Stocks Surging into Final Hour on Buyout Activity, Falling Energy Prices and Positive Earnings Reports

BOTTOM LINE: The Portfolio is slightly higher into the final hour on gains in my Computer longs, Medical longs and Networking longs. I have not traded today, thus leaving the Portfolio 100% net long. The tone of the market is slightly positive today as the advance/decline line is about even, most sectors are rising and volume is above-average. My intraday gauge of investor angst is around average levels. The NYSE reported late last week that short interest on the exchange, from mid-June through mid-July, rose from 12.47 billion shares to 12.95 billion shares, which is yet another all-time high. Moreover, the 3.9% increase leaves NYSE short interest up an astounding 35% since mid-February, the largest five-month percentage jump since at least 1991, when Bloomberg began tracking. This is even more shocking considering the S&P 500 jumped another 7.3% during that period and the DJIA was breaking records on its way to 14,000. It is also noteworthy that odd-lot short sales spiked into Friday's sell-off to levels exceeding those seen during the peak in sub-prime fears in March. This is just more evidence, in my opinion, that the many bears continue to party like it's 2000-2003, despite the S&P 500's 109% gain from that period's lows. NYSE short interest was basically flat from mid-2002 through first quarter 2005, which is what I would expect considering the extraordinary number of new hedge funds created during that period and a large stock rally off the bottom in October 2002. The recent parabolic rise in short interest is stunning, however, and is symptomatic of the current “U.S. negativity bubble”, in my opinion. Moreover, the only ETF that is ranked in the top 40 NYSE short positions is the iShares Russell 2000 Index (IWM). The rest are all equities. I think this is a direct result of the massive capital that has been 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. As well, many investors continue to see a 2000-type market meltdown lurking around every corner. I suspect, given their 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 U.S. 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.

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

1. Beazer Homes (BZH) +18.2%
2. Fortress Investment Group (FIG) +16.5%
3. Hovnanian (HOV) +13.8%
4. Titanium Metals (TIE) +13.8%
5. KBW Incorporated (KBW) +12.7%
6. Talbots (TLB) +11.9%
7. Primus Guaranty (PRS) +11.3%
8. Assured Guaranty (AGO) +11.1%
9. Central Vermont Public Service (CV) +11.1%
10. Novastar Financial (NFI) +10.8%
11. Emergency Medical Services (EMS) +10.4%
12. MVC Capital (MVC) +10.0%
13. Citadel Broadcasting (CDL) +9.7%
14. AZZ Incorporated (AZZ) +9.3%
15. General Maritime (GMR) +9.2%
16. Valhi (VHI) +9.2%
17. TriMas (TRS) +8.4%
18. Cal Dive International (DVR) +8.3%
19. Skilled Healthcare Group (SKH) +8.2%
20. Alesco Financial (AFN) +8.0%
21. Grubb & Ellis (GBE) +7.85%
22. Genco Shipping & Trading (GNK) +7.7%
23. RSC Holdings (RRR) +7.6%
24. Best Buy (BBY) +7.5%
25. Meritage Homes (MTH) +7.5%

I expect US stocks to trade modestly higher into the close from current levels as earnings optimism, buyout speculation and falling energy prices offsets lingering sub-prime concerns and profit-taking.

Today's Headlines

Bloomberg:
- Justin Fuller, senior equity analyst at Morningstar Inc. says the Bear Stearns(BSC) hedge fund fallout is “a blip on the radar screen.”
- NY Democratic Governor Eliot Spitzer disciplined two members of his staff after a report by the state attorney general found they improperly used state police to collect information about the use of state aircraft by one of Spitzer’s political rivals, Senate Majority Leader Joseph Bruno.
- Hedge funds attracted $58.7 billion in new money in the second quarter, the industry’s second-highest amount following a record first quarter.
- United Rentals(URI) agreed to be bought by Cerberus Capital Management LP for $4 billion, the third sale of a US construction equipment-rental company in the past year.
- Merck(MRK) and Schering-Plough(SGP) beat analysts’ estimates for second-quarter profit as doctors wrote more prescriptions for their cholesterol drugs Bytorin and Zetia. Merck’s stock rose the most in more than two years.
- Transocean Inc.(RIG) agreed to buy GlobalSantaFe(GSF) for about $17 billion, combining the world’s two largest offshore oil and gas drillers in a market where demand for rigs has never been higher.
- Natural gas is plunging 6.2% today to nearly a seven-month low in NY as a combination of mild temperatures and record inventories served to undercut demand and push prices down.
- Cumulus(CMLS), a radio company with stations in 67 US markets, agreed to be bought for about $1.3 billion by an investor group led by CEO Lewis Dickey.
- Hewlett-Packard(HPQ) will buy Opsware Inc., the software company founded by Internet pioneer Marc Andreeseen, for about $1.6 billion to extend its push into business programs.
- Google Inc.(GOOG), escalating a battle with AT&T(T) and Verizon Wireless(VZ), may team up with smaller mobile-phone service providers to create its own multibillion-dollar network.

NY Times:
- Mattel Inc.(MAT) is releasing a new Barbie doll line that can be linked to a computer to access games, online chat rooms and virtual shops.

Barron’s:
- SAP AG(SAP) may attract a takeover offer from a leveraged buyout firm because its shares are cheap and the company’s earnings are growing.

TheStreet.com:
- Nokia Siemens Networks is considering a $7 billion bid for Tellabs Inc.(TLAB).

NY Post:
- Phillips-Van Heusen(PVH) has begun rolling out an Izod clothing line for women 40-55.
- General Electric’s(GE) NBC plans to move as many as 1,000 employees to a corporate park in Englewood Cliffs, NJ, from offices in Manhattan because of space shortages.

USA Today:
- NY Senator Hillary Rodham Clinton is building what amounts to a separate organization devoted to winning women’s votes. Tonight 400 women plan to hold house parties to watch the Democratic candidates debate, twice as many parties as women held for Illinois Senator Barack Obama on June 24. Clinton’s campaign has special groups targeting nurses, businesswomen, minority women, New Yorkers, young women and graduates of Wellesley College, her alma mater.

Heren Energy:
- French power production at hydro plants rose 40% in June compared with the same month last year, citing monthly stats published by the country’s grid operator.

Financial News:
- Goldman Sachs(GS) is preparing to buy stakes in independent research firms to boost income from research while keeping costs down.

Economic Releases

- None of note

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Monday Watch

Weekend Headlines
Bloomberg:
- Shares of Williams-Sonoma(WSM) surged the most in almost three years today on speculation the biggest gourmet-cookware retailer in the US may be a takeover target, according to an analyst at Thomas Weisel Partners.
- China’s government shut down three companies whose tainted products were used in medicine and pet food, amid efforts to address concerns about the Asian nation’s food safety.
- HIV drugs will be given to people who don’t have the virus by US scientists to determine whether the medicines can protect those at greatest risk of catching the AIDS-causing disease.
- Germany will not be blackmailed into pulling its military forces out of Afghanistan, Chancellor Angela Merkel said, dismissing demand by Taliban insurgents who are reported to have taken German citizens hostage.
- Borders Group(BGP) sold 1.2 million copies of “Harry Potter and the Deathly Hallows” yesterday, giving the 1,200-store chain the highest single-day sales of any title in its history.
- Ev3 Inc.(EVVV), a maker of catheter-based devices to treat vascular diseases, agreed to buy FoxHollow Technologies(FOXH), the maker of a device to treat arterial blockage, for $780 million in cash and stock.
- Crude oil is falling a second day in NY on signs fuel stockpiles will increase as refiners increase output.
- Treasuries Attract Pension Funds Overflowing With Stock Gains.
- Bear Stearns(BSC) Shares Show Cayne’s Dummy ‘Body Blow’ Won’t Hurt.
- China’s copper imports, the largest in the world, fell 6.8% in June from May as rising prices reduced the profitability of shipments.

Wall Street Journal:
- Trying to cash in on investors’ fascination with alternative investments, Wall Street is pitching a complex new product that aims to mimic hedge-fund performance while avoiding the gigantic fees that real ones charge.
- Barclays Plc is trying to recover $400 million it invested in a Bear Stearns(BSC) fund, a conflict that could lead to arbitration or litigation.
- Technology demand is showing an unexpected surge, driven by rapidly falling prices for components such as computer chips and disk drives, business spending and a rush by people around the world to get on the Internet.
- Numbers Game: Why ‘Guidance’ May Not Matter.
- States Aim to Stem Tide of Home Foreclosures with Funds for Refinancing.

NY Times:
- A record number of fires, power failures, leaks, spills and breakdowns at US oil refineries this year has caused disruptions that have pushed up wholesale gasoline prices 35%.
- General Electric CEO Immelt faces pressure from stockholders to boost the company’s shares.
- Podcasters Unite to Figure Out a Role for Ads.

Business Week:
- The Best Product Design of 2007.
- The Dow's sprint isn't over. One big reason: Of the index's 30 components, at least nine are trading way below their fair market, or intrinsic, value, according to some valuation studies.

AP:
- Iranian and US officials will meet July 24 to discuss the security situation in Iraq, citing Hoshyar Zebari, Iraq’s foreign minister.

Reuters:
- OPEC concerned oil price may hurt global economy. Tight supplies of refined products in the US, investment fund buying of oil futures and international political tension have pushed the price higher, said OPEC President Mohammed al-Hamli.

Washington Post:
- Presidential candidates, including Democratic Senator Hillary Rodham Clinton and Republican Senator John McCain, have made stops at Google’s(GOOG) headquarters in an effort to show they are in touch with the company that has come to represent innovation in Silicon Valley.

Crain’s Chicago Business:
- The Chicago Board Options Exchange has barred about 600 members of the Chicago Board of Trade who haven’t exercised their CBOE trading rights from the exchange.

EE Times:
- Apple flash memory demand triggers shortage fears.

Star-Ledger of Newark:
- New Jersey Democratic Governor Jon Corzine urged United Parcel Service to obey state law and give benefits to partners in same-sex relationships.

CNNMoney.com:
- A fair price for both oil producers and consumers for a barrel of oil would be around $60 to $65 a barrel, a Kuwaiti state oil newsletter quoted the head of OPEC's research division as saying.

Financial Times:
- Merrill Lynch(MER), Lehman Brothers(LEH), Morgan Stanley(MS) and Citigroup(C) are among a group of investment banks developing an electronic trading platform for unregistered securities to compete with existing systems such as the one created by Goldman Sachs(GS).

Daily Telegraph:
- Facebook Inc., a social-networking Web site, is getting 150,000 new members a day.

South China Morning Post:
- China has indefinitely postponed the release of a so-called “Green GDP” because of bureaucratic infighting and local authorities’ opposition, citing Wang Jinnan, who devised the plan.

Hong Kong Commercial Broadcasting:
- China’s government will further tighten monetary policy after increasing lending and deposit rates last week, Hong Kong Monetary Authority Chief Executive Joseph Yam said.

Weekend Recommendations
Barron's:
- Made positive comments on (BBBY), (M), (KSS), (VIA), (KDN), (BBY) and (LVS).

Night Trading
Asian indices are -.75% to unch. on average.
S&P 500 futures -.01%.
NASDAQ 100 futures -.07%.

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Earnings of Note
Company/Estimate
- (ALTR)/.21
- (AXP)/.86
- (ACI)/.27
- (ATHR)/.22
- (AV)/.15
- (CGNX)/.11
- (GNTX)/.21
- (HAL)/.56
- (HAS)/.18
- (LNCR)/.62
- (MRK)/.72
- (NFLX)/.24
- (SGP)/.35
- (STN)/.55
- (TASR)/.04
- (TXN)/.42
- (WFT)/.70

Upcoming Splits
- None of note

Economic Releases
- None of note

Today’s Other Potential Market Movers
- None of note

BOTTOM LINE: Asian indices are mostly lower, weighed down by automaker and utility shares in the region. I expect US stocks to open modestly lower and to rally into the afternoon, finishing mixed. The Portfolio is 100% net long heading into the week.

Weekly Outlook

Click here for The Week Ahead by Reuters.

Click here for Stocks in Focus for Monday by MarketWatch.com.

There are some economic reports of note and a number of significant corporate earnings reports scheduled for release this week.

Economic reports for the week include:

Mon. – None of note

Tues. – Richmond Fed Index, weekly retail sales

Wed. – Weekly EIA energy inventory data, weekly MBA Mortgage Applications report, Existing Home Sales, Fed’s Beige Book

Thur. – Durable Goods Orders, Initial Jobless Claims, New Home Sales

Fri. – Advance 2Q GDP, Advance 2Q Personal Consumption, Advance 2Q GDP Price Index, Advance 2Q Core PCE, Univ. of Mich. Consumer Confidence

Some of the more noteworthy companies that release quarterly earnings this week are:

Mon. – Altera Corp.(ALTR), American Express(AXP), Atheros Communications(ATHR), Avaya Inc.(AV), Halliburton(HAL), Hasbro(HAS), Lincare(LNCR), Merck(MRK), Schering-Plough(SGP), Station Casinos(STN), Taser Intl.(TASR), Texas Instruments(TXN)

Tues. – Aflac(AFL), Amazon.com(AMZN), AT&T(T), Biogen Idec(BIIB), BJ Services(BJS), Bowater(BOW), Burlington Northern(BNI), CDW Corp.(CDWC), Centex Corp.(CTX), Cerner Corp.(CERN), Cheesecake Factory(CAKE), Chubb Corp.(CB), Countrywide Financial(CFC), Domino’s Pizza(DPZ), Eli Lilly(LLY), EMC Corp.(EMC), Energizer Holdings(ENR), Illumina Inc.(ILMN), Kimberly-Cark(KMB), Lam Research(LRCX), Legg Mason(LM), Lexmark Intl.(LXK), Linear Tech(LLTC), Lockheed Martin(LMT), McDonald’s(MCD), Nabors Industries(NBR), Northrop Grumman(NOC), Panera Bread(PNRA), PepsiCo(PEP), Raymond James(RJF), Stanley Works(SWK), United Parcel Service(UPS)

Wed. – Akamai Technologies(AKAM), Alcon(ACL), Allegheny Technologies(ATI), Anheuser-Busch(BUD), Apple Inc.(AAPL), Baidu.com(BIDU), Boeing Co.(BA), Colgate-Palmolive(CL), ConocoPhillips(COP), Corning Inc.(GLW), E*Trade(ETFC), F5 Networks(FFIV), Freeport-McMoRan(FCX), General Dynamics(GD), Genzyme Corp.(GENZ), LSI Coprp.(LSI), Norfolk Southern(NSC), PF Chang’s(PFCB), Pulte Homes(PHM), Qualcomm Inc.(QCOM), Ryland Group(RYL), Sealed Air(SEE), Symantec(SYMC), Terex Corp.(TEX), Timberland(TBL), Tractor Supply(TSCO), Tribune(TRB), Zimmer Holdings(ZMH)

Thur. – 3M Co.(MMM), Aetna(AET), AmerisourceBergen(ABC), Amgen(AMGN), Apache Corp.(APA), Beazer Homes(BZH), Becton Dickinson(BDX), Black & Decker(BDX), Bristol-Myers(BMY), CB Richard Ellis(CBG), Celgene(CELG), Cummins(CMI), Deckers(DECK), Dow Chemical(DOW), DR Horton(DHI), Exxon Mobil(XOM), Flextronics(FLEX), Ford(F), Ingram Micro(IM), Intercontinental Exchange(ICE), Kellogg(K), KLA-Tencor(KLAC), L-3(LLL), Level 3(LVLT), MBIA(MBI), McAfee(MFE), McKesson(MCK), Office Depot(ODP), QLogic(QLGC), Raytheon(RTN), Riverbed(RVBD), Royal Caribbean(RCL), Tidewater(TDW), VeriSign(VRSN), Wendy’s(WEN), Western Digital(WDC), XM Satellite(XMSR)

Fri. – Baker Hughes(BHI), Chevron Corp.(CVX), Clear Channel(CCU), Fortune Brands(FO), ITT Corp.(ITT), Medco Health(MHS)

Other events that have market-moving potential this week include:

Mon. – None of note

Tue. – The Fed’s Mishkin speaking, Fed’s Poole speaking

Wed. – The Fed’s Poole speaking, Fed’s Geithner speaking

Thur. – (MSFT) Analyst Meeting

Fri. – None of note

BOTTOM LINE: I expect US stocks to finish the week mixed as better-than-expected earnings reports, more economic optimism and short-covering offsets profit-taking and lingering sub-prime concerns. My trading indicators are giving mostly bullish signals and the Portfolio is 100% net long heading into the week.