Stocks Soaring into Final Hour on Unexpected 50 Basis Point Fed Rate Cut

BOTTOM LINE: The Portfolio is higher into the final hour on gains in my Biotech longs, Medical longs, Semi longs, Networking longs and Retail longs. I covered my (IWM)/(QQQQ) hedge today, thus leaving the Portfolio 100% net long. The overall tone of the market is very positive today as the advance/decline line is substantially higher, almost every sector is gaining and volume is above average. While Lehman's(LEH) pretax earnings may have been seen as a disappointment by some, they were far from the unmitigated disaster that the stock had been pricing in as it moved relentlessly lower during July and August. As well, Lehman said its liquidity position is stronger than ever and the worst of the credit correction was behind them. The CEO of Hovnanian (HOV) also made some positive comments today. He said that credit availability was "not an issue at this time" and "traffic has been holding up quite nicely." The UK’s Northern Rock also said this morning that it has seen a significant fall-off in withdrawals. European bourses are up 1.5%-2%. Best Buy(BBY) beat estimates and raised its outlook today. This is also a large positive as the imminent consumer collapse argument continues to be supported by little evidence. As well, weekly retail sales rose 2.5% this week vs. a 2.8% gain the prior week. This is still near average rates and up from 1.4% in early July. The retail sector is one of today's best performers, rising 5.0%. There are also several other positives today. The yen is weakening against the U.S. dollar. The three-month Libor rate is falling another basis point and has declined 14 basis points in seven days. The speculative grade credit default swap index is down 3.6% over the last five days. The JPMorgan Emerging Market Bond Index is up 1.0% over the last five days, and the Bear Stearns (BSC) high-yield index is 0.61% higher over the same period. The CBOE total put/call 50-day moving average is 1.09, the highest in history. The VIX was still near early 2003 levels at 25.0 this morning. The 50-day moving average of the ISE Sentiment Index is 118, near its historic low at 110. Moreover, short interest has gone parabolic this year and is just off records. Public short-selling is at record levels, and large equity index futures traders are positioned very bearishly. The Fed has unexpectedly cut the fed funds rate and discount rate by 50 basis points. This has resulted in a gap higher, leaving many large investors likely very underexposed and feeling trapped. The S&P 500 is breaking free from its 50-day. The Nikkei is indicating an up 460 open in Japan. The 10-year yield, the best long-term predictor of inflation, is only 2 basis points higher so far. Fed funds futures are now placing a 72% chance of another 25 basis point cut in October. I expect US stocks to trade mixed-to-higher into the close from current levels on short-covering, performance anxiety, bargain-hunting and less economic pessimism.

Producer Prices Decline Substantially, Net Long-term TIC Flows Decelerate

- The Producer Price Index for August fell -1.4% versus estimates of a -.3% decline and a .6% rise in July.

- The PPI Ex Food & Energy for August rose .2% versus estimates of a .1% gain and a .1% increase in July.

- Net Long-term TIC Flows for July fell to $19.2 billion versus estimates of $85.0 billion and $97.3 billion in June.

BOTTOM LINE: Prices paid to US producers fell more than forecast in August, diminishing concern over inflation as the Fed considers lowering interest rates, Bloomberg said. A drop in fuel costs brought prices down in August and slowing demand should further restrain raw-material costs, according to economists. The spread between the yield on the 10-year and inflation-indexed bonds, which reflects investor expectations for inflation, is 2.34% today, down from an average of 2.39% over the last six months. Over the last 12 months, producer prices have risen 2.2% versus a 4% gain in July. As well, the PPI Ex Food & Energy rose 2.2% year-over-year versus a 2.3% gain in July. After an uptick next month, I expect producer prices to resume their intermediate-term deceleration. I still think all main measures of inflation have peaked for this cycle.

Foreign buying of US financial assets slowed in July as the weakness in subprime mortgages tempered international demand for American bonds, Bloomberg said. Including short-term securities, such as T-bills and non-market trades such as stock swaps, foreigners bought a net $103.8 billion, up from $34.4 billion the prior month. International holdings of US stocks rose a net $21.2 billion versus a net $28.8 billion in purchases during June. The difference between the US trade deficit and securities purchased by foreigners is an indication of how easily the US can finance its external obligations, according to economists. The trade deficit shrank .3% in July as exports surged the most in three years. Caribbean banking centers, which analysts link to hedge funds, sold a net $7.4 billion in treasury securities, bringing holdings to $29.4 billion, the lowest level since April 2002. Chinese investors increased their US government debt holdings by $2.7 billion to $407.8 billion. I continue to believe foreign demand for US assets will remain strong over the intermediate-term.

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Tuesday Watch

Late-Night Headlines
Bloomberg:
- VeraSun Energy Corp., the third-largest ethanol producer by capacity, and three other makers slid to one-year lows after separate analyst reports suggested an oversupply of the fuel would push prices lower. Ethanol has declined 35% this year, closing today on the Chicago Board of Trade at $1.61/gallon.

Wall Street Journal:
- E*Trade(ETFC) Warns of Mortgage Fallout.

MarketWatch.com:
- NY Times(NYT) said Monday evening that online content previously available through its paid, TimeSelect subscription service will be free, starting Wednesday.
- Fox Business Network opens a window. Commentary: Strategy becomes clearer before Oct. 15 launch.

NY Times:
- Some Toy Makers Shun the China Label.
- Google(GOOG) to Sell Web-Page Ads Visible on Mobile Phones.

CNNMoney.com:
- Why $80 oil won’t mean $3 gas. Experts say declining demand, cheaper blends will keep gasoline prices from following crude much higher.

Financial Times:
- The French government of President Nicolas Sarkozy on Monday stepped up its hostile stance towards Iran’s nuclear programme, raising for the first time the prospect of a European-wide sanctions regime against Tehran.
- Microsoft(MSFT) faces the threat of fresh antitrust probes and escalating financial penalties after a top European Union court upheld Brussels’ landmark 2004 competition ruling that found the world’s biggest software group guilty of abusing its dominant market position.

Late Buy/Sell Recommendations
Citigroup:
- Reiterated Buy on (CAG), target $33.
- Reiterated Buy on (HUM), target $66.
- Rated (CYPB) Buy, target $22.

Morgan Stanley:
- We have analyzed Countrywide’s(CFC) liquidity position in the wake of recent market disruptions. According to our revised projections, we tentatively conclude that the company has enough cash and cash flow to operate and repay financial obligations through 2008, without unsecured capital markets access. Our revised estimates of intrinsic value range from $20 to $31, based on assumptions of normalized profitability two-three years out, after the current crisis subsides. However, limited visibility into 2008 EPS, which range from $1.20 to $2.35 in our bear and bull cases, could limit upside potential in the short term. We remain Equal-weight.
- Reiterated Overweight on (MON), target raised to $95.

Night Trading
Asian Indices are -1.0% to unch. on average.
S&P 500 futures -.11%.
NASDAQ 100 futures -.11%.

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Earnings of Note
Company/EPS Estimate
- (AZO)/3.25
- (BBY)/.44
- (CBRL)/1.02
- (DRI)/.70
- (KR)/.34
- (LEH)/1.48

Upcoming Splits
- None of note

Economic Releases
8:30 am EST
- The Producer Price Index for August is estimated to fall .3% versus a .6% gain in July.
- The PPI Ex Food & Energy for August is estimated to rise .1% versus a .1% gain in July.

9:00 am EST
- Net Long-term TIC Flows for July are estimated to fall to $100.0 billion versus $120.9 billion in June.

1:00 pm EST
- The NAHB Housing Market Index for September is estimated to fall to 20 versus 22 in August.

2:15 pm EST
- The FOMC is expected to lower the fed funds rate to 5.0% from 5.25%.

Other Potential Market Movers
- The (CMI) Investor Conference, (AHS) analyst meeting, (WM) Investor Day, (AMB) Investor Forum, (PFE) analyst meeting, ThinkEquity Growth Conference, AG Edwards Emerging Growth Conference, CSFB Homebuilders Conference, Bank of America Investor Conference, Goldman Sachs Communacopia Conference, Merrill Lynch Media Fall Preview, UBS Global Paper and Forest Products Conference, Keybanc Basic Materials & Packaging Conference and Merriman Curhan Ford Investor Summit could also impact trading today.

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

Stocks Lower Ahead of Brokerage Sector Earnings and FOMC Announcement

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Stocks Mildly Lower into Final Hour on Rising Apprehension Ahead of FOMC Announcement

BOTTOM LINE: The Portfolio is slightly lower into the final hour on losses in my Biotech longs and Retail longs. I added (IWM)/(QQQQ) hedge today, thus leaving the Portfolio 75% net long. The overall tone of the market is negative today as the advance/decline line is lower, most sectors are falling and volume is below average. Investor uncertainty over the outcome and commentary of the upcoming Fed meeting remains high. According to Bloomberg, futures imply a 48% chance of a 50-basis-point fed funds rate cut. There is a 52% chance for a 25-basis-point cut. I still think a 25-basis-point cut is likely in the fed funds rate. As well, given recent financial market stability, the move higher in commodity prices and better economic data, the Fed's policy statement is likely to contain somewhat more hawkish commentary than many expect. If the Fed only cuts the fed funds rate 25 basis points, however, and shifts its policy bias to neutral, investors will likely be disappointed initially and sell stocks. I don't expect this selling to last and will look to increase market exposure into any weakness. Given the current extreme pessimism for the U.S. dollar, a bounce higher in the currency is likely, which may also pressure oil. While the investment banks' earnings reports won't be pretty, for the most part, I view the lifting of uncertainty regarding this issue as a large positive. As well, many investors, both pros and the public, remain positioned quite bearishly ahead of this week's significant uncertainty, which is another big positive. The three-month Libor rate is falling another 5 basis points and has dropped 13 basis points in six trading days. As well, the JPMorgan Emerging Market Debt Index has risen 1.1% over the last five days, and the Bear Stearns High-Yield Index is 0.25% higher over that same period. I expect US stocks to trade mixed into the close from current levels as rising apprehension ahead of the FOMC announcement and Lehman Brothers(LEH) earnings report tomorrow offsets short-covering and less credit market anxiety.