Monetary Policy & GDP Report

Monetary Policy
The FOMC left it unchanged today, as most had expected. With ZIRP
in hand, the focus has been on Fed liquidity support for the credit
markets. The benchmark indicators that guide the setting of the
Fed Funds rate remain deeply depressed. The credit supply /
demand pressure gauge remains very distorted. Demand is weaker
as business loans roll - off (normal), but banking system funding
remains rather tight. Hence the large liquidity injections and the
ballooning of the Fed's balance sheet.

The Fed remains committed to expanding liquidity further if the
economy keeps weakening, but of important interest as well is how
FOMC will behave if the economy extends the very recent
stabilization and then begins to expand before year's end. The
traditional indicators would suggest that a turn to tightening in terms
of rates and monetary liquidity would a good ways off, and the
Fed has many liquidity enhancing swap programs on its balance
sheet that need to be pared in a recovery. If we do see a stronger
economy later this year as I expect, the FOMC management of
the massive liquidity support will be a subject of intense interest
and speculation.

GDP Report
I saw no surprises here. The downturn is very broad and in full
flower based on the report for Q 1. Inventory liquidation was huge
as expected and it will be interesting as well to see how much further
inventories might be pared in the current Q. Another large liquidation
would likely create more bounce back potential later in the year
than is now generally perceived.

Stock Market -- A Brief Sabbatical For Me

The call-the-short-term-top "space" is packed to the rafters with
technicians and pundits. It has been a terrific rally, with many stocks
up more thean 50% from the early Mar. low. The very short term is
less interesting to me than is the time period through June. If the
market stays on this very strong trend, the SP 500, which today
closed at 857, will take out 900 and challenge the Jan. high over 930
over the next 10 trading days. Maybe, maybe not.

Traders who stay long now, if they are experienced and smart, will
have less money out and with tighter stops.

From a percentages point of view, I am more interested in waiting
over the next week or two to see what kind of support develops for
the market and whether that could provide a framework for a further
significant advance post any consolidation or pullback which could
develop over the next couple of weeks. That's also in keeping with
my philosophy of leaving a little money on the table, and, it is also in
line with my interest in looking at other topics besides the daily Dow.

Stock Market -- Fundamentals

Back on 1/3/09, I posted that my primary fundamental indicators
had turned positive. Ditto the secondary as well. I expressed some
considerable misgivings -- overbought market, unstable psychology
and my worry that a turn in earnings was still "out there" in time.
I suspected January could be bumpy, but had no idea that SP 500
operating earnings would collapse into the first ever quarterly loss
for Q 4' 08. I had a low end of the range number of $10. and it
wound up - $.o9. I also did not expect the Fed to drain so much
liquidity from the system in January, either. Blindsided on 2 counts.

Well, my indicators -- trends in short rates, liquidity measures, BBB
bond yields and confidence measure yield spreads are not likely to
turn bearish until the Fed tightens liquidity and raises short rates.
So, I am stuck on positive. My secondary indicators remain in positive
territory as well.

My longer range economic indicators continue to point to a Half 2 ' 09
economic recovery. the shorter term indicators suggest a stabilizing
economy, but not recovery yet. I have been guessing a market bottom
over Mar. - May 2009 in lieu of earnings recovery later in 2009.
So far so good on that.

My SP 500 Market Tracker has fallen to fair value of 750 in April as
12 month earnings have sunk much further. The earliest bottom in
earnings is likely after the June quarter. ( 12 mo. earns. now $45.51).

Analysts have been incinerated by a collapse in SP 500 profitability
relative to their earlier expectations and consensus going forward
through 2010 is now much more muted.

The market is at a 13% premium to the Tracker in April as investors
are again trying in a moderate way to discount the bottom of earnings
and look toward recovery. I believe investors are also rejecting the
idea of anything more than a very transitory brush with deflation.

If earnings bottom later this year and recover moderately through
2010, there is still very sizable upside in the market from current
levels. Earnings recovery up to the mundane long term trend of $70.
by the end of 2010, would get you 1155 - 1200 on the SP 500.

Now the bottom line of all of this is that we need to see those shorter
term leading economic indicators start doing a fair bit better in the
months straight ahead. Otherwise, it's back to the drawing board.

Stock Market -- Technical

I still have this rally as intact despite yesterday's peppering. There
was a sharp sell off back 3/17-18 that took the market off its rocket
trajectory, but it has remained on positive trend since and it held
important short term support yesterday.

Much of the short term overbought was taken out yesterday, but
intermediate term overboughts ranging from 6-13 weeks are in
place, so there can easily be more short term volatility ahead.

My upside target for this rally has been SP 500 850 - 900 through
the end of April. We did close at 870 on Fri. 4/17. So the market
hit nearly the mid-point of the target range. But, since the rally is
still intact, I am happy to see it meander along.

This rally has taken out important trend resistance, and though it
is quite a way from testing measures of longer term durability, I
would not just blythly call it a bear market rally even if time shows
that's what it is. Technically, it commands attention for now.

I would be inclined to write off the rally if the SP 500 takes out
the 800 - 810 level in the days ahead on further selling pressure.

Gold Price

The gold price is in weak seasonal mode, so not to make that much
of it. If the price still looks sickish by Jul / Aug, best sit up and take
note.

Gold traded very nicely against my macroeconomic directional
indicator from 1999 until Aug. 2008, when the indicator tanked on
collapses of oil and industrial commodities prices. This development
created a decisive break in the long term trend of the macro indicator.
Gold weakened too, but no major long term trend lines were broken.

The macro indicator went into recovery in late 2008 as oil and
industrial commodites stabilized and then turned up. The last time
the macro indicator was at its current level was late 2007, when gold
traded at $800 -850 oz., so the discrepancy in relative behavoir is
not so large.

My economic value estimates have gold in a range of $500 - 600. and
the main long term chart trend at $650 - 750. Gold went to a large
premium to all these measures starting at the outset of 2006 and has
maintained a premium ever since.

By my long term estimates, silver, oil, most industrial commodities and
natural gas are all dirt cheap relative to gold and my preference would
be to play rallies in these markets rather than futz with an item that has
as much as 40% price downside.

I have attached a chart for the GLD etf. When you pull it up, you'll see
a double top and a shorter term downtrend. A price of 85 is an
important pivot point and a break below 85 could get you 75. Ok, but
a more interesting time may come when gold approaches a stronger
seasonal interval as summer kicks off. Chart.

Coincident Economic Indicators

Measured yr/yr, the recession deepend through Q1 ' 09 as the
decline in the CEI expanded to -5.6%. Real retail sales showed
a stabilization pattern over the quarter, but were still down 9.8%
yr/yr, as households continued to focus on rebuilding savings
and reducing debt.

Industrial production fell again in March and is now -12.8% yr/yr.
That is steep indeed. My rule of thumb for a depression is -15.0%,
so the US is nudging closer in my view. I use that rule because it
would take a good several years to make up the deficit in production
and because a 15% yr/yr drop has such negative implications for
profits and employment. Capacity expanded at only 0.5% yr/yr
through Mar. This reflects the steepening reduction of base capital
spending in the economy.

With retail sales more stable and production in a sharp decline,
business inventories are running off and physical working capital
is shrinking. So, pipelines are emptying out and as often happens
in such a situation, job losses have accelerated, with total employment
now down 3.5% yr/yr.

The income side is becoming more mixed. Per capita cash buying
power is as strong as it has been in many years. Total payroll (in
which I include unemployment benefits) remains positive but is
losing momentum. Moreover, the number of out-of-work folks
losing benfits is on the rise. On the plus side, new lower tax
withholding rates have just kicked in. In all, cash buying power
is still above water, and this factor continues to give the economy
a shot at recovery in the months ahead.

Now, we have pent up demand building for home sales, autos,
inventories and capital spending, with home sales and autos acute.
The factors to initiate recovery are in place and are visible.
What's needed, of course, is for consumers to begin to pick up the
pace of spending a bit, so that retail can start to move up from
stabilization.

Monetary Policy -- Liquidity

The Fed has started to step on the liquidity accelerator again after
a 3 month hiatus. The growth of the basic money supply has
stalled after a rapid increase over Half 2 '08, and the Fed has
recently stepped up the expansion of the monetary base to
counterract slow M-1. The Fed should probably push for another
$100 billion of cash for the system given how slow credit is. The
new round of tax cuts and the Fed's Treasury purchase plan should
help. I scratch my head about it, but it could be the case that the
tightening in monetary liquidity we saw from 12/08 - 3/09 did
adversely affect the stock market.

The broader measure of credit-driven liquidity growth has slowed
to 0.9% yr/yr through Mar. Here, one can more readily see how the
Fed is battling weaker credit demand via a deep recession. The
banking system's loan book has declined. As you would expect, the
major shortfull has come in the real estate loan book, which is running
15% below the long term trend and will fall further behind in the
months ahead. The C&I loan book is also running off, but slowly, as
businesses keep their credit lines drawn against any possible
negative policy reviews by the banks. As a consequence, the banks
are experiencing a run-off of jumbo deposits to go along with the
reductions in commercial paper offerings. Thanks to TARP, the
system's capital book has steadied out despite the large increases
in loan loss reserves and charge-offs.

Significant expansion of the broader base of liquidity is going to
require help from a turnaround of the economy.

Stock Market Quickie

The SP 500 closed today at 857 on the SP 500. So the rally has
pushed on and is now in the 850 - 900 range I have been
envisioning for a couple of weeks. So far, the uptrend has been
steep and persistent enough not to let cautious guys waiting for
a hefty pullback to get in. I have heard every argument in the
book to fight the tape and even some of the pundits are fighting
each other in print. Interestingly, the market did take out
another important downtrend line today.

I am planning a nice three day weekend and do not intend to
think about it until next week.

Stock Market -- Technical

The current rally is a bit more than a month old. As discussed in
posts over the past two weeks, it has exhibited a rocket trajectory
and has twice vaulted to exceptional short term overbought
readings. Even after today's sharp sell off, it remains moderately
overbought.

It has been a tradeworthy rally nonetheless, and remains of interest
to me, since it has broken out from the deep downtrend lines that
bounded the action over the past 6 months. The SP 500 closed
today at 816, and the market will continue to hold my interest as
long as it stays above 790 in the days ahead. A sharp break below
that level would indicate a trajectory of more questionable import.

Only the brain dead have missed the notion that the rally did get
ahead of itself, and my e-inbox is full of warnings that it's earnings
season and that dismal reports will threaten to smack it down.

Ah, but in my perverse way, I find that the inability of sellers to
crush such a high flown market overbought signifies a change of
some sort is afoot. Going back to late 2007, short term overboughts
have been treated in a rude, quick fashion from far less lofty levels.

So, I will keep the focus light turned on, and absent a break of
consequence below SP 500 790 - 800 over the next week or so,
will look for logical completion of the rally within 850 - 900 over
the course of April.

Economic Indicators

Leading Indicators
The weekly indicator sets remain at very depressed levels but
improved over the course of March. The indicators rose up through
the deep crash downtrend lines in force since mid-2008, and when
measured yr /yr, momentum, although depressed, has improved
steadily since Nov. '08. That's a decent positive. However, the
indicators themselves have not improved enough yet to call for a
positive reversal.

The monthly indicators too are depressed, but bounced up sharply
in March, reflecting a large rise in US manufacturing order rates.
The bounce in total new order breadth is the strongest since 3/03.
One swallow does not make a summer, but I'll take it for now.

Global new order breadth remains at very low levels with no
improvement despite the rise in US manufacturing. The global
new order data does show stabilization since last Nov., however.

The Economic Power Index for The US has weakened modestly
recently following a large positive surge since last Aug., when
inflation pressure fell away and allowed the real wage to rise
markedly. The real wage is still strong by historical standards, a
continuing plus for the economy. The employment side of the ledger
has turned awful, now -3.5% yr / yr through Mar. This is of
course undercutting purchasing power and the creation of slack in
the labor market can be expected to weaken the growth of the wage.
The decline of the full Power Index overstates the case as it does
not include safety net income from a more robust social security
payout and jobless benefits. Ahead, worker compensation will benefit
from a modest reduction of tax witholding -- a plus.

On balance, the sharp increase in the real wage has worked to
stabilize the economy despite a new consumer penchant to save more.
We need to see a continued more balanced approach between
spending and saving to see the economy regain more positive traction.

New mortgage purchase applications bounced positive in Mar. on
a seasonally adjusted basis -- another small but favorable sign.

My long term leading indicator remains positive and still signals
economic recovery by mid-2009. One indicator, the real oil price, is
turning negative reflecting a substantial recovery so far in 2009. You
have to watch this closely, as a speedy rise in the oil price, if
sustained, will ultimately damage the broader economy.

The capital slack measure shows a continuing large build in idle
economic resources and underscores why a substantial and vocal
contingent of economists want to see much higher levels of pro-job
government spending.

Stock Market -- Short Term

An interesting few days lie ahead. the rally is very much intact and
the market remains very much overbought in the short run. The
boyz took profits this pm in anticipation of the jobs numbers to be
released tomorrow. The main impulse for this rally has been
recognition that the economy has been stabilizing after a steep slide.
But, Team Obama has been painting the tape green as well, and
with a positive spin having been put on G20 (big hat, small rabbits),
the team might print a jobs number tomorrow that, although
bad, is better than expected. If you are trading around this rally,
be extra light on your feet over the next couple of days.

Stock Market -- Short Term Technical

Today's sell off continued the one started on Friday, only with more
smack. It ended a plainly unsustainable rocket run up that produced
a massive short term overbought on price (the breadth overbought
reading was mundane). The market could lose a little more ground
over the next day or two and still would be well positioned to move
higher if it catches decent bids. Too early to throw up one's hands.

The short term overbought we saw last week doubled anything
I have seen for quite some time.

Corporate Profits

Profits for the nonfinancial sector for Q1 ' 09 should be lower than
for the prior quarter and down substantially from the prior year
reflecting weak output comparisons and a loss of pricing power,
with the latter especially telling for commodities producers. Ditto
foreign earnings, and, for the offshore net of US companies, we have
to tack on an additional penalty for a stronger US$.

The financial sector maintained a high level of net revenues.
Downsizing likely cut noninterest operating costs, but the flow down
to the bottom line will primarily reflect the magnitude of loan loss
reserves and securities losses from the continuing unwind of the
mortgage paper crisis. That's all guesswork at this point. Naturally,
AIG -- the current poster child for the meltdown -- could have
more bad news to report.

With SP 500 profits broadly bad, companies are cutting dividends
to conserve cash. Measured yr /yr, the Sp 500 dividend is down 16%.

12 month earning power for the "500" is now a low $45. per share.
In a moderate global economic expansion with an accompanying
reduction of finance sector loan losses, earning power could be
$75 - 85. per share in the latter part of 2010.

The drop and crash of the stock market from 2007 is every bit
warranted by the drop and crash of big company earnings. US GDP
corporate profits -- a broader measure but one which has peculiar
economic adjustments -- is down about 33% off its peak, which is
still lousy.

The SP 500 Market Tracker, which uses current 12 month eps, is
priced now at 750 and reflects the current awful state of index profits.
The current rally underway in the stock market reflects an effort
to begin discounting a more stable economy with a bit more investor
confidence about the future.

Stock Market -- Short Term Technical

Yesterday's big rally took the market up to an obscenely high
short term overbought. We saw a pullback today, but the market
is still strongly overbought and vulnerable to more selling pressure.
Such would be the case even if bull market conditions ruled.

The market is at the gate of an intermediate term rally -- 6 -13
weeks -- that could carry the SP 500 up into a congestion / resistance
zone of 850 - 900 (as opposed to today's close of 806). However, the
trajectory up from the 3/9 closing low of 677 was such a rocket it
leaves about 5% further downside before it would enter onto a more
"normal" rally trajectory.

More conservative traders looking long may well hold out to gauge
if they can enter orders at meaningfully lower prices.

The market has moved sharply outside of a strong bear market
trajectory for the first time since the fall-into-crash kicked off after
Labor Day, 2008. So, for long side players this is the most interesting
rally in months and this suggests interest may stay high for a while.

The intermediate term breadth indicators I like still have the market
in oversold territory looking out several more weeks.

Financial Liquidity & Monetary Policy

Early in the calendar year, the Fed tends to drain liquidity from
the banking system following the holiday season. This year, for
reasons not disclosed, the Fed shrunk its balance sheet by a
whopping $400 bil. This action led to a contraction of the basic
money supply and a $150 bil. contraction in my broader measure
of credit driven liquidity. For a central bank intent on easing
credit, the tightening caper makes little sense, unless they wanted
to see how the credit markets would react to so big a change.

In any event, the Fed came along this week to announce they would
buy a little over $1 tril. of paper, including $300 bil. of Treasuries.
With this and their other facilities, the potential is there to expand
their balance sheet by $1.4 tril. or 70% to a ginormous $3.4 tril.
God bless us, that's a lot of money. Piker that I am, I would have
been satisfied if they had replaced the funds they drained and added
perhaps $100 bil. more via buying Treasuries.

So as discussed in the prior post, They are creating liquidity to
support credit growth far in excess of what the US is likely to need
over the next couple of years. Perhaps these planned purchases
will help hold Treasury yields down in the short run. We'll see.

Another gambit the Fed could have tried would have been to stop
paying interest on reserves and to start charging interest instead.
That might have served to get banks to reduce their excess reserves.

Well, we have moved much further in to a new ball game in the
annals of US monetary policy. This move has the potential to help
the economy in the short run, but it also could serve as a destabilizing
force in the long run.

The Fed -- Maybe They've Gone Over The Top

Ok, the FOMC has announced it is committing to buy up to $1 tril.
additional securities, including $300 bil. of Treasuries (quantitative
easing). They want to rescue the economy and do Their bit to help
out globally. I get it. But, this latest round of monetary expansion
grievously offends my sense of proportion and balance. To
analogize, the FOMC is building this enormous casino with every
gambler's interest and amenities provided for. But, the US private
sector is looking maybe to enter the casino once in a while, and needs
but a cup to hold quarters for the slots. In short, the Fed is
seeking to replace a credit regimen that may be too large for the
times we have entered.

Inflationary? Could be. But this action will create a liquidity load
in the system that could destabilize the economy and the capital
markets, especially when it comes to shrinking this vast pool.
Monetary tightening down the road that could involve removing
$1 tril. from the system could have unintended but very disturbing
consequences, inflation notwithstanding. Restoring integrity to the
Fed's balance sheet long term could prove a daunting task indeed.

I say all of this because I do not think the economy needs this much
liquidity to recover and prosper. Savings = investment, so even if
the economy saves more at the expense of a measure of short term
growth, liquidity for longer term investment will be provided
internally. I would like to see economic growth proceed from cash and
carry to modest credit expansion, which seems far more appropriate.

I understand the fear of a deflationary spiral into depression. But I
think folks need time to reassess their priorities and to budget
accordingly. That means a blend of incremental spending and
savings should be expected rather than having everyone only
pinch pennies and wait around to be laid off.

So, I am now out of synch with this decision to build so grand a
monetary edifice. It raisies substantially the risk of unintended
economic disequilibrium and dislocation.

Coincident Economic Indicators

Viewed yr / yr, the recession deepend further. The Feb. index of
CEI was down 5.1% vs. 4.5% for Jan. All components softend. My
indicators are overstating the weakness somewhat because they do
not capture the large increase in the social security disbursement
rate. The real hourly wage remains a very strong 3.6%, which when
coupled with per capita real SS disbursement of over 5%, gives the
consumer the stongest per adult cash buying power in many years.
That remains the bright spot in the outlook.

Real per capita income growth is being undercut by the rising tide of
employment losses and a weakening job market will eventually lead to
a softening of wage rates. Short term, real retail sales is showing
stabilization, which is a hopeful sign. Seen yr/yr, real retail sales is
down about 9.9%, which continues to show how strongly consumers
are interested in boosting liquidity or savings. Short term, the
liquidity preference has weakened, and this is precisely what is needed
to restart the economy. Come April, wage earners will get another
boost from lower tax witholding rates.

Production fell a whopping 11.2% yr/yr through Feb. That means that
inventories are being liquidated relative to sales and that the pipeline
is thinning out. Weak production also reflects the dramatic decline of
US exports under way over the past half year or so.

In all, it remains premature to give up on the idea of a stronger Half 2
economy for 2009, although the outlook remains a cliffhanger.

Stock Market -- Technical

Well, the rally has moved up and past the quick sucker format and
is threatening to become more substantial. The SP 500 has risen to
an overbought at 3.1% above its 25 day m/a, so I think we now are
at a level to test bullish intentions as overboughts above 3.0% have
tended to correct within days after the rallies have topped that
modest level (past six months only).

The 25 day oscillator has broken up through a downtrend underway
since early Jan. ' 09. That's a positive as it suggests the downleg
from Jan. may be over. The 10 day m/a is rising. The 25 day m/a is
still falling and the "10" is below the 25. So, it is still only a short term
run. My 25 day indicators are turning up but do not a confirm a
rally of more consequence as yet. Chart here.

The important 40 week oscillator with 13 week smoothing may be
entering a bottoming phase. This indicator indicated a topping phase
which began in the spring of 2007, ran on, and wound up hinting at
the major top that was to come. In a similar vein, the 40 week osc.
could run on in a bottoming phase for some time as well, although
as with all things technical, it need not.

Stock Market -- Technical & Psychology

Technical
Over the past 3 days, the market has rallied from a deep oversold
up to a modest oversold. Last week, I saw it as a coin toss whether
stocks could rally or fall further to match the kind of oversold %
readings we saw last autumn. Unlike the intermittent rallies we
witnessed through much of 2008, the upsurges this year have all
been cruel sucker moves that have trapped all but the most nimble
of day traders. At the moment, the jury is out on whether this is
just another sucker-doo.

This is the 3rd time this year the market has rallied out of a deep
downtrend line. So, it will be interesting now to see whether the SP
500, which closed today at 751, can advance further, and of greater
importance, can hold above the 710 level through next week's close.
Then, we might have something more interesting.

Psychology
Market psych. has improved this week because leading banks have
pointed out that net revenues remain at high levels and that cash flows
net of reserves remain substantial. The promise here is that if
the economy is more stable and loan loss reserves are more contained,
the earnings leverage will be quite positive. As well, both the SEC and
the accounting standards board (FASB) are under tremendous
pressure from Congress to modify the ridiculous market-to-market
rules which are making banks take losses they may well not realize.
Both the FASB and SEC are now under strong pressure to respond,
pronto. Congress gets my vote on this one. Finally, it should be
noted that retail sales, a forward but not a leading indicator, are
showing some stabilization (More on this next week when the
co-incident economic indicators are reviewed).

I enjoy trying to gauge market psycology, but the recent change to
positive is a great reminder of just how fast psychology can change
and why you have to be so careful with it.

Oil Price

The oil price retains good economic value below $50 bl. The price
is giving mixed signals during this normally strong seasonal period
which can run out through March. It is well off the late 2008 crash
low of $33+, but has not been able to take out short term resistance
in the $46-47 area. At present the shorter term uptrend in evidence
since mid- Feb. '09 is the firmest to date since the price moved up off
the crash level.

Still, the price should be doing better. It is behaving atypically for a
new cyclical advance during this normal strong seasonal period, and
the failure to clear resistance puts it closer to bear market behavoir.
Since cyclical bear markets in oil typically last 12 - 18 months, the
late 2008 low looks suspicious given that the all time price high of
$147 came in mid-2008 as well as the severity of the decline in
global petroleum demand. So, although it has a good short term
technical profile and could push higher before the end of the month,
claiming that the price "bottom is in" is an against-the-house bet.

Fundamentally, despite the OPEC production cuts, inventories are
high on a seasonal basis and gasoline demand in particular remains
on the weak side. Capacity at the well head will expand moderately
this year as well. So, it could be late in this year or 2010 before
supply and demand align more favorably for price recovery.

Long positions should be attentive to how oil behaves as it winds up
the seasonal push around month's end. For a technical chart, click
here.