Stocks Building on Yesterday's Sharp Gains into Final Hour on Rapidly Improving Credit Markets, Low Inflation Reading

BOTTOM LINE: The Portfolio is higher into the final hour on gains in my Internet longs, Medical longs and Computer longs. I have not traded today, thus leaving the Portfolio 100% net long. The overall tone of the market is positive today as the advance/decline line is higher, almost every sector is gaining and volume is above average. Morgan Stanley (MS) reported disappointing results, however the brokers are surging another .65% today after yesterday’s huge move higher. This, along with Lehman's (LEH) report, just shows how much bad news is already priced into this sector. Moreover, Morgan Stanley said the worst of the credit crisis is over. Financial sector credit default swaps have plunged the last two days. The CPI for August came in below estimates and is rising at a 2.0% rate year-over-year, well below the long-term average of 3.1%. The 10-year/TIPS spread, a gauge of inflation expectations, is falling 6 basis points, to 2.32%. However, the 10-year yield is rising 5 basis points on a flight from safety. The dollar-based three-month Libor rate is plunging 35 basis points today, to 5.24%, the lowest since May 2006. The 10-year swap rate is plunging 12% today, to 60.25 basis points, over Treasuries. The 30-year average jumbo fixed-rate mortgage is dropping another 8 basis points today, to 7.03%, down 31 basis points in six days. Weekly mortgage applications rose 2.4%, boosted by a 4.6% surge in refis. According to Rasmussen, consumer confidence is beginning to improve, with only 17% rating their finances as poor. Oil inventories fell more than estimates, but gas supplies unexpectedly rose. According to the API, U.S. oil demand was down 2.2% in August. The yen is lower against the U.S. dollar again, which is a positive. A number of sectors are rising more than 1% again today. The VIX fell below 20 for the first time since Aug. 8. Despite the last two days gains, my intraday gauge of investor angst is only around average levels. The LCDX leveraged loan index, which tracks prices on credit derivative swaps for U.S. junk bonds, is improving rapidly. It is now back to levels seen in mid-July, right before the credit market turmoil began to accelerate. This is another large positive. A significant leveraged buyout right now certainly would catch many by surprise. Given the news over the last two days, I am actually surprised stocks aren't up more. Most U.S. stocks are still cheap given the macro backdrop. Back during August, I said that I strongly disagreed with those who said that a Fed rate cut wouldn't help the economy or stocks. The evidence over the last two days overwhelmingly backs up that view. 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.

Today's Headlines

Bloomberg:
- The European Central Bank might have to cut interest rates, even if the immediate outlook for growth and inflation suggests otherwise, because a general credit crisis could cause a recession, according to Eric Chaney, Morgan Stanley’s chief economist for Europe.
- Clean Energy Fuels Corp. rose the most since May after co-founder Boone Pickens said the company is “ahead of the curve” by selling natural gas that the US will use as a transportation fuel because it’s “going green.”
- Morgan Stanley(MS) said it sees no hedge fund defaults in its prime brokerage unit.
- The risk of lending to US companies fell to the lowest in almost a month on optimism the Fed’s rate cut will coax investors back to the corporate debt market, according to credit-default swap traders.
- Honeywell Intl.(HON) won $16 billion contract to build and service mechanical systems for Airbus SAS’s A350 wide-body plane, work that will take place over at least two decades.
- Carlyle Group co-founder David Rubenstein, who was forced to delay the sale of cable-television operator Insight Communications, said the Fed’s interest-rate cut may help clear a bottleneck of transactions.
- The Bush Administration reversed policy, allowing Fannie Mae(FNM) and Freddie Mac(FRE), the nation’s two largest providers of mortgage finance, to expand their investments in an effort to make mortgages easier to get.

Wall Street Journal:
- Defense Secretary Robert Gates sketched out a long-term vision for securing Iraq that includes a continuing American military force that is a fraction the size of the one there today, no permanent US bases and a significant Navy and Air Force presence in the Persian Gulf region.

NY Times:
- To gain an edge in attracting top talent, some NY hedge funds offer their employees an amenity that once was available only in residential buildings: a gym right in the workplace.

CNNMoney.com:
- China may import as much as 10 million metric tons of liquefied natural gas a year by 2010, citing Zeng Jian, vice commissioner of the Economic and Trade Commission of Guangdong province.

Dow Jones:
- Citigroup(C), the largest US bank, is planning raises for the majority of the brokers in its Smith Barney brokerage unit. The increase, scheduled to be announced in October by the NY-based bank, will boost the pay of 80% of Smith Barney’s brokers, especially those who generate $300,000 or more annually in commissions and fees.

Reuters:
- The Federal Reserve’s deep cut in benchmark US interest rates may revive the loan market by early 2008, a Bear Stearns(BSC) director and other top executives said at Reuters Loan Pricing Corp.’s Gold Sheets conference on Wednesday.

Daily Telegraph:
- Lloyds TSB Group Plc may be working with UBS AG on a possible bid for at least some of Northern Rock Plc, the UK lender bailed out by the Bank of England last week.

Consumer Inflation Decelerates Further, Housing Starts Fall

- The Consumer Price Index for August fell -.1% versus estimates of unch. and a .1% increase in July.

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

- Housing Starts for August fell to 1331K versus estimates of 1350K and a downwardly revised 1367K in July.

- Building Permits for August fell to 1307K versus estimates of 1348K and an upwardly revised 1389K in July.

BOTTOM LINE: Consumer prices in the US unexpectedly fell in August for the first time this year, as Americans paid less for gasoline and housing costs were unchanged, Bloomberg said. Gasoline prices fell 4.9% during the month. Clothing prices fell .5% following a .4% gain in July. Medical prices rose .5% versus a .6% increase in July. Auto prices rose just .1%. The Consumer Price Index is now rising at a 2.0% rate year-over-year versus the long-term average of 3.1% and 4.3% in June of last year. I continue to believe inflation has peaked for this cycle and that the long-term trend of disinflation remains firmly in tact.

Builders in the US began work on the fewest homes in 12 years in August, which should help reduce bloated inventories, Bloomberg reported. Residential construction is now down 19% over the last 12 months. The decrease in starts was led by a 38% drop in the Northeast and an 18% decline in the West. Construction increased 11% in the South and 4.2% in the Midwest. I continue to believe home construction will remain muted over the intermediate-term as homebuilders work down inventories.

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Wednesday Watch

Late-Night Headlines
Bloomberg:
- Most ABX indexes jumped, suggesting the perceived risk of subprime-mortgage securities fell, after the Fed lowered its benchmark interest rate a half-percentage point to blunt the effect of a slowdown in housing.
- JPMorgan Chase(JPM) promoted Tom Lee to chief US equity strategist, filling the position vacated when Abhijit Chakrabortti joined rival Morgan Stanley(MS) last month.
- Russian and Chinese spying on the US is approaching Cold War levels, the top US intelligence official told a House committee.
- Typhoon Wipha slammed into the eastern coast of China with winds of 116 mph and headed toward Shanghai, the country’s financial capital, where 200,000 people were evacuated.

Wall Street Journal:
- Stocks Soar as Bernanke Tackles Credit Crunch With Half-Point Move.
- Sun Microsystems(JAVA) expects revenue in China to double within three years, citing executives.
- Countrywide Financial Corp.(CFC) plans to double the number of branches that offer certificates of deposit and money-market accounts, aiming to obtain more deposits to fund mortgage lending.

MarketWatch.com:
- The move by E-Trade Financial(ETFC) to unload its troubled wholesale mortgage business makes the online broker much more attractive as a prospective buyout candidate, according to several analysts.
- Kiss-ups and slackers are equally annoying at work: poll.

NY Times:
- Intel(INTC) gave the first public demonstration on Tuesday of a new generation of computer processors that significantly increase performance without consuming more power.

CNNMoney.com:
- Fed cut could buoy housing markets.

CNBC.com:
- Darden Restaurants(DRI) reported a 20% rise in quarterly net earnings, helped by higher prices and increased customer traffic at its Red Lobster and Olive Garden restaurants. Shares of Darden traded up 1.5% in post market trading after finishing the regular session up 3.5% at $43.84.

Forbes.com:
- Countrywide Financial Corp.(CFC) Chairman and CEO Angelo Mozilo delivered a bullish outlook Tuesday for his company as it grapples with the ongoing housing downturn.

USA Today.com:
- Mattel toys’ lead was 180 times the limit.
- Wal-Mart, whose health coverage for employees has been a target of critics, says it will offer improved options for workers next year that include $4 generic drugs and monthly premium costs of as low as $4.36 on some of its plans.
- Murdoch: Fox business channel aiming at Main Street. “CNBC is a financial channel for Wall Street,” Murdoch told an investor conference in NY sponsored by Goldman Sachs(GS). “We’re for Main Street.” “They dwell too much on failures or scandals,” Murdoch said. “We want to put a lot on innovations and successes, people who are making money.”

Financial Times:
- China Construction Bank, the nation’s second-largest lender, reduced its investment in the country’s “overheated” property market, citing Chairman Guo Shuqing.
- Dick Parsons, chairman and chief executive of Time Warner(TWX), said the company was taking a “hard look” at spinning off its cable division.
- Lehman Brothers(LEH) helped ease concern about the effect of the credit squeeze on bank earnings on Tuesday when it reported better-than-expected third-quarter results and signaled its belief that the worst of the market turmoil was over.

Reuters:
- Fed brightens bank picture, may help deal makers.
- Nasdaq Stock Market(NDAQ) is poised to launch an index made up of companies whose primary focus is the development of drugs, devices and diagnostics to treat neurological disorders, including Alzheimer’s disease, Parkinson’s disease and schizophrenia.
- News Corp.(NWS/A) chief Rupert Murdoch on Tuesday sketched out early plans for Dow Jones, saying he leaned toward making the online Wall Street Journal free but had not yet made a decision.

Economic News:
- Infosys Technologies Ltd. may compete with Microsoft Corp.(MSFT) in a $6.4 billion bid for Sage Group Plc. Intuit Inc.(INTU) and Goldman Sachs(GS) are also likely bidders for Sage. Sage is Britain’s biggest maker of accounting software.

Late Buy/Sell Recommendations
Citigroup:
- eBay’s(EBAY) core growth rate trends in the US improved materially this week, with core down 6.9% y/y QTD, an improvement versus down 8.1% y/y last week. Listings were up 3% w/w, as September promotion and seasonality continue to drive w/w growth acceleration. Maintain Buy rating.
- Reiterated Buy on (NLY), target raised to $19.
- Reiterated Buy on (INTC), target $31.

Night Trading
Asian Indices are +1.0% to +3.25% on average.
S&P 500 futures -.08%.
NASDAQ 100 futures -.04%.

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Earnings of Note
Company/EPS Estimate
- (AIR)/.39
- (KMX)/.29
- (CKR)/.21
- (CLC)/.49
- (CMTL)/.47
- (DBRN)/.42
- (GIS)/.80
- (MLHR)/.50
- (MS)/1.55

Upcoming Splits
- None of note.

Economic Releases
8:30 am EST
- The Consumer Price Index for August is estimated to rise 0.0% versus a .1% gain in July.
- The CPI Ex Food & Energy for August is estimated to rise .2% versus a .2% gain in July.
- Housing Starts for August are estimated to rise to 1350K versus 1381K in July.
- Building Permits for August are estimated to fall to 1348K versus 1373K in July.

10:30 am EST
- Bloomberg consensus estimates call for a weekly crude oil drawdown of 2,025,000 barrels versus a 7,011,000 barrel decline the prior week. Gasoline supplies are estimated to fall by 1,000,000 barrels versus a 666,000 barrel decline the prior week. Distillate supplies are expected to rise by 1,225,000 barrels versus a 1,793,000 barrel build the prior week. Finally, Refinery Utilization is expected to fall by .5% versus a 1.56% decline the prior week.

Other Potential Market Movers
- The weekly EIA energy inventory report, weekly MBA Mortgage Applications report, (NCX) analyst meeting, RBC Consumer Conference, Keybanc Capital Basic Materials & Packaging Conference, ThinkEquity Growth Conference, AG Edwards Emerging Growth Conference, Bank of America Investor Conference, Goldman Sachs Communacopia Conference and UBS Global Paper and Forest Products Conference could also impact trading today.

BOTTOM LINE: Asian indices are sharply 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 Soar Most in 4 Years as Fed Unexpectedly Slashes Rates 50 Basis Points

Indices
S&P 500 1,519.78 +2.92%
DJIA 13,739.39 +2.51%
NASDAQ 2,651.66 +2.71%
Russell 2000 806.63 +3.97%
Wilshire 5000 15,239.90 +2.92%
Russell 1000 Growth 609.96 +2.70%
Russell 1000 Value 853.05 +3.08%
Morgan Stanley Consumer 734.34 +2.35%
Morgan Stanley Cyclical 1,049.51 +3.90%
Morgan Stanley Technology 651.96 +2.52%
Transports 4,932.86 +3.92%
Utilities 504.87 +2.01%
MSCI Emerging Markets 139.42 +2.67%

Sentiment/Internals
Total Put/Call 1.05 +1.94%
NYSE Arms .29 -74.36%
Volatility(VIX) 20.35 -23.15%
ISE Sentiment 118.0 +24.21%

Futures Spot Prices
Crude Oil 82.29 +2.1%
Reformulated Gasoline 207.76 +1.63%
Natural Gas 6.53 -1.73%
Heating Oil 226.02 +1.41%
Gold 732.50 +1.20%
Base Metals 233.63 -.38%
Copper 349.0 +2.06%

Economy
10-year US Treasury Yield 4.47% +1 basis point
US Dollar 79.18 -.67%
CRB Index 326.79 +.59%

Leading Sectors
Homebuilders +6.12%
Steel +6.06%
Retail +5.3%

Lagging Sectors
HMOs +1.64%
Hospitals +1.51%
Foods +.47%

Evening Review
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Afternoon Recommendations
Citigroup:
- Reiterated Buy on (VECO).

Afternoon/Evening Headlines
Bloomberg:
- US stocks rallied the most in four years, gold climbed to a 27-year high and two-year Treasury notes gained after the Fed cut its benchmark lending rate by half a percentage point to keep the economy from slowing.
- The Fed lowered its benchmark interest rate by a half point to 4.75%, the first cut in four years.
- Bill Gross, manager of the world’s biggest bond fund at PIMCO, said the Fed may cut interest rates another 2 percentage points.
- The SEC is examining hedge funds for signs of insider trading, demanding information about relationships between managers, employees, family members and public companies.
- Brokerage stocks had their biggest gain in more than a year after the Fed cut its benchmark lending rate to keep the real estate slump from dragging down the US economy and Lehman(LEH) reported a smaller-than-expected drop in profit.
- Hogs fell to a six-month low after China said it will spend $200 million to boost domestic production in a bid to curb high pork prices and food inflation.
- Crude oil climbed above $82/bbl. to a record in NY after the Fed reduced US interest rate more than economists expected.
- US options prices plunged the most since June 2006 on speculation the Fed’s first interest-rate cut since 2003 will calm share-price swings and prevent a recession.
- Best Buy(BBY), the largest consumer-electronics retailer, reported an unexpected rise in profit and increased its yearly earnings forecast on computer and international sales. The shares had their biggest gain in a year.

Advertising Age:
- Google Inc.(GOOG) hired Andy Berndt, co-president of Ogilvy & Mather’s NY office, to head a new unit that will work with marketers, ad agencies and entertainment companies, citing executives.

AP:
- The National Weather Service will narrow areas covered by storm warnings, thanks to a technology that promises to more accurately predict which places are in danger.

BOTTOM LINE: The Portfolio finished higher today on gains in my Retail longs, Biotech longs, Semi longs, Internet longs and Medical longs. I did not trade in the final hour, thus leaving the Portfolio 100% net long. The tone of the market was very positive today as the advance/decline line finished substantially higher, every sector rose and volume was above average. Measures of investor anxiety were slightly above-average into the close, despite today’s gains. Today's overall market action was very bullish. Many stocks and sectors rose substantially more than the major averages. Moreover, the best predictor of long-term inflation, the 10-year yield, is only 1 basis point higher, to 4.48%, on the Fed's move, and the yen is at session lows vs. the U.S. dollar. Fed fund futures now imply an 86% chance of another 25-basis-point cut in October. The 10-year swap rate fell 8.1% today, to 62.63 basis points, over Treasuries. This is the lowest reading since July 5 and a large positive. November home price futures ticked up to $212,800 from $212,200 today. Nikkei futures are now indicating an up 500 open in Japan tonight. The S&P 500 busted free from its 50-day moving-average today and is only 1.8% from its record high reached in July. Many growth stock managers I know are up 30%-40% year-to-date, at their performance highs for the year. Once again, it didn't pay to panic when the usual suspects were screaming about bear markets, crashes and depressions right at the bottom. It is always important to remember that there has never before in U.S. history been so many investors that actually need the market and economy to implode for their style to make sense, and this was never more evident than during the latest correction in this major bull run. It is also one of the main reason sthat stocks likely have much further upside from current levels.