Stocks Higher into Final Hour as Fed Says Core Inflation is Moderating, Leaves Benchmark Rate at 5.25%

BOTTOM LINE: The Portfolio is higher into the final hour on gains in my Medical longs, Software longs and Networking longs. I have not traded today, thus leaving the Portfolio 100% net long. The tone of the market is positive as the advance/decline line is mildly higher, almost every sector is rising and volume is above average. The Fed left the benchmark rate unchanged at 5.25%. They made both hawkish and dovish comments in the ensuing policy statement. They said core inflation has improved modestly, but that it may not be sustained. The other statements were about the same as prior ones. They did not stress a focus on headline inflation rather than core, as some investors had feared. Natural gas has broken down again technically, which seems to be weighing on oil service stocks despite today’s rise in oil. As well, corn has plunged 19% in nine days, even as oil has risen and talk of alternative energy has grown louder. Nasdaq reported that short interest on the exchange surged another 9.2% to 9,170,000,000 shares, from mid May through mid June, hitting another all-time high. Moreover, as on the NYSE, the last four months have seen Nasdaq short interest soar an astounding 30.2%, the largest four-month percentage increase since at least 1991, according to Bloomberg data.

Here are the 25 Nasdaq stocks with the largest percentage increase in their short interest relative to their float from mid May through mid June:

1) USNA +20.6%
2) SMTC +18.0%
3) BBND +13.7%
4) PODD +11.6%
5) GMTN +10.9%
6) OATS +9.4%
7) TRMP +8.6%
8) KLIC +8.4%
9) TRGL +7.6%
10) MCHX +7.5%
11) LPHI +7.2%
12) GMET +7.0%
13) SNTA +7.0%
14) AGEN +6.9%
15) GLBC +6.6%
16) MNKD +6.6%
17) PALM +6.4%
18) ENTG +6.3%
19) SIRO +6.2%
20) MALL +6.1%
21) UHAL +6.1%
22) CHIP +5.9%
23) COMV +5.7%
24) SHFL +5.6%
25) TSCM +5.6%

The S&P 500 also reported short interest data. Here are the five industries in the S&P 500 with the largest percentage increase in their short interest from mid May through mid June:

1) Utilities +16.3%
2) Information Technology +12.8%
3) Health Care +8.3%
4) Financials +7.9%
5) Telecom Services +3.5%

Here are the 20 S&P 500 stocks with the largest percentage increase in their short interest relative to their float from mid-May through mid-June:

1) NSM +13.8%
2) PNW +5.6%
3) KLAC +5.2%
4) RSH +4.8%
5) HAS +4.7%
6) CIEN +4.0%
7) MBI +3.3%
8) TRB +3.0%
9) WFMI +3.0%
10) EQR +2.8%
11) NVDA +2.6%
12) GNW +2.4%
13) IBM +2.1%
14) LIZ +2.1%
15) SSP +1.9%
16) MU +1.9%
17) HBAN +1.9%
18) DTE +1.9%
19) MYL +1.8%
20) DCT +1.8%

I expect US stocks to trade modestly higher into the close from current levels on short-covering, diminishing sub-prime angst and bargain-hunting.

Today's Headlines

Bloomberg:
- Venezuelan President Hugo Chavez attacked US dominance as he visiting Russia looking to secure a deal for eight Russian submarines and greater energy cooperation.
- A US District Court froze the assets of Lake Shore Asset Management, a hedge funds run by a former chairman of the Chicago Mercantile Exchange, after misrepresentations in the fund’s financial statements were uncovered by the Commodity Futures Exchange Commission. Chicago-based Lake Shore purported to manage $1 billion for investors and traded in US commodities futures contracts with a 13-year profitability record. A review later showed the fund had about $466 million. Lake Shore barred regulators from inspecting its accounts on June 14, a violation of the Commodity Exchange Act.
- Jeremy Siegel, a professor at the University of Pennsylvania’s Wharton School of Business doesn’t see “excessive leverage” in the economy.
- Corn in Chicago fell for a third session this week as rains revive crops in the US Midwest threatened by unusually hot, dry weather earlier this month. Corn has plunged 19% in 9 trading days.
- Natural gas is plunging 5% to a five-month low after a weekly government report showed inventories are 18% above the five-year average for this time of the year as industrial demand falters.
- The Fed kept the benchmark US interest rate at 5.25% and said that core inflation has moderated, but that the moderation may not be sustainable.
- Petro-Canada, the third-largest oil company in Canada, and its partners will spend $24.6 billion on an oil-sands project in northern Alberta that’s one of the world’s most costly energy developments.
- A bald eagle swept above a crowd at the Jefferson Memorial in Washington as the Interior Department declared that the national bird is no longer threatened with extinction after four decades as an endangered species.
- GM(GM) agreed to sell its Allison Transmission unit to buyout firms Carlyle Group and Onex for $5.6 billion.
- Robert Steel, the US Treasury’s top finance official, said concerns that the near failure of two money-losing hedge funds run by Bear Stearns(BSC) might spark a financial crisis or hurt the economy are unfounded.
- Shares of Build-A-Bear Workshop(BBW) rose the most in almost three years after the maker of stuffed animals hired Lehman Brothers(LEH) to explore a sale, following a forecast of declining profit.
- The US Senate again blocked passage of comprehensive immigration legislation, almost certainly ending chances Congress will act this year on it.
- Ford Motor(F) said it’s offering three-year, no-interest loans on all 2007 Ford, Lincoln and Mercury vehicles to start making room at dealerships for next year’s models.
- Intel Corp.(INTC) was upgraded to “overweight” from “equal weight” at Lehman Brothers, which said a new series of semiconductors designed for laptop computers may boost revenue and earnings growth.

Wall Street Journal:
- Visa International Inc. will pay $170 million to sponsor soccer’s World Cup for eight years, citing FIFA President Sepp Blatter.
- Enterprise Rent-A-Car is opening a branch in Washington DC where customers will be offered vehicles that run on E85, a fuel comprising 85% ethanol and 15% gasoline.
- Chipotle Mexican Grill(CMG), the Chicago Tribune(TRB) and Visa will sponsor the first Windy City Cornhole Classic on July 28 at Soldier Field in Chicago. The bag-tossing game known as cornhole, Bags, and Baggo has become the latest fad in the US Midwest at bars, parties and church picnics.
- Some US House Republicans have aligned with Wall Street in an attempt to halt a congressional proposal that would raises taxes substantially on financial firms.

AP:
- The Democrat-controlled House of Representatives endorsed a $4,000 pay raise that would increase their salaries to almost $170,000.

Expansion:
- Acciona SA has acquired the rights to develop wind parks in the US from EcoEnergy LLC. EcoEnergy has the rights to develop 1,300 megawatts of wind power. Acciona plans to invest $1.75 billion before 2009 in wind energy in the US.

Final GDP and GDP Price Index Revised Slightly Higher, Job Market Still Healthy

- Final 1Q GDP rose .7% versus estimates of a .8% gain and a prior estimate of a .6% gain.

- Final 1Q Personal Consumption rose 4.2% versus estimates of a 4.4% gain and a prior estimate of a 4.4% increase.

- Final 1Q GDP Price Index rose 4.2% versus estimates of a 4.2% gain and a prior estimate of a 4.0% increase.

- Final 1Q Core PCE QoQ rose 2.4% versus estimates of a 2.2% gain and a prior estimate of a 2.2% increase.

- Initial Jobless Claims for last week fell to 313K versus estimates of 315K and 326K the prior week.

- Continuing Claims fell to 2490K versus estimates of 2500K and 2517K prior.

BOTTOM LINE: The US economy expanded at an annual pace of .7 percent in the first quarter, Bloomberg reported. According to economists, this quarter was the low point for the year as the trade deficit narrows and corporate spending accelerates. Spending on residential construction fell at a 15.8% annual pace last quarter versus a 19.8% pace in the fourth quarter. The decline subtracted .9 percentage point from growth. I continue to believe US growth will come in at 3%+ this quarter before decelerating modestly below trend in 3Q.

Fewer Americans filed first-time claims for unemployment benefits last week, signaling the labor market remains healthy, Bloomberg said. The four-week moving average of jobless claims rose to 316,000 from 315,000 the prior week. The unemployment rate among those eligible for benefits, which tracks the US unemployment rate, held steady at 1.9% for the ninth consecutive week. The unemployment rate is currently a historically low 4.5%. I continue to believe the job market will remain healthy over the intermediate-term without generating substantial unit labor costs increases.

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Thursday Watch

Late-Night Headlines
Bloomberg:
- Apple Inc.'s campaign to build excitement about its iPhone may be the most successful marketing effort ever, surpassing the drive to promote Ford Motor Co.'s 1964 Mustang and Microsoft Corp.'s Windows 95.
- CryoCor Inc.(CRYO) won the backing of US advisers for its experimental device to treat a type of irregular heartbeat, moving the product a step closer to approval more than a year after regulators rejected it.
- UBS AG, Europe’s largest bank by assets, was accused by Massachusetts regulators of “dishonest and unethical” practices in dealings with hedge-fund advisers.
- The yen fell from a two-week high against the US dollar and euro on speculation investors resumed sales of the currency in search of higher returns elsewhere.
- Japan’s industrial production unexpectedly dropped for third month in May, the longest losing streak in almost two years, raising concern that the world’s second-largest economy is slowing.
- The fate of US immigration legislation was cast into doubt when at least six senators who helped revive the proposed overhaul said they either oppose or are leaning against a move to permit a vote on final passage.

Financial Times:
- Motorola(MOT) is worried about the effect of Apple’s(AAPL) iPhone but believes the device has weaknesses, citing an interview with Padmasree Warrior, Motorola’s chief technology officer.
- Signs emerged on Wednesday that efforts by federal officials to tackle the competitiveness of the US capital markets are speeding up.
- Ten international banks, including HSBC and Standard Charter, have been punished by China’s foreign exchange regulator for breaching strict capital controls by helping to funnel huge amounts of foreign exchange into the country’s soaring stock and property markets.
- Iran’s parliament on Wednesday night agreed to press ahead with plans to introduce fuel rationing in the face of panic and rioting across the country over the proposals.

Late Buy/Sell Recommendations
Citigroup:
- We strongly recommend investors take advantage of current weakness to add to their (ABK, target $103) and (MBI, target $74) positions. Valuations are neat the trough, yet market conditions for new business are the most attractive they have been since 2003 as spreads are finally widening.
- Reiterated Buy on (JCI), target raised to $131.

Night Trading
Asian Indices are +.25% to +1.0% on average.
S&P 500 indicated +.05%.
NASDAQ 100 indicated +.12%.

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Earnings of Note
Company/EPS Estimate
- (COMS)/.02
- (ACN)/.55
- (APOL)/.71
- (ARRO)/.37
- (BMET)/.48
- (BBOX)/.61
- (CBK)/.30
- (STZ)/.15
- (FDO)/.41
- (FINL)/-.10
- (GIS)/.63
- (KBH)/.26
- (MU)/-.24
- (MON)/1.00
- (TONS)/.98
- (PALM)/.14
- (RAD)/.00
- (RBN)/.59
- (SLR)/.05
- (TIBX)/.02
- (WOR)/.36

Upcoming Splits
- (FLO) 3-for-2

Economic Releases
8:30 am EST
- Final 1Q GDP is estimated to rise .8% versus prior estimates of .6% increase.
- Final 1Q Personal Consumption is estimated to rise 4.4% versus prior estimates of a 4.4% increase.
- Final 1Q GDP Price Index is estimated to rise 4.0% versus prior estimates of a 4.0% gain.
- Final 1Q Core PCE QoQ is estimated to rise 2.2% versus prior estimates of a 2.2% gain.
- Initial Jobless Claims for last week are estimated to fall to 315K versus 324K the prior week.
- Continuing Claims are estimated to fall to 2500K versus 2523K prior.

2:15 pm EST
- The FOMC is expected to leave the benchmark Fed Funds rate at 5.25%.

Other Potential Market Movers
- The Wachovia CEO Summit, RBC Energy Infrastructure/Trust Conference and Jeffries Healthcare Conference could also impact trading today.

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

Stocks Finish Sharply Higher on Diminishing Sub-Prime Worries and Short-Covering

Indices
S&P 500 1,506.34 +.90%
DJIA 13,427.73 +.68%
NASDAQ 2,605.35 +1.21%
Russell 2000 838.46 +1.49%
Wilshire 5000 15,187.08 +.96%
Russell 1000 Growth 596.72 +1.0%
Russell 1000 Value 858.88 +.85%
Morgan Stanley Consumer 730.23 +.51%
Morgan Stanley Cyclical 1,072.66 +.82%
Morgan Stanley Technology 625.94 +1.30%
Transports 5,129.77 +1.05%
Utilities 496.11 +1.70%
MSCI Emerging Markets 130.21 +.16%

Sentiment/Internals
Total Put/Call 1.05 -2.78%
NYSE Arms .72 -41.42%
Volatility(VIX) 15.53 -17.79%
ISE Sentiment 116.0 -15.94%

Futures Spot Prices
Crude Oil 69.01 +1.83%
Reformulated Gasoline 225.46 +.34%
Natural Gas 6.93 +.76%
Heating Oil 202.51 +1.60%
Gold 645.80 +.08%
Base Metals 246.31 -2.53%
Copper 335.25 +1.09%

Economy
10-year US Treasury Yield 5.08% unch.
US Dollar 82.32 +.03%
CRB Index 312.30 +.51%

Leading Sectors
Biotech +2.20%
REITs +2.08%
Alternative Energy +2.12%

Lagging Sectors
Insurance +.20%
Gaming +.08%
Hospitals +.05%

Evening Review
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Afternoon Recommendations
Bank of America:
- Rated (SPR) Buy, target $42.

Oppenheimer:
- Rated (CRWN) Buy, target $9.25.

Afternoon/Evening Headlines
Bloomberg:
- Treasury Secretary Henry Paulson said Congress shouldn’t punish Blackstone Group LP with higher taxes because it became a publicly traded partnership, and he warned against “unintended consequences” of broader efforts to tax hedge funds and buyout firms.
- Merrill Lynch(MER) CEO O’Neal and Goldman Sachs Group(GS) CEO Lloyd Blankfein offered reassurance to investors today, saying they see few risks of widespread turmoil in the credit markets.
- James Glassman, senior US economist at JPMorgan(JPM), sees the Fed “on the sidelines” and the price of oil dropping.
- Corn fell to a six-week low in Chicago on speculation that rains will revive Midwest crops threatened by hot, dry weather earlier this month.
- Sugar fell in NY on renewed speculation that rising Brazilian and Indian production will widen a global glut.
- A Senate panel probing the National Security Agency’s domestic terrorism surveillance program issued subpoenas to the White House, VP Dick Cheney and the Justice Dept. for documents showing the Bush administration’s legal justification for the program.
- Shares of Nike Inc.(NKE), the world’s largest sneaker maker, posted their biggest gain in 4 ½ years after the company said orders for clothing and shoes rose 12%, the most since 1997.
- Shares of ComScore Inc.(SCOR), Data Domain(DDUP) and Spreadtrum Communications(SPRD) soared in their first day of trading as demand for speedier wireless connections and Web content renewed investor appetite for technology stocks.
- Bed Bath & Beyond(BBBY) said first quarter profit rose 4.2% after customers bought less bedding and curtains as US home sales slowed. The stock fell 4.3% in after-hours trading.

WABC television:
- NYC is experiencing scattered power outages, affecting parts of the South Bronx, East Harlem and the Upper East Side.

BOTTOM LINE: The Portfolio finished higher today on gains in my I-Banking longs, Medical longs, Semi longs, Biotech longs and Base Metal shorts. I did not trade in the final hour, thus leaving the Portfolio 100% net long. The tone of the market was positive today as the advance/decline line finished higher, every sector rose and volume was above average. Measures of investor anxiety were above-average into the close. Today's overall market action was very bullish. Growth stocks were especially strong, however, every sector I follow finished higher. Technology stocks outperformed again today, and the MS Tech Index is now 10.6% higher year-to-date vs. a 7.2% gain for the S&P 500. Corn fell another 3.6% and has completely broken down technically. I continue to believe a major top in the commodity is already in place. This spurred another 1% decline in the Goldman Ag Commodity Sub-Index. Retail options traders exhibited bearish sentiment throughout the day. The Nikkei futures are indicating an up 100 open in Japan. I suspect U.S. stocks will build on today's gains tomorrow.

Here is a five-year chart of NYSE short-interest:

As you can see, short interest was basically flat from mid-2002 through first quarter 2005, which is what I would expect considering the massive number of new hedge funds created during that period and a large stock rally off the bottom in October 2002. However, the recent parabolic rise in short interest, the largest four-month percentage increase on record (+30%), is stunning considering recent stock gains and is symptomatic of the current U.S. negativity bubble, in my opinion. Moreover, the only ETF that is ranked in the top 30 NYSE short positions is the iShares Russell 2000 Index (IWM). The rest are equities. I think this is a direct result of the massive capital that is allocated to low correlation U.S. stock strategies and the undying belief by the herd that the U.S. will continue to underperform all other global markets indefinitely. I suspect, given their horrific risk-adjusted underperformance over the last few years, that some low-correlation U.S. stock strategies will see significant redemptions at year-end and that a large percentage of this capital will move into more positively correlated U.S. stock strategies. As well, I think a chain reaction of events has already begun that will lead to a dramatic positive change in perception by global portfolio managers regarding the prospects for US stocks vs. most other global markets. The recent parabolic rise in short interest is unsustainable and only brings the "mother of all short-covering rallies" closer, in my opinion.