Stock Market In Perspective

Early last autumn, when I turned more cautious on the market, it
was on an astoundingly strong trajectory. Even after the Jan. ' 10
break, it was still on a trajectory that would have taken the SP 500
to new record highs by year's end. Not impossible, but not a good
bet, either. So, yes, the rise in the market was too steep, but it was
partly understandable given the extraordinary rebound of corporate
profits.

My SP 500 Market Tracker currently projects the index to rise 25%
from current levels to 1350 by year-end 2010 as 12 month net per
share surges higher. From a technical perspective, this would put the
market on a trajectory that is still extremely strong by price chart
standards, but the Tracker is merely assigning a moderate 16.5 p/e
to earning power in excess of $80 per share.

Now, here is where it gets more tricky. S&P profits have exceeded
those suggested by the sharp run ups in my leading indicator sets
reflecting the deep cost cutting companies have undertaken. Since
the bulk of the cost cutting is past, profit growth was bound to
moderate. Moreover, when measured on yr/yr % change, the
weekly economic leading indicators have hit and have just crossed
an inflection point, signaling that a slowing of profits growth is out
ahead. A significant slowdown in profits momentum is factored into
the $80+ per share projection for the "500". But, there is a problem.
Once the leading indicators break the initial recovery signal surge,
further upside momentum of the indicators is not only far more
mild, it is more difficult to project with confidence. On top of that,
the "fit" between the indicators and the profit trend loosens past
the inflection point of the indicators, although it must be said that
profits often do better than expected anyway.

The long and short of it is that with a sharp moderation in the trend
of the leading indicators underway, the stock market could not hold
a nearly impossibly strong price trend and has corrected since a clear
signal has been sent that profits growth is going to slow. This is
the fundamental event I warned about last autumn, an event that
came later than expected.

I am on the hook for expecting a solid year of economic and profits
recovery in 2010 and for expecting a continuation of the cyclical bull
market. Since earnings currently remain in a sharp upswing, I
think the market has overshot to the downside by 10%, although
conceding that a reaction of real consequence was required given
the extraordinary trajectory of the market from 3/09 - 4/10.

I expect a sharp recovery rally to get underway over the next 5-7
trading days. But I do see a period of uncertainty ahead for a couple
of months until we see how well the leading economic indicators
progress.

Stock Market -- Technical

The confirmed short term downtrend is obvious enough. the market
is substantially oversold and is at levels to support a rally. But, one
right an oversold market has, is to get itself more oversold. I do not
short significant oversolds, so my penchant now for a trade is to look
for a bounce / recovery, and at a minimum the preference is to first
see some stabilization in the short term price oscillators as this
development would signify a loss in negative price momentum.

The market did not make a classic serious top. The bad news is that
we have an uncharacteristically deep short term oversold for a
cyclical bull market. and that means you have to be more cautious
on the long side with perhaps a gradual fill when you get the short
term set-up you prefer.

When I look at my NYSE buying pressure vs. selling pressure
measures, the market is moderately oversold at -50 and deeply
and very reliably oversold at below -100. We are currently a
tad below -50, so this measure is still risky. My cycle work
suggests a 13 - 15 week bottoming pattern is just now upon us.
So, there could be a sharp price recovery in place by the end of
next week.

I try to keep technical and fundamental analysis separate on the
premise that when two widely different disciplines tell you the same
thing, your chances of being correct are better than when you rely
on just one discipline. But, sometimes using both techniques in
one analysis can be handy, and I plan to do that a little later this
week.

SP 500 weekly chart.

Inflation Potential

Gauges which signal future inflation rebounded dramatically over
roughly the past year or so. However, the rebound in the pressure
gauges merely signaled from deflation to mild inflation. Moreover,
as a result of recent weakness in commodities prices, inflation
thrust has fizzled in the short run. (CRB commodities chart)

Commodities were set to be the inflation driver this year as they
were in 2009. Last year, commodities rose rapidly on a strong
global economic turnaround off very depressed levels, but that
price uptrend was broken earlier this year as traders figured
that inventory pipeline refilling would be complete by mid - 2010.
There has been extra downward pressure on the CRB recently as
China -- a major buyer of raw materials -- has been signaling it
desires to avoid overheating -- and as traders handicap a
presumed slowdown in Europe's recovery in the wake of the
recent uproar over debt addled EU members such as Greece
and Spain.

Now, note that the CRB is moving toward an oversold situation in
the short run, and note too, that commodities can be volatile.
Thus, one cannot vouchsafe a flattish CPI for more than a couple
of months.

My longer range inflation thrust measure, which keys off the US
capacity utilization rate and the leading economic indicators, is
currently very tame for 2010, but suggests a sharp acceleration
of inflation pressure in 2011 as operating rates rise significantly
further and cost pressures build broadly. These currently still
low broader measures of economic activity have indeed partially
offset the impact for the inflation picture from commodities over
the past year, but that could all change in 2011 as economic
recovery progresses.

Stock Market -- Fundamentals

Core fundamentals -- interest rates, liquidity, confidence measures
remain positive and support continuation of an "easy money"
cyclical bull market.There has been some slippage in the indicators.
This is entirely normal and I note that the erosion is from nearly
unprecedentedly strong levels.

Corp. earnings remain in a strong uptrend and continue to accelerate
relative to the long run trend. Importantly, profits, though rising,
remain well below levels that would signal a cyclical peak and
fundamental trouble for the market.

My SP500 Market Tracker, which started to bottom a year or so
ago with a value of 655, has jumped to the 1190 level on a dramatic
recovery of earning power. For most of the cyclical bull run since
3/09, the SP 500 actual has traded at a substantial premium to the
Tracker value. With the recent sell-off, however, the market is
currently running at a 9.6% discount. So, the market is now
attractive relative to fair value as the Tracker has caught up with
and surpassed the index. Estimated Tracker value based on full
year 2010 expected earnings is just shy of 1350 and I do not have
an issue with that number at this time.

Now for a couple of secondary indicators. The sharp run-up in the
real price of oil off its 2009 low did not appear to have damaged the
market. Moreover, the oil price has recently sold off sharply along
with the stock market. Thus, the oil price indicator has not been
useful so far. The other secondary indicator concerns financial
liquidity and this requires some discussion.

The large liquidity tailwinds the stock market enjoyed over 2009
have ended. For example, combined retail and institutional money
market funds aggregated a record $3.50 tril. in 3/o9. By the end of
April, 2010 the combined mm fund total stood at $2.66 tril., or 24%
below the '09 record. In turn, the $2.66 tril. of 4/10 compares with
the $2.9 tril. on hand in mm funds at y/e 2007. In short, the large
build up of cash that occurred over the recession and the deep bear
market has been more than fully drawn down. Also note that total
system financial liquidity has been shrinking mildly while real
economic output has been rising. Thus, the liquidity tailwinds
have reversed course viv a vis the stock market, and are now
headwinds. This is a short term issue for the stock market, but
you have to be careful not to draw dire conclusions yet, since
economic recovery will prompt mm fund growth and, eventually,
private sector credit growth, which will expand the base of liquidity
available to the capital markets. However, suffice it to say that since
the Sp 500 is dramatically above the 2009 cyclical low, plenty of the
bucks available have been put into play.

Post Traumatic Stress & Profit Taking

One of my concerns about the stock market over recent months
has been the potential for a collective emotional backslide that
could be triggered by events that remind investors of the original
trauma of the economic / financial crisis of 2007 - early 2009.
I think it is crazy to expect that investors would skate right out of
that nightmare without experiencing subsequent shivers or
without looking back. The problems the EU is encountering and
some mild policy tightening by China have been the catalysts to
have ignited fears.

And, of course, from the 3/09 low into 4/10, the SP 500 advanced
by a staggering 80+%. That advance included the funky, out-of-
place rally of the early spring. What better time for a bunch of
traders to finally take profits?

I do not want to minimize the various problems the EU is facing
now nor do I wish to wave off China's mild tilt toward temperance.
But these are issues that are being encountered in a global economic
recovery with unprecedented monetary and fiscal support. I will
keep an eye on these problems, but as of now, I think the risks
they pose are rather mild.

I am leaning more to the diagnosis of post traumatic stress jitters
coupled with good old fashioned profit taking and portfolio
restructuring to account for the recent flight from risk taking. Yet,
you have to be respectful of these factors as a re-stoking of the old
fears and the profit motive are all too human.

Oil Price -- Interesting Moment

Greybeard traders know that oil often experiences moderate
seasonal price weakness running from late April into June / July.
The big seasonal build of petrol stocks completes in the spring
and demand eases off. Gasoline production is up about 5% this
year in the US, providing extra stock for the upcoming prime
driving season. But Jun. '10 oil has plunged from near $88 bl. in
April to close near $71.50 today. Down 18.5%, this is not your
mild seasonal dip.

Traders have concerns beyond goodly refined product supply. They
have taken note that China -- a huge crude buyer -- is inching along
toward a tighter monetary policy. they see that to preserve the EU
as it stands, southern and far eastern Europe are under pressure
from the markets to reduce budget deficits. And, they are taking into
account continuing Euro weakness and US dollar strength as the
markets adjust for a more sluggish and fractious EU vs. the US.

The crack in the oil market has penalized sector investors, but it
will also work to reduce cyclical inflation pressure and enhance the
real wage in the US which are plus factors for the economy.

The weakness in the oil price has broken its uptrend off the early
2009 cyclical low and it has brought oil down to an important
support level. The price drop is leading to development of a sharp
short term oversold condition, which might well give players a
longside shot at moderate seasonal price strength starting late in
the summer.

Right now the psychology for oil is not good what with the
realizations that Europe may grow more slowly and that China is
now snugging up on policy. We have to wait a bit on the EU, but I
doubt China is prepared to slam the door on growth. Given the
grand power of the central gov., China can play stop / go with
monetary policy far more freely than can governments in the
West.

If you are like me, and drive and heat your home with oil, an
opportunity to hedge your cost with a long position in an oversold
oil market is worth keeping an eye on. Oil price chart.

Stock Market -- Technical

The normal admonition is to say beware of spike bottoms, as
long term history shows they hold up no more than 50% of the
time in bull markets. Yet, this cyclical advance has relished spike
bottoms, so traders need to have that fact in mind.

The sharp decline in the market last week wiped out the over-
boughts across the time spectrum and left the market deeply
oversold on a short term basis. The deep sell-off ended abruptly
but started gradually enough to provide trade worthy shorts
which should have been covered on Friday.

As we moved into this week, I found I no longer had a firm technical
case for urging caution as much of the excess was wrung out in
sudden fashion.

This week the market has rallied sharply from a deep short term
oversold up to neutral. The market is in a confirmed short term
downtrend, but has been strong enough this week to make it
reasonable to expect a test of the short term downtrend line, which
if breached on the upside, would be a preliminary signal that a
positive reversal might be in order.

I did have a short position coming into last week's decline. That
position was closed on 5/7. I have not jumped into the market
on the long side and will probably look to see whether there is a
confirmed positive short term reversal before coming off the
sidelines.

I have to warn that I am now charting off closing prices as
I am unclear as to how much of the tape on Thursday, May 6 will
turn out to involve broken and hence phantom trades. Chart.

Economic Indicators

Leading Indicators
As discussed previously, global leading economic indicators did
flatten out over the 9/09 - 2/10 period following rapid recovery
earlier last year. This was true of the eurozone and no doubt added
to creditor concerns regarding the weaker links such as Greece. The
good news is that there has been substantial improvement in more
recent months both in the eurozone and around the globe.

US weekly leading indicators have regained positive momentum
after a Jan. - Feb. '10 dip. US monthly leaders also remain strong.
The improvement in the breadth of new orders has been steady
enough, and although high, remains below record levels. The $ trend
of new orders has also accelerated sharply off the low early 2009
base.

Yr/yr % momentum of the leading indicators may be peaking now,
but momentum has been unusually strong and signals good growth
in output and profits through Aug. '10.

My Economic Power Index is now showing recovery again. The
yr/yr change in the real wage has flattened out but is holding up
better than earlier expected, and the yr/yr change in employment,
although still negative is improving rapidly. The index looks set to
break out of a broad three year downtrend in the months ahead.
At this juncture the continuing expansion in jobs held is necessary
to sustain consumer confidence and spending. Internet job listings
have jumped in recent months and have reversed a steep downtrend
in place since late 2007.

The Business Strength Index has recovered enough to signal
that the Fed should raise short rates. However, the capacity
utilization component is still low by the Fed's reckoning, and there
has also yet to be a decisive turn in short term business credit
demand (The re-activation of swap agreements between the Fed
and Europe's central banks could also affect US monetary policy
in the short run).

There remains large slack in the US economic system and this
now includes banking system liquidity. Thus, the economic
recovery continues to have the potential to be a lengthy one.

Stock Market Update

I am away from my home office and am posting this on a remote
terminal, so I will keep it brief. Since last autumn, I have cautioned
about the stock market potential from several different perspectives.

Basically, I have argued for over a year that the advance from 3/09
represented not only a cyclical bull market, but a potentially powerful
one if anticipated strong earnings could be delivered smoothly. Even
so, by autumn of 2009, I came to regard the trajectory of the upmove
to be too strong. Not reckless, but unsustainable. This caution was
extended when the 2/10 rally broke out to new cyclical highs after
completion of a classical cyclical upleg. It marked the untimely arrival
of the "johnny-come-lateleys".

The recent sharp sell off has gone along way toward eliminating the
overheated trajectory of the market and has ended the rally from the
late arrivals. It has brought the market to a more logical place and
has eliminated the overbought condition. Chart.

Stock Market -- Short Term Technical

For weeks now, schooled technicians have known the market was
overbought. A correction or consolidation was thus widely
anticipated. Well, we have a correction which has quickly wiped
out the short term overbought and brought the market into a
mildly oversold condition with the SP 500 at 1166.

A bit more weakness over the next several days would lend
confirmation to the downtrend in place as the 10 and 25 day m/a's
would both be down and a longer term trendline pegged off the
3/09 and 2/10 lows would likely be broken.

So there is trendline support around 1160 on the SP 500 and there
is obvious support at 1150. A more attractive and deeper oversold
would develop down in the 1125 - 1135 range.

The abatement of selling pressure today lends hope to the idea the
market could stabilize for a spell in the days ahead, but that is a
hope only.

From a trading perspective, I would prefer to see further weakness
down to the 1125 - 1135 range before dropping the shorting
mentality and looking long again.

SP 500 chart.

The Lever On The Way Up Is The Screw On The Way Down

Once leverage or borrowing gets into the game, the borrower needs
to generate the cash flow to service the debt and to generate
sufficient income to manage expenses and have enough left over to
get the return on equity boost leverage can bring. Credits get
shaky as debt service outlays begin to consume large portions of
cash flow. Credit quality erodes even faster when cash flow is
unstable and its visibility is called into question. Tossing about
leverage ratios without regard to how well debt is being serviced
and without a careful analysis of a borrower's income and cash
flows is an idle game.

Which brings us to the European Union where debt ratios are high
and where income / cash flow are now under pressure at the state
level. The economic recovery is but inching forward in the eurozone.
The revenue take of sovereigns is under pressure, and state
spending has been pushed higher to fund recession countermeasures
such as unemployment insurance. The problem is now being
compounded by sharply rising funding costs for Greece, Spain et al
as investors worry about debt service capability in the present
but down the road as well if greater austerity drags incomes further
down as a result of restructuring programs.

Sound thinker Edward Hugh holds forth on the subject for the
EU here.

Stock Mkt Capitalization Preference

The p/e ratio on estimated 2010 eps for the Value Line equal
weighted arithmetic index (1700+ stocks) is now over 20x as it
is for the Russell 2000 smaller cap index. This compares to a
15.1 p/e for the SP 500 on a comparable estimate. The p/e
premium for the mid / small cap indices has been expanding
as this cyclical bull market rolls along. Moreover, the smaller
the cap, the faster has been the acceleration of relative p/e.

My view on this issue is that too many stocks are now trading
at riskier high p/e's and that if you like the smaller caps as I do,
you have to become far more selective going forward. The big
problem with smaller cap, faster growing companies is that folks
rarely are realistic in looking at how quickly and rapidly growth
potential can decay over time. they tend to extrapolate high
growth rates out too far in time to justify the p/e ratio so that
the earn-out period remains competitive with other stocks. Thus,
when the smaller guys go to a premium, it is likely that the
universe of overpriced srocks is expanding. So, you have to
research the potential of smaller cap stocks more carefully now
and not rely on the positive price momentum of the market
to bail you out.

The best method I know to tell when capitalization size preference
may be changing is to look at the relative strength of the mid /
smaller universe compared to the cap weighted SP 500. Have
a look at the Value line Arithmetic ($VLE) compared to the
SP 500 which I link to below. Notice the importance of RSI in
the short run and the power of trend favoring the $VLE since
late 2008. It will take a substantial break of trend to confirm a
change of leadership. Chart.

A Note On Goldman Sachs

I first did business with Goldman in 1974. I had a nifty battle or two
with their research partners over the outlook for the bond market
back in 1982, and was then codified as "acerbic" at their shop. They
have been as arrogant as other Street guys for all those years, but
have also exhibited a certain sanctimony that annoys folks. They
are masters of coating the firm with teflon no matter how nit-picky
an issue might be. And like the Gov. they used to like to ask "How
can we help?"

Our policy as fund managers was never to tell them anything they
could use for a trade or a marketable idea unless you wanted them
to do something that benefited your performance. SOP.

Goldman is not an especially creative firm. Their strengths are early
trend spotting in banking and trading and the willingness to commit
sizable resources to back a product or service on the way up and, to
find ways to exploit same on the way down.

The SEC suit involves allegation of fraud in the marketing of a highly
specialized private placement by Goldman and will be decided on
the cumulative weight of the evidence the SEC presents. If the
SEC makes its case, and this is not the tip of a large iceberg, few
large Goldman clients will depart. After all, there is no shortage of
guys out there who have clipped GS once or twice over the years,
either.

Short Rates, $USD, Fed Policy

My nearly 100 year long T-bill / inflation regression model suggests
the 3 mo. bill should be 2.1% presently. By the end of this year, the
model will likely provide a reading of 3.5%. The Fed is keeping it low
indeed.

Measured yr/yr, inflation has been running over 2% this year. So,
with deposit rates negligible, the US dollar is again losing purchasing
power and savers are taking the hit. You have to go out 5 years on
the Treasury curve to cover the inflation nut currently. With
sovereign risk credit issues in Europe, the trade weighted dollar has
been firming on a modest flight to quality, but the underlying
fundamentals for the $ have turned weak.

The Fed is resolved to maintain its 0.0 - 0.25% policy on the FFR%.
My indicators are now at 50% in favor of a rate hike. As the economic
recovery proceeds and capacity utilization and private short term
credit demand firm up, the case will be much stronger to raise
rates. The US operating rate is now around 73.5%. Normally, the
Fed has waited until that CU% rises above 80% to increase short
rates, although it started raising the short rate in 2004, when the
operating rate hit 77%. Waiting to raise rates until capacity
utilization moves toward 80% is a longstanding Fed practice because
it is at that level when inflation, excluding energy and fuels, begins to
accelerate, and is also when capital spending can begin to outstrip
business sector internal cash flow to put added pressure on credit
demand. So, the Fed figures it still has time before it should push up
rates and is not abandoning a long held practice.

Despite the ZIRP Fed policy, the odds of serious bubbles arising are
low since the broad measures of credit-driven liquidity are barely
growing. Individuals and institutions have been drawing down
money market holdings to fund the capital markets, but that is an
exercise with considerable finitude.

the yield on the 1 yr Treasury has been creeping up, but it might have
to take out .75% to suggest players are sick and tired of the Fed's
ZIRP policy. 1 yr. chart.

Stock Market -- Shorter Term Technical

The rally that started in early Feb. has been shaky for several weeks
as today marked the third break of a short term uptrend line. the
market also was swept below the 10 and 25 day m/a's and has
turned down on MACD and ADX measures.

It was not materially overbought on my short term momentum
measures, but it was on my advance vs. decline measure (6 week
cumulative) reflecting the strong surge in mid and smaller cap.
issues. Likewise, my 6 week selling pressure gauge has been rising
from low levels for a few weeks, indicating the beginnings of some
distribution.

So, we have a heads up on vulnerability, but my indicators do not
offer strong clues on downside. In total, the indicators suggest there
could be unsettled conditions for up to six weeks. If you had to
make a call, the easiest one would be to say the indices would trace
down to Jan. '10 resistance (See chart).

Top calling in this rally has been like watching Wiley E. Coyote
trying to stop the Road Runner. As I have said for a couple of
months, this rally has been way out of place relative to the steep
advance that preceded it, so I am in humble student of the game
mode when it comes to guessing about whether it can be rescued
or whether a more appropriate and several months long period
of weakness / basing lies ahead. In this regard, one of my top
indicators -- a smoothed 40 week price oscillator -- has whipsawed
me for only the second time in 30 years. When a good one goes
kerflooey on you, it makes you think twice.

Stock Market In Longer Term Context

The stock market panic of 2008 brought the market to its lowest
level compared to its very long term price trend since the 1970s -
early 1980s period when accelerating inflation and sharply rising
interest rates viciously suppressed the p/e multiple. Before that
you can go back to the immediate post-WW2 era when investors
feared the economy would re-enter economic depression. Each of
these three intervals presented great long term buying
opportunities. (I'll never forget being at a Bear Stearns luncheon
circa 1980 when a smart young lady opined that folks interested in
the stock market were mildly retarded.)

The post WW2 bull took about 15 yrears to run to the top of the
long term price channel. The bull run from the 1974 low took 22
years to top the long term price channel before it went into full
bubble mode for the first time since 1927. We then had something
of a mini-bubble running from late 2002 into 2008, before the
crystal chandelier fell to the floor.

The cyclical bull move from early 2009 has been so strong off an
historically low level that we are now only about 15% below
regaining that trend channel top (SP 500 at 1425). This is an
expensive market based on latest 12 months earnings. However,
players are looking forward to $80 earning power on the SP 500
by late 2010 and $100 - 105 earning power at the end of 2011.
Given those projections, it is easy to talk about a 1500 level for
the SP 500 at some point in 2011.

Now, earnings are in a rapid recovery uptrend. But what has really
been most surprising has been just how fast confidence has returned
to the capital markets. Just look at the performance of smaller cap
stocks and junk bonds off the 2009 price lows. I know I was
guilty of underestimating just how fast the BIG money would
regain its swagger in the wake of a near death experience in 2008.

So, the market has experienced an amazing lift-off from depressed,
cheap levels to where it is possible that within 12 - 18 months, the
market could already be in a zone where only exceptional economic
performance going forward would warrant longer term players
remaining on board.

Everyone should feel free to debate return potential for stocks over
the next two to three years. Until I see otherwise, I am in the bull
camp despite seeing the market as overbought currently. Yet, I
would insist we have moved from a low risk / high return market
profile to one that involves above normal price risk going forward.
In short, earnings have to continue very good and inflation and
interest rates have to behave well and moderately when cyclical
forces push them higher or else the market will have significant
vulnerability.

Earnings In Longer Term Perspective

Since the end of WW2, cyclical expansions in corporate profits have
averaged 4.2 years. The band around the average is wide and there
have been observable "double dips" in profits even during ongoing
economic expansions and stock bull markets.

If the current cyclical recovery / expansion of profits meets the
average for the postwar years, then profits could well expand into
2013. The stock market tends to make cyclical tops around the time
profits are cresting. Thus, if the current uptrend in profits is an
average one, it would be fair to say that the stock market would also
make a cycle top in early 2013.

If the cyclical rise of profits is decently normal, then SP 500 profits
could peak around $115 - 120 in 2013, and the stock index could
rise another 60+% from current levels.

The object of this post is not to make earnings or stock market
projections, but to get you the reader to maintain an open mind and
to do your homework as an investor. Look, earnings might grow only
through 2011 before cresting, or profits could expand to early 2016.
Neither development would be a "black swan." In a similar vein,
earnings could experience an average expansion but the p/e ratio
could be sharply crimped by accelerating inflation or, we could
see a little bubble up in p/e on development of a goldilocks mentality.

My own view is that the economy has the potential to expand out to
2016, but that the ride will be bumpy as there is likely to be a
cyclical acceleration of inflation and higher interest rates to contend
with.

But, it is important for you to have a reasonable plan and to be set
to change strategy as your risk tolerance allows when events start
to deviate from plan as they often do. (Risk tolerance is an objective
measure, but it is best defined in terms of each investor's particular
circumstances, both financial and emotional.)

For now, with the economy in the early stage of recovery you should
open up your thinking to include the possibility of much higher profits
over the next few years, even if such a thought seems to be almost
impossibly close in time to the economic free-fall of 2008.

Financial System Liquidity

The Fed wound up its quantitative easing program at the end of Q 1
2010, so we are now seeing a leveling off in its balance sheet, as well
as a flattening out of the monetary base and the basic money supply.
Liquidity in the system is being further constrained by the continuing
run-off of financial co. commercial paper and a drawdown of low and
no reserve jumbo deposits.

Some areas of the banking system's loan book are picking up after
months of decline, including consumer loans, credit card balances
and even C&I loans to business. To fund an expansion on the asset
side of the balance sheet, banks are doing more open market
borrowing for now.

In the short run then, the Fed has left target interest rates unchanged
but it may have just started tightening up on the provision of liquid
balances to the system. From a long term perspective, I would much
prefer to see the Fed be moderately more liberal with the provision
of monetary liquidity, but its foot is off the accelerator for now.
Should the Fed continue with the current liquidity tightening regimen,
My stock market support and long term economic growth indicators
will start to lose positive traction as it would suggest the economy
will grow more dependent on private sector credit creation. These
would be normal non-fatal developments as the economy recovers,
but I regard loss of growth momentum of monetary liquidity as
signalling an upturn in fundamental risk.

It is still a little early to proclaim that short term business credit
demand has turned the corner and is headed up, but a turn does
seem to be getting closer. A turn in business loan demand strong
enough to reverse the downtrend of my credit supply / demand
gauge would be another factor in favor of the Fed raising target
short rates.

Profits Indicators

The corporate profits indicators have been on the right side of a
strong "V" pattern for months. Viewed yr/yr, the indicators are
consistent with both sales growth and profit margin expansion.
This all on top of massive cost cutting done in late 2008 and
through 2009. Estimates for earnings are on the rise as normally
happens in the early phase of an economic upswing. The stock
market is discounting a rapid recovery of earnings out about six
months in time. Projections for SP 500 earnings range from $75 -
80 per share for this year and from $90 - 98 for 2011 (The prior
record high was a restated $91.47 for the 12 months ending in
mid-2007).

If you've been reading the blog for a good while, you know I have
long regarded a big bounce in 2010 SP500 net per share to be an
easy mark to hit. The indicators currently suggest a strong run
for profits well into Q 3 '10 and probably the final Q as well. But,
my indicators are mute on 2011. When it comes to next year, we
are looking at assumptions. To hit the high end of the range for
2011 of $98 per, sales are going to need to grow by 7-8%, and this
in turn would involve the return of broader pricing power for
companies. So, we would need to see a normal full second year of
economic recovery, and we would also have to witness the onset of
fiscal stimulus withdrawal and a turn to a more restrictive
monetary policy with both developments having minimal effect. In
short, the analytical work that has brought us this far constitutes
the easy part of the job when it comes to earnings. Looking well
into 2011 is going to be more tricky.

Technical, Sentiment, Psychology Summary

I thought I had it nailed when the SP 500 dropped sharply over
latter Jan. into early Feb. '10. That break came on time and so did
the rally, but the rally, contrary to historical market behavoir,
developed into a much stronger one than expected coming after
a classic three upleg run from the 3/09 low. I figured we would
see a rally of substance after a good several months had transpired.
I made some money in it, but to compound my frustration, we
are now seeing the upmove extend despite the fact that plenty of
capable analysts / traders have known it was overbought for
at least a couple of weeks. Well, I'll stay with my trading discipline,
but this has been a frustrating several weeks.

This morning at 9:33 am on CNBC, floor commentator Bob Pisani
says, "Folks, there's a wall of money coming into the market...That's
what traders are telling me." So we know sentiment is bullish and
is at extreme levels on a couple of measures. And we also know
that the trading/research/strategy side of The Street has its
swagger back, and that there are a raft of money managers on TV
to tell us the market is cheap on 2011 eps estimates. You know,
guys who were hiding under their desks a year ago.

My ex-post reading on psychology is that with the downward break
in the market into early Feb. there had to be a large number of
money managers who saw a chance to jump on board after the
Greek debt crisis subsided and the economic indicators improved.
These were the guys who were low on equities exposure.

So, all told, this cyclical bull went into fast forward mode timewise,
and even if stocks get dumped for a week or two straight ahead
(it's overdue), I plan to hunker down and trend follow for a good
several weeks before I try to be the first kid on the block to make a
fresh call on direction.