Stock Market -- Short Term Technical

The broad market has entered a period of price compression, and
it is neither overbought or oversold. I find it very difficult to get
any sort of edge in a market like this and almost always allow the
compression period to resolve before taking a trade. Ahead in
September we have a period of seasonal weakness to traverse,
and that is likely keeping some money on the sidelines. From
my perspective, it is still an up market based on its position
relative to the 10 and 25 day m/a's. Obviously though, there
is clear short term overhead resistance, so the powder shall
remain dry.

The daily SP 500 chart is here.

US Economic Outlook

First off, I think it is going to take a year or so to straighten out the
statistical mess building in the GDP accounts. Measured yr / yr,
the GDP price inflator advanced a paltry 1.9% through Q2 '08.
That compares to a 5.6% advance for the CPI. The use of the
modest deflator enables the BEA to show real growth over the
past year, which is unlikely with the CPI over 5%. So, at some
point, the Gov. will have to come cleaner on the data. This all
might await the departure of GWB and his crew.

So, we have a weak economy with housing development and
retail sales -- durables particularly -- the main culprits. Total
Gov. spending has been a slight positive offset. A bigger plus has
been good inventory management, with retail running an especially
tight ship. The biggest offset to a weak consumption / housing
picture has been the strong performance of export sales, which
has helped keep production and employment levels from falling
more sharply.

The shorter term lead indicators remain in firm, strong downtrends.
The longer term indicators have turned progressively more positive.
We have lower short rates, a positively sloped yield curve, a sharp
downward break in fuels prices and a Fed that is moving to add
monetary liquidity to the system, however gingerly. The longer lead
indicators are mediocre when it comes to timing, but my guess is
that a return to sustainable 3% real growth could be a good year out
in time. If commodities prices were to fall significantly further, this
would likely allow the Fed to speed up reliquifying the economy, and
would shorten the time frame for recovery worth the name.

The economy is deriving some benefit currently from the tax rebates.
The bulk of this program will have passed before very long, leaving
some vulnerability in its wake. In addition, with global growth
decelerating, the US export book will eventually reflect the global
trend.

The two vital elements I see are inflation and Federal Reserve
flexibility. The surge of inflation over the past year has punished the
economy. Wage growth has actually been slowing, so real take home
pay has been hit hard. A slow global economy needs to work to
suppress the commodities speculation party to relieve inflation
pressure on wages and profit margins. A hefty deceleration of the
inflation rate would allow for a recovery of real purchasing power, and
would further allow the Fed to operate more freely to open the spigot
further.

I would have to say that the earnings estimates I see for late 2008
running through 2009 do look too high at present. But I suspect that
the big players in the stock market are making some allowance for
that.

I rarely us the GDP accounts for macro analysis because of the wide
lattitude the White House uses in playing around with the price
deflators. These accounts can be helpful in looking over sector
comparative performance. I prefer the Fed's production series and
a host of monthly series, especially those that are privately sourced.

Ok. Enough of the big picture. Back to the grind for a spell.

Stock Market -- Fundamentals

The liquidity cycle is edging a little more positive for stocks in that
inflation may have peaked for a spell. However, the growth of
monetary liquidity, which the Fed controls, is improving too slowly
to underwrite a new cyclical advance for stocks. As well, credit
quality spreads remain wide across the yield spectrum, indicating
low confidence in the US economy's prospects. Confidence readings
of this sort differ from measures of market sentiment in that the
former reflect the attitudes of people playing with real money while
the latter indicate opinion. When confidence in the riskier segments
of the capital markets is low, you are betting heavily against the
weight of the tape when you maintain sizable exposures. Better to
have some more risk takers out there with you.

The SP 500 is trading near 1270 as I write this. My SP 500 Market
Tracker hit a low 0f 1050 in July and is now around 1100 reflecting
the deceleration of inflation pressure underway. So, the market is
continuing to trade well above the Tracker as it has done in recent
months. Players continue to discount an earnings rebound to
start as 2008 wears down, and are also looking for the inflation rate
to moderate significantly.

The market has a 15.5% premium to the Tracker. The value of the
Tracker may well rise more in the months ahead if the inflation
readings turn more subdued, but fundamental risk will remain
elevated in the absence of a stronger liquidity push by the Fed
and some improvement in the very low level of investor
confidence. I harp on the issue of money liquidity because a
strong positive turn in growth is very important to an eventual
rebound of earnings.

Election 2008 -- 1

This year the national conventions are coming up back to back.
After these shows close, the candidates will be on the road to
sell their programs to the voters. Give 'em a week or so after
that, and the campaign will be back down in the gutter with new
and even uglier messaging. So the convention weeks offer a
brief period to glean what each party officially has in mind.
These stories often have some rationale behind them as well
and give the public a sense of what priorities are and what the
candidates are for. It does not mean you can take any of it to
the bank, but these moments can be helpful. Once we are past
the conventions and the program roll outs, it will be back to the
food fight. The GOP convention may be the less informative
since Sen. McCain may well plan to stab the rightie faithful
square between the shoulder blades should he get elected. He
has an option on his current Faustian bargain.

Inflation To Ease

By now, all know that the CPI for the US reached a multi year
peak of 5.6% measured yr /yr through July. As a result, take home
pay in real terms was slashed, profit margins contracted and all
of the incremental liquidity in the financial system was sucked up
by a rising price level. All this did come to pass from hefty
speculation in commodities even as global growth momentum was
declining.

As discussed, my inflation thrust indicator surged sharply starting
in early 2007. Commodities prices, particularly fuels, did the trick.
Other components, such as capacity and labor utilization rates,
ticked down over the interval. The thrust indicator is now coming
down reflecting the negative reversal in the broad commodities
market. Even so, there will be drag effects. Commodites will have
to weaken further in the months ahead just to get the twelve month
CPI back a little below 4.5% by year end '08.

Looking back over the past twenty odd years, there have been five
surges in the thrust indicator, with the last one being the swiftest and
the steepest. After each surge, the indicator has dropped steeply,
and the CPI has followed suit, with the yr / yr CPI % falling by 50%
on average. If the historical behavoir pattern holds, we could look to
a twelve month CPI of 2.8% out there in 2009 at some point. There
is no doubt that at the peak in 2007, global operating rates hit very
high levels. But the speculative run in commodities was so strong,
that a blow out could occur which would take these price indices
down sharply further as weaker demand and modest capacity growth
bring supply and demand into better balance across much of the
spectrum. History does favor the rapid downward adjustment once
demand growth gives out.

Be Careful This Week...

As detailed in the 8/15 piece "Be Careful Next Week", we have
seen changes in the momentum or direction of markets of
interest. As expected, the US dollar has backed off from key
resistance at 78, oil is trying to bounce and gold is as well.
I also pointed out the vulnerability of the stock market, which
failed to take out minor resistance last week and which broke
down today in a minor way. Of all these trades, I am most
interested in the US$ at this point. The dollar experienced a near
vertical liftoff in recent weeks and needs to find a trend.

I owe some more substantive posts, but have been sneaking out
with grandson for some fishing and swimming. I should be back
on track soon.

Be Careful Next Week...

The price of oil is getting sticky a bit above support at $110 and
is short term oversold. The $USD is set to test important
resistance at 78 on the index. Gold is hovering above major
trend support at $770. The SP 500 is mildy overbought short
term but should have taken out minor resistance this week.
All of this says to me that players are set to have a look around
to see what others are up to. Traders know that the USD is
overbought short term and want to see if it will back and fill
a little. They also want to see how well the oil market holds up.
The failure of the SP 500 to take out minor resistance this week
is a sell signal to some traders and at the least shows the reticence
to proceed with extended levels for the USD (up) and oil (down).
The gold bugs were creamed on the first attempt to rally the
metal from $810, but since gold did not collapse through $770 oz.
on Friday, hopes may rebound. Tread lightly in all markets on
Monday.

Gold Price ($833 oz.)

Gold remains in a long term bull trend. My macroeconomic trend
directional indicator confirmed it by hitting a new all time high a
few weeks back. Both the trend indicator and the price of gold
remain extended to the upside reflecting the strong rise in the
oil price and in industrial commodites over the past year.

The gold price shifted to a high return / high risk profile in early
2006 and remains in that mode despite the recent price correction.
The macroeconomic directional has declined sharply since 7/11/08
on oil and industrials pricing weakness and the gold price has
followed suit.

Gold is now in a steep short term price downtrend and recently
broke important pivotal support at $850. It touched $810 oz.
earlier in the week and is rebounding from a steep oversold,
helped no doubt by a bounce in the oil price. Gold needs to
take out $850 on the rebound to arrest the short run sell -off.

Gold remains in mania mode and needs to stay above the $770
oz. level to hold the high return / high risk profile. If I push the
macro indicator hard to produce a high value, I can come up with
a price of $760 oz. So, gold is still priced out of my league.

The metal has entered a strong seasonal period in an oversold
state, so expect the bugs and bulls to push hard to get you into
a long position. If my guess that oil may sell down to $90 bl.
by late this year is correct, my macro indicator is likely to
weaken further, which suggests to me that a powerful
seasonal rally in gold would be a highly speculative affair lacking
much fundamental substance.

I would like to see gold trade down in the $600 - 650 oz. area
before it would get me interested on the long side, but I do not
have a case for that now.

Interestingly, when gold did trade above $1000 oz. late this
winter, dealers and larger commercial jewelers saw a goodly
amount of supply come across their counters. I continue to
see a gold price above $1000. as bubble territory and have
been surprised there was no bandwagon effect when the
metal crossed that threshold. Gold chart here.

Oil Price

The oil price has continued to sink in recent weeks, closing today
around $113 bl. Strong indications of a global slowdown that is
still in the intensification phase have aroused concerns that the
oil market may come back into more equitable balance reflecting
slower demand and conservation efforts. Oil is moving into a
seasonally weak period now, and without surprise supply or
demand developments, it is reasonable to guess that the oil price
could decline to $90 bl. by late this year.

The fabulous overbought that we saw earlier this summer has
been eliminated, and the market is neutral intermediate term as it
approaches its 200 day m/a. Oil is getting oversold on a short term
basis and that has traders looking for a bounce off support at
$110 (chart link below). The $100 level is very much a pivotal
one for oil, but there may be a short covering rally before that
level is tested. Click for chart.

Stock Market -- Fundamental Profile

Right now, the SP 500 is priced for sustainable earning power of
20.00 per quarter, or 80.00 annually at a 16.1 p/e multiple. That
multiple translates roughly to an assumption of a 4.0% inflation
rate. Investors have wearied of earnings estimates which have
proven too high consistently over the past year. On the plus side,
they are not buying into a continuation of the acceleration of the
inflation rate witnessed over the past year, and which could see
an interim peak of 5.2% yr / yr. for July. Inflation has been
dominated by a large run up of commodities, particularly oil,
gasoline, natural gas and raw foods. Since the broader commodites
composites have fallen by nearly 16% in recent weeks, one can
see the rationale for reduced concern over inflation.

The market is looking forward in conservative fashion, not yet
willing to buy into a rapid recovery in earnings over the next
6-9 months. Quarterly earning power had reached about 24.00
for the SP 500 by mid-2007. Net per share for Q 2 '08 may come
in around 19.40. The roughly 20% decline in quarterly net
primarily reflects a 95% hit to the financial sector income account,
which constituted nearly 25% of SP 500 eps at its peak. The
earnings forecasting errors by analysts following the financials have
been huge, as the industry has struggled to come to grips with
estimating its loan and securities losses during the recent debacle.
Overall, it would appear investors are not now factoringin a rapid
recovery of financial sector profitability, and are viewing
prospects for non -financial earnings conservatively in view of
concerns about when the economy may regain momentum seen as
sustainable.

the weakness in the stock market this year has been severe enough
to raise the question of whether investors are reducing longer term
expectations for earnings growth. It is hard to do much with this
issue so far, because the damage to earnings over the past year has
been heavily confined to one sector -- the financials.

The Fed has opted to keep short term interest rates low and to allow
monetary liquidity -- a key building block for economic and profits
recovery --to grow a little faster. These are encouraging early stage
developments that have to be seen in tandem with the temporary
benefits to the economy from the recent round of tax rebates, as
the latter may confuse the issue of the extent of Fed ease of liquidity
for a few more months.

Leading economic indicators that have started to soften again
coupled with still large credit quality spreads signify continuing
economic risk and low investor and trader confidence in the
environment. If the Fed continues to re-liquify the economy and
we see those credit quality spreads start to come in, we may have
something good to work with.

Monetary Policy / Trades To Watch

Monetary Policy

Fed's FOMC met today and left the FFR% at 2.0% as all expected.
The statement carried no significant surprises, either. Key
economic variables supported a "no change" stance. However,
recent economic indicator readings show renewed economic
weakness in industrial and commercial order rates. If fresh data
on these series to come in early September show further erosion
in order rates as we move into the 2008 election homestretch,
figure FOMC members will receive phone calls from Power
suggesting a further ease might be in order.

Trades To Watch

The price of oil has broken sharply again this week and, at $119 bl.
or so, is right down on trend support for the powerful up-channel
in evidence since early 2007. Nat. gas has already broken down, and
further weakness in oil below $120. would signify a change of
direction not just for trader sentiment but for supply / demand
perceptions as well. Weak oil is helping the stock market and is
providing support for the US dollar, which is on the cusp of an
intermediate term breakout (see chart). The combo of a firmer
dollar and the drop in the oil price is also pressuring the gold price
as well.

The next couple of weeks will be important for traders and maybe
investors, too. Weak oil / stronger dollar is a major change in the
environment, likely reflecting concern that the global economy is
cooling fast and leading players to look over fresh horses. Just
remember that markets like oil, gold and the US$ can be fickle or
volatile or both.

Economic Indicators

The weekly leading indicator sets hit new cyclical lows and are
consistent with: a) development of a recession; and b) further
deterioration within a downturn.

The purchasing managers' index for new orders dropped sharply
in July and is now much closer to recession levels. The same is
true for the global PM composite. Even China's overall mfg. PM
reading fell below 50 in July (Olympics clean up?).

Underlying purchasing power within the US economy declined
to -1.8% yr/yr reflecting a falling real wage and lower total
civilian employment. When the tax rebates are added in, the
purchasing power measure improves markedly.

A strong export book plus rising public expenditures is continuing
to help the economy stay afloat. Momentum of global trade would
appear to be set to slow soon reflecting sharpened slowdowns in
domestic economies.

US manufacturers used the period of weaker order inflows to
work down backlogs and inventories and maintain high shipment
levels. Heavy inventory liquidation suppressed GDP. Backlogs
still remain elevated. Attention to working them down will
help shipments, but suppress capacity growth.

Clearly, the tax rebates are helping to sustain the economy
presently, and if these rebates do not spark more sustainable
growth, an extension may well be on the table for 2009.

The longer term leading indicators improved markedly as
July rolled on, reflecting a weakening in oil and gas prices. The
critical advance money liquidity indicators also improved, but
remain very modest.

Stock Market -- Still Just Looking

As previously discussed, the sharp sell off running from the
latter part of May through mid-July created a deep oversold
condition. Since this sell down also made it clear the US is
still in a bear market, it was suggested one be an angel and
not a fool in approaching the oversold. The market has moved
erratically up from the deep oversold and has even been nice
enough to form a channel. Even so, the signs I like to watch for
a change of trend have been scant indeed. So, despite the stray
thunderstorm, I have been relaxing out on the deck with the
occasional libation.

But, I have not lost heart, and continue to monitor the situation
for a long side trade. Specifically, I am watching the action of
the 10 and 25 day moving averages, and MACD and Stochastic
for the weekly charts. The daily SP 500 is here.

Liquidity Cycle

The Fed has tightened the growth of monetary liquidity for several
years. With the advent of the subprime mortgage and housing
debacle last year, the commercial paper market crashed to the tune
of $700 billion, sharply reducing the rate of credit driven liquidity
growth. Profit shrinkage generally follows hits to liquidity, and we
are seeing that, although the damage is primarily in the financial
sector. Economic slack has increased in the US and this usually sets
up a contraction of inflation. However, a strong global economy and
a weak US dollar stemming from cuts to the Fed Funds rate, did
keep the inflation pressure on an upswing until recently.

The commodities market -- the dominant inflation force -- has been
weakening in recent weeks, including the petroleum and gas markets.
Normally, once there has been a liquidity and profits recession that
results in a weakening of inflation, the Fed will relax the restraints
on the growth of monetary liquidity, and one can begin to look
forward to a stronger economy and a profits turnaround.

With slowing global growth, the Fed needs to assess carefully whether
enough slack will develop to underwrite further weakness in
commodities prices which would "green light" the Bank to allow
faster growth of its portfolio and the monetary base. The Fed has
been badly stung by the commodities boom of the past year, and has
been extremely tentative in providing liquidity to the system overall.
The Fed also knows that if it holds rates steady as inflation recedes,
the dollar may strengthen further, giving them another leg up on the
commodities market.

It naturally remains to be seen whether this liquidity cycle blueprint
develops as usual. For now, the pieces are starting to fall in place,
although the Fed remains very tentative, as it is hard to relax after
such a daunting and powerful run in the commodities market. The
latter has greatly inhibited the Fed in its liquidity provision
decisions, and has also punished business, consumer and investor
confidence.

Stock Market -- Fundamentals

I keep a short list of indicators to help me gauge the fundamental
outlook. The one clear positive has been the downtrend of short
term rates. My monetary liquidity indicators are turning from
negative to positive, but the readings are wan and have been
temporarily inflated by the addition of the Morgan / BSC deal to
the Fed's balance sheet and by the flow of income tax rebates.
On the negative side, corporate bond yields are rising across the
quality spectrum reflecting low confidence in the business
environment and the acceleration of inflation.

The SP 500 Market Tracker remains in a bear trend and sits
down at 1130, well below current levels in the market. The
Tracker may drop more as we head into August as a probable
further hike of CPI inflation measured yr / yr will suppress
the model's p/e ratio further. On the plus side, the recent sharp
decline in broad commodities indices points to lower inflation
readings down the road.

I would pay less attention to the Tracker if the primary indicators
were on a stronger footing. However, those indicators are too
weak on balance to support development of a cyclical bull market
at this point.

Shoot First, Ask Questions Later....

The above is a once popular adage for traders to move quickly on
dramatic changes in price and enquire at their leisure what the
causative factors may be. The idea is clear enough : If one plunges
into an analysis of factors behind sudden change, the work time
might bring one too late to the party. Balance that admonition
with the realization that many of you are competing against large,
mobile pools of capital that may have better short term info than
you and have the wherewithal to reverse course on a dime to
pursue a newly hot trade.

The fast downward break in oil and natural gas prices has helped
shepard in a rapid price decline in the commodities markets. The oil
move is complex -- rapid profit taking in the wake of a short run
momentum failure, concerns about greater demand weakness, the
spectre of Congressional meddling in the futures market. But a
rapid decline in costs to consumers and business promotes a
healthier economic environment. Presto! as commodities dip,
the equities market come back to life, with the most depressed
issues such as airlines and banks leading the way.

What is interesting in the moment, is the dramatic changes have
come so quickly and forcefully that new short term trend
confirmations have not been established yet. The charts are
"cuspy" but are not there yet. As one who likes to control his
risk, my impulse is to take profits, await the trend signal, then
return on the first test. Each of us has his/her own preferences in
fast markets like this. Just do not get greedy and go for the top or
bottom ticks.

Stock Market -- Chancy Action

A breakaway downleg ended this past week without the advent of
the furious, downside volume that would serve well to mark a low
point. Instead, we observe a "spike" bottom made by a powerful
upside burst led by the bedraggled financials. From a purely
statisitical / historic perspective, one should be sceptical of the
sudden spike low, particularly in a bear market.

Even with the surge up, though, the market remains oversold and
that leaves exploitable territory for the bulls who may wish to play
on for a few more days.

There is talk out there of a "reverse" trade -- short oil or, perhaps
the OSU ETF, and go long the SP 500 or even the financial sector,
like the XLF Spyder, which remains heavily oversold. This is
interesting concept stuff as the oil market has weakened sharply,
and a further decline would lead to better real economic growth
prospects down the road. But this is a trade only for the more
venturesome at this point, as there is little evidence that the oil market
has indeed shifted. Oil is still moderately overbought, so the "reverse'
trade could work further for only a brief while before the herd of
oil bulls try for a comeback.

The results of the meeting of Security Council members, the IAEA
and Iran in Geneva provided no resolution to the geopolitical issue
of Iran's nuke program. Attendance by US ambassador Burns seemed
to mark only determination to have the Iranians choose the carrot or
the stick within a couple of weeks. I mention this because all short term
players will need to watch the oil pits straight off tomorrow.

Oil Price

In a spate of infectious profit taking, the boyz in the pits have taken
oil from the $146bl. area to just under $130. As discussed over the
past several weeks, I mentioned that oil was spectacularly and
fabulously overbought. For the disciplined trader, oil is still
substantially overbought, although the current measure is within
reason and no longer silly.

The powerful price uptrend underway suggests oil can trade within
a range of $142 - 117 bl. for July. At the lower $117 level, oil would
not be overbought given the volatility of the price.

Now oil closed just under shorter term support around $130bl., so it
will be interesting to watch the action around that level for the next
few days.

It should also be noted that with August, comes a seasonally weak
period for oil as the market anticipates a drop off in gasoline demand
in the northern hemisphere as summer drive time winds down.

I am happy to see the oil correct, but I will be watching carefully to
see if oil breaks decisively below $117 over the next few weeks, as
that would be much stronger evidence that this ominous uptrend
is expending itself. The best you can say now is that the players
are taking profits in the wake of dramatic gains through 2008 to
date.

I will not insult your intelligence by pulling up some fundamental
explanation in a market that lacks both transparency and veracity.

Chart here.

Stock Market -- Fundamental Note

With today's big rally, let me sneak a little not so good stuff in
under the radar. CPI inflation hit 5.0% yr/yr for June, for the
highest reading since 1991. That news puts a significant crimp
on the SP 500 Market Tracker p/e multiple and sends the
reading for late June / early July down to 1130 (vs 1245 for 7/16).

Commodities prices, particularly energy, is by far the dominant
driver in the inflation outlook. Since commodities can be so
volatile, forecasting visibility is low. For example, broad
commodities composites are down by about 5% since July 4.

Inflation is gobbling up the liquidity in the US financial system,
suppressing output, profits, and incomes and leaving a liquidity
headwind for equities.

The SP 500 has trailed the Tracker on the way down over
the past year, but has stayed above the Tracker's line. This
suggests that despite a bear market, investor optimism has
not fully burned out yet.

There are two additional factors to keep in mind. The stock
market is highly sensitive to commodities prices now because
they dominate inflation. Secondly, even if there is inflation
relief ahead, one has to go along carefully and check back to
make sure the inflation surge to date has not damaged the
economy more than we've already observed. In short, should
the commodities scene cool off, it does not mean an automatic
free pass to a bull run in stocks.

Stock Market -- Technical

The market's oversold condition has deepened over the first couple
of weeks in July. As pointed out in the 6/27 comment on the
market, I have, as a gentleman of leisure, opted to spend quality
time out on the deck with the occasional drink and cigar. I have
stayed away from the market, and I may do so further. The
break below important support in late June reaffirmed the bear
market and, as subsequently mentioned, set up the possibility of a
breakaway downleg, which we have been experiencing. The
failure of the bulls to sustain a rally in recent weeks plus the
absence of heavy downside volume relative to upside volume
leaves me cold -- concerned that traders are looking for a
demonstrative capitulation to the downside before stepping in
to rally the market. In short, we have a breakaway downleg that
could spike down on heavy downside volume before this move
completes.

Hunches can get you into trouble as easy as not, and since I
have no trading capital in the market, I would like to find a spot
to play a rally from a deep oversold. But I am not going to push it
and instead will take my cue from the action ahead.