Economic Week in Review

ECRI Weekly Leading Index 133.80 +1.67%

The U.S. economic expansion is "solid" and inflation is "well-contained," Federal Reserve Bank of Richmond President J. Alfred Broaddus said. "In general the economy seems clearly to be in a much stronger position than it was a year ago or even at the beginning of the year," Broaddus said. Recent slowing in job growth and business investment are not a major concern, he said.

The ISM Non-Manufacturing Index for June came in at 59.9 versus expectations of 63.0 and a reading of 65.2 in May. "We aren't running as fast as in the previous several months, but those were unusually strong and it's only natural to look for this index to cool somewhat," said Michael Moran, chief economist at Daiwa Securities. The index has been above 50, showing expansion, for 15 straight months and Moran said he considers the report's separate indicators of higher orders and employment to be "encouraging." "This is one of those really odd reports -- the headline was terrible but the details were really good," said Joel Naroff, president of Naroff Economic Advisors.

A higher percentage of U.S. companies said profit margins widened last quarter, making businesses "upbeat" about the rest of the year, according to a survey by the National Association for Business Economics(NABE). 41% said they plan to increase hiring in the next six months, up from 34% in April. 61% expect to boost capital spending during the next year, up from 53% in the previous survey released in April. 37% said profit margins widened in the second quarter, the highest percentage since the fourth quarter of 1987. Finally, confidence among chief executives in the economy held near a 20-year high in the second quarter, with more than 70% of corporate leaders surveyed saying conditions are better than six months ago. "It doesn't look like we're at a point where we have to worry about anything that might derail the economic recovery," said Duncan Meldrum, chief economist of Air Products & Chemicals, and president of the economics group that conducted the survey. NABE's survey results "suggest any apparent weakness in the monthly data for retail sales and jobs is probably temporary," Meldrum said. "The underpinnings to the economy -- productivity growth that doesn't hold back hiring, strong capital spending, and healthy demand -- are still there," he said.

An index of optimism among U.S. manufacturers rose to a record high in the second quarter as more reported an increase in orders, a private industry survey found. Manufacturers Alliance/MAPI said its quarterly index measuring the change of business activity over the next three months rose to 80, the highest since the survey began in 1972. Manufacturing accounts for about a seventh of the U.S. economy, boosting job and income growth. The report "indicates that the expansion of manufacturing activity is real and robust," said Donald Norman, the group's economist and survey coordinator. A slowdown in China's economy and expanded production of key commodities may help contribute to lower inflation, the survey also found.

Initial Jobless Claims for last week fell to 310,000 versus estimates of 341,000 and a downwardly revised 349,000 the prior week. Last week's decline of 39,000 was the best showing since 2001, Bloomberg reported. The government said the total was likely skewed too low because fewer auto factories than it predicted shut to retool. Continuing Claims fell to 2872K versus estimates of 2950K and a downwardly revised 2957K prior. "When the dust settles from auto shutdowns, payrolls will increase at 150,000 to 175,000 a month on average," said Michael Englund, chief economist at Action Economics. The U.S. economy has created 1.3 million jobs so far this year, the biggest 6-month gain since before the stock market bubble burst and the economy began to plunge into recession in 2000, Bloomberg reported.

Consumer Credit for May rose to $8.2B versus estimates of $7.5B and $5.3B in April. U.S. consumer borrowing rose for a sixth straight month in May, as personal incomes increased and shoppers bought new cars at the fastest pace since December. Non-mortgage debt rose at an annual rate of 4.9% during the month the report showed. "The trend in borrowing has remained stronger than expected," said Christopher Low, chief economist at FTN Financial.

Wholesale Inventories for May rose 1.2% versus expectations of .5% and a .2% rise in April. More machinery, electrical equipment and imported cars brought the value of stockpiles to $305.5 billion. Supplies at distribution centers, warehouses and terminals in May were enough to last 1.13 months at the current sales pace after April's all-time low of 1.12 months. The U.S. is experiencing "the best economy we've seen in years," said Jeff Immelt, CEO of General Electric, the word's biggest company. The need to build inventories should boost economic growth for the rest of the year, according to Morgan Stanley economist Richard Berner, Bloomberg reported.

The U.S. economy will expand at least 4.5% by year-end, helped by low tax rates and strengthening global demand, said Thomas Hoenig, president of the Federal Reserve Bank of Kansas City. The forecast suggests inflation "will stay below the 2% level in terms of the core consumer price index," Hoenig said. "We do not want to get ahead of the curve -- don't want to raise rates so quickly that we staunch the recovery -- and yet we don't want to get behind the curve." "Is there a defined path? No there isn't, there can't be," because the Fed must respond to new information, he said. He also said he wasn't discouraged by the June jobs report, which showed 112,000 new payroll employees for the month. "It would be a mistake to allow one month to cause a loss of confidence in this recovery." The outlook for the economy "is very positive," he said.

Bottom Line: The ISM Non-manufacturing reading of 59.9, while below recent all-time high levels, was still very high and the details of the report bode well for the near-term outlook of the service sector. With executive confidence at 20-year highs and profit margins expanding at more companies than in 17 years, it appears that the recent dip in hiring was only temporary. Manufacturing continues to improve at the fastest rate on record. As well, increased production of commodities and slowing U.S./Chinese growth from recent torrid levels, bodes well for declining inflation over the intermediate-term. Companies are beginning to rebuild inventories from record-low levels in a show of confidence in future demand. Multiple Fed members proclaimed that the economy will continue to grow at very healthy levels while inflation will remain in check. Overall, last week's data was very encouraging. I continue to believe that the economy is either pausing before another exceptional burst of growth later in the year or down-shifting to a more sustainable and less inflationary rate of growth. Expanding profit margins, increasing consumer/executive confidence and inventories near record low levels supports my view. Unseasonably wet/cooler weather, all-time high American vacationing and very strong home sales are likely resulting in lower-than-expected retail sales in some select areas. As well, continued overcapacity from the late 90's technology bubble results in earnings shortfalls in some companies with any slight downtick in demand as too many companies are still competing for the same dollars. I continue to expect an increase in technology spending later this quarter.

Weekly Scoreboard*

Indices
S&P 500 1,112.81 -1.43%
Dow 10,213.22 -1.17%
NASDAQ 1946.33 -3.43%
Russell 2000 563.73 -3.21%
S&P Equity Long/Short Index 972.67 -.70%
Put/Call .74 -8.64%
NYSE Arms 1.02 -63.7%
Volatility(VIX) 15.78 +3.82%
AAII % Bulls 55.10 -3.28%
US Dollar 87.42 -1.66%
CRB 272.69 +1.30%

Futures Spot Prices
Gold 407.90 +2.87%
Crude Oil 39.96 +3.39%
Unleaded Gasoline 132.15 +7.97%
Natural Gas 6.14 -1.11%
Base Metals 113.33 +3.08%
10-year US Treasury Yield 4.46% unch.
Average 30-year Mortgage Rate 6.01% -3.22%

Leading Sectors
Commodity +1.56%
Energy +1.18%
Oil Service +.83%

Lagging Sectors
Computer Boxmakers -7.11%
Software -7.60%
Airlines -8.36%

*% Gain or loss for the week

Mid-day Update

S&P 500 1,111.24 +.19%
NASDAQ 1,941.47 +.32%

Leading Sectors
Disk Drives +2.20%
Software +1.62%
Semis +1.38%

Lagging Sectors
Computer Boxmakers -.41%
Utilities -.53%
Airlines -.76%

Other
Crude Oil 40.00 -.82%
Natural Gas 6.11 -1.13%
Gold 408.00 -.07%
Base Metals 113.17 +.73%
U.S. Dollar 87.51 -.03%
10-Yr. T-note Yield 4.46% -.18%
VIX 15.97 -1.42%
Put/Call .62 -30.34%
NYSE Arms .87 -56.06%

Market Movers
JBHT -8.4% after announcing that it had received from Burlington Northern and Santa Fe a notice of arbitration.
STK +10.3% after lowering 2Q estimates and increasing share buyback.
LI +12.7% after exceeding 3Q estimates.
FWHT +7.5% after announcing it would be added to S&P small-cap 600.
SAP +4.7% after raising 2Q guidance.
UIS -14.7% after cutting 2Q forecast.
CTMI -11.52% after cutting 3Q/4Q forecasts.
ACI -5.7% after cutting 2Q forecast.

Economic Data
Wholesale Inventories for May rose 1.2% versus estimates of a .5% rise and a .2% rise in April.

Recommendations
HOTT, ROST cut to Underweight at JP Morgan. MAXY raised to Overweight at JP Morgan. DRI raised to Buy at UBS. WFMI cut to Reduce at UBS, target $82. STZ raised to Buy at UBS, target $45. VRSN rated Buy at Deutsche Bank, target $24. WBSN rated Buy at Deutsche Bank, target $42. ISSX rated Buy at Deutsche Bank, target $19. SNDK rated Outperform at CSFB, target $35. LEXR rated Outperform at CSFB target $10. XXIA raised to Outperform at Thomas Weisel, target $12. IT rated Outperform at CSFB, target $18. CMC rated Overweight at JP Morgan. Goldman Sachs said Non-life Insurance stocks will surprise on the upside. Goldman reiterated Outperform on VZ, AIG, RE, FD, GE, SII and AGN. Citi SmithBarney reiterated Buy on BCII, target $30. Citi reiterated Buy on CEY, target $44. Citi reiterated Buy on AMGN, target $90.

Mid-day News
U.S. stocks are modestly higher mid-day on better-than-expected earnings reports from General Eelectric and SAP. Rail lines in Boston and New York, the sites of national political conventions, are vulnerable and easily accessible to terrorists for a possible attack, the Washington Times reported. FedEx plans to build a 218,000 square-foot distribution center in Carson, California, the LA Times said. Bear Stearns was removed as a co-manager of Chicago's $500 million bond sale because of the company's links to a state regulatory panel being investigated for steering work to associates, the Bond Buyer newspaper said. Amgen could lose sales of its best-selling Epogen drug if a new Medicare policy that calls for stricter review of reimbursement claims for the drug is adopted, the LA Times reported. Vail Resorts has hired an investment bank to help sell its assets, the Denver Post reported. Jeff Immelt, CEO of General Electric said, "This is the best economy we've seen in years," Bloomberg reported. New outbreaks of bird flu in China, Thailand and Vietnam show that the virus, which can spread to humans, is "still endemic" to the region, the United Nations' Food and Agriculture Organization said. Gilead Sciences said it will reduce the price of its HIV treatment Viread, the company's biggest drug, by 37% in Africa and 15 countries elsewhere that the United Nations classifies as "least developed," Bloomberg reported. Copper futures in New York rose to a one-month high and are headed for their biggest weekly gain since December on signs of improved demand in China, the world's biggest buyer, Bloomberg said.

BOTTOM LINE: The Portfolio is slightly lower today on weakness in my base metal longs and strength in my software and internet shorts. I have not traded today and the Portfolio is still 25% net short. Investor complacency is still too high as evidenced by the plunging Put/Call and Arms readings. The AAII % Bulls is still relatively high and the VIX is relatively low, as well. I expect U.S. stocks to fall modestly into the close on high oil energy prices, terrorism worries and earnings concerns.

Friday Watch

Earnings of Note
Company/Estimate
ABT/.54
DLP/.86
FAST/.41
GE/.37
GNW/.51
PWAV/-.02

Splits
BPOP 2-for-1

Economic Data
Wholesale Inventories for May estimated +.5% versus -.1% in April.

Recommendations
Goldman reiterated Outperform on FS, HOT, AMGN, GILD and TRMS. Goldman reiterated Underperform on PSS and VRTX. CNX may rise to $80 a share as the company would profit from rising coal prices sparked by a shortage in supply, Business Week reported. PIR is now cheap enough to draw investors, Business Week said. Shares of ERJ are worth at least $36, Business Week reported.

Late-Night News
Asian indices are mostly higher on rebounding financial shares. The SEC plans to sue more individuals at Invesco Funds Group, the Wall Street Journal reported. China is prepared to use foreign reserves to buy $256 million of Hong Kong government bonds to show its support for the city's government, the Hong Kong Economic Times reported. U.S. natural gas prices may rise to a record unless measures are introduced quickly to boost supply or slow demand, the Financial Times said. China's banks are the most at risk to a financial crisis and a bailout of the industry would cost about $650 billion, Standard & Poor's said. Afghan women are being targeted in attacks blamed on Taliban fighters trying to disrupt elections planned for September, the UN said. New York crude-oil futures may fall next week as rising output by OPEC boosts inventories in consuming countries, according to a Bloomberg survey of traders and analysts. Corporate insider stock purchases are up 11% year-over-year and up 75% from the first quarter, Bloomberg reported.

Late-Night Trading
Asian Indices are unch. to +1.0% on average.
S&P 500 indicated +.18%.
NASDAQ 100 indicated +.28%.

BOTTOM LINE: I expect U.S. stocks to open modestly higher in the morning on strength in Asia, stronger U.S. earnings reports and a bounce from today's sell-off. However, rising energy prices, elevated investor complacency and worries over terrorism will likely hold any rally in check. It is good to see insider buying accelerating. My short-term trading indicators are giving sell signals and the Portfolio is 25% net short.

Thursday Close

S&P 500 1,109.11 -.82%
NASDAQ 1,935.32 -1.56%

Leading Sectors
Drugs +.24%
Fashion +.21%
Defense +03%

Lagging Sectors
Software -3.13%
Airlines -3.95%
Homebuilders -4.89%

Other
Crude Oil 40.18 +2.81%
Natural Gas 6.17 -3.14%
Gold 407.50 -.17%
Base Metals 112.35 -.35%
U.S. Dollar 87.60 -.05%
10-Yr. T-note Yield 4.47% -.09%
VIX 16.20 +2.47%
Put/Call .89 -9.18%
NYSE Arms 1.98 +76.79%

After-hours Movers
None of note.

Recommendations
Goldman Sachs reiterated Underperform on PBG.

After-hours News
U.S. stocks finished lower today on rising oil prices, terrorism worries and earnings concerns. After the close, DaimlerChrysler said its commercial vehicles unit may use its China truck-making joint-venture as a base to export to India, Russia and South Korea, the Financial Times reported. Cases of syphilis increased so much among homosexual men in San Francisco and Los Angeles that U.S. government scientists are warning about the risk of a wider spread in the virus that causes AIDS, Bloomberg reported. Adelphia Communications founder John Rigas and his son Timothy were convicted of conspiring to loot the company to fund lavish lifestyles and lie about finances before its bankruptcy, Bloomberg reported. Philip Morris agreed to pay about $1 billion over 12 years to settle European Union charges that the company aids cigarette smuggling, a person familiar with the situation said.

BOTTOM LINE: The Portfolio finished unchanged today. I added a few new shorts in the afternoon, leaving the Portfolio with 25% net short market exposure. One of my new shorts is ERTS and I am keeping a $53.50 stop-loss on this position. Another bad day for the bulls and it appears as though there is still too much investor complacency for a short-term bottom. As well, the recent spike-up in oil will continue to pressure stocks until investors begin to anticipate a reversal.

Mid-day Update

S&P 500 1,111.17 -.64%
NASDAQ 1,942.11 -1.22%

Leading Sectors
Drugs +.69%
Semis +.41%
Fashion +.21%

Lagging Sectors
Software -3.02%
Airlines -3.09%
Homebuilders -4.66%

Other
Crude Oil 40.0 +2.33%
Natural Gas 6.19 -2.75%
Gold 408.40 +.05%
Base Metals 112.35 -.35%
U.S. Dollar 87.51 -.15%
10-Yr. T-note Yield 4.47% -.09%
VIX 15.75 -.38%
Put/Call .90 -8.16%
NYSE Arms 1.62 +44.64%

Market Movers
YHOO -5.5% after meeting 2Q estimates and guiding lower for 3Q.
SEBL -12.1% after cutting 2Q forecast and multiple downgrades.
TUES +14.4% after raising 2Q forecast and Friedman Billings upgrade to Outperform.
CKFR +9.8% after announcing it signed a five-year contract extension with Wachovia to provide fully outsourced electronic billing and payment services to its customers.
JCP +4.3% after raising 2Q forecast.
PLCE -16.1% after lowering 2Q guidance.
BWS -16.2% after cutting 2Q forecast.
BMC -12.5% after cutting 1Q estimates.
TLB -11.5% after lowering 2Q forecast and Prudential downgrade to Neutral.
CAO -16.6% after lowering 2Q forecast and Raymond James downgrade to Market Perform.
STGS -7.8% after lowering 2Q guidance.
SCHN -9.66% after beating 3Q estimates and giving weaker 4Q forecast.

Economic Data
Initial Jobless Claims for last week were 310K versus estimates of 341K and a downwardly revised 349K prior week.
Continuing Claims came in at 2872K versus estimates of 2950K and a downwardly revised 2957K prior.

Recommendations
MRO raised to Overweight at JP Morgan. BAC rated Overweight at JP Morgan. ARDI cut to Reduce at UBS, target $6. BRKS rated Buy at Deutsche Bank, target $22. MOT raised to Outperform at Thomas Weisel. PIR raised to Strong Buy at Raymond James, target $28. DISH rated Sector Underperform at CIBC. BK rated Buy at Bank of America, target $37. MEL rated Buy at Bank of America, target $36. R rated Outperform at CSFB, target $45. QLTY rated Outperform at CSFB, target $13. FWRD rated Outperform at CSFB, target $50. STT rated Buy at Bank of America, target $58. NTRS rated Buy at Bank of America, target $52. CHRW rated Outperform at CSFB, target $52. CNF rated Underperform at CSFB, target $35. WERN rated Outperform at CSFB, target $23. SWFT rated Outperform at CSFB, target $21. JBHT rated Outperform at CSFB, target $45. Goldman Sachs reiterated Outperform on YHOO, IGT, AA, HOT, FS, ABK, CFC, AXP, DNA, MDT, AET, TYC, FDC, JNPR and AIG. PGN cut to Sell at Citi SmithBarney, target $38.50. Citi reiterated Buy on CKFR, target $39. Citi reiterated Buy on MOT, target $25. Citi reiterated Buy on SEBL, target $11.

Mid-day News
U.S. stocks are lower mid-day on weakness in software, homebuilding and airline shares. The U.S. Defense Department is beginning long-range planning on how to cut the number of U.S. soldiers in Iraq now that an interim government is established, the NY Times said. Israeli Prime Minister Sharon is ready to discuss making the Middle East a nuclear-free zone as part of future peace talks in the region, the AP reported. The Pentagon's top official for personnel and readiness told Congress that the military has no plans to reinstate a draft to support operations in Iraq and Afghanistan, the Washington Post reported. Two EBay customers have filed suit against the world's largest Internet auction company, questioning the company's billing practices, the San Francisco Chronicle reported. About 200 pounds of explosives and bomb-making equipment, stolen last weekend in California from a storage locker used by two public safety agencies, were found in a stolen van yesterday, the AP reported. Former Enron Chairman Ken Lay, charged yesterday in a sealed indictment in connection with the collapse of the former energy giant in 2001, surrendered to federal authorities in Houston this morning, Bloomberg reported. The ruble fell the most against the dollar in a month after Moody's Investors Service said it may reduce the credit ratings of 18 Russian lenders, adding to concern about the stability of the country's banks, Bloomberg said. The number of U.S. workers filing new claims for jobless benefits plunged by 39,000 last week to 310, 000, the lowest since October 2000, Bloomberg reported. DaimlerChrysler and Ford agreed to invest another $100 million in Ballard Power Systems, giving the money-losing maker of automotive fuel cells cash as the U.S. steps up programs to develop cars run by fuel cells, Bloomberg said. China bowed to pressure from Bush administration trade officials and agreed to drop a tax break that U.S. semiconductor makers said put them at a disadvantage, Bloomberg reported. Nextel will be required to pay about $3.2 billion to exchange some airwaves, $1 billion more than it had offered, Bloomberg said.

BOTTOM LINE: The Portfolio is slightly lower today as weakness in my internet, homebuilding and Chinese ADR longs is offsetting declines in my internet and retail shorts. I added a few new shorts this morning, thus bringing the Portfolio to market neutral(shorts-longs=0). One of my new shorts is ANF and I am using a stop-loss of $37.25 on this position. I expect stocks to remain weaker to neutral into the close on terrorism concerns, weakening technology shares and rising oil prices.