Stocks Sharply Lower into Final Hour on Economic Concerns

BOTTOM LINE: The Portfolio is lower into the final hour on losses in my Computer longs, Semi longs and Medical longs. I have not traded today, thus leaving the Portfolio 75% net long. The overall tone of the market is negative today as the advance/decline line is substantially lower, every sector is falling and volume is about average. I wrote several times earlier in the week about the likelihood of a weaker-than-expected jobs report, however I am surprised that the market's reaction is this harsh to something that many were expecting. I think this report solidifies a 25-basis-point cut at the upcoming Fed meeting and puts the possibility of a 50-basis-point cut on the table. A 50-basis-point cut would likely require more significant economic data weakness over the next 10 days and a move in the 10-year yield below 4.25%. I think that is unlikely and still expect a 25-basis-point cut at the Sept. 18 meeting. BMW, Audi and Mercedes all said August sales were healthy today. The High Yield Index and Emerging Market Debt Index are 0.4% and 0.6% higher, respectively, over the last five days. Also, the 10-year swap rate is falling 6%, to 65.1 basis points over Treasuries, which is also positive. The AAII percentage of bulls fell to 38.4% this week from 40.3% the prior week. This reading is still below average levels. The AAII percentage of bears fell to 42.4% this week from 46.3% the prior week. This reading is still approaching elevated levels. Moreover, the 10-week moving average of the percentage of bears is currently at 39.3%, a high level. The 10-week moving average of the percentage of bears peaked at 43.0% at the major bear-market low during 2002. The 50-week moving average of the percentage of bears is currently 37.1%, an elevated level seen during only two other periods since tracking began in the 1980s. Those periods were October 1990-July 1991 and March 2003-May 2003, both of which were near major stock market bottoms. The extreme readings in the 50-week moving average of the percentage of bears during those periods peaked at 41.6% on Jan. 31, 1991, and 38.1% on April 10, 2003. We are currently very close to eclipsing the peak in bearish sentiment during the 2000-2003 market meltdown, which I still find astonishing, notwithstanding the recent correction. The S&P 500 is still 101.3% higher from October 2002 lows and is only 5.9% lower from its recent record set in July. I expect US stocks to trade modestly higher into the close from current levels on more Fed rate cut speculation, short-covering and bargain-hunting.

Today's Headlines

Bloomberg:
- Losses stemming from funds that borrow in the asset-backed commercial paper market are “manageable” for most banks, Fitch Ratings said.
- The US dollar is falling to the lowest in a month against the euro and weakened versus the yen after the jobs report.
- Treasury two-year notes had their second-largest gain in three years as a loss in jobs last month bolstered expectations the Fed will cut rates by at least a quarter percentage point this month.
- TXU stockholders approved the $32 billion sale of the largest Texas power producer to a group led by KKR and TPG Inc., clearing the way to complete the biggest leveraged buyout in US history.
- Investors added $197 million to high-yield bond funds in the past week, the most since May, as confidence in more risky debt instruments improved, according to JPMorgan Chase, citing AMG Data Services.
- AU Optronics(AUO) led shares of liquid-crystal display makers higher in Asia after the company posted record monthly sales and prices increased for panels used in computer monitors and notebooks.

Wall Street Journal:
- In a bid to rejuvenate lagging sales of its big sports drink, Gatorade, PepsiCo Inc.(PEP) is launching a low-calorie drink aimed at athletes off the field.
- Congressional Democrats are considering a proposal that would dramatically reduce hedge-fund manager’s ability to put off paying taxes on their compensation.
- GAM, one of the largest fund-of-hedge-funds managers, and rival Thames River Capital are primed to make substantial investments in the stalled bank-loan market, buying debt at a discount from lenders anxious to have it removed from their balance sheets.
- Morgan Stanley’s(MS) quantitative investment unit, known as PDT, for Process Driven Trading, lost about $500 million between the last week of July and Aug. 9.

NY Times:
- General David Petraeus, the top US commander in Iraq, wants to keep heightened troop levels in Iraq though much of next year to maintain military gains.
- US presidential candidate Mitt Romney wants to end taxes on most investment earnings for families that makes less than $200,000 a year.

BusinessWeek.com:
- Light at the End of the Subprime Tunnel.

San Francisco Chronicle:
- San Francisco would offer its own identification cards to illegal immigrants, under legislation being drafted by city Supervisor Tom Amiano. The cards would be accepted by all city agencies and organizations that receive city funding.

Forbes.com:
- Larger financial institutions will increasingly purchase hedge fund firms, potentially fueling industry consolidation over the next three years, according to a survey conducted by CPA firm Rothstein Kass.

AP:
- Fugitive Democratic fund-raiser Norman Hsu was arrested in Colorado late yesterday.
- Former North Carolina prosecutor Mike Nifong reported to jail today to begin serving a 24-hour sentence for lying to a judge during the now-discredited Duke lacrosse rape case.

Financial Times:
- Carlyle Group, the buyout firm run by David Rubenstein, may buy financial services companies and is hiring a team of former bank executives, citing Jean-Pierre Millet, head of Carlyle’s European business.

Reuters:
- India’s Simbhaoli Sugar Mills Ltd. will boost ethanol production 50% by March because of declining sugar prices.
- Goldman Sachs(GS) has raised more than $1.5 billion for a fund that will acquire distressed debt, including mortgages and buyout loans. Several other hedge funds and private-equity firms are seeking capital for distressed-debt funds.
- Cisco Sytems(CSCO) CEO John Chambers said the US economy may be headed for a “soft landing” and the Federal Reserve may cut interest rates.

Non-farm Payrolls Decline, Unemploymen Rate Remains Historically Low, Average Hourly Earnings Very Healthy, Inventories Rise Less Than Estimates

- The Change in Non-farm Payrolls for August was -4K versus estimates of 100K and a downwardly revised 68K in July.

- The Unemployment Rate for August came in at 4.6% versus estimates of 4.6% and 4.6% in July.

- Average Hourly Earnings for August rose .3% versus estimates of a .3% gain and a .3% rise in July.

- Wholesale Inventories for July rose .2% versus estimates of a .4% gain and a downwardly revised .3% increase in June.

BOTTOM LINE: The US economy unexpectedly lost jobs in August for the first time in four years, increasing speculation that the Federal Reserve will reduce interest rates at its Sept. 18 meeting, Bloomberg reported. The 10-year yield is falling 14 basis points to 4.37%. Manufacturers, builders and the government led the drop in payrolls. Service industries, which include banks, insurance companies, restaurants and retailers, added 60,000 jobs last month. Average weekly hours held steady at 33.8. As well, Average Weekly Earnings rose to $591.50 in August, up from $589.81 in July. Moreover, Average Hourly Earnings rose 3.9% year-over-year, almost twice most measures of inflation. While the labor market is going through a near-term transition, the unemployment rate is still historically low. Next month will likely show further weakness, however I still expect the job market to remain healthy over the intermediate-term.

Inventories at US wholesalers rose less than forecast in July, Bloomberg reported. Sales at wholesalers gained .1%. Companies had goods on hand to last just 1.11 months at the current sales pace, the same as June. I continue to believe inventory rebuilding will help boost overall US economic growth over the intermediate-term as companies gain confidence in the sustainability of the current expansion.

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Friday Watch

Late-Night Headlines
Bloomberg:
- California’s Senate approved a bill that would force the state’s two public pension funds, the largest in the US, to sell their investments in some companies that do business in Iran.
- Democratic Representative Sander Levin said he would introduce legislation allowing universities such as Harvard, Yale and Stanford to invest in hedge funds in the US without incurring a tax penalty.
- SAC Capital Advisors LLC raised $1 billion from investors in August as financial markets fell on concerns that subprime-mortgage defaults would slow the economy. The new money increased SAC’s assets to about $15 billion during a month when the Stamford, Connecticut-based firm’s main fund lost 3%, according to an investor.
- Following are comments by Robert Steel, the US Treasury’s undersecretary for domestic finance, on the slump in the commercial paper market. “We’re vigilant on this issue and we’re understanding it and monitoring it. I think for now, things are working and they have improved from where they were at the bottom. We believe liquidity is beginning to come back, but we are vigilant and focused on the issue.”
- Pakistan won’t be a “soft state” for terrorists, President Pervez Musharraf said, after more than 270 people were killed in attacks since July, including two bombs this week in Rawalpindi where he has a residence.

AP:
- Lower-division schools are eligible for the AP’s college football Top 25 poll for the first time in its 71-year history following Appalachian State’s season-opening upset of Michigan. The AP said several poll voters this week expressed interest in voting for the Mountaineers, who play in the Football Championship Subdivision – the second tier formerly known as Division I-AA – and that the decision was made because programs that show they can compete with top-level schools should be recognized with them..

Financial Times:
- Goldman Sachs(GS) made $300 million last month from rescuing one of its hedge funds.

AFP:
- Osama Bin Laden will address the American people in a video message on the sixth anniversary of the Sept. 11 attacks, citing US monitoring service SITE.

Commercial Times:
- Acer Inc.’s notebook computer shipments will reach 15 million units this year, exceeding the company’s projection.

Late Buy/Sell Recommendations
Citigroup:
- Reiterated Buy on (IDTI), target $20.
- Reiterated Buy on (GOOG), target $600. Updating out long thesis based on 3 factors: 1) Analysis of comScore’s search tracking changes indicates a stronger GOOG market position than prior realized. comScore’s recently revamped search tracking methodology reveals that in July, Google enjoyed over 55% US query market share, up 9% Y/Y vs. Y/Y share declines for each of the other major search destinations. 2) Takeaways from GOOG’s presentation at out Tech Conference signals still material upside in core search. GOOG’s recent paid search algorithm change is showing initial positive results on both click-thru rates and CPCs, GOOG would appear to be relatively well insulated from mortgage advertising weakness and underlying advertiser demand remains robust. 3) Analysis of YouTube’s ad innovations highlights new, albeit near-term small, revenue opportunity. We estimate $135 million in 08 net revenue.

Morgan Stanley:
- Reiterated Overweight on (CBG), target $47.

Night Trading
Asian Indices are -.25% to +.50% on average.
S&P 500 futures -.14%.
NASDAQ 100 futures -.16%.

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Earnings of Note
Company/EPS Estimate
- (HITK)/-.22

Upcoming Splits
- (MTW) 2-for-1
- (MDR) 2-for-1
- (NVDA) 3-for-2

Economic Releases
8:30 am EST
- The Change in Non-farm Payrolls for August is estimated at 100K versus 92K in July.
- The Unemployment Rate for August is estimated at 4.6% versus 4.6% in July.
- Average Hourly Earnings for August are estimated to rise .3% versus a .3% gain in July.

10:00 am EST
- Wholesale Inventories for July are estimated to rise .4% versus a .5% gain in June.

Other Potential Market Movers
- The (MOT) financial analyst meeting, Thomas Weisel Healthcare Conference and the Morgan Keegan Equity Conference could also impact trading today.

BOTTOM LINE: Asian indices are mostly higher, boosted by technology and commodity stocks in the region. I expect US equities to open modestly lower and to rally into the afternoon, finishing mixed. The Portfolio is 75% net long heading into the day.

Stocks Finish Mildly Higher on Positive Economic Data

Indices
S&P 500 1,478.55 +.43%
DJIA 13,363.35 +.44%
NASDAQ 2,614.32 +.32%
Russell 2000 792.92 +.31%
Wilshire 5000 14,863.57 +.40%
Russell 1000 Growth 598.0 +.45%
Russell 1000 Value 825.49 +.37%
Morgan Stanley Consumer 715.36 +.80%
Morgan Stanley Cyclical 1,027.64 +.71%
Morgan Stanley Technology 645.56 +.48%
Transports 4833.73 +.06%
Utilities 493.75 +1.15%
MSCI Emerging Markets 135.41 +1.20%

Sentiment/Internals
Total Put/Call .90 -21.74%
NYSE Arms .92 -42.51%
Volatility(VIX) 23.99 -2.40%
ISE Sentiment 152.0 +46.15%

Futures Spot Prices
Crude Oil 76.39 +.87%
Reformulated Gasoline 197.30 -1.18%
Natural Gas 5.59 -3.57%
Heating Oil 213.75 +1.79%
Gold 705.40 +2.11%
Base Metals 226.94 -2.58%
Copper 330.25 +1.21%

Economy
10-year US Treasury Yield 4.51% +4 basis points
US Dollar 80.46 -.20%
CRB Index 311.76 +.27%

Leading Sectors
Biotech +1.68%
Steel +1.45%
Utilities +1.15%

Lagging Sectors
Homebuilders -.77%
Airlines -1.05%
Tobacco -1.06%

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Afternoon Recommendations
RBC:
- Rated (TEL), target $41

Oppenheimer:
- Rated (PRM) Buy, target $20.

Afternoon/Evening Headlines
Bloomberg:
- US stocks resumed their late-summer recovery from a deepening housing slump after retailers’ August sales exceeded estimates and the government said worker efficiency is improving.
- Four regional Fed bank presidents declined to endorse a cut in the benchmark interest rate this month, as policy makers gauge the impact of the credit-market rout on the US economy.
- Apple Inc.(AAPL) CEO Jobs apologized to customers who bought the iPhone before he cut the device’s price by $200 yesterday.

BOTTOM LINE: The Portfolio finished about even today as losses in my Retail longs and Computer longs offset gains in my Medical longs and Biotech longs. I added to my (EEM) short and (IWM)/(QQQQ) hedges in the final hour, thus leaving the Portfolio 75% net long. The tone of the market was slightly positive today as the advance/decline line finished mildly higher, most sectors rose and volume was below average. Measures of investor anxiety were slightly above average into the close. Today's overall market action was mildly bullish. Commodities and biotechs were sources of strength today. Growth stocks again outperformed value. Given some of the Fed's comments today, the market once again displayed resilience. Oil is 0.57 higher, but natural gas dropped another 3.5%. Gold broke higher today, which I believe is more a function of diminishing global credit worries rather than rising inflation concerns. Apple (AAPL) headed into positive territory this afternoon only to be knocked down after news broke of the $100 iPhone rebate to existing customers. While I don't think the rebate was necessary, it likely turned a PR negative into a PR positive. Apple will be perceived as a company that "did the right thing" at a time when that is viewed as unusual by most consumers. I still think the stock moves substantially higher from current levels.