a severe 3 year downtrend. This suggests a lift to
housing sales (already recently seen). The Monster Inc. index of web
job listings peaked over 2007 and heralded the end of expansion. It
is now in basing mode and jumped up sharply in August (Monster).

Economic Power Index
The swift positive turnaround in this index over Half 2 '08 helped
significantly to stabilize consumer spending and the economy. The
turn was fuelled by a fast rise in the real wage as inflation fell away.
The index is now only slightly positive. Measured yr /yr, the real
wage remains a strong 4.2%, but this is nearly offset by a 3.9%
decline of civilian employment. There will be a dicey interval ahead.
Job losses are moderating, but so is the real wage.

Capital Slack Measure
This measure continues to show deeply ample slack: Short rates are
near zero, unemployment is at 9.7% and capacity utilization is very
low. The extent of the slack is sufficient to underwite a prolonged
period of expansion if the recovery takes hold.

Global
Worldwide indicators replicate the recent US performance. With 50
= to expansion, the global output measure has moved up sharply
from a 11/08 low 0f 35.5 to 52.1 through 8/09, and the new
orders component has jumped from a 11/08 low of just 35.2 to 51.1
through 8/09. Both series are giving the "V" sign for now.

Natural Gas -- Time For Me To Study Up

As all seasoned traders know, few commodities can break your
spirit and your pocketbook faster than playing natural gas. Well,
it has been crashing on oversupply concerns, and as anyone who
cares to look can see, the vast bulk of downside price risk in
absolute $ terms is now behind it.

So, I am going to dust off the NG file and have a look see at what
might be done about this free falling substance. I plan to look at
the trade and investment possibilities and come back soon on it.

Weekly NG chart is here.

Long Treasury Bond

Short Term Situation
Back on May 29, I opined that a deeply oversold long bond was
setting up for a countertrend long side trade as rapidly falling
bullish advisory sentiment was nearing an attractive contrarian
signal. Well, the market has been choppy since then, but did
afford two nice long side trades. Now, with advisory sentiment
neutral and with the oversold condition greatly reduced, I have
closed out to the sideline.

My 52 wk. rate of change in yield indicator turned negative at
year's end 2008, and did signal a rising yield straight through the
end of 6/09. It has since turned neutral and may even be set to
signal a lower yield straight ahead, as the weakness of the stock
market, coming off a large overbought condition, may aid the T
bond.(Scroll down at link below for the 52 ROC).

On the fundamental side, my indicator of industrial commodites
prices plus production has steadfastly signaled a rising Treasury
yield since early 2009. However, this indicator has leveled off in
recent weeks as sensitive materials prices have eased off a bit
following a strong run. The run up in the long Treasury yield
this year has far outpaced my very broad measures of the
economy / inflation, so that the run in sensitive materials prices
has been the dominant driver this year. Normal mid -year seasonal
weakness in the industrial commodities market did not occur in
2009, but the recent easing up may be a delayed reaction.

In sum, the Treasury bond market is developing a modest positive
bias on price short term, and still remains interesting, although my
original reasons for buying the bond have been satisfied.

Long Term
I have linked to a long term chart of the 30 yr. T bond. The bull
market remains intact and clearly implies that investors are not
yet ready to give up on a low inflation environment. Should
economic recovery proceed and inflation intensify on a cyclical basis,
folks may change their minds and reverse the downtrend in yield.
The bulls remain in charge for now. Treasury yield chart.

Financial System Liquidity

Basic monetary liquidity, the most critical element to starting an
economic recovery, remains in growth mode. The large increase in
this composite over the past year brings the 5 year growth up to a
level sufficient to give the economy a fighting chance at expansion.
It also serves as a major positive fundamental for stocks, as rising
real M-1 lets you know you are betting with the Fed.

The broader measure of credit driven liquidity has continued to
decline and is now down about 1.6% yr/yr. The market for financial
company commercial paper outstanding has sunk another 38%
yr/yr or nearly $600 bil. as the shadow banking system continues to
be unwound. Large time deposits at banks have fallen nearly $200
bil. as banks let C&I loans run off and remain with a flat real estate
book. Even the massive M-2 money measure would be down were it
for the large growth of M-1 primary liquidity.

Both retail and institutional money market funds have declined in
2009. Some of this decline is attributable to the purchase of goods
and services by individuals and businesses, but with market short
rates near zero, investors have extended maturities to capture more
yield and have no doubt used funds to fuel the rally in stocks on
expectations of economic recovery.

Individuals have increased savings by over $500 bil. and companies
have added to their liquidity by slashing inventories, capital expend.
and payrolls. So, the economy does not need an ample supply of
private credit to fund economic expansion in the early stages.

Monetary velocity, measured in terms of the cyclical side of the
economy has plunged despite a 1.6% decline in the broad, credit
driven measure of financial liquidity. This has created a large pool
of liquidity that runs over and above the needs of the real economy,
and, as mentioned above, has fuelled the stock and corporate bond
markets.

The Fed and other central banks continue to maintain a network of
large currency swaps to provide liquidity to serve those trapped by
the major decline of global trade. Peak -to-trough, US dollar outflows
have fallen nearly 75% on a monthly basis as the trade deficit has
contracted substantially.

Credit quality spreads have narroweded globally and liquidity appears
sufficient to underwite the initial phase of global economic recovery.
Banking system liquidity is improving as loans run off, but capital is
still not adequate to fund an extended economic expansion.
However, in the US, rising business cash flow and the appearance
of stabilization in home prices will serve to ease the way for banks
to access the capital markets going forward.

Beach Days

The weather is simply too nice. As a retired gentleman of leisure,
I am taking full advantage this week and will not be posting on
the usual subjects.

Stock Market -- Quick Note

The steep sell down on Mon. of this week did wipe out the hefty
short term overbought. It is interesting that we have had "dip"
buyers in the aftermath, as there is rarely a shortage of guys who
say they will buy a dip, but do not. Volume has been light. The beach
days have arrived.

The market remains overbought looking out 30 days and longer, so
it is unclear whether the recent dip marked but a way station on the
way higher. Traders will be watching to see whether the current
bounce off the Mon. low carries to a new rally high and beyond with
any conviction.

Stock Market -- Fundamentals Profile

Observations

1. The market remains in earnings recovery anticipation mode. SP
500 eps for the past 12 months (7/31/09) stand at $39.70. Investors
are presently pricing in a return to $60. earning power, which
primarily reflects heavy cost cutting and slight growth just ahead.
(Q 2 '09 eps should come in around $14.)

2. On a very long term trend basis, SP 500 net per share for 2009
works out to $75. Using the same model, top-of-the-channel eps
would equal about $85. With 12 month earns running about 47%
below the "normal" $75., you get a good sense of how deep the
recession has been.

3. Investors have not changed the broader valuation framework for
the market during this steep downturn. Specifically, players are
pricing in a return to moderate inflation of 3.0 - 3.5% with economic
recovery and have ignored the mild 12 month deflation readings
witnessed recently. This is important. Should economic recovery not
occur and should deflation pressures continue, the market would be
vulnerable to a downward adjustment of earnings and fears that a
period of more prolonged deflation could signal a lengthy period of
sub-par economic performance. This kind of serious further downside
would not be a foregone conclusion, but it would be a reasonable one.

4. Looking out over the next year, the speed of global economic
recovery should be the dominant feature for the stock market. With
a lower cost structure evident, and with the SP 500 companies now
holding prodigious cash, there exists sizable positive earnings leverage
from economic recovery, even if it is mild in scope. With recovery,
profit margins will expand and earnings will benefit from cash mergers
and acquisitions.

5. Despite the rapid run-up in stocks since 3/09, the SP 500 price level
does not include a presumption of a sizable positive take-off in earns.
In my framework, players are looking at $60 earning power now, with
the potential to scale that number up if recovery does indeed take hold.
My thinking is that in a moderate economic recovery, expectations
for SP 500 earning power of $75. - 80. will take hold sooner rather
than later, and that the market would chart a course for 1250 - 1325.

6. The problems the banks and investment banks have experienced
coupled with exceptional weakness in sales over the past year or so
have left a residue of investor fear and no willingness yet to take the
concept of a decent global economic recovery for granted. We have
now entered a period where there is substantial downside price
risk to a failed recovery as well as continuing large upside price
potential should recovery proceed smoothly. This means that eyes
will be fixed on progress, and not just benefits from cost cutting, but
from a resumption of top line growth as well. Given this risk / reward
profile, there is good potential for elevated volatility over the next 6
odd months as investors monitor news carefully for indications of
progress.

7. The SP 500 dividend stands at $21.50. With recovery, the dividend
will likely increase to about $30. by Half '1 2011.

For more detail on SP 500 earnings, go here.

Coincident Economic Indicators

The CEI data sets I follow posted a small increase form the preceding
month in July, for the first month on month increase in the past 14.
So, the US economy appears to have expanded modestly in July.
On my indicators, the growth reflects a 0.1% increase in real retail
sales plus a 0.5% positive in industrial production.

This increase in activity came right on time relative to the turn in the
leading indicators. However, I would have to say that the gain in
inflation adjusted retail sales was quite low, and we are going to have
to see the pace of recovery in sales pick up markedly in the months
ahead if the US economy is to have anywhere near a normal first year
of recovery.

In passing, I would note that both US exports and imports did gain
in June (latest month available).

Measured yr/yr, the coincident indicators declined by more than
6%, reflecting deep declines in real retail sales and production. The
one bright spot remains the change in the real wage, which reached a
record high 4.6% for the 12 months through July. In past recoveries
a large positive change in the real wage of this magnitude would likely
have triggered much stronger consumer spending. But with the
depth of the recession coupled with large losses in home values and
equities portfolios, folks have skewed activity toward building savings
and paying down all manner of revolving credit. The balance needs
to tilt away from emphasis on liquidity and more toward spending
if there is to be a recovery worthy of the name.

I would note that the momentum of job losses is declining rapidly,
and more level sales and production could continue this sharp reversal
in job losses, as companies did make dramatic cuts to employment
and will not want to blow orders because they are short on people.

But, bottom line, I would chalk up July as a month favoring those
who are the more conservative regarding the economy, and this on
the basis of scant progress in real retail sales.

Stock Market -- Technical & A Note

The short and intermediate uptrends remain intact, although the
new intermediate uptrend line has not been tested since the SP 500
touched the 879 level on 7/10. (I link to the "500" chart below and
it features an extended MACD you might find interesting.)

The current shorter term upleg started on 7/13. Since then, the
SP 500 has shown hefty price momentum overboughts daily and
is now materially overbought on RSI (% of "up" days) as well. This
kind of strong positive action has trashed the shorts and has forced
many long side traders to chase stocks.

The market is also registering significant overboughts on breadth and
on positive spread over the 13 and 40 wk. moving averages. You have
to go back to the 1995 - 2000 period to recapture the upward drive
we have seen recently.

the SP 500 chart is here.

Note: On the fundamental side, the market has fully discounted the
positive bounce to earnings from sheer cost cutting alone. Extended
strength from here would imply players are moving on to the
assumption of the commencement of rising sales for businesses and
the prospect of improving profit margins.

Monetary Policy & The Banking System

The Fed has convened its normal 2 day FOMC meeting. The basics
for rate setting that I follow continue to point to maintenance of a
low short rate. Business activity in the US has moved sharply from
deep recession to sufficient breadth to be just below the expansion
threshold. Change has been very rapid so far in 2009. However,
expansion must proceed apace for at least several months before it
would signal it was time to raise rates. As well, capacity utilization
remains depressed and would normally be expected to improve
substantially before the Fed reversed course. Finally, the short term
credit demand / supply pressure gauge continues to move in favor
of slack, as C&I loans run-off as expected. So, a change in FOMC
rate posture would be quite a surprise.

Now, since there has been some inflation pressure from the petrol
sector, and, since economic recovery is now expected to begin sooner
rather than later, the markets and the many observers of the Fed are
likely to begin questioning how long the Fed may maintain its several
large liquidity injection programs. This latter issue is distinct from the
rate setting function, and at some point soon, the Fed may well have
to provide more specifics about keys to closing out these programs.

There is a potential kicker here for the markets. Fed diligence in
framing out how it will move to restore long term integrity to its
balance sheet could have significant consequences for the US dollar,
Treasury securities and precious metals and commodities prices.
The impact of Fed commentary on this issue for equities is less
clear, but could be important nonetheless. Bottom line: the Fed
will want to show it is supportive of recovery but is also increasingly
sensitive to restoring monetary integrity. The sooner it does this,
the faster worries of substantial eventual inflation should dissipate.

Banking system lending has been flat now since mid-2008. No
surprise here at all. A deep recession brings lower private sector
credit demand which can persist for a while even as recovery begins.
C&I loans are running off, the real estate book is very sluggish, and
home equity loans, which did spike up over Half 2 '08, have begun
to level off as borrowers grow more confident about the security of
those lines. The real estate book for the industry is now running
about $800 billion below the longer term trend.

Even with the loss of momentum to real estate lending, total bank
lending is running about $1 tril. or 17% above its 10 year trend. This
suggests continued vulnerability of the banks to further significant
loan losses ahead. Bank net interest cash flow has flattened out, but
bank profitability can still improve markedly if loan losses come in
below recent horrific levels. Capital remains level and system
liquidity is improving as borrowers rely more on their internal
cash flows.

Economic Indicators

Leading Indicators
The data, both weekly and monthly, continue to trend strongly
upward from the deeply depressed levels of late 2008 - early
2009. The data suggest the US economy is closing in fast on
expansion, with the global economy moving in a likewise fashion.
The same may be said for profits recovery. The volatility of the
indicators remains remarkable. My new orders diffusion index
suggests an expanding book of mfg / commercial business at 100.
It fell from 103.3 in 5/08 to a startingly low 73.8 in 2/09, but has
since bounced back up to 103.4 for July. The weekly and monthly
leading indicators are just now starting to show positive trend
reversals.

Economic Power Index
This somewhat longer term index foreshadowed significant
recession by falling from 4.0% (yr/yr) to -2.5% by 8/08. The
index then rallied sharply through year end on a powerful rise of
the real wage as hourly rates kept rising while inflation fell quickly
away. This exceptionally positive development did portend
eventual economic recovery in the US, which I hope is at hand.
However, as I have warned, the growth of wages in current $ is
slowing with growing slack in employment, and the power
index will falter more later in this year if the real wage erodes as
expected and if the drag effect of job loss momentum does not
abate. As of now, job loss momentum, measured month-to-month,
is quickly easing so that the yr/yr measure may soon show some
improvement from the current sharply negative -3.8%.

There are current offsets -- higher social security payout, tax cuts,
unemployment insurance and the ramp up of federal spending for
projects. Consumers also have the option to finance more of their
spending. However, over time, low or no real wage growth coupled
with a weak job market will not sustain economic expansion.

Inflation Indicators
The inflation pressure gauges I use have stopped signaling deflation.
These measures have turned up, and now suggest a return to mild
inflation (measured yr/yr) by late 2009. This development
underscores the need to see the monthly rate of job losses continue
to be cut very quickly as the year progresses.

Commodities Market

The CRB composite closed around 267 today, which puts it just
slightly ahead of initial long term resistance of 265 (dates back
to the latter 1970's). Interestingly, even if the CRB is poised to run
much higher, it may well test 265 as support before moving on.

Historically, commodities are most sensitive to liquidity and
monetary policy conditions and are likely to rise as central bankers
ease monetary policy. Commodities are also sensitive to a basic shift
in direction of the leading indicators, and have been particularly so
this year, accelerating when weekly leading indicator data reversed
positively during 3/09. All sensible enough.

The action of the CRB so far in 2009 has been somewhat unusual
in that the dramatic rise in the petrol sector, which has come early
in the new liquidity cycle, has provided it with a strong tailwind. So,
the CRB is perhaps a bit ahead of itself, to the extent that the oil
price has lifted off so early.

The broad commodites market has been deeply oversold over much
of the past 9 months, but with the rally since 3/09, it has tended to
veer toward modest short term overboughts. However, we have yet
to see the sorts of surges that signal too racy a market.

The potential for the CRB is to move higher in the context of an
expected continuation of monetary ease. But I would note that since
the weekly economic lead indicators have jumped so sharply, the CRB
could be vulnerable to moderation in the dramatic progress of these
indicators (there is some overlap between the two series).

I hope this post might prove timely in that the market is just a little
above long term initial resistance, a factor most well seasoned traders
will have in mind.

Recent CRB action here.

Stock Market -- Shorter Term Alert Still In Force

A modest rise in the aggregates over the past week keeps the
market in overbought territory, and it is extending out past
the very short term. In a strongly rising market, there can be
shorter term overboughts that can drag on for several weeks as
more players pile in from the sidelines to get on board. This type
of situation can be very difficult to short for a quick play, and it
can be frustrating for folks who are trying to maintain discipline
and buy dips that seem to be erased quickly. But best you know
that they have started to chase them a little bit.

On the fundamental side, the SP 500 is, I believe, now fully
discounting $60 a share in 12 month earning power, and further
near term upside would imply that players are moving beyond
recognizing earnings benefits of cost cutting to the expectation of
earnings driven more by a recovery of sales volumes. This is also
worth noting, since not everyone may be ready to make that transition
in their thinking, and so you have to realize there may be some profit
takers who may decide to wait for some confirmation of this
important transition in the weeks ahead.

Long Treasury Bond

With the 5/29 and 6/9 posts on the bond, I indicated there could be
a good short term long side countertrend tade in the offing reflecting
a steep yield premium to the 200 day moving average and "too many
bears" among trading advisors. Well, there was a good 6 point (in
price) leveraged trade there, but it turned out to come in well below
expectations. With the recent weakness in the price of the bond, the
yield is again at a substantial premium to the 200 m/a, with this
implying a sharply oversold market. Bearish sentiment has abated,
and this weakens the logic for a long side trade. Even so, there has
just this week been a small shift in trader psychology away from being
long industrial commodities. So, this keeps the bond interesting and
in play as a candidate for re-placing the trade. Since traders are
now a little concerned about whether cyclical risk exposure is ahead
of the fundamentals, the bond could get another play. However, this
would be a trend / momentum call with odds of getting the best
price low.

30 year Treasury yield.

US Economy -- Baseline

As a retired guy who no longer gets paid to do economic forecasting,
I do not do it. As readers know, I rely heavily on time tested
indicators to look ahead. But I do develop a baseline outlook on
an occasional basis, particularly after economic / markets watershed
events. No time like the present, then.

Basically, I think the US economy can experience an economic
recovery / expansion which can run 8 - 10 years from Q3 ' 09. This
expansion should averge 4% growth in the early part followed by a
multi-year run averaging 2.75% annually. I look for growth to be
well balanced between consumption and investment, and for a
solid base of export sales to be a key driver. So, I do look for an
eventual substantial recovery of employment and profits. I expect
the dramatic increase of entrepreneurship we have seen over the
past 15 years to continue and for the economy to grow ever more
diverse. I expect inflation pressure to return and to average
about 3.5% over this lengthy period. I see short term interest
rates recovering to a range of 3.o - 6.0% and anticipate that
bond yields will rise significantly. Following a strong 2 year
recovery period, I have corporate profits growth settling in at a
6.5% growth rate. Investor pressure to increase dividend
payout will eventually grow as retirement funds look for more
stable income.

The expected long duration of the expansion reflects the very large
build up of capital slack in capacity, employment and financial
resources and the length of time it will take to redeploy these
resources profitably.

There should be exceptional political battles to come as the Feds
face more market pressures to regain budget discipline and
re-prioritize spending against a revenue stream which cannot be
easily augmented by tax increases. The country is greying and
through increased geographic dispersion has grown more conserva-
tive politically (This is so even though the GOP has turned truly
and well stupid and is in need of broad new leadership).

I also suspect the Fed finally realizes that asset bubbles can be
every bit as damaging as high inflation and that monetary policy
will turn more balanced in the years ahead.

Finally, I would say that the 2007 - 2009 economic debacle will
serve as a reminder to all to pursue more balance in economic,
business and investment affairs. This fresh probity will of course
wear off with time, but not, I think, for a good while.

Stock Market ALERT & A Note

Market Alert
The market advanced nicely for the week. It will no doubt be seen as
a Godsend for many suffering with depressed 401Ks. The trend is
positive. However, we have a fairly strong overbought condition on
both my 25 day oscillator (SP 500 is a hefty 6.6% above the 25 m/a)
and on RSI (See chart link). Shorter term players should take note.

SP 500 chart.

Earnings Note
Some of the boyz along The Street are starting to play fast and loose
with interpretations of earnings. they want that red ink Q 4 '08
number to go away. So, some have pulled out AIG, GM and other sick
pups that collapsed in value. Others are working to "normalize" the
earnings data so that the 12 month net per share reading will not look
so awfully low against the current level of the market. Now, S&P
observed that companies rushed to write off everthing their auditors
would let them get away with in last year's final quarter. They may
have written off up to $ 10 a share, thus "borrowing" losses from
2009.

SP 500 eps for the 12 months through 7/09 is most probably around
$40. That gives a whopping 24.5 p/e ratio -- a tough sale, no? To make
matters worse, that nettlesome Q 4 will not drop off the 12 month
running total until Oct. '09. In my view, investors have simply put the
12 month number aside and are looking at earning power going forward
in a recovery. I think they are now pricing in $15 quarterly earning
power for the SP 500 and $60 annual. That is not a "stretch" number
at this point. If you are looking at material wherein the analyst is
putting forth a $60 number as the current 12 month number, you are
reading the work of a charlatan.

Now a final point here. Since companies in toto may have shifted $10 a
share in losses from 2009 to late 2008, then it follows that current
comparisons yr/yr are are overstated. It also follows that the $60 in
estimated earning power is also a bit overstated, say by $5. I would
conclude the market is fairly valued for the next several months, but
is far from undervalued.

US Economy Through Year's End 2009

My view for months has been that the economy will be in recovery
mode over most of Half 2 ' 09, with July either the transition or
turnaround month. The leading indicator sets I follow suggest a
strong initial bounce for the economy, with industrial output up by
as much 6.5% from mid -year levels through early 2010. I would
also expect to see profits recover sharply from depressed levels.

Ironically enough, my longer range economic leading indicators rose
to the strongest level in many years last autumn, just as the economy
fell off the cliff. The longer term indicators -- liquidity and interest
rate measures plus the real wage and the oil price -- remain positive,
although the unusually strong rebound of the oil price has brought
the composite below truly exceptional levels. For now, 2010 looks
like a solid recvovery year, although a continued strong uptrend in
oil and other commodities composites would prove problematic.

The main issue of concern near term is liquidity preference and debt
minimization evidenced in reaction to the deep economic decline. We
will indeed need to see consumers loosen up and spend more freely
to regain solid footing and to start refilling depleted inventory
pipelines.

The US economy is in a deep hole presently when measured by such
key cyclical indicators as residential construction, real retail sales,
industrial production and unemployment. Business investment has
tailed off to the point where production capacity is now down 0.5%
yr / yr. On balance, the cyclical side of the US economy is right at
a depression level, and it will take several years of solid growth to
bring it back to prior peaks. In a volatile and uncertain global
climate, such a straight forward run back up and through the old
peaks is far from assured.

Stock Market -- Technical

Back on 7/08, I posted that the market correction had brought
stocks to a significant short term oversold. The action on that
day was suspect enough that I let a few days go by to see if some
sort of rally could develop. Well, contrary to my initial suspicion,
investors and traders did turn the market around off key support
and in the intervening days have brought the rally up to new highs
following the deep early Mar. low.

Now of course, we have a confirmed short turn uptrend which is
getting overbought in the short run. My 6 week buying and selling
pressure gauges do not indicate an overbought yet at all, so from a
technical perspective, I could not argue with the idea that the
market, although subject to short term pullback, could advance for
another several weeks, before a much more substantial overbought
condition could develop.

This recent advance has brought the major composites plus the NYSE
adv/dec line up through major downtrend lines with origins well back
in 2008. From a simple chart perspective, this is very good news.

The up action of the market since the early part of July will embolden
some technicians to argue that we have started a second leg up in the
early phase of a cyclical bull market. Could be, but too early to tell
with any assurance.

SP 500 daily chart.

Shanghai Express -- 2009 Version

Back in early 2007, I highlighted the Shanghai Stock Index because a
mania had formed that could induce a bubble. The index was trading
around 3500, and I argued that to form a true, spectacular bubble,
the index would have to rise to 6700, perhaps in 2008. Well, it
continued on its parabolic way and did top 6000 by 10/07, before
rolling over into a deep bear. That run was bubble enough for most
people.

The Shanghai entered a new cyclical bull market in 10/08 as players
responded to a massive $580 billion stimulus package, and so it
qualifies as a cycle leader presently. Using a long term 10% real
economic growth rate, I value the Shanghai at 3200 - 3500 presently.
The index is now trading a little below the 3200 mark . Two big
caveats are in order on fundamental value. First, this is a volatile
index. Second, it can trade away from fundamental value for
extended periods of time. It was, as examples, deeply undervalued
over the 2001 - 2005 period and seriously overvalued for much of
2007 and a good slug of 2008.

I have included a price chart for the index and it shows that the
market is getting overbought short term. You will note that for
most markets, an RSI of 70 is a good warning of an overbought, but
for the Shanghai, make that a 90 RSI as this baby likes to blow off.

There are some good objective sources on China. One is economist
Mike Pettis, a Beijing based finance prof. (http://mpettis.com) and
the other is Caijing (http://english.caijing.com.cn). Check both as
counterweights to the China mavens.

Shanghai chart.

Liquidity Factors

Federal Reserve Bank Credit
The Fed is keeping its balance sheet greatly enlarged to support the
financial markets and the economy, with credit out more than double
a year ago. The Fed has allowed a couple of the TALF facilities to
lapse, so that credit offered is about $200 bil. below the peak level
seen in 12/08. To return to more normal pre-crisis levels, the Fed
will need to let about $1 tril. of swap facilities expire and will be
under close scrutiny when economic recovery is underway.

Monetary Liquidity
Thanks to massive liquidity infusions in Half 2 '08, the 5 year growth
rate for the basic money supply has risen to 6% and 3% inflation
adjusted. This is adequate for economic pump priming and is vital
now since consumers have been paying down installment debt and
have been purchasing on a cash and carry basis.

Credit Driven Liquidity
My broad measure of credit driven liquidity is down an astounding
0.7% yr/yr, with both commercial paper and jumbo bank deposits
lower. The market for financial service company commercial paper
is about $1.2 tril. or 53% below the 8/07 level, which was the high
water mark for the shadow banking system and the CMO market.

The banking system's loan book is contracting and is at levels last
seen in early 2008, at the outset of the recession. Even so, the loan
book is a full $1 tril. or 14% above a reasonable and conservative
longer term trend. The boyz went on quite a bender from 2003 -
2008. The loan book could remain flattish for another 12 months
even if the economy recovers.

Excess Liquidity Measure
The $ cost of US production is down nearly 15% yr/yr. Thus, even
though the broad measure of credit driven liquidity is down yr/yr,
large production losses and mild deflation have created substantial
excess liquidity in the system. Put another way, the velocity of
money has fallen very rapidly, as the economy has shrunk even
faster than the financial system.

Excess economic liquidity usually, but not always, forms a strong
tailwind for the stock market as investors have funds to anticipate
an economic recovery.

Trade Window Liquidity
A collapse in US trade saw imports fall far more rapidly than did
exports. The outflow of dollars from the US has declined deeply and
rapidly, forcing the major central banks to engage in a variety of
sizable currency swaps to keep the global system halfway liquid. Still,
the inability of smaller, less seasoned economies to earn reserves in
these treacherous times has worked hardships and leaves capital
flows restrained. There will be more financial fall out in the form of
failed loans abroad.
------------------------------------------------------------------------

As tattered as it is, the global liquidity framework should be sufficient
to edge economies forward into recovery if confidence returns as
expected.

Oil Price

The oil price started to anticipate economic recovery and improved
oil supply / demand fundamentals early this year. That in itself is
remarkable, given how oil tends to weaken and dawdle following one
of its periodic price busts. Then matters veered toward ridiculous
as oil surged to over $70 bl., near the top of a longer term range,
bubble price moves excluded. In fact, oil above $55. is trading as if
there are already pressures developing on excess production capacity.
Nothing could be further from the truth. There is significant excess
capacity at the well head, and there is a huge amount of oil in
storage as carry stock. Moreover, demand remains subdued.

Last week the Commodity Futures Trading Commission announced
it would hold hearings this summer on the advisability of limiting
position size in the futures market. It realized that hedgies and long
only oil index funds were holding huge long positions. These are funds
with no intention of ever taking delivery, and guided by computer
models, are essentially momentum followers who have again driven
the price to levels out of line with fundamentals.

With the pro big oil Bush / Cheney team out of the picture, the CFTC
and other power centers in DC have a freer hand to stop or at
least retard this foolishness before it again does substantial damage
to the economy.

Oil at $60. ought to be trading no higher than $55. and, probably even
less on supply / demand fundamentals. If oil, which has corrected
sharply in recent weeks, is set to progress more sensibly, a range of
$48 - 61 bl. would make sense from a purely technical perspective.

It will be interesting to see if the newer big players in this market
are ready to challenge the CFTC with some "in your face" fresh
buying or whether they will be smart enough to lay lower at least
for the summer.

The oil price is getting modestly oversold short term.

Corporate Profits

Earnings performance from mid-2007 through the end of 2008
represented one of the worst in US history, including a never
before seen loss of $.09 per share for the SP 500 in the final
quarter. The dramatic bear market was fully sensible given the
profound collapse of profitability.

Top down earnings indicators have bottomed over the past 6
months and almost all are on the rise. SP net per share was about
$10.00 in Q 1 ' 09 and the indicators presently suggest it will rise
sequentially through Q 4 '09. Viewed sequentially, sales have yet
to rise, but profitability has improved reflecting lower cost structures
for many companies. Some of this improvement has been
"manufactured" via the taking of massive inventory, termination
and closing losses in Q 4 '08. In my book, the market is now pricing
in 12 month earning power of $50 - 55 a share. This a humble
number when you consider that earning power based on the
past 23 years' range is a midpoint of $92 per share. Also of note is
that in the spring of 2008, the consensus for SP 500 eps in 2009
was $112. The recent pause in the stock market's progress is a
direct reflection of caution concerning earnings recovery prospects.

The strength of the leading economic indicator sets I follow suggests
that at some point over the second half of the year, investors may
raise the consensus for 12 month earning power from the current
$50 - 55 to $60 - 65.

Viewed on a yr/yr basis, earnings are not now expected to top the
prior year until late in 2009.

Stock Market -- Technical

As expected based on my 6/2 post, the market has entered a
corrective phase, with the SP 500 down about 7% from the 6/2
close. The down trend was confirmed by rollovers in the 10 and
25 day m/a 's and a break by the market below both. We have
reached a short term oversold level, and it is the steepest since
just after the market's positive turn in Mar.

The SP500 is at an interesting spot now. It is at the bottom of
my short term oscillator channel and smack on support around
880 based on the close. Since today's late rally up to support may
be but a "head fake", I would not get too excited about jumping
right back in. This cute action was too neat by half. A oversold can
be a bad thing to waste, but I plan to sit back for a few days on this
one.

A rally off 880 would suggest to many the development of a range
bound market. We'll see. After such a powerful bull run from
Mar. through early Jun., it is not unreasonable to suggest that a
10% correction off the 6/2 close of 945 down to 850 could well be
in order. If such were to occur, I would have to say that I would
have mixed feelings from a technical perspective about the
future course of the market. But, I plan to worry more about that if
and when we get there.

SP 500 daily chart is HERE.

Long Treasury Bond

Back in late May and again on 6/9, I posted that the long Treasury
was deeply oversold and that advisory sentiment was approaching
being overly bearish. I suggested I would be looking for a counter-
trend long side trade. Well, a rally of sorts has developed, although
it has been a slow one. Sentiment is less bearish now, but the bond
remains substantially oversold against its 200 day m/a. The ongoing
uptrend in the industrial commodities price composite is acting as a
strong headwind as Treasury traders like to stock up on the long side
when industrials weaken. I was hoping for some seasonal slack in
this sector of the commodities market from late June into July,
but that has yet to materialize, either. So, although the price trend
for Treasury is ok, the trade is on shakier ground, pending some
help from the industrials commodites sector. Monitoring very
closely.

Treasury price chart : $USB.

Economic Indicators

The weekly and monthly leading indicators continue to progress,
and signal the US is coming ever closer to closing out this very
deep recession. My business strength index, which made an
astounding cyclical low of just 101.9 for 12/08, has risen to
113.4 through June, with a reading of around 120.0 tantamount
to recovery. So, recession pressure has receded substantially,
and the pieces are all in place for a positive turnaround, including
an exceptionally strong reading for real disposable income of
the consumer sector to reflect a battery of fiscal counter -
recession programs. What's needed now is more confidence to
spend at retail and invest in housing and less emphasis on
building liquidity and savings. The window is there now,
especially after a large round of inventory liquidation, which
has taken production well below consumption.

There is not a ready formula to determine when consumers will
decide to reduce the flow of money into savings and to increase
their spending. At this point, it is much more a matter of psychology
than a macro econonomic fine point. For more on spending vs
savings, go here.

Gold Price "Heads Up"

Gold went out today around $927 0z. It failed to hold the strong
rally uptrend from 11/08 into 02/09, and now it is close to a
further breakdown on a more extended uptrend measured from
11/08 with an intermediate "touch" of the line around mid- April
' 09. This is a charitable read since the lengthier uptrend has yet
to fully confirm by taking out the Feb. high. Failure of gold to
rally over the next 5 trading days could set the metal up for a
deeper correction down to the $800 level. Time to pay a little
more attention.

The gold macro directional indicator has moved steadily higher in
2009 on expanded monetary liquidity, a rising oil price and a strong
rally in industrial commodities. But the indicator has also leveled
off over the past 2 weeks and its trend, like that of gold, is about to
be tested, especially as oil has flattened out and turned a little
wobbly around $70 bl.

Since gold led the rally back into riskier assets off its 11/08 low,
it's worth watching shorter term from a broader perspective.

Daily gold chart here.

The Fed Relies On Its "Gap Chart"

The FOMC finished up today. They left policy unchanged and
commented that the recession and price deflation are easing and
that sustained inflation is not in sight. they are relying on a tool --
the "Gap Chart" -- a tool that has been a cornerstone of monetary
policy for longer than most of you have lived. The chart compares
the trend of production and capacity and measures whether the gap
is growing or retreating. A growing gap means capacity is advancing
faster than production, which means the operating rate for the
economy is receding and that so should inflation pressure. The gap
is huge now, with the operating rate at a low 68% and still falling.
So, for now, the Fed sees no reason to expect a sustainable rise
of inflation pressure.

They have been dead wrong on this since late winter. Inflation
pressure -- measured without seasonal adjustment -- has been on
the rise even as the production / capacity "gap" has opened
wider. The FOMC did not acknowledge this fact today and has
opted to project that continued US and global economic slack will
kill off inflation pressure from rising commodities prices in the
weeks and months ahead.

Commodities players have an accomodative monetary policy at
their backs and are also armed with the knowledge that since the
recession in new order rates has been unwinding rapidly, prices
should improve with needed inventory restocking. When the
economy does come off deep recession, commodities can bounce
sharply on inventory pipeline refilling, only to settle back as
players realize that underlying demand, although set to recover,
must rise from very low levels. That is the Bernanke bet for the
time being. If commodities players, which now include the big
hedgies and long only funds, can keep the markets stoked, the
Fed will fall well behind the curve.

Commodities do exhibit a slight bias toward seasonal weakness
over the second half of the year, but not nearly enough to rescue
the bet. That will require a round or two of profit taking by
the speculators who have had the markets in play.

Inflation (Deflation) Pressure Gauges

12 Month Deflation
The CPI measured yr/yr showed deflation of 1.3% through May, and
the yr/yr CPI for June and July could well give deflation readings of
2.5%. No surprises here, and no surprise that the 2.5% deflation
mark may reflect the bottom on pricing pressure for 2009.

Inflation Potential
The inflation gauges I use appear to have made bottoms here in Half
1 '09. The CPI remains sensitive to the direction of commodities
prices, especially fuels. With a positive monetary liquidity cycle
underway and low short term interest rates, traders have been
running up the petrol sector and commodities broadly as they look
toward economic recovery. Right now we appear on track to see a
reversal of direction in the yr/yr CPI toward inflation on the order of
up to 2.5% by year's end 2009. Commodites are volatile indeed and
the current uptrends are running ahead of the economy. Whether
the action in the trading pits can sustain the direction of commodities
over the course of the year remains an open question. It will be
interesting to see if the Fed's FOMC addresses this issue in its
6/24 statement and at upcoming meetings.

Stock Market -- Long Term Technical

A broad variety of longer term indicators shows that the market has
turned up from one of its weakest periods in history. The one
exception is the Wilder ADX indicator, which has yet to flash a buy
outside of 20 weeks. It has signalled a change in the direction of
the trend to positive, but is moving very slowly toward a full scale
buy. Several indicators, and I have looked at over 10, show that
positive price momentum off the early Mar. '09 low has been very
strong, too strong perhaps for the longer term.

The SP 500 is also nearing a very important downtrend line that
extends from the May, '08 rally and catches the Aug. '08 interim
high. This line down is significant because the market rapidly fell
apart into a crash shortly thereafter. So this will be a big test of
trend out ahead. The market is now well through and past the crash
down lines.

The SP 500 13 wk. m/a is rising and is threatening to pop above
the 40 wk m/a. Some technicians call this eventuality a "golden
cross" which is seen as providing a confirmation of a durable
advance (providing the 40 wk m/a soon turns up, too). CHART.

Measured on a 40 wk. price oscillator, the market is but rather
mildly overbought. But, when I go out one derivative and look at
that oscillator against a 13 wk. average of itself, I see an
extremely overbought market. Here again, the momentum has
been uncharacteristically strong, even for the onset of a cyclical
bull market. To be to the point, the trajectory of this advance
is nearly twice normal, which suggests that at some point out there
in time, there will be a sharp price correction or extended period
of range bound consolidation or both. In short, when viewed long
term, we are contending with a price rocket.

Now, because the SP 500 took out its 2002-03 lows during the
crash late 2008 - early 2009, we not only ended a long term bull
market, but we have entered a bear market of indeterminate
length. We can see powerful cyclical advances during such a period
and we do not have to plunge to even fresher lows at some point.
But we have to recognize the possibility.

From a short term perspective, resolution of the price rocket
issue is not necessarily a worry. We could see a moderate
correction and a tradable rally in the interim. However, looking
out a month or more, resolution of the price rocket saga could
become more pressing.

Coincident Economic Indicators & Liquidity

Measures which coincide with the level of economic activity showed
that the US economy declined for the 12th consecutive month
through May 2009. Measured yr/yr, the two sets of indicators I
use were down about 6.5%. The big declines are in retail sales and
production which were down 11.1% and 13.4% respectively. The
lone positive has been the real wage which is up 4.4% yr/yr.
Inventories were still likeley being run off through May, and
productivity -- by any sensible measure -- is down as output has
been falling more sharply than employment and hours worked.

My profits indicators for nonfinancials show yr/yr weakness. This
reflects both lower sales and profit margins in the US as well as
abroad. Net revenues for financials have been holding up, but
loan and securities losses likely continue large.

A broad array of indicators suggest that the US economy may hit
bottom in July '09. A very rough guess at this point suggests the
economy could be up by 2.5% by year's end or early 2010.

Viewed historically, consumer spending should already be running
much stronger given the very large yr/yr growth of the real wage.
Householders are obviously continuing to build a savings cushion
and trim their debt. This development should keep everyone
hoping for recovery edgy.

With output down sharply yr/yr, the velocity or turn over of money
has fallen, providing excess liquidity relative to the real needs of the
economy. This is quite a development given that my broad measure
of financial liquidity is running flat yr/yr. Traditionally, excess
liquidity of this sort provides a strong tailwind for the stock market,
although this is not always the case.

I am watching the production data carefully. It has been badly
punished not only by the downturns in autos, other durables and
housing, but by a large decline in export sales as well. Should there
be further significant weakness in production, I would be willing
to call this downturn an economic depression given how far the
production composite has fallen below trend and how long it will
take to recover to new high levels.

Financial Regulation

Ultimately, you cannot legislate away the pernicious effects of
stupidity and greed and their profound influence on the stability
of the financial markets and systems. The US and other economies
are littered with past financial crises, most of which could have been
avoided by prudent foresight and courageous action. But, every so
often, emotion like greed and fear combine with ignorance and
outright stupidity to overwhelm the system.

We could all benefit greatly from a more stable monetary policy and
less monetary tinkering. Consumers would all benefit if they had
exposure to finance, banking and economics in their student days,
and regulators could benefit greatly from keen and diligent
gathering of financial and market intelligence so that they at least
know what we could be getting ourselves into during heady
financial times.

However, investors and lenders who do not do their homework
thoroughly and maintain sensible disciplines will avoid getting
burned in the markets only if they are lucky. Caveat Emptor!

Stock Market -- Technical Warning Lights

Back on 6/2, with the SP500 at 945, I mentioned in a post that I
thought the market was due for a correction. After failing to break
out top side last week, the market has headed down so far this
week, and some technical damage is evident. The SP500 has
fallen through its 10 and 25 day m/a's, and both of the m/a's in
question have turned down. Moreover, the ADX tool shows
that +D1 has just fallen below a rising -D1 on declining momentum.
Note though that the 10 day m/a has yet to confirm a downtrend
by falling through the 25 day m/a CHART.

I know full well how short term technicals can whipsaw you, but
I think enough of this type of analysis to say the amber light is on.

IF a correction is finally underway, my best guess now is that if the
SP500, now 911, is contained in a range of 865 - 880, then it would
remain plausible to argue that the powerful bull leg in evidence
since Mar. '09 could well run further before it confronts more
substantive headwinds. IF there is a break below 865, then the
argument for a cyclical bull from a technical perspective becomes
more problematic, although not necessarily fatally flawed.

With the downdraft this week, the market has turned ever so
slightly oversold, and I plan to keep an eagle eye on it, which I
have not done for a few weeks. It might also be wise to look at
some of the longer term issues in an upcoming post to come
shortly.

Financial Liquidity & Monetary Policy

On balance US financial system liquidity has changed little since early
in the year. My broad measure of credit driven liquidity remains
flattish as further contraction of the commercial paper market and
shadow banking system are offset by rising personal and business
savings via money markets and CDs. The Fed has drawn authority
to increase its balance sheet by nearly $1 tril. more, but has not used
it. In fact, Fed bank credit has contracted since the 2008 holiday
season.

Banking system equity capital has increased by 9.5% yr/yr, as
TARP money and new offerings by larger banks have dwarfed
miniscule internal growth for the system. Liquidity is still tight
at the margin as C&I loans remain in the early stage of a cyclical
run-off. Total loan exposure remains flat, which is not atypical in
a major economic downturn.

On a global basis, the breadth of new manufacturing orders has
increased sharply in 2009, with the US and China leading the way.
There have been numerous reports that China is stocking basic
materials, including bunker crude. With some inventory speculation
underway, petro prices have jumped as have commodities, as traders
get on the recovery anticipation bandwagon. The CPI in the US,
excluding seasonal adjustment, has been rising this year so far. The
Fed has maintained a ZIRP policy and has fallen behind the seasonal
increase of inflation. Basic economic benchmarks for Fed policy are
giving readings well below what would normally trigger rate increases
as the economy has yet to move into an expansion phase. The
continuation of a ZIRP with commodities on the upswing has probably
contributed somewhat to a steepening yield curve and a weaker US
dollar.

The Fed would prefer not to jeopardize the now fabled "green shoots"
with tighter monetary policy, and probably does not now mind a
weaker $. However, persistence of fuel and commodities price rises
over the remainder of 2009 would put the Fed well behind the curve,
as inflation pressures would increase.

Ideally the Fed would like to wait for economic recovery to take hold.
With short rates near zero, the central bank would have ample leeway
to move rates toward more normal levels as the economy expands as
well as contract a Its very large balance sheet.

For the moment however, it is in a less comfortable position than it
was just a few months back, and it will be interesting to see how it
balances the prospects for the economy against higher materials
prices at its upcoming FOMC meeting, Jun. 23-24.

Long Treasury Bond

The bond is sharply oversold and advisory sentiment -- usually
wrong at key turning points -- has dropped into the upper
reaches of "too many bears" territory. The bond price is hovering
just above important support. Conditions continue to fall into
place for what could be a sharp counter-trend rally.

The long Treasury remains very sensitive to the trend of industrial
commodities prices, which are in a clear uptrend now. So, what is
needed now is a spot of negative news on economic recovery
prospects to shake the industrials market into a round of profit
taking. That would serve to rally the T-bond.

Long bond chart here.

The Commodities Market

The availability of commodities ETFs and long position mutual funds
coupled with a large bull market in commodities from 2001 - 2008
has lead to a substantial increase of interest in this area and has
re-positioned commodities from consummables to an asset class.

Over the long term, commodities have been a poor investment. The
famed CRB composite has appreciated by just 2.5% per annum since
1970. Commodities prices have tended to move in 6 year cycles, but
there have been 2 longer term bull markets in recent years: 1970 -
1980, and 2001 - 2008. There are pundits out there who maintain
that a long term or secular bull market is in place, but such claims
sorely test credulity. However, a multi year bull run in commodities
as occured over 2001 -2008 can be highly profitable for an investor
with rigorous discipline.

History shows commodities are most sensitive to interest rates and
the liquidity cycle. Now with short rates low around the world and a
new liquidity cycle underway to reflect easier monetary policy,
commodities have been moving up since Feb. '09, with this move
aided by a positive bounce in the leading economic indicators.

Since 1980, most advances in the CRB index, which closed today at
258, have been constrained in a range of 260 - 280. Breaks above that
level in 1979 and again in 2003, heralded sharp advances. So the
market is approaching important resistance, and with this test thought
near even before the global economy breaks into expansion, you can
appreciate the enthusiasm of commodites bulls as they anticipate
economic growth with the added fillip of inventory rebuilding.

I will do more on commodities going forward. Relative to the long
term trend of the CPI, commodities are indeed cheap as a class.
Below, I have linked to the CRB index chart. I would put resistance
in two close together spots -- 260 / 280 and again at 300. I would
also point out that commodities are crash prone when evidence of a
tough credit crunch emerges, as happened in 1980 and again in 2008.

CRB CHART.

Economic Indicators

The weekly and monthly leading indicators continue to move up
sharply, signaling that the US economy is setting up to recover
from deep recession. The indicators have surged from very
depressed levels, so it remains a little foggy to tell just how
imminent expansion may be. The Economic Power Index remains
positive but the index is being carried entirely by lower tax
witholding rates, unemployment insurance and the large increase
in Social Security payout. The real wage remains strong, but the
continued deterioration of employment has flattend the US
payroll pretax. Straight ahead, there will be pressure in DC to
make sure the spending stimulus dollars are being pumped out. The
very large inventory liquidation underway since late 2008 puts
the economy in a position to benefit from pipeline refilling as final
demand continues to stabilize. Continuing constraints to growth in
the short term remain strong private sector liquidity preference and
the large inventory of unsold homes ( A measure of pending home
sales is showing recovery.)

Capital slack continues to increase and is quite large with
employment, capacity utilization and business credit demand at low
levels. The Obama spending program has been designed to take up
some of this slack. If private sector interest in building liquid assets
up does not ease off some with improved confidence, then Team
Obama may look to enlarge the scope of fiscal stimulus.

No shortage of issues and worries here, but the indicators are
pointing northward, which what is needed most.

On a global basis, total output and new orders measures continue to
recover from exceptinally low levels registered around the end of
2008. these measures are a little more than half way to expansion
readings.

Stock Market

Technical
The strong rally underway since early Mar. remains intact. There
is another short term overbought in place now and the market
remains o-bought out through 13 weeks as well. The trajectory of
the rally is now verging on unusually strong. The SP500 closed
today at 945, and I would be happy if it was down somewhere
around 865-885. So, I think it is nearing a point where it is overdue
for a pull back, even though there are no indications yet of
difficulties with trend. I have linked to a chart which features an
intermediate term MACD and a 40 day RSI. Note that the RSI is
moving toward an intermediate term o-bought at 60%. CHART.

Fundamental
As readers know, I am on the hook for a cyclical bull market call.
Now, it is normal for a cyclical advance in stocks to pre-date a
positive turn in earnings (6.5 months on average). Still, the SP500
is now running about 45% above very depressed 12 months net per
share. Granted that the 12 month figure contains one unprecedented
red ink quarter -- Dec. '08 -- when companies wrote off everything
they could get away with, the 45% premium is a whopper -- large
by historic standards. In short, this baby is counting on the green
shoots to turn into stronger fibre soon. A pause in the upward
trajectory of the market for a month or two would not bother me at
all.