Market Week in Review

S&P 500 1,505.62 +.77%

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BOTTOM LINE: Overall, last week's market performance was bullish as the DJIA hit another all-time high and the S&P 500 is off to its best start to a second quarter since 2004. The NYSE cumulative advance/decline line rose to an all-time high, most sectors gained and volume was above average on the week. Measures of investor anxiety finished the week modestly above average levels. However, the AAII percentage of bulls fell to 28.57% this week from 39.24% the prior week. This reading is now at depressed levels. The AAII percentage of bears soared to 54.29% this week from 37.97% the prior week. This reading is now at elevated levels. These pessimistic readings come as the DJIA is in the middle of its most prolific winning streak since 1955. The 10-week moving average of the percentage of bears is currently 38.82%, an above-average level. The 10-week moving average of the percentage of bears peaked at 43.0% at the major bear-market low during 2002. Moreover, the 50-week moving average of the percentage of bears is currently 37.9%, a very high level seen during only two other periods since tracking began in the 1980s. Those periods were October 1990-July 1991 and March-May 2003, both being near major market bottoms.

The extreme readings in the 50-week moving average of the percentage of bears, during those periods, peaked at 41.6% on January 31, 1991 and 38.1% on April 10, 2003. We are very close to eclipsing the peak in bearish sentiment during the 2000-2003 market meltdown, which is astonishing considering the macro backdrop now and then.

I continue to find that steadfastly high bearish sentiment in many quarters is mind-boggling, considering the 25.1% rise in the S&P 500 in just over ten months, the 104.3% gain for the S&P 500 since the 2002 major bear market lows, the NYSE cumulative advance/decline line hit a new record high last Wednesday, all market-caps and styles are participating, the market had one of the best August/September/October runs in U.S. history, the fact that the Dow made another all-time high Friday and that we are in the early stages of what is historically a very strong period for U.S. equities after a midterm election.

As well, despite recent gains, the forward P/E on the S&P 500 is a very reasonable 16.1, down from 16.2 at the beginning of the year, due to the historic run of double-digit profit growth increases and better-than-expected earnings and guidance this quarter. The S&P P/E multiple has contracted for three consecutive years. It has only contracted four consecutive years two times since 1905. Each point of multiple expansion is equivalent to a 6.6% gain in the S&P 500. I strongly believe we will finally see expansion this year. The many bears still remain stunningly complacent, in my opinion.

As I have said many times over the last few months, it seems every pullback is seen as a major top, and every move higher is just another shorting/selling opportunity. I see few signs of capitulation by the bears and their ranks remain historically crowded given recent gains. Even most bulls seem to want the market to decline to redeploy cash they raised in anticipation of a meaningful correction. I still sense very few investors believe the market has meaningful upside from current levels and are positioned accordingly.

As well, there are many other indicators registering high levels of investor anxiety. The ISE Sentiment Index hit a depressed 94.0 on Tuesday. Moreover, the 10-week moving average of the ISE Sentiment Index is hovering just off a record low at 111.2. The CBOE total put/call ratio 10-week moving average is currently 1.0. It has been higher during only two other periods in the last 12 years. Moreover, NYSE short interest has soared 14.6% the last two months, the largest two-month jump on record, to a new all-time high. Nasdaq short interest has surged 13.8% over the last two months, also the largest two-month jump on record, and also to a new record high. Furthermore, public short interest continues to soar to record levels, and U.S. stock mutual funds have seen outflows for most of the last year, according to AMG Data Services. The percentage of U.S. mutual fund assets in domestic stocks is still the lowest since at least 1984, when record-keeping began.

There has been an historic explosion of hedge funds created with absolute return, low correlation or negative correlation U.S. stock strategies that directly benefit from the perception of a stagnant or declining U.S. stock market. Commodity funds, which typically have a low or negative correlation with stocks, have been created in record numbers. The managers of these funds are all over major media outlets helping to pump air into the current U.S. “negativity bubble.” A short-sighted day-trading pessimistic mentality has thoroughly permeated the investment landscape. Research boutiques with a negative bias have sprung up to cater to these many new funds. "Permabears" are more widely followed than ever, despite the market's triple-digit percentage gain from the major bear market lows during 2002-03. At this major market bottom, "permabulls" had been shunned and chastised for a couple of years. Wall Street analysts have made the fewest "buy" calls on stocks this year since Bloomberg began tracking in 1997. "Buy" calls have been trending lower for 10 months, despite the huge rally in stocks.

According to Ticker Sense, investment blogger sentiment remains subdued at 33.3% bears, 33.3% bulls. The UltraShort QQQQ ProShares (QID) continue to see soaring volume. There is still a very high wall of worry for stocks to climb substantially from current levels as the public and many professionals remain very skeptical of this strong bull market and continue to trade with "one foot out the door."

I continue to believe this is a direct result of the strong belief by the herd that the U.S. is in a long-term trading range or secular bear environment. There is still overwhelming evidence that overall investment sentiment regarding U.S. stocks has never been this poor in history, with the Dow at an all-time high. I still expect the herd to finally embrace the current bull market this year, which should result in another substantial move higher in the major averages as the S&P 500 breaks out to an all-time high to join the Dow and Russell 2000.

It's hard to believe after the bombardment of pessimism, depression comparisons and "crash" calls over the last two months that the average U.S. stock is still doing very well this year. The Value Line Geometric Index (VGY), the best gauge of the broad market, is 7.8% higher this year. Moreover, mid-caps stocks are sporting 10% gains already this year. Based on the action over the last two months, even more cash has piled up on the sidelines as money market funds recently hit record levels.

I continue to believe that a significant portion of this cash will be deployed into true "growth" companies as their outperformance vs. "value" stocks gains steam throughout the year. There is massive bull firepower on the sidelines at a time when the supply of stock is still shrinking. I still believe the coming bullish shift in long-term sentiment with respect to U.S. stocks will result in the "mother of all short-covering rallies."

The average 30-year mortgage rate was unchanged this week at 6.16%, which is 64 basis points below July 2006 highs. There is still mounting evidence that the worst of the housing downturn is over, despite recent worries over sub-prime lending, and that sales activity is stabilizing at relatively high levels. Even after the recent slide, existing home sales are still 4.5% above the peak during the late-90s stock market bubble. About 14% of total mortgage loans are sub-prime. Of those 14%, another 13.3% are delinquent. Thus, only about 2% of total mortgage loans outstanding are currently problematic. I do not believe sub-prime woes are nearly large enough or will become large enough to meaningfully impact the prime market and bring down the U.S. economy. The Fed’s Bernanke said recently that the prime market is still strong and that he sees no spillover from the sub-prime problems. As well, the Fed’s Poole said recently that, “there is no danger to the economy from sub-prime loan defaults.” There are just too many other positives that outweigh this negative. Treasury Secretary Paulson also said recently that all the signs he looks at lead him to conclude housing is near or at the bottom. Moreover, the Fed’s Hoenig, Lacker, Plosser, Fisher and Bies all made positive comments recently regarding the prospects for the US housing market. Finally, the ABX-HE-BBB-07-1 sub-prime Index, the source of much concern, has risen 9.3% from its March lows.

Mortgage applications rose .6% this week and continue to trend higher with the decline in mortgage rates and healthy job market. Moreover, purchase applications jumped 4% and are at the highest level since January. The NAHB Housing Market Index came in at 33 in March, up from 30 in September of last year. Within the NAHB Housing Index for March, the future sales component came in at 44, up from 37 in September. The Mortgage Bankers Association said recently that the US housing market will “fully regain its footing” by year-end. Moreover, the California Building Industry Association recently gave an upbeat forecast for housing, saying production would be near last year’s brisk levels. Finally, the House Price Index rose 1.1% in the fourth quarter of last year versus a 1.0% gain in the third quarter.

The Housing Sector Index(HGX) has risen 23.5% from July 2006 lows. The Case-Shiller housing futures have improved and are now projecting only a 2.1% decline in the average home price through August, up from projections of a 5.0% decline 9 months ago. Considering the median house has appreciated over 50% during the last few years with record high US home ownership, this would be considered a “soft landing.” I continue to believe the many U.S. stock market bears are exaggerating, in every media outlet possible, the overall impact of housing on the economy in hopes of scaring investors, consumers and the government into a panicked state, thus making the problems worse than would otherwise be the case. Housing activity and home equity extractions had been slowing substantially for 2 years and the negative effects were mostly offset by many other very positive aspects of the US economy.

Home values are more important than stock prices to the average American, but the median home has barely declined in value after a historic run-up, while the S&P 500 has risen 25.1% in just over ten months and 104.3% since the Oct. 4, 2002 major bear market low. Americans’ median net worth is still at record high levels as a result, a fact that is generally unrecognized or minimized by the record number of stock market participants that feel it is in their financial and/or political interests to paint a bleak picture of America.

Moreover, energy prices are down significantly, overall consumer spending remains healthy, unemployment is low by historic standards, interest rates are low, inflation is below average rates and wages are rising at above-average rates. The economy has created 2 million jobs in just the last year. As well, the Monster Employment Index hit another record high in April. The 50-week moving average of initial jobless claims has been lower during only two other periods since the 70s. Finally, the unemployment rate is a historically low 4.5%, down from 5.1% in September 2005, notwithstanding fewer real estate-related jobs and significant auto production cutbacks. The unemployment rate’s current 12-month average is 4.6%. It has only been lower during two other periods since the mid-50s.

The Consumer Price Index for March rose 2.8% year-over-year, down from a 4.7% increase in September of 2005. This is below the 20-year average of 3.1%. Moreover, the CPI has only been lower during four other periods since the mid-1960s. Several other measures of inflation are still below long-term average rates. The Fed’s preferred inflation gauge, the PCE Core, rose 2.1% year-over-year in March versus the 20-year average of 2.5%. Furthermore, most measures of Americans’ income growth are now almost twice the rate of inflation. Americans’ Average Hourly Earnings rose 3.7% year-over-year in April, substantially above the 3.2% 20-year average. The 10-month moving-average of Americans’ Average Hourly Earnings is currently 4.04%. 1998 was the only year during the 90s expansion that it exceeded current levels.

The benchmark 10-year T-note yield fell 5 basis points for the week on diminishing inflation worries. According to Intrade.com, the chances of a US recession beginning this year have fallen to 13.5% from 35% in January. In my opinion, many investors’ lingering fears over an economic “hard landing” still seem misplaced. The housing slowdown and auto-production cutbacks impacted manufacturing greatly over the last nine months, but those drags on growth are starting to subside. Many gauges of manufacturing activity have improved meaningfully over the last month. Factory Orders have jumped over the last two months by the largest amount since the 70s. Moreover, for all of 2006, US GDP growth was an above-average 3.2%, notwithstanding the housing and manufacturing headwinds.

While the drag from housing is subsiding, housing activity will not add to economic growth in any meaningful way this year as homebuilders continue to reduce inventories and sales stabilize at lower, but still relatively high by historic standards, levels. As well, recent substantial manufacturing inventory de-stocking helped produce below-average growth in 1Q. I still expect a smaller GDP deflator, inventory rebuilding, rising auto production, increased business spending and a still healthy service sector to boost US economic growth back to around 3% before year-end.

Manufacturing accounts for roughly 12% of US economic growth, while consumer spending accounts for about 70% of growth. U.S. GDP growth came in at a sluggish 1.1% and 0.7% during the first two quarters of 1995. During May 1995, the ISM Manufacturing Index fell below 50, which signals a contraction in activity. It stayed below 50, reaching a low of 45.5, until August 1996. During that period, the S&P 500 soared 31% as its P/E multiple expanded from 16.0 to 17.2. This was well before the stock market bubble began to inflate. As well, manufacturing was more important to overall US economic growth at that time. Stocks can and will rise as P/E multiples expand, even with more average economic and earnings growth.

Weekly retail sales rose .1% last week vs. unchanged the prior week. These slight gains are still mainly the result of the timing of the recent Easter holiday. The job market remains healthy, housing has improved modestly, wage growth has accelerated, stocks are substantially higher and inflation has decelerated to below average rates. Finally, I expect consumer confidence to make new cycle highs later this year as gas prices fall, the job market remains healthy, stocks rise further, home sales stabilize at relatively high levels, inflation decelerates more and interest rates remain low. This should help sustain healthy consumer spending over the intermediate-term.

Just take a look at commodity charts, gauges of commodity sentiment and inflows into commodity-related funds over the last couple of years. Net assets invested in the Goldman Sachs Commodity Index rose to almost $70 billion in 2006 from $15 billion in 2003. There has been a historic mania for commodities by investment funds that has pushed prices significantly higher than where the fundamentals dictate. That mania is now in the stages of unwinding. The CRB Commodities Index, the main source of inflation fears has declined -11.0% over the last 12 months and -14.8% from May 2006 highs despite a historic flood of capital into commodity-related funds and numerous potential upside catalysts. Oil has declined $17/bbl from July highs. As well, this year oil plunged $12/bbl. over the first 18 days of trading at the beginning of the year. Last year, oil rose $2.05/bbl. on the first trading day of the year and $7.40/bbl. through the first three weeks of trading as commodity funds, flush with new capital, drove futures prices higher.

I suspect, given the average commodity hedge fund fell around double-digits last year as the CRB Index dropped 7.4%, that many energy-related funds saw outflows at year-end. Recent reports have also indicated that institutional investors are switching from commodity funds that trade energy futures to hedge funds that buy energy-related equities. The commodity mania has also pumped air into the current US “negativity bubble.” Talk of runaway inflation, drought, world wars, global warming, a US dollar collapse, recession/depression and global pandemics, to name a few, has been fueled by the mania for commodities. In my opinion, that is why it is so easy for most to believe that US housing was in a bubble, but then act shocked when commodities plunge. I continue to believe inflation fears have peaked for this cycle as global economic growth slows to average levels, unit labor costs remain subdued and the mania for commodities continues to reverse course.

The EIA reported this week that gasoline supplies fell less than expectations even as refineries remain very slow to come back online after recent “outages.” Refinery utilization is 88.3%, very close to levels seen after the historical hurricanes in 2005 destroyed energy infrastructure in the Gulf of Mexico. However, gasoline futures fell for the week and have plunged 23.8% from September 2005 highs even as some Gulf of Mexico oil production remains shut-in and fears over future production disruptions persist. The gasoline crack spread hit an all-time record high this week, surpassing the levels seen during Hurricane Katrina’s aftermath and last year's euphoric top in oil prices. It will be interesting to see if members of Congress threaten investigations as they did the last time gasoline crack spreads were near current levels. Crack spreads peaked last August right before oil fell $28/bbl. in less than six months. It is also interesting to note that commercial hedgers, the “smart money”, continue to maintain their net short oil position into this historic spike in crack spreads, which is highly unusual. Temporary refinery “outages” are helping to prop up the entire energy complex. However, the very elevated level of current gas prices will only further dampen global fuel demand, sending gas prices substantially lower over the intermediate-term.

Recently, the EIA lowered second and third quarter global demand growth for oil by 400,000 barrels per day. The 10-week moving-average of US oil inventories is also still approaching 8-year highs, as well. Oil consumption in the 30 OECD countries fell last year for the first time in over two decades, while global economic growth boomed 5.3%. Global demand destruction is pervasive. Over the last three years, global oil demand is only up 3.1%, despite the strongest global growth in almost three decades, while global supplies have increased 4.0%, according to the Energy Intelligence Group. The EIA recently forecast that bio-fuels should rise to the equivalent of more than five million barrels of crude oil production a day within four years. Recently, Energy Secretary Bodman said the US will likely remove tariffs to boost bio-fuel imports, which should reduce fears over a potential corn shortage. Corn has already dropped 10.3% from February highs and has likely put in a major top.

As well, OPEC said recently that global crude oil supply would exceed demand by 100 million barrels this quarter. Worldwide oil inventories are poised to begin increasing at an accelerated rate over the next year. There is a very fine line in the crude oil market between perceptions of "significantly supply constrained" and "massive oversupply." One of the main reasons I believe OPEC has been slow to actually meet their pledged cuts has been the fear of losing market share to non-OPEC countries. Moreover, OPEC actually needs lower prices to prevent any further long-term demand destruction. I continue to believe oil is priced at elevated levels on record speculation by investment funds, not the fundamentals.

The Amaranth Advisors hedge fund blow-up last year was a prime example of the extent to which many investment funds have been speculating on ever higher energy prices through futures contracts, thus driving the price of the underlying commodity to absurd levels for consumers and businesses. This is considered “paper demand”, which is not real demand for the underlying commodity. Amaranth, a multi-strategy hedge fund, lost about $6.5 billion of its $9.5 billion under management in less than two months speculating mostly on higher natural gas prices. I continue to believe a number of other funds will experience similar fates over the coming months after managers “pressed their bets” in hopes of making up for recent poor performance, which will further pressure energy prices as these funds unwind their leveraged long positions to meet rising investor redemptions. Moreover, the same rampant speculation that has driven the commodity mania will work against energy as downside speculation increases and drives down prices even further than the fundamentals would otherwise dictate.

Cambridge Energy Research, one of the most respected energy research firms in the world, put out a report late last year that drills gaping holes in the belief by most investors of imminent "peak oil" production. Cambridge said that its analysis indicates that the remaining global oil base is actually 3.74 trillion barrels, three times greater than "peak oil" theory proponents say and that the "peak oil" theory is based on faulty analysis. I suspect the substantial contango that still exists in energy futures, which encourages hoarding, will begin to reverse over the coming months as more investors come to the realization that the "peak oil" theory is hugely flawed, global storage tanks fill and Chinese/US demand slows further.

Global crude oil storage capacity utilization is running around 98%. OPEC production cuts have resulted in a complete technical breakdown in crude futures. Oil closed below its 50-day and 200-day moving averages this week. Spare production capacity, which had been one of the main sources of angst among the many oil bulls, rises with each OPEC cut. As well, demand destruction which is already pervasive globally will only intensify over the coming years as many more alternative energy projects come to the fore. Moreover, many Americans feel as though they are helping fund terrorism or hurting the environment every time they fill up their gas tanks. I do not believe we will ever again see the demand for gas-guzzling vehicles that we saw in recent years, even if gas prices plunge further from current levels, as I expect. If OPEC actually implements all their announced production cuts, with oil still at very high levels and weakening global growth, it will only further deepen resentment towards the cartel and result in even greater long-term demand destruction.

I continue to believe oil made a major top last year during the period of historic euphoria surrounding the commodity with prices above $70/bbl. and calls for $100/bbl. oil commonplace. Even during the peak of anxiety in the recent Iranian/UK hostage stand-off, oil only rose about $6/bbl., despite renewed calls from numerous traders, analysts and pundits for $100+/bbl. oil. Falling demand growth for oil in emerging market economies, an explosion in alternatives, rising global spare production capacity, increasing global refining capacity, the complete debunking of the hugely flawed "peak oil" theory, a firmer U.S. dollar, less demand for gas guzzling vehicles, accelerating non-OPEC production, a reversal of the "contango" in the futures market, a smaller risk premium and essentially full global storage should provide the catalysts for oil to fall to $35 per barrel to $40 per barrel later this year. I fully expect oil to test $20 per barrel to $25 per barrel within the next three years.

Natural gas inventories rose more than expectations this week. However, prices for the commodity rose as historic investment fund speculation persists even with supplies now 19.2% above the 5-year average and near all-time high levels for this time of year. Furthermore, the EIA recently projected global liquefied natural gas production to soar this year, with the US poised to see a 34.5% surge in imports and another 38.5% increase in 2008. Natural gas prices have collapsed 50.1% since December 2005 highs. Notwithstanding this severe decline, natural gas anywhere near current prices is still ridiculous with absolute inventories poised to hit new records this year. The long-term average price of natural gas is $4.63 with inventories much lower than current levels.

Gold rose on the week despite the decline in oil prices, diminishing inflation worries and a stronger US dollar. Perceptions of emerging market demand for the metal seem to be the greatest determinant of prices. Copper rose on diminished worries over global demand and short-covering. Copper is still 8.0% lower from the euphoric highs set last year. I suspect the recent bounce in copper has almost run its course. Natural gas, oil, gold and copper all look both fundamentally and technically weak longer-term. The US dollar rose for the week as traders covered shorts bets and US economic worries diminished.

I continue to believe there is very little chance of another Fed rate hike anytime soon. An eventual rate cut is more likely this year as inflation continues to decelerate substantially. An eventual Fed rate cut should actually boost the dollar as currency speculators anticipate faster US economic activity relative to other developed economies. Moreover, the US budget deficit is now 1.4% of GDP, well below the 40-year average of 2.3% of GDP. As well, the trade deficit has been shrinking over the last six months. I expect foreign investors’ demand for US securities to remain strong. Telecom stocks outperformed substantially for the week on positive earnings reports. REIT stocks underperformed on earnings worries and profit taking.

Current US stock prices are still providing longer-term investors very attractive opportunities, in my opinion. In my entire investment career, I have never seen the best “growth” companies in the world priced as cheaply as they are now relative to the broad market. By contrast, “value” stocks are quite expensive in many cases. A CSFB report late last year confirmed this view. The report concluded that on a price-to-cash flow basis growth stocks are cheaper than value stocks for the first time since at least 1977. The entire decline in the S&P 500’s p/e, since the bubble burst in 2000, is attributable to growth stock multiple contraction. Many “value” investors point to the still “low” price/earnings ratios of commodity stocks, notwithstanding their historic price runs over the last few years. However, commodity equities always appear the “cheapest” right before significant price declines. I still expect the most overvalued economically sensitive and emerging market stocks to underperform over the intermediate-term as the manias for those shares subside as global growth slows to more average rates.

The emerging markets’ mania, which has mainly been the by-product of the commodity mania, is likely nearing an end, as well. The Financial Times reported today that China's pollution problem is rapidly worsening on their soaring investments in energy-intensive industries. According to the FT, China now accounts for almost half of the world's flat glass and cement production, more than one-a third of steel output and 28% of global aluminum production.

In my opinion, China is building for the sake of building, such as the world's largest mall, to promote the appearance of even more exceptional growth than would otherwise be the case. This is giving a false sense of demand for most of the world's commodities. This is the main reason why I believe long-term interest rates remain exceptionally low. I continue to believe when the manias for emerging markets and commodities end, the mild bout of inflation we have experienced will turn into a mild bout of deflation. The iShares Lehman 20+ Year Treasury Bond (TLT) remains a core long position for me.

I am keeping a close eye on the Vietnam Stock Index(VNINDEX), which has dwarfed the Nasdaq’s meteoric rise in the late 90s, rocketing 286% higher over the last 24 months. It is 26.4% higher this year, however the index has dropped 19% over the last seven weeks. The bursting of this bubble in Vietnam, may well signal the end of the mania for emerging market stocks. I continue to believe a chain reaction of events has already begun that will result in a substantial increase in demand for US equities.

S&P 500 profits had risen at double-digit rates for 18 consecutive quarters, the best streak since recording keeping began in 1936. So far this quarter, with 80% of S&P 500 companies reporting, earnings are rising at an 8.5% rate versus estimates of a 3.5% increase before reporting began. Notwithstanding a 104.3% total return(which is equivalent to a 16.9% average annual return) for the S&P 500 since the October 2002 bottom, its forward p/e has contracted relentlessly and now stands at a very reasonable 16.1. The 20-year average p/e for the S&P 500 is 23.0.

In my opinion, the US stock market continues to factor in way too much bad news at current levels. One of the characteristics of the current US “negativity bubble” is that most potential positives are undermined, downplayed or completely ignored, while almost every potential negative is exaggerated, trumpeted, obsessed over and promptly priced in to stock prices. “Irrational pessimism” by investors has resulted in a dramatic decrease in the supply of stock. Booming merger and acquisition activity is also greatly constricting supply. Many commodity funds, which have received a historic flood of capital inflows over the last few years are now seeing redemptions as the CRB Index continues to languish. Some of this capital will likely find its way back to US stocks. As well, money market funds are brimming with record amounts of cash. There is massive bull firepower available on the sidelines for US equities at a time when the supply of stock has contracted.

A recent Citigroup report said that the total value of U.S. shares dropped last year, despite rising stock prices, by the most in 22 years. Last year, supply contracted, but demand for U.S. equities was muted. While overall USUS stock mutual funds have seen modestly increasing cash inflows of late. This should make the many bears very nervous, as keeping the public excessively pessimistic on U.S. stocks has been one of their main weapons. I still suspect accelerating demand for U.S. stocks, combined with shrinking supply, will make for a lethally bullish combination this year. public sentiment is still depressed given the macro backdrop, I am seeing some signs that irrational pessimism is lifting a bit.

Considering the overwhelming majority of investment funds failed to meet the S&P 500's 15.8% return last year, I suspect most portfolio managers have a very low threshold of pain this year for falling substantially behind their benchmark once again. Investment manager performance anxiety is likely quite elevated already this year. The fact that last year the US economy withstood one of the sharpest downturns in the housing market in history and economic growth never dipped below 2% and averaged 3.2% illustrates the underlying strength of the economy as a whole. While significant inventory de-stocking has led to a mid-cycle slowdown, I expect inventory rebuilding to begin adding to economic growth this quarter.

I continue to believe the historically extreme readings in many gauges of investor angst over the last two months indicated the US market was cleansing itself of “weak hands” at an extraordinarily rapid rate. Buyout/merger speculation, a stronger US dollar, lower commodity prices, election cycle strength, decelerating inflation readings, a pick-up in consumer spending, lower long-term rates, increased consumer/investor confidence, short-covering, investment manager performance anxiety, rising demand for US stocks and the realization that economic growth is poised to rise around average rates should provide the catalysts for another substantial push higher in the major averages this year as p/e multiples expand significantly. I still expect the S&P 500 to return a total of about 17% for the year. "Growth" stocks will likely lead the broad market higher, with the Russell 1000 Growth iShares(IWF) rising a total of 25%. Finally, the ECRI Weekly Leading Index rose slightly this week to another new cycle high and is forecasting healthy US economic activity. The 10-week moving average of the ECRI Weekly Leading Index is also at a new cycle high.

*5-day % Change

Weekly Scoreboard*

Indices
S&P 500 1,505.62 +.77%
DJIA 12,264.62 +1.09%
NASDAQ 2,572.15 +.58%
Russell 2000 832.88 +.38%
Wilshire 5000 15,160.25 +.72%
Russell 1000 Growth 594.48 +.65%
Russell 1000 Value 865.38 +.90%
Morgan Stanley Consumer 742.12 +.64%
Morgan Stanley Cyclical 1,040.59 +2.67%
Morgan Stanley Technology 608.18 +1.27%
Transports 5,171.09 +.95%
Utilities 526.24 +.35%
MSCI Emerging Markets 124.81 +1.72%

Sentiment/Internals
NYSE Cumulative A/D Line 76,597 +.54%
Bloomberg New Highs-Lows Index +536 -7.1%
Bloomberg Crude Oil % Bulls 35.0 -17.4%
CFTC Oil Large Speculative Longs 195,239 -2.1%
Total Put/Call .81 -19.0%
NYSE Arms .97 -21.1%
Volatility(VIX) 12.91 +3.85%
ISE Sentiment 142.0 +4.41%
AAII % Bulls 28.57 -27.19%
AAII % Bears 54.29 +42.98%

Futures Spot Prices
Crude Oil 61.85 -6.65%
Reformulated Gasoline 221.45 -1.69%
Natural Gas 7.88 +1.13%
Heating Oil 182.98 -4.22%
Gold 690.70 +1.04%
Base Metals 281.66 +4.9%
Copper 375.15 +6.1%

Economy
10-year US Treasury Yield 4.64% -5 basis points
4-Wk MA of Jobless Claims 328,800 -1.4%
Average 30-year Mortgage Rate 6.16% unch.
Weekly Mortgage Applications 657.20 +.60%
Weekly Retail Sales +.10%
Nationwide Gas $3.01/gallon +.11/gallon
US Heating Demand Next 7 Days 34.0% below normal
ECRI Weekly Leading Economic Index 142.40 +.92%
US Dollar Index 81.73 +.26%
CRB Index 311.24 -.94%

Leading Sectors
Telecom +3.22%
Defense +2.93%
I-Banks +2.67%
Airlines +2.52%
Internet +1.78%

Lagging Sectors
Hospitals -.79%
Homebuilders -.82%
Retail -1.42%
Gaming -1.83%
REITs -2.49%

One-Week High-Volume Gainers

One-Week High-Volume Losers

*5-Day Change

DJIA Hitting Another All-Time High into Final Hour on Economic Data, Buyout Speculation

BOTTOM LINE: The Portfolio is slightly higher into the final hour on gains in my I-Banking longs and Retail longs. I have not traded today, thus leaving the Portfolio 100% net long. The tone of the market is slightly positive as the advance/decline line is slightly higher, most sectors are rising and volume is heavy. The ECRI Weekly Leading Index is hitting a new cycle high and has a growth rate of 4.4%. Moreover, the bond market seems to like today's jobs number as the 10-year yield is down 3 basis points. The growth rate of the ECRI future inflation gauge is -5.7%, the lowest since January 2004. The Case-Shiller August Housing price futures are ticking higher again, from $214,800 last week to $215,400 this week. Tech stocks are outperforming today, boosted by news of the potential acquisition of Yahoo! (YHOO) by Microsoft (MSFT). While this deal makes sense on paper, I suspect it would indeed eventually become a mess on the scale of AOL/Time Warner (TWX). In my opinion, Google (GOOG), which I already view as egregiously undervalued relative to the broad market and its Internet peers, would be the monster winner. The gasoline crack spread is now 32.42, eclipsing the post-Katrina record highs set in 2005. While this is temporarily boosting prices in the energy complex, I continue to believe it is doing significant long-term damage to oil demand, which will become evident as the nationwide rash of refinery "outages" subsides. I expect US stocks to trade mixed-to-higher into the close from current levels on lower long-term rates, short-covering, falling energy prices and buyout speculation.

Today's Headlines

Bloomberg:
- Crude oil is falling another $1.37/bbl. to $61.82/bbl. in NY as investment fund speculation that gasoline supplies aren’t adequate to meet summer driving demand subsides.
- Sunoco Inc.(SUN), the largest gasoline refiner in the US Northeast, will shut its Tulsa, Oklahoma, refinery for most of June for “maintenance,” the company’s vp of investor relations and planning said. Historically low refinery utilization as a result of a rash of refinery “outages” has been the main reason for the recent surge in gasoline prices.
- US ethanol daily average production rose 2.9% to 386,000 bbl./day last month, according to a Dept. of Energy report.
- Brazilian President Luiz Inacio Lula da Silva broke the patent on Merck’s(MRK) AIDS drug Efavirenz after the company’s offer to cut prices failed to satisfy demands from the country’s health ministry.
- Interactive Brokers Group(IBKR) shares gained 10% after the second-largest US IPO this year made the electronic derivatives trader more valuable than the company that owns the Chicago Board of Trade.
- NY state is drafting a new plan to renovate the Penn Station area that includes expanding the train terminal, moving Madison Square Garden and adding 5.5 million square feel of office space.
- Two hurricanes and three tropical storms may strike the US East and Gulf coasts this year. The forecasters lowered their prediction for the number of tropical storms that will form in the Atlantic during the June-to-November season to 16 from 17.
- Shares of PetroChina, the nation’s largest oil producer, surged after the company announced China’s biggest oil discovery in 50 years.
- Saudi Arabia aims to increase its crude-oil reserves by 76% and gas reserves by 40%.
- Bank of America Corp.(BAC) will buy a minority stake in a hedge fund created by its former chief investment officer, joining other lenders in expanding into the fast-growing industry.

Wall Street Journal:
- Imposing deadlines on Iraq could lead to greater violence and insecurity by helping the resistance and weakening moderates, US Deputy Secretary of State John Negroponte said in an editorial. Diplomatic, political and economic progress is being made that is the basis for a stable Iraq, he wrote.
- Wealthy US collectors are equipping their wine cellars with motion sensors, video surveillance, infrared alarms and other expensive security paraphernalia to protect their valuable assets.
- Florida is calculating the electoral impact of a decision to allow convicted felons to retain their civil rights, including the right to vote. At least 950,000 released felons in Florida may regain their voting rights.
- Max Baucus, the head of the US Senate finance committee, said rules on taxation of hedge-fund managers deserve a review because they might be outdated. Baucus, a Montana Democrat, said aides have been reviewing whether fund managers should pay higher taxes on profit.
- The US Treasury Dept. will soon announce changes designed to stop complaints that European and Asian financial markets are winning business because of the regulatory and legal climate in the US.
- Rupert Murdoch, the CEO of News Corp.(NWS/A) who made a bid to buy Dow Jones(DJ), said he wouldn’t make broad changes to the Wall Street Journal if his offer is accepted.

NY Post:
- Microsoft Corp.(MSFT) has asked Yahoo! Inc.(YHOO) to enter formal negotiations over a possible acquisition, citing unidentified banking sources. The company is working with Goldman Sachs(GS) over a possible deal. An agreement between the two would raise the combined companies’ share of the search advertising market to 27% compared with Google’s(GOOG) 65%. Yahoo has been valued at as much as $50 billion by Wall Street analysts.
- Westwood One(WON), a provider of sports, weather and traffic information, has hired UBS to find a possible buyer.
- Ion Media Networks(ION) yesterday approved a takeover bid from hedge fund Citadel Investment Group and NBC Universal.

Financial Times:
- European Union finance ministers will stop short of calling for restrictions on hedge funds in recommendations due next week.
- Billionaire Sam Zell, who is making an $8.2 billion purchase of Tribune Co.(TRB), said he isn’t interested in selling the LA Times, the Chicago-based media chain’s biggest newspaper.
- A US Supreme Court ruling last week that will make it easier to challenge existing patents is a welcome change which should help cut back on undeserved patents.

Reuters:
- ICAP Plc’s stock jumped on speculation the world’s biggest broker of trades between banks may be the target of a takeover by Deutsche Boerse AG.

Globe and Mail:
- Thomson Corp. is in takeover talks with Reuters Group Plc, which said today that it received an approach from an undisclosed company.

El Universal:
- Venezuela was one of two countries in Latin America and the Caribbean to record foreign capital outflows last year, citing the UN’s Economic Commission on Latin America and the Caribbean. Foreign companies took $543 million out of Venezuela last year while the region, led by Brazil, Mexico and Chile, received $72 billion of direct foreign investment.

88,000 New Non-Farm Jobs in April, Unemployment Rate Still Historically Low at 4.5%, Hourly Earnings Still Substantiall Exceeding Inflation

- The Unemployment Rate for April rose to 4.5% versus estimates of 4.5% and 4.4% in March.
- The Change in Non-farm Payrolls for April was 88K versus estimates of 100K and 177K in March.
- The Change in Manufacturing Payrolls for April was -19K versus estimates of -14K and -18K in March.
- Average Hourly Earnings for April rose .2% versus estimates of a .3% gain and a .3% rise in March.

BOTTOM LINE: Employers in the US last month added fewer jobs and the unemployment rate rose slightly, Bloomberg reported. The unemployment rate ticked slightly higher, but still remains historically low and is down from 5.1% in September 2005, notwithstanding fewer real estate-related jobs and significant auto production cutbacks. The unemployment rate’s current 12-month average is 4.6%. It has only been lower during two other periods since the mid-50s. The economy has created almost 2 million jobs in just the last year. As well, the Monster Employment Index hit another record high in April. The 50-week moving average of initial jobless claims(318,700) has been lower during only two other periods since the 70s. Furthermore, most measures of Americans’ income growth are now almost twice the rate of inflation. Americans’ Average Hourly Earnings rose 3.7% year-over-year in April, substantially above the 3.2% 20-year average. The 10-month moving-average of Americans’ Average Hourly Earnings is currently 4.04%. 1998 was the only year during the 90s expansion that it exceeded current levels. I continue to believe the labor market will remain healthy over the intermediate-term without generating substantial unit labor cost increases.

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