Stocks Lower into Final Hour on Profit-taking and Higher Long-term Rates

BOTTOM LINE: The Portfolio is higher into the final hour on gains in my Internet longs, Networking longs and Computer longs. I have not traded today, thus leaving the Portfolio 100% net long. The tone of the market is negative as the advance/decline line is lower, every sector is declining and volume is above average. Google (GOOG) is rising another 1.7% today and is making a new all-time high at $515.79. So far, my long additions to Google into the weakness a few months ago are paying off. Even at a new record high, I view the stock as undervalued and believe it will prove a devastating mistake for global technology fund managers to exclude this company from their portfolios. I continue to believe it is beyond comprehension why investors are willing to pay 50x forward estimates for Yahoo! (YHOO) and only around 30x conservative forward estimates for GOOG, which is arguably the most dominant growth stock in the world. My $600 per share target on Google before year-end is now looking conservative as numerous upside catalysts are coming to the fore more quickly than I had anticipated. It still isn't too late to board the Google train, in my opinion. My largest long position remains Google, with Apple (AAPL) a close second. I expect US stocks to trade modestly higher into the close from current levels on buyout speculation, more economic optimism, lower energy prices, short-covering and investment manager performance anxiety.

Today's Headlines

Bloomberg:
- European Central Bank President Jean-Claude Trichet and US Federal Reserve Chairman Ben S. Bernanke said they are concerned that investors are underestimating the amount of risk they are taking on in global markets.
- Rick Wagoner, CEO of GM(GM) says the company is making “major progress” in its recovery plan.
- Billionaire investor George Soros plans to invest a “significant amount” in Brazil’s ethanol industry.
- Crude oil is falling $.70/bbl. on speculation that a government report will show US refineries increased fuel output after a historical rash of nationwide “outages” recently pushed down gasoline supplies and boosted prices.
- White sugar dropped 3.4% in London on concern sales by producer countries are exacerbating an oversupply of the commodity.
- Goldman Sachs(GS) dropped its forecast for the Fed to reduce borrowing costs this year because of a resilient labor market and a reacceleration of growth in the industrial sector of the economy.
- NYC won its highest credit rating by S&P as surging Wall Street profits and a buoyant real estate market boost revenue, and as surplus funds are set aside to help pay for future costs.
- Fed Chairman Ben Bernanke said “tighter” lending standards for mortgages will “restrain” housing demand for longer than policy makers anticipated.
- A US agency today called a Chinese-made all-terrain vehicle unsafe, just weeks after regulators questioned the quality of products such as pet food and toothpaste that also bear the label “Made in China.”
- Al-Qaeda leader Osama bin Laden is alive and is still issuing instructions to his commanders in the field, a leading Taliban member said.
- Treasuries are falling, and the benchmark 10-year note’s yield touched a nine-month high, as an unexpected increase in a gauge of service industries prompted traders to undo bets that the Fed will cut interest rates.
- Exxon Mobil(XOM) and pipeline owner Enbridge Inc. said they’ve begun discussions with shippers to build a conduit capable of delivering Canadian crude oil to Houston refineries.
- UK broadcaster Channel 4 said it will air pictures of the aftermath of the car crash that killed Diana, Princess of Wales, rejecting a last minute plea for restraint from her sons Princes William and Harry.

Wall Street Journal:
- SAP AG(SAP) of Germany and California-based Oracle Corp.(ORCL) are competing to win software orders from small and medium-sized companies, and Oracle seems to be getting better reviews from customers, citing a survey by Nucleus Research.
- Vodafone Group Plc could be worth more split into parts than whole, leading to speculation that AT&T Inc.(T) or a group of hedge funds could be interested in a takeover.
- Genentech Inc.(DNA) is under increased pressure in Congress and from Medicare to cut the prices it charges for new drugs. The company’s strategy is to develop drugs needed and otherwise unavailable and to charge enough to recover research and development spending, which reached $1.8 billion last year. CEO Levinson says the company needs “healthy” margins on Avastin because the drug is a success and many others aren’t.
- Ron Burkle, the billionaire supermarket investor who tried to buy Tribune Co.(TRB), joined an effort by a Dow Jones(DJ) employees union to seek alternatives to Rupert Murdoch’s bid for the company.

NY Times:
- P. Schoenfeld Asset Management LLC, an investor in Biomet Inc.(BMET), plans to vote against the $10.9 billion bid for the maker of artificial hips and knees by a private equity group.
- Apple Inc.(AAPL) and Microsoft Corp.(MSFT), makers of the operating systems that power 750 million computers, are working on new systems that will integrate Internet-based programs.
- New Haven, Connecticut, officials voted yesterday to provide municipal identification cards for city residents, including illegal immigrants.

Washington Post:
- Some Democratic leaders are concerned that Representative William’s Jefferson’s indictment yesterday on racketeering and bribery charges could rekindle a smoldering dispute between House Speaker Nancy Pelosi and black lawmakers. Pelosi didn’t indicate what action she may take against Jefferson, instead calling the charges “extremely serious” and, if true, “an egregious and unacceptable abuse of public trust and power.”

NY Post:
- William Ackman, general partner of Pershing Square Capital Management, has raised $2 billion to buy a controlling interest in a company with a market capitalization of $30 billion to $40 billion. The target is an “iconic American company,” though Ackerman won’t identify the company.

Star-Ledger of Newark:
- Trump Entertainment Resorts(TRMP) may receive bids from an Atlantic City executive and a private equity firm.

Financial Times:
- A Chinese market slump may not lead to disaster if investors grow more discerning and stock values get more realistic.

BBC:
- Basque separatist group ETA has said it plans to end its ceasefire with the Spanish government tomorrow.

Bilan:
- UBS AG plans more acquisitions of banks that oversee rich people’s assets as the largest Swiss lender aims to expand its share of the global wealth management market, Chairman Marcel Ospel said.

Arab News:
- The Saudi Arabian General Investment Authority, or SAGIA, traveled to the US to promote $500 billion in new investment opportunities in the kingdom.

ISM Non-Manufacturing Highest in Over a Year

- ISM Non-Manufacturing for May rose to 59.7 versus estimates of 55.8 and a reading of 56.0 in April.

BOTTOM LINE: Service industries expansion in the US unexpectedly accelerated last month to the highest level in more than a year, a sign the economy is strengthening, Bloomberg said. The New Orders component of the index rose to 57.4 from 55.5 the prior month. The Prices Paid component rose to 66.4 from 63.5 the prior month. The Employment Component of the index rose to 54.9 from 51.9 the prior month. I continue to believe US economic growth is accelerating substantially this quarter to around 3% or slightly higher, however growth is likely to decelerate back below 3% in 3Q as the effects of higher long-term rates take hold. This should push the 10-year yield back down to around 4.75%.

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Tuesday Watch

Late-Night Headlines
Bloomberg:
- China’s stocks are dropping another 6.4%, extending a slide that’s wiped out at least $402 billion of market value, or more than Taiwan’s gross domestic product since, May 30.
- Avaya Inc.(AV), a computer-networking company, said it agreed to be bought by Silver Lake Partners and TPG Inc. for $8.2 billion in cash.
- Google Inc.(GOOG), owner of the most popular Internet search engine, said more than half of its US customers can also buy radio ads through a company service that will be available to all US advertisers by the end of the month.
- comScore, a leader in measuring the digital world, today released its comScore Video Metrix rankings for March 2007, showing Google Sites as the top US streaming video property with 57.4 million unique people streaming and 1.2 billion video streams initiated. YouTube.com drove the lion’s share of the video streaming activity at the Google Sites property with 53.5 million unique streamers and 1.1 billion streams initiated.
- The euro rose to a record high versus the yen on prospects the European Central Bank will raise interest rates tomorrow, encouraging Japanese investors to seek the higher yields available in Europe.
- Citic Securities, the most profitable brokerage in China, plans to sell 350 million new shares, worth about $2.5 billion at yesterday’s closing price, to finance expansion.
- Rupert Murdoch held “constructive” talks today with Dow Jones’(DJ) controlling Bancroft family over his proposal to purchase the company for $5 billion.
- Bed Bath & Beyond(BBBY) said first-quarter profit was between 36 cents and 38 cents a share, less than the 40 cents analysts had estimated.
- Tropical Cyclone Gonu weakened slightly into a Category Four storm with winds of 249 kilometers per hour as it headed across the Arabian Sea toward the Gulf of Oman, the US Navy said.

Ming Pao Daily:
- Hong Kong’s de-facto central bank has prepared a contingency plan for the city’s financial system in case of a sharp tumble in China’s stock markets.

China Securities Journal:
- Mutual funds investing in Chinese stocks are being redeemed as investors have turned more wary after the recent slump in the domestic stock market. Fund managers have been pressed to “dump blue-chip stocks” from their portfolios to generate cash to meet investors’ redemption. The confidentiality of the Hong Kong Monetary Authority’s plan ranks as high as the documents related to the Hong Kong-US dollar peg, the Chinese newspaper said, without specifying what measures the government may take in the event of a meltdown in China’s stock markets.

Economic Daily:
- Hon Hai Precision Industry has won desktop computer orders from Dell Inc.(DELL), the first time Dell has outsourced such orders.

Late Buy/Sell Recommendations
Stifel, Nicolaus & Company:
- Reiterated Buy on (GOOG), raised estimates and target to $620 from $585. Google has quietly compiled and recently announced the launches of important initiatives such as iGoogle, Universal Search, Google Gears, an acquisition of FeedBurner, and an agreement with Hearst-Argyle(HTV). The products/initiatives that have been announced could change the landscape of commerce, community, search, and software, over time, in our opinion. We continue to believe many of Google’s initiatives will be “winner take all” over the long-term. Google has become the technology leader of this cycle and it has uniquely built its dominant franchise on consumer choice rather than previous positions that were built on customer lock-in. Google is, by far, our best large-cap idea.

Night Trading
Asian Indices are -.25% to +.25% on average.
S&P 500 indicated -.19%.
NASDAQ 100 indicated -.22%.

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Earnings of Note
Company/EPS Estimate
- (ABM)/.24
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- (CPRT)/.41
- (SCHS)/-.45

Upcoming Splits
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Economic Releases
10:00 am EST
- ISM Non-Manufacturing for May is estimated to fall to 55.8 versus a reading of 56.0 in April.

Other Potential Market Movers
- The Fed’s Bernanke speaking, Fed’s Warsh speaking, weekly retail sales reports, (VRSN) Analyst Day, (ONXX) Analyst Briefing, ASCO Annual Meeting, Deutsche Bank Media & Telecom Conference, Merrill Lynch Agricultural Chemical Conference, RBC Energy Conference, Sidoti Emerging Growth Institutional Investor Forum, Goldman Sachs Lodging/Gaming/Restaurant/Leisure Conference and Lehman Brothers Industrial Distribution Conference could also impact trading today.

BOTTOM LINE: Asian indices are mostly higher, boosted by automaker and energy stocks in the region. I expect US equities to open modestly lower and to rally into the afternoon, finishing modestly higher. The Portfolio is 100% net long heading into the day.

Stocks Close Near Session Highs Despite Perceived Headwinds

Indices
S&P 500 1,539.18 +.18%
DJIA 13,676.32 +.06%
NASDAQ 2,618.29 +.17%
Russell 2000 855.10 +.20%
Wilshire 5000 15,528.98 +.22%
Russell 1000 Growth 608.66 +.28%
Russell 1000 Value 885.03 +.10%
Morgan Stanley Consumer 751.04 -.24%
Morgan Stanley Cyclical 1,090.93 +.01%
Morgan Stanley Technology 618.96 +.29%
Transports 5,290.52 -.67%
Utilities 518.25 -.20%
MSCI Emerging Markets 129.25 +.42%

Sentiment/Internals
Total Put/Call .89 unch.
NYSE Arms .95 +19.51%
Volatility(VIX) 13.29 +4.0%
ISE Sentiment 168.0 +41.18%

Futures Spot Prices
Crude Oil 66.04 +1.46%
Reformulated Gasoline 222.80 -.74%
Natural Gas 8.18 +3.83%
Heating Oil 196.20 +2.04%
Gold 676.50 -.06%
Base Metals 267.82 -.08%
Copper 347.0 +1.91%

Economy
10-year US Treasury Yield 4.93% -2 basis points
US Dollar 82.04 -.34%
CRB Index 315.55 +.46%

Leading Sectors
Oil Service +2.63%
Internet +1.94%
Computer Hardware +1.38%

Lagging Sectors
Steel -.83%
Biotech -1.24%
Airlines -2.75%

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Afternoon Recommendations
Goldman Sachs:
- Rated (M) Buy.

Afternoon/Evening Headlines
Bloomberg:
- Ritchie Capital Management Ltd. is preparing to seek bankruptcy protection for life-insurance holdings in its flagship hedge fund, a month after blaming its co-investor for more than $700 million in losses.
- Openwave Systems(OPWV) rejected a $335 million offer from Harbinger Capital Partners to buy control of the mobile-phone software maker.
- The average US pump price for regular gasoline fell 5.2 cents to $3.16/gallon in the week ended yesterday.
- The perceived risk of owning US corporate bonds held at a 10-week low, according to credit-default swap traders who bet on corporate creditworthiness.
- Gasoline futures fell on forecasts for a fifth weekly rise in US inventories.
- Global spending by oil and natural-gas producers will probably rise 13% this year, according to a Lehman Brothers survey.

Nikkei English News:
- Japan’s government will set targets for industries to improve energy efficiency as it tries to take the lead in cutting greenhouse-gas emissions.

BOTTOM LINE: The Portfolio finished higher today on gains in my Internet longs, Medical longs and Computer longs. I did not trade in the final hour, thus leaving the Portfolio 100% net long. The tone of the market was neutral today as the advance/decline line finished mildly higher, sector performance was mixed and volume was above average. Measures of investor anxiety were above average into the close. Today's overall market action was bullish as the major averages finished near session highs, notwithstanding the plunge in Chinese shares, profit-taking and higher energy prices. The rise in oil today was mostly a function of worries over the category 5 cyclone heading into the Strait of Hormuz. Gasoline futures actually fell 0.47%, and the crack spread closed floor trading below its 50-day moving average for the first time in several months. The 10-year yield is near session lows, despite the rise in oil, falling over 2 basis points. If Chinese shares come under significant pressure again tonight, we will likely see more morning weakness in US shares tomorrow. I continue to observe unbelievable complacency in the bearish camp given what has transpired over the last year and the positive macro backdrop for US stocks.