Sunday, June 03, 2007

Growth, yet lower inflation: there you go again.<

- Economic data, new money help close out a solid week.
- Growth, yet lower inflation: there you go again.
- After a strong surge off near support the indices could use another rest.

A week that once more turned selling to its advantage.

Two Thursdays back the major indices sold off on strong volume with NASDAQ and SP600 threatening to break their uptrends. A week later and NASDAQ surged on volume that equaled the selling volume. Friday it broke to a new post-2002 high and it topped its uptrend channel. SP600 and its sister SP400 exploded to new all-time highs.

The economy and the market are undergoing something quite special. Friday it was more of the same that has helped propel the indices higher and higher: improving economic data in the US and a lot of money in the world from strong world economies. That money is being put to use for all manner of purposes, such as buying back stock, buying US goods (our exports continue to surge), buying companies, and of course, buying US financial instruments. All the past week there were more stock buybacks, more company buyouts, and more money flowing into US stocks.

Friday it was the economic data that capped a week brimming with economic news. Things started dicey with the ECB (UK central bank) huffing and puffing about rate hikes to stave off inflation, but that inanity was overrun by the US economic news. Jobs rose 157K, better than expected and a solid showing, though not really reflecting the strong dip in jobless claims the past few months. That received all of the headlines at first, but as we surmised, it was the annualized core PCE data that was the real story. After a 2.1% showing for Q1 and for March, it fell to 2.0%, the top of the Fed's 'comfort' zone. Growth and lower inflation. Nirvana. What about the weak GDP? Old news; the last vestige of the mid-cycle slowdown. As we have written about for a couple of months, the mid-cycle slowdown is turning back to growth.

The futures were higher on the news and the market was up solidly out of the gates, but as is often the case, however, the market sniffed out this result ahead of time and was up nicely for the week ahead of the number. Friday stocks rose again, but after the initial surge they faded. It was not a reversal, not by any means. The indices held onto some of their gains but they were going through the motions after the strong Thursday. Basically a perfunctory bow to the anticipated solid economic data.

The large cap indices all closed with the same gains, roughly 0.3% though it is notable that NASDAQ 100 was flat on the session. After a solid move higher they struggled near their upper channel lines, moving marginally higher but again, no real power on the session. At the same time the small and mid-cap indices had no such issues. They surged to new all time highs, closing near their session highs. As noted Thursday, that only means good things for the economy as these indices are dependent upon economic growth for their earnings expansion, and they are pricing in a solid return for the economy.

Technically the action for the week was solid with the strong Thursday trade accompanying the push to new highs. Friday was not as strong overall though it did cap a week of gains with more upside. The start was strong but then the large caps muddled to the close. Volume was lower after the Thursday surge. As noted, the small and mid-caps surged to more new highs as the large caps struggled some, but all are a bit extended once more after this move with NASDAQ and SP500 trading just over the top of their channels. Steady action indeed as they continue to bounce in their uptrends. We wanted to see SP500 breakout of its channel; it started to do that, NASDAQ as well. If the new money continues to move in they can continue higher, but given the run to get to this point there is likely a test back and a higher low to get a running start at the move to join DJ30 in setting up new, higher channels.

Of course there is always the prospect of a more serious pullback given the run; that has been the case for months. Thus far, however, money continues to seize each downturn to push back in. That cannot continue uninterrupted; there are always sharp downturns in even the strongest uptrends. Right now strong leadership continues pushing to the fore in waves, and that is propelling the market higher. We have lamented NASDAQ's inability to take and hold leadership, only rising to the occasion when SP500 and DJ30 stall. It is playing a stopgap role, however, with money moving to it when the large cap NYSE indices need a breather. It is hard to complain too much, particularly given this is typically the start of a weaker period for technology.

Thus we have to remain on guard if stocks start to break down. Indeed we used Friday's upside surge that capped the week as an opportunity to take some gain off the table on strong movers and on some plays that were not providing as great a move as we wanted. It is never a bad idea to bank some gain after a good surge. At the same time we are letting many positions continue higher, and they are posting very impressive runs, racking up the gains. With the rally continuing and with stocks stepping up in rotation, we are continuing to look for new positions and moving in when they show us the moves we want to see. There will likely be a pullback after this week of moves given NASDAQ and SP500 are bumping their channels. That, however, is the same action the market has shown all the way higher.


Regan/Clinton era low inflation and prosperity breaking out all over.

There they go again. There is so much erroneous talk going around about economic strength and inflation. On the financial stations you hear predictions of recession or a 'growth' recession prompted by the housing market, consumer debt, the trade deficit, oil, etc. Take your pick. You also hear central banks talking of inflation caused by too much economic strength and thus the need for rate hikes and tighter money. Case in point was the ECB on Friday talking tough about inflation and the need to stand tough and hike rates if need be. Recession or prosperity with inflation. Tough choices.

Time for a reality check. All of this misinformation clouds the truth that history shows: economic growth unfettered by overregulation alleviates inflation pressures versus fanning them. Why? Money wants to make more money. Thus if the producers and manufacturers see there is an unmet need or envision a new technology they can utilize, money moves to fill the need or make use of the technology. In other words, supply meets demand or in times of innovation, supply creates demand. Remember when the PC first came out? I still remember reading the articles questioning who would ever need one. Now you cannot live without one. Supply created demand. Innovation creates its own demand. Former Dallas Federal Reserve president McTeer advocated this position and of course that is why Dallas was typically the lone dissenter during the Greenspan years. If there were more who thought his way the crash of 2000 and 2001 would not have been so ugly. It could not have been avoided; Greenspan artificially hiked the markets beyond reason with his freewheeling easy money policies and then jerked it all away in one motion. The markets have a hard time reconciling that kind of micromanaged overregulation. But in my anger toward Greenspan (not bitterness, just anger), I digress.

Right now we have a marvelous confluence of events. While many bemoaned the recent economic downturn as the start of a new recession, we were talking of a mid-cycle slowdown similar to 1994 when the Fed hiked, the economy and market went flat, the Fed stopped, the market took off and the economy followed it. That is precisely what is happening now. The Fed stopped hiking in July and the market took off in August, hardly looking back. That move was in anticipation of the second half 2006 slowdown turning again into expansion, and that is exactly what it is doing. The jobless claims show that the jobs market is strong, the manufacturing indices have jumped back into the game, and business investment is now back in the black after a 3 quarter hiatus. All of this happening while . . . inflation falls. Improving economic conditions and falling inflation. Who would have thought? Anyone who looks at economic history.

That is a dynamic set of events that set the spark to the market. It is building in gains ahead of the re-expansion even as earnings growth was flagging along with the expansion. Again, the market builds in the future before it happens and when the Fed paused before it put the Vulcan death grip on the economy, the market started higher with conviction. (And for those 'Star Trek' aficionados, yes we know the Vulcan death grip was a hoax)

As dynamic as these are many still make argument with the housing decline, high gasoline prices, the disparity in income growth - - there are many potential negatives and you can bet they are dissected every day on the financial stations. The problem is, these have not slowed the market or the economic recovery. There is more to the economy than housing. As we wrote last week, housing is typically an early cycle sector and it is supposed to drop off as the economy improves. It was up an atypically long period due to 9-11 and Greenspan holding rates too low too long. Consumers took advantage of it and that along with baby boomers buying second homes kept it alive past its usual term. That leads to a harder crash, or so it seems; activity was very high so the fall seems extreme (the higher they climb the farther they fall). Nonetheless, it has not derailed the climb. Thus far neither have soaring gasoline prices. The forces at work in the rest of the economy are stronger as evident by the climb in the market and the turn back up in the economy. While we say 'there you go again' to those badmouthing prosperity, we can also say that phrase as well with respect to the economy's ability to grow and work off that inflation that the poorly reasoned initial demand-side tax cuts fomented back in 2001 and 2002.

By: Jon Johnson, Editor

Jon Johnson is the Editor of The Daily at

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