Stocks at Session Lows into Final Hour on Terrorism Fears, Subprime Worries and End-of-Quarter Profit-taking

BOTTOM LINE: The Portfolio is slightly lower into the final hour on losses in my I-Banking longs, Software longs and Biotech longs. I have not traded today, thus leaving the Portfolio 100% net long. The tone of the market is mildly negative as the advance/decline line is mildly lower, most sectors are lower and volume is about average. The PCE Core year over year rose 1.9% in May, the smallest increase since March 2004. This is also well below the 20-year average of 2.5% and within the Fed's comfort zone. The myth of problematic inflation lives on; however, if oil begins collapsing in the third quarter as it did last year, this argument will become extremely difficult to make. The fundamentals for oil are even worse this year, in my opinion. The 10-year yield is at session lows, falling 8 basis points. It has dropped 30 basis points in less than two weeks. The NYSE Arms is an above-average 1.23, the VIX is rising 8.2% and the CBOE total put/call is an above-average 1.0. Sloppy action over the last few days appears to me to be a function of buyers stepping away after a great quarter and aggressive funds selling/shorting winners. I expect large buyers to re-emerge next week. I also think better-than-expected earnings, a break below 5% in the 10-year yield, diminishing subprime fears and a large acquisition could provide upside catalysts for the broad market over the coming weeks. I expect US stocks to trade modestly higher into the close from current levels on lower long-term rates and subsiding end-of-quarter profit-taking.

Today's Headlines

Bloomberg:
- The DJIA is poised to post its best quarterly performance since the fourth quarter of 2003.
- UK police dismantled a car bomb found outside a nightclub packed with hundreds of people near London’s Piccadilly Circus, raising concern about terrorism.
- US treasuries are rising after a government report showed the Fed’s most closely watched measure of inflation slowed in May. The 10-year yield has plunged 27 basis points in less than 2 weeks.
- The Canadian dollar fell after the nation’s economy unexpectedly registered zero growth in April.
- Washington Mutual(WM), the biggest US savings and loan, will refinance up to $2 billion in subprime loans. The loans will be refinance or modified at discounted rates to help borrowers’ stabilize their finances and avoid foreclosure.
- BP Plc(BP), Europe’s second-largest oil company, and UK biofuels developer D1 Oils Plc said they plan to start a joint venture to plant jatropha for use as biodiesel.
- General Motors(GM) will invest $945 million over the next five years in Europe to introduce more fuel-efficient vehicles that cause less pollution.
- The price of US steel sheet fell for a third straight month in June because of reduced demand from manufacturers and a drawdown of inventories by distributors, Purchasing magazine said.
- Corn plunged to a 12-week low in Chicago after a government report said US farmers planted more acres than forecast in March.
- Crude oil rose to a 10-month high in NY on speculation by investment funds that low supplies of gas will continue to boost prices into the summer.
- Talbots Inc.(TLB) appointed apparel-industry veteran Trudy Sullivan as its new CEO in an effort to stem five years of declining profit at the women’s clothing retailer.
- Chicago Board of Trade’s(BOT) largest shareholder, Sydney-based hedge fund Caledonia Investments, has voted against the proposed sale to the Chicago Mercantile Exchange because the price is too low.
- Bear Stearns(BSC) hired Jeffrey Lane from Lehman Brothers Holdings(LEH) to run its asset-management division after the near-collapse of two hedge funds forced the firm to put up $1.6 billion for a bailout.

Wall Street Journal:
- Discover Financial Services, set to be spun off by Morgan Stanley(MS), is far smaller than rivals Visa USA Inc. and MasterCard Inc., yet its shares may be attractive because credit-card demand is growing.
- Delta Air Lines may be the leading contender to gain the first new non-stop flights between the US and China, to be awarded under agreements signed in May.
- Iowa Senator Charles Grassley, the top Republican on the Senate Finance Committee, may determine the outlook for legislative proposals to raise taxes on the hedge-fund and private-equity industries.
- Lawmakers moved to salvage parts of a grand compromise on immigration reform following the collapse of the broad package.

Boston Herald:
- Massachusetts is considering creating a loan pool backed by as much as $200 million in state bonds to enable homeowners to refinance unaffordable mortgages.

Washington Post:

- Russian authorities have shut down a US-funded non-profit training organization for journalists and filed criminal charges that critics say are politically motivated.

LA Times:
- Doug Frantz, managing editor of the LA Times, will become the Middle East bureau chief for the Wall Street Journal next month.

AP:
- The California State Assembly approved another 17,000 slot machines at casinos run by four Southern California tribes that will bring the state hundreds of millions of dollars in new revenue.

CNBC:
- The SEC is increasing its scrutiny of Bear Stearns’(BSC) hedge fund business.

Financial Times:
- Goldman Sachs Group(GS) was the top investment banking adviser in the world in the first half of 2007, citing Dealogic data.

China Knowledge:
- BP Plc(BP), Europe’s second-largest oil company, aims to double the import and sale of liquefied petroleum gas in China by 2010.

Incomes/Spending Rise Less Than Estimates, Inflation Decelerates Further, Chicago Manufacturing Strong, Construction Jumps, Confidence Revised Higher

- Personal Income for May rose .4% versus estimates of a .6% gain and a -.2% decline in April.

- Personal Spending for May rose .5% versus estimates of a .7% increase and a .5% gain in April.

- The PCE Core (MoM) for May rose .1% versus estimates of a .1% gain and a .1% increase in April.

- The Chicago Purchasing Manager Index for June came in at 60.2 versus estimates of 58.0 and a reading of 61.7 in May.

- Construction Spending for May rose .9% versus estimates of a .1% gain and a .2% increase in April.

- The Final Univ. of Mich. Consumer Confidence reading for June rose to 85.3 versus estimates of 84.0 and 83.7 in May.

BOTTOM LINE: Americans spent less than forecast in May and the Fed’s preferred inflation gauge cooled, Bloomberg reported. The Core PCE, the Fed’s favorite inflation gauge, rose 1.9% from a year earlier, the smallest gain since March 2004. This is also well below the 20-year average of 2.5% and within the Fed’s comfort zone. Consumer spending will come in below average rates this quarter, however spending should substantially exceed estimates of 2.5% in the second half of the year as interest rates come back down, energy prices fall substantially, sentiment improves, inflation decelerates further, stocks rise further, incomes continue to outpace inflation and housing sales stabilize at relatively high levels.

A measure of US business activity unexpectedly held near a two-year high this month, suggesting business spending will support continued growth, Bloomberg reported. The Prices Paid component fell to 68.1 from 70.2 in May. The Employment component of the index fell to 52.7 from 57.3 the prior month. The New Orders component fell to 65.7 from 71.1 the prior month. I continue to believe manufacturing will help boost US growth back to 3%+ this quarter.

Spending on US construction projects rose more than forecast last month as work on non-residential and government projects helped overcome cutbacks in homebuilding, Bloomberg said. The .9% increase was the biggest gain since February 2006. Every category besides residential construction showed an increase, spurred by the building of factories and utilities. I still expect construction spending to trend below average rates as homebuilders further pare down inventories and commercial construction slows modestly.

Confidence among US consumers came in above the level economists had expected for June, Bloomberg reported. While the average price of gas has fallen to $2.97/gallon from the record $3.23/gallon on May 23, it is still 28% higher this year. Consumers believe inflation will rise 2.9% over the next five years, down from 3.1% the prior month. I continue to believe both main gauges of consumer sentiment will rebound back near cycle highs before year-end.

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Friday Watch

Late-Night Headlines
Bloomberg:
- Research In Motion Ltd.(RIMM), maker of the BlackBerry e-mail phone, said first quarter profit rose 73% on demand for new devices with cameras and music players. The company also announced a 3-for-1 stock spit. Shares soared 17% in after-hours trading.
- Some seafood imported to the US from China will be detained by regulators because of possible contamination with unsafe drugs, the latest health warning about products from that country.
- FedEx Corp.(FDX) truck drivers would be able to join unions more easily under US legislation approved by a House panel today, in a victory for organized labor.
- The yen headed for the biggest quarterly loss against the US dollar since 2001 before reports that are forecast to show falling prices and slowing consumption in Japan.
- North Korea’s pledge to close its Yongbyon reactor and dismantle its nuclear program may help establish a security agreement for northeast Asia, South Korean Foreign Minister Song Min Soon said.
- Japan’s consumer prices fell .1% in May, a pace of decline that’s unlikely to deter the central bank from raising its benchmark interest rate, the lowest among major economies.
- The US House of Representatives moved toward giving small companies an additional year to adhere to the Sarbanes-Oxley Act’s accounting rules, which are being revised by the SEC.
- Consideration of an energy package in the House of Representatives that had been scheduled for July may be delayed until September partly because of pending work on other legislation, Speak Nancy Pelosi said.
- The highest-rated collateralized debt obligations holding subprime mortgages may be worth buying if an abundance of selling causes prices to drop, according to Morgan Stanley.
- Members of the International Swaps and Derivatives Assoc. said they will not change trading contract language to address concerns raised by a group of hedge funds that banks who invest in derivatives tied to subprime mortgage bonds may try to suppress defaults by buying bad loans out of the deals.
- Apollo Group(APOL), the for-profit education company, reported profit excluding some items of 81 cents a share in the third quarter and said it plans to buy back as much as $500 million of its own stock. The stock rose 6.7% in after-hours trading.
- Komag(KOMG), the maker of computer disk-drive components, agreed to be bought by Western Digital(WDC) for $32.25 a share, or $1 billion, in cash. Komag rose 7.7% in after-hours trading.
- South Korea has accepted new labor and environment provisions for its free-trade agreement with the US, allowing it to be signed tomorrow, Kim Jong Hoon, the Asian country’s chief negotiator said.

Wall Street Journal:
- Apple Inc.(AAPL) may not be able to meet demand for its iPhone, Chief Executive Officer Steve Jobs said. The iPhone hasn’t had an effect on iPod sales, Jobs said.
- Ford Motor(F) plans to resume paying a dividend sometime in the future, citing a video of CEO Mulally talking to dealers.

LA Times:
- Doug Frantz, managing editor of the LA Times, will leave the paper, citing Editor James O’Shea.

Daily Mail:
- Russia wants to add oil reserves twice the size of Saudi Arabia’s by laying claim to untapped oil and natural gas fields beneath the North Pole.

Late Buy/Sell Recommendations
Citigroup:
- Reiterated Buy on (MON), target raised to $77.
- Rated (CMG) Buy, target $100.
- Reiterated Buy on (SNDK), target $52.

Needham & Co.:
- Rated (SNDK) Buy, target $55.

Business Week:
- Shares of USG Corp., the No. 1 maker of gypsum wallboard in the US, may rebound next year if the housing market turns around. The stock may rise 44% to $70 a share in the next year, citing Michael Metz, chief investment strategist at Oppenheimer Holdings.
- Shares of Kaydon Corp.(KDN) may rise as increased interest in wind energy will strengthen demand for the anti-friction bearings the company makes for turbines.
- United Retail Group(URGI), whose clothing caters to women wearing size 14 or larger, will benefit from summer sales.

Night Trading
Asian Indices are -.25% to +.75% on average.
S&P 500 indicated +.05%.
NASDAQ 100 indicated +.12%.

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Earnings of Note
Company/EPS Estimate
- (NDN)/.01
- (AZZ)/.42

Upcoming Splits
- (CXW) 2-for-1

Economic Releases
8:30 am EST
- Personal Income for May is estimated to rise .6% versus a -.1% decline in April.
- Personal Spending for May is estimated to rise .7% versus a .5% gain in April.
- PCE Core (MoM) for May is estimated to rise .1% versus a .1% gain in April.

9:45 am EST
- The Chicago Purchasing Manager Index for June is expected to fall to 58.0 versus a reading of 61.7 in May.

10:00 am EST
- Construction Spending for May is estimated to rise .1% versus a .1% gain in April.
- Final University of Michigan Consumer Confidence for June is estimated to rise to 84.0 versus a prior estimate of 83.7.

Other Potential Market Movers
- The JPMorgan Global Tobacco Conference could also impact trading today.

BOTTOM LINE: Asian indices are mostly higher, boosted by automaker and technology 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 Mixed on Quarter-end Profit-taking

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