Chart of the Week

BOTTOM LINE: The above chart shows the year-over-year change in the Core Consumer Price Index(the red line) for the last 20 years. While current prices are rising, they are well within the 20-year downtrend in their rate of change. The latest CPI report showed core prices rising at a 1.6% annual rate. This is not a rate to be overly concerned about at the present time.

Market Week in Review

S&P 500 1,134.61 -.41% for the week.

U.S. stocks finished mostly lower on the week as investors rotated out of perceived riskier and interest-rate sensitive stocks and into energy and defensive shares. Pharmaceuticals paced gains for the week on this rotation and Johnson and Johnson's strong 1st quarter report. Energy-related stocks continued their outperformance on rising crude oil prices as very strong U.S. and Asian economies spur demand.

Small-caps and technology shares fell on the week as investors fear rising rates will hurt riskier stocks the most. The exceptionally strong retail sales report sparked fears that the Fed is falling behind the curve on inflation, thus sending interest rates higher. This resulted in continued selling in interest-rate sensitive sectors such as homebuilding and financials. Finally, small/mid-cap security-related stocks plummeted as traders began to sober up on the prospects for many of these companies, thus putting an end to the recent mania in these shares.

BOTTOM LINE: Reports from Intel, Nokia and IBM contributed to the weakness in tech stocks. I viewed both the Intel and IBM reports as moderately positive and think both will be higher by the end of the year. Nokia has its own company-specific problems and I would not be a buyer at these levels. Small-caps hit an all-time high two weeks ago. It is not surprising that these stocks are seeing the majority of the profit-taking on interest rate fears. In the short-run, I expect tech to continue to underperform. However, I think this sector will significantly outperform in the second half of the year. Interest-rate sensitive sectors will remain under pressure until the first Fed rate hike. I also expect energy-related stocks to continue to outperform as there is no quick fix for the world's current energy shortage. Finally, I expect pharmaceutical shares will outperform until the first rate hike. However, I then expect political banter to bring these shares back to the low end of their trading ranges.

I was disappointed to see the amount of complacency displayed by investors last week. Notwithstanding steep loses across a broad array of technology stocks, rising energy prices and rising interest rates, the AAII Bullish % rose 8.46% last week and the VIX fell 8.12%. This, along with the short-term sell signals generated by my technical models, leads me to believe that the tech sector has further to go on the downside, while the broad market should remain neutral to slightly lower in the short-run.

Economic Week in Review

ECRI Weekly Leading Index 134.30 -.89%

Advance Retail Sales for March rose 1.8% versus expectations of .7% and a 1.0% rise the prior month. Retail Sales Less Autos for March rose 1.7% versus expectations of .6% and a .6% gain in February. This was the strongest retail performance since just before the stock market bubble burst in March of 2000. "This is a huge number, one of the strongest I've ever seen," said Cary Leahey, a senior economist at Deutsche Bank. Moreover, building material and garden supply stores sold 10.6% more last month, the biggest increase ever recorded. Finally, Wal-Mart, J.C. Penney and Target said that March sales were stronger than expected, as shoppers spent tax refunds and demand for spring clothing surged. Consumer spending, which accounts for 70% of GDP, is now projected to grow 3.7% this year after a 3.1% gain in 2003. "Consumers are spending as if job and income prospects are solid," wrote Deutsche Bank economists LaVorgna and Riccadonna, in a report to clients.

The Consumer Price Index for March rose .5% versus expectations of .3% and a .3% rise the prior month. CPI Ex Food & Energy rose .4% in March versus a .2% forecast and a gain of .2% in February. So far this year, consumer prices are rising at a 5.1% annual rate compared with a 5.4% pace at the same time last year. Increasing demand is helping companies lift prices and giving them more confidence to hire. Finally, San Francisco Fed Bank President Robert Parry told reporters that while the rise in prices wasn't "comforting," the Fed won't become "excessively concerned" until there's a series of similar monthly increases.

The Empire Manufacturing Index rose to 36.05 in April versus expectations of 28.25 and a reading of 25.33 in March. The Empire Manufacturing Hiring Index more than doubled this month to 19.8 from 9.7 in March. The Philadelphia Fed reported a rise to 32.5 in April versus expectations of 26.1 and 24.2 the prior month.

Industrial Production in March fell .2% versus expectations of a .3% rise and up .8% in February. The drop in production at the nation's factories, mines and utilities was the first since May. "It really was held down by utilities, and that is just a weather effect," said Robert Mellman, an economist at JP Morgan. The third-warmest March in 110 years depressed utility production.

The University of Michigan Consumer Confidence Index preliminary April reading fell to 93.2 versus expectations of 97.0 and 95.8 last month. A burst of violence in Iraq, the 9/11 hearings and record-high gas prices contributed to the drop.

The economy is now projected to grow 4.6% this year, the most since 1984, according to the median estimate of 74 economists surveyed by Bloomberg News. One sign companies are having trouble keeping up with demand is that inventories in February were enough to last only 1.33 months, the leanest ever. As well, Treasury Secretary John Snow said strong economic growth is lifting tax revenues and should reduce the Treasury's borrowing needs this year.

BOTTOM LINE: There are several key takeaways for the week. The exceptionally strong retail reports and inventory building leads me to believe that 1st quarter GDP growth will be closer to 6.0% than 5.0%. The current estimate by economists is for 4.8% growth. Improving job prospects, tax refunds, all-time high consumer net worth, the fastest U.S. economic growth in 20 years, relatively low interest rates and a stock market up almost 30% in the last 12 months are all contributing to a significant pick-up in spending by the U.S. consumer. Companies have begun building inventories, but not enough to meet rising demand. Thus, leaving inventories at record lows relative to sales, which bodes well for further inventory building in future months.

While prices of many goods are rising, they are only now back to their 20-year trend and are increasing at a slower rate than at this same time last year. Subdued unit labor costs and a rising U.S. dollar will likely keep inflation in check for the foreseeable future. Without the burst of violence in Iraq and the politically-charged 9/11 hearings, I believe consumer confidence would have risen substantially. The fact that it is now apparent that there was not a "mass up-rising" in Iraq and the end of the 9/11 hearings should lead to a much better consumer confidence report next month. The bears and the mainstream press harped incessantly about the "weakness" of the "jobless" recovery. Now that these arguments appear ridiculous, inflation will be the scare tactic of choice. Deflation was the worry just a few months ago. 70% of inflation comes from unit labor costs which are historically low, only 5% comes from commodity costs. While it is possible that inflation will become a problem within the next 5 years, I don't expect it to rise substantially in the foreseeable future.

Weekly Scoreboard

Indices
S&P 500 1,134.61 -.41%
Dow 10,451.97 +.09%
NASDAQ 1,995.74 -.32%
Russell 2000 583.37 -2.43%
Wilshire 5000 11,078.10 -.79%
Volatility(VIX) 14.94 -8.12%
AAII Bullish % 63.75 +8.46%
US Dollar 89.94 +1.14%
CRB 277.52 -2.31%

Futures Spot Prices
Gold 401.60 -4.52%
Crude Oil 37.74 +1.64%
Natural Gas 5.61 -5.32%
Base Metals 112.93 +1.26%
10-year US Treasury Yield 4.34% +3.58%
Average 30-year Mortgage Rate 5.89% +1.73%

Leading Sectors
Drugs +4.42%
Oil Service +3.86%
Energy +3.15%

Lagging Sectors
Semis -6.18%
Broadband -6.57%
Disk Drives -6.82%

*% Gain or loss for the week

Friday Close

S&P 500 1,134.61 +.51%
NASDAQ 1,995.74 -.32%

Leading Sectors
Gaming +2.49%
Papers +1.92%
I-Banks +1.81%

Lagging Sectors
Semis -1.76%
Broadband -2.50%
Disk Drives -2.88%

Other
Crude Oil 37.74 +.45%
Natural Gas 5.61 -2.16%
Gold 401.60 +.83%
Base Metals 112.93 +1.45%
U.S. Dollar 89.94 -.13%
10-Yr. Long-Bond Yield 4.34% -1.27%
VIX 14.94 -5.08%
Put/Call .77 -8.33%
NYSE Arms 1.44 +51.58%

After-hours Movers
DNA +7.31% after announcing an increase in its authorized shares of common stock from 1.2B to 3B shares and declaring a 2-for-1 stock split.

Recommendations
MOLXA raised to Buy at Citi Smith Barney. Goldman Sachs reiterated Outperform on ROH, DOW, PKG, MCK, CAH and CLS.

After-hours News
U.S. stocks finished mixed as declining rates boosted shares of consumer cyclicals and financials while technology stocks continued their recent underperformance. After the close, Bloomberg reported that Japanese bonds fell for a fifth week, their longest slide in more than two years, on prospects that an export-led economic recovery will be sustained after reports signaled growth will accelerate in the U.S. Ernst & Young will be barred from accepting new public company audit clients for six months because of independence violations, a U.S. SEC judge ruled.

BOTTOM LINE: The Portfolio finished down on the day. I rotated out of some losing tech positions and into a few consumer cyclical and energy-related stocks, leaving the portfolio with market neutral exposure. The technology sector appears to have further downside in the near-term, while many other sectors seem to be stabilizing.

Mid-day Update

S&P 500 1,135.13 +.56%
NASDAQ 2,003.02 +.04%

Leading Sectors
Gaming +1.93%
Restaurants +1.85%
I-Banks +1.85%

Lagging Sectors
Semis -1.46%
Broadband -1.87%
Disk Drives -2.49%

Other
Crude Oil 37.36 -.56%
Natural Gas 5.65 -1.38%
Gold 400.50 +.55%
Base Metals 112.93 +1.45%
U.S. Dollar 89.88 -.21%
10-Yr. Long-Bond Yield 4.36% -.91%
VIX 14.85 -5.72%
Put/Call .78 -7.14%
NYSE Arms 1.59 +67.37%

Market Movers
NOK -8.35% after lowering 2Q estimates and multiple downgrades.
DCLK -25.6% after missing 1Q sales estimates, lowering 2Q forecast and multiple downgrades.
LEXR -30.5% after missing 1Q estimate, lowering 2Q forecast and multiple downgrades.
AVID +10.78% after beating 1Q estimates.
GWW +6.97% after beating 1Q estimates and raising 04 forecast.
TASR +9.4% on further short-squeeze and anticipation of quarterly report next week.
NFLX -16.66% after saying it expects more customers to cancel subscriptions this quarter after raising fees.

Economic Data
Housing Starts for March 2007K vs. 1900K estimate.
Building Permits for March 1946K vs. 1910 estimate.
Industrial Production for March -.2% vs. +.3% estimate.
Capacity Utilization for March 76.5% vs. 76.8% estimate.
U. of Mich. Consumer Confidence preliminary April 93.2 vs. 97.0 estimate.

Recommendations
GTK raised to Buy at Merrill, target $68. CPB rated Sell and Bank of America. MOGN raised to Buy at Bank of America, target $74. Citi Smith Barney recommending Sell Brazilian debt. Citi says MOT will meet or exceed estimates. Citi lowered rating on DCLK to Sell. Citi reiterated Buy on UNH, target $74. Citi reiterated Buy on SEBL, $19 target. Citi reiterated Buy on CCI, target $18. Goldman Sachs reiterating Outperform on JCI, UNH, IBM, TRB and FD. TheStreet.com has a positive column on MRCY.

Mid-day News
U.S. stocks are rising mid-day as commodity and consumer cyclicals rise on a fall in interest rates. Xerox plans to detail in a report "major progress" toward fabricating electronics from low-cost, flexible plastic, the NY Times reported. Shiite cleric al-Sadr said a compromise with the coalition in Iraq "will not work", Agence France-Presse reported. Copper futures in NY had their biggest gain in two months after a government report showed a surge in U.S. housing starts last month, reviving expectations for increased metal demand, Bloomberg reported. The U.S. economy is showing signs of accelerating without significant risks of inflation, as consumer spending strengthens and companies invest in more workers and equipment, said Alfred Broaddus, president of the Federal Reserve Bank of Richmond.

BOTTOM LINE: The Portfolio is down today as one of my longs is falling significantly and shorts are unchanged. I have not traded as of yet, thus the Portfolio is still market neutral. The broad market is looking much better, with the exception of tech. Tech looks like it is heading lower in the short-run, while the rest of the market will likely remain neutral to slightly higher. I will look to add market exposure in gaming and cyclicals on any weakness from tech selling.