GDP Surges Above Trend, Inflation Decelerates Meaningfully, Confidence Rises

- Advance 2Q GDP rose 3.4% versus estimates of a 3.2% gain and a .6% increase in 1Q.

- Advance 2Q Personal Consumption rose 1.3% versus estimates of a 1.5% gain and a 3.7% increase in 1Q.

- Advance 2Q GDP Price Index rose 2.7% versus estimates of a 3.4% increase and a 4.2% gain in 1Q.

- Advance 2Q Core PCE is estimated to rise 1.4% versus estimates of a 1.4% increase and a 2.4% rise in 1Q.

- Final July Univ. of Mich. Consumer Confidence came in at 90.4 versus estimates of 91.2 and a prior estimate of 92.4.

BOTTOM LINE: The US economy grew more than forecast last quarter, propelled by rising exports, commercials construction and government spending, Bloomberg said. The 3.4% gain in GDP was the best showing in more than a year. The Advance 2Q PCE Core, the Fed’s favorite gauge of inflation, rose only 1.4%, a meaningful decline from first quarter and the smallest increase in four years, even with oil in the $70s. Fed policy makers, including Bernanke, have said they prefer for the core pce to rise between 1-2%. Business Fixed Investment, which includes spending on commercial construction as well as equipment and software, rose at an 8.1% annual rate versus a 2.1% rate in 1Q. As I forecast back in March, when talk of an imminent recession was all the rage, growth came in above trend this quarter. I suspect growth will average around 3% for the remainder of the year as this quarter comes in slightly below trend and fourth quarter comes in slightly above trend. As well, inflation measures should continue to decelerate meaningfully, thus providing a very positive backdrop for stocks.

Confidence among US consumers rose in July as gasoline prices dropped from record highs and the labor market continued to show strength, Bloomberg said. The final index of confidence rose to 90.4 from 85.3 in June. The current conditions component of the index rose to 104.5 from 101.9 the prior month. The average price of a gallon of regular gas has fallen from $3.23 on May 23 to $2.92/gallon yesterday. I continue to believe both main gauges of consumer sentiment will reach new cycle highs over the intermediate-term as stocks rise further, gas prices fall meaningfully, inflation decelerates further, housing-related fears subside, wages continue to substantially outpace inflation and unemployment remains historically low.

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Friday Watch

Late-Night Headlines
Bloomberg:
- Shares of AU Optronics Corp.(AUO), Taiwan’s largest marker of liquid-crystal displays, rose after the company reported a 33-fold jump in profit, beating analysts’ estimates, after prices for computer and TV screens increased.
- One measure of the US money supply rose by $14.2 billion in the week that ended July 16, according to Federal Reserve statistics released in Washington. That left M2 growing at an annual rate of 6.2% for the past 52 weeks, above the target of 5% the Fed once set for maximum growth.
- Crocs(CROX), the maker of a colorful line of casual shoes, said second-quarter profit tripled as sales of its namesakes footwear and accessories climbed. The stock surged 15% in after-hours trading.
- Deckers Outdoor(DECK) reported second quarter sales increased 26.4%. The stock rose 9.4% in after-hours trading.
- The New York State Ethics Commission will investigate actions by Democratic Governor Eliot Spitzer’s staff to pressure state police to compile travel records on Senate Majority Leader Joseph Bruno.
- Bear Stearns(BSC) took control of debt securities held by one of its failed hedge funds to control their sale and guard against “further price declines.”
- US Treasury Secretary Henry Paulson said the decline in the subprime mortgage market reflects a reassessment of risk that doesn’t pose a threat to the economy. “I don’t think it poses any threat to the overall economy,” Paulson, a former CEO of Goldman Sachs(GS), said.
- Japan’s consumer prices declined for a fifth month, undermining the central bank’s case that inflation will take hold and interest rates need to be raised.
- Intel Corp.(INTC) broke antitrust laws by giving illegal rebates to computer makers to wrest sales away from rival Advanced Micro Devices(AMD), European regulators said.
- The yen fell from a three-month high against the US dollar on concern sliding Japanese stocks and declining consumer prices will cause the central bank to delay raising interest rates in coming months.

Wall Street Journal:
- The US government said China boosted transfers of sensitive military technology to Iran, harming efforts to pressure the Islamic Republic to abandon its nuclear program.
- The Federal Regulatory Commission accused collapsed hedge fund Amaranth Advisors LLC and two former traders of manipulating the US natural gas market early last year.
- Wireless provider Sprint Nextel Corp.(S) said it would include a range of Google Inc.’s(GOOG) Web and communications applications on its coming “WiMax” mobile devices, a boost for Sprint as it rolls out the new technology and a breakthrough for Google in the US wireless industry.

Business Week:
- Americans spend $41 billion a year on their pets, more than what they shell out for movies, video games and recorded music combined, citing research firm Packaged Facts.

Late Buy/Sell Recommendations
Citigroup:
- Upgraded (JWN) to Buy, target $58.
- Reiterated Buy on (RTN), target $68.
- Reiterated Buy on (GT), target $45.
- Reiterated Buy on (BWA), target $100.
- Upgraded (NLY) to Buy, target $16.

Business Week:
- Shares of Starbucks Corp.(SBUX) will probably emerge from a slump after hitting bottom last month. McAdams Wright Ragen’s Dan Gelman said the stock could climb 57% to $44 in the next 12 months.

Night Trading
Asian Indices are -2.25% to -1.5% on average.
S&P 500 futures +.32%.
NASDAQ 100 futures +.12%.

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Earnings of Note
Company/EPS Estimate
- (AXL)/.61
- (BHI)/1.10
- (CVX)/2.28
- (CCU)/.45
- (CEG)/.73
- (FO)/1.44
- (IDXX)/.84
- (IR)/.95
- (ITT)/.90
- (MHS)/.78
- (MSTR)/1.20

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Economic Releases
8:30 am EST
- Advance 2Q GDP is estimated to rise 3.2% versus a .7% gain in 1Q.
- Advance 2Q Personal Consumption is estimated to rise 1.5% versus a 4.2% gain in 1Q.
- Advance 2Q GDP Price Index is estimated to rise 3.4% versus a 4.2% gain in 1Q.
- Advance 2Q Core PCE is estimated to rise 1.4% versus a 2.4% gain in 1Q.

10:00 am EST
- Final Univ. of Mich. Consumer Confidence for July is estimated at 91.2 versus a prior estimate of 92.4.

Other Potential Market Movers
- The Morgan Keegan Insurance Conference could also impact trading today.

BOTTOM LINE: Asian indices are sharply lower, weighed down by commodity and automaker stocks in the region. I expect US equities to open modestly higher and to maintain gains into the afternoon. The Portfolio is 75% net long heading into the day.

Stocks Fall Sharply, Finish Well Off Lows

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Stocks Sharply Lower into Final Hour on Credit Fears and Emerging Market Worries

BOTTOM LINE: The Portfolio is lower into the final hour on losses in my I-Banking longs and Retail longs. I added to my (GS) long and took some profits in my (TLT) long today, thus leaving the Portfolio 75% net long. The tone of the market is very negative today as the advance/decline line is substantially lower, every sector is declining and volume is heavy. My intraday gauge of investor angst is at an elevated level. This gauge is now close to the levels seen during the lows in March. The VIX is jumping 26%. The NYSE Arms is an above-average 1.21. The CBOE total put/call is a high 1.51. The ISE Sentiment Index is plunging 17%, to a depressed 94.0. Given how large short interest is, how well many stocks have done this year, losses over the last few days and the potential for a positive catalyst to materialize tonight or tomorrow before the open, I suspect we could see some significant short-covering into the final hour. Deep cyclicals are getting hit the hardest, and growth stocks are substantially outperforming value stocks again. Tech shares are holding up relatively well, notwithstanding losses in the major averages. I continue to believe that we are just in the very early stages of a multiyear period of outperformance by the “growth” style over the “value” style. With the DJIA down 320, I am still seeing many growth stocks up or just slightly lower. Leading growth stocks are dramatically outperforming the market. Moreover, year-to-date outperformance of growth over value is becoming very large. I think this big story is barley mentioned due to the fact that there are very few true growth managers left after seven years of underperformance by the style. Take a look at Apple (AAPL), Google (GOOG), Intuitive Surgical (ISRG), Synchronoss Technologies (SNCR), Baidu (BIDU), Nvidia (NVDA), Illumina (ILMN), Celgene (CELG), EMC Corporation (EMC), F5 Networks (FFIV), Crocs (CROX), Riverbed Technology (RVBD), Qualcomm (QCOM), Garmin (GRMN), Research In Motion (RIMM), First Solar (FSLR), Omniture (OMTR), Psychiatric Solutions (PSYS), Cabot Microelectronics (CCMP), MEMC Electronic Materials (WFR), AU Optronics (AUO), Amazon (AMZN), etc. A significant change is under way. These types of stocks will lead the market for years, in my opinion. Apple (AAPL) is surging another 7% today after crushing third-quarter estimates and providing conservative fourth-quarter guidance. As I have said many times over the last few months, I believe the "halo effect" is accelerating at a much faster pace than analysts had expected. I had forecast a 50% gain for AAPL shares at the beginning of the year, however, given recent developments, $180 now looks likely before year-end. The stock remains my second largest long position. I expect US stocks to trade higher into the close from current levels on bargain-hunting, lower long-term rates, lower energy prices and short-covering.

Today's Headlines

Bloomberg:
- Democratic presidential candidate John Edwards unveiled a tax policy that raises the top capital gains rate to 28% from 15%.
- Then benchmark for US stock volatility, or VIX, surged to the highest in 13 months.
- Exxon Mobil Corp.(XOM) reported its first profit decline in more than three years.

Wall Street Journal:
- Porsche AG, the Stuttgart, Germany-based maker of 911 sports cars, is developing a hybrid gasoline-electric engine in conjunction with Volkswagen AG for its Cayenne sport-utility vehicle.
- Billionaire investor Warren Buffett took a stake of less than 5% in Kraft Foods(KFT), citing a person familiar with the investment by Berkshire Hathaway(BRK/A).
- Al-Rajhi Bank, Saudi Arabia’s largest lender by market value, is being monitored by the US government for allegedly financing extremists.
- Picnik is a useful photo-editing software program available free on an Internet Web site, which will soon become a mostly pay-for-use service, Walt Mossberg wrote.
- US home sales are still slumping, yet an increase in inventories of unsold houses is slowing, citing its own survey of 28 major metro markets.
- Nielsen Co. plans to present today the first results from Nielsen GamePlay Metrics, the service that tracks what games users are playing, on which devices and when.

NY Times:
- Mattel Inc.(MAT), which makes 65% of its toys in China, is a model for other toy companies doing business in the country.
- RC2 Corp.(RCRC) fired the Chinese-based producer of the lead paint and the maker of the wooden “Thomas & Friends” train toys that were recalled this year because of lead in the paint.

Xinhua News Agency:
- China will maintain a tight monetary policy to prevent the economy from “overheating,” reiterating the government’s top policy goal for the second half of 2007.

China Daily:
- China vowed to tighten rules ensuring the safety of its toy exports amid international concern over its product quality.