Stocks Slightly Lower into Final Hour on End-of-Quarter Profit-Taking

BOTTOM LINE: The Portfolio is slightly higher into the final hour on gains in my Networking longs, Retail longs and Internet longs. I have not traded today, thus leaving the Portfolio 100% net long. The overall tone of the market is slightly negative today as the advance/decline line is mildly lower, sector performance is mostly negative and volume is below average. High Yield Corporate Bond Funds saw $405 million in inflows this week, the greatest amount since June 1, 2005, which is a big positive. Once again, domestic mutual funds, which have been completely shunned during this bull market, saw outflows while non-domestic mutual funds saw inflows. Keeping the public afraid of U.S. stocks remains one of the bears' most successful weapons. I still believe the eventual participation by the general public in U.S. stock gains will help contribute to the "mother of all short-covering rallies." The proliferation of hedge funds and significant increase in turnover by many other funds since the bubble burst in 2000 usually leads to mild profit-taking at quarter's end, in my opinion. Bespoke Investment Group recently said that, since the fourth quarter of 2002, the S&P 500 has averaged a -0.01% decline over the final two days of the quarter and a -0.28% decline on the final day of the quarter. The Fed's Lockhart made several comments this morning. He painted an economic picture of mildly below-trend growth and moderate inflation, which is what I have been saying for some time. He said he expects third-quarter growth to come in at 2.5% and fourth-quarter growth to be lower. I have been saying that growth would average around 2%-2.5% during the second half of the year, notwithstanding fed funds rate cuts. He also said the Fed's Sept. 18 rate cut action was a "tactical move" to reduce the risks facing the economy from the rout in financial markets that gathered momentum in August. Fed funds futures now imply an 84% chance of a 25-basis-point fed funds rate cut at the October meeting. The AAII percentage of bulls rose to 49.4% this week from 39.2% the prior week. This reading is now modestly above average levels. The AAII percentage of bears rose to 34.2% this week from 31.7% the prior week. This reading is now above average levels. Moreover, the 10-week moving average of the percentage of bears is currently at 39.4%, 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 36.8%, 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 108.6% higher from October 2002 lows and is only 1.3% lower from its recent record set in July. While the percentage of bulls has rebounded recently, I would have to see several readings in the high 50s-low 60s before becoming concerned. US stock mutual funds have seen outflows for most of the past 5 years, there has been an explosion in low correlation/negative correlation US stocks strategies, there have been huge spikes in gauges of investor anxiety over the last couple of years on relatively mild market pullbacks, a fairly large chunk of the public generally hates US stocks and says they won’t ever invest in them again, the mainstream press obsesses with what is wrong or what could go wrong and long-term investors are denigrated, while day-trading is championed as a crash is always seen as just around the corner. I continue to believe overall investor sentiment regarding US stocks has never been worse in history with the S&P 500 right near a record high, which bodes very well for further outsized gains. I expect US stocks to trade modestly higher into the close from current levels on short-covering, bargain hunting, less economic pessimism, lower energy prices and investment manager performance anxiety.

Incomes Rise, Spending Jumps, Inflation Decelerates, Manufacturing Healthy, Construction Spending Rebounds, Confidence Still Low

- Personal Income for August rose .3% versus estimates of a .4% gain and a .5% increase in July.

- Personal Spending for August rose .6% versus estimates of a .4% gain and a .4% increase in July.

- The PCE Core for August rose .1% versus estimates of a .1% gain and a .1% increase in July.

- The Chicago Purchasing Manager Index for September rose to 54.2 versus estimates of 53.0 and 53.8 in August.

- Construction Spending for August rose .2% versus estimates of a .3% decline and a downwardly revised .5% decline in July.

- Final Univ. of Mich. Consumer Confidence for September fell to 83.4 versus estimates of 84.0 and a reading of 83.8 in August.

BOTTOM LINE: Consumer spending in the US rose more than forecast in August, despite the credit market turmoil, and real consumer spending rose the most in more than 2 years, Bloomberg reported. Moreover, the core PCE, the Fed’s favorite inflation gauge, rose 1.8% year-over-year, the smallest gain since February 2004. This inflation gauge is also well below the long-term average of 2.5%. Inflation-adjusted spending on durable goods, autos, furniture, and other long-lasting items, surged 2.8%. Receipts at automobile dealerships and parts stores rose the most since July 2006. Considering the gloom and doom perpetuated 24-7 in almost every media outlet during the month of August, the consumer spending number was very impressive. As well, the 10-year yield is falling another 3 basis points today as investors continue to ratchet down long-term inflation expectations. I still think inflation worries have peaked for this cycle and the long-term trend of disinflation remains firmly in tact, despite the rise in commodities and decline in the dollar which are being driven mostly by investment fund speculation. I expect consumer spending to remain relatively healthy over the intermediate-term as sentiment improves, housing fears subside, inflation continues to decelerate, interest rates remain low, the job market stays healthy, the unemployment rate remains historically low and stocks continue their major bull run.

US business activity accelerated more than expected this month as production and employment expanded and a measure of prices companies paid fell to the lowest since January, Bloomberg reported. The new orders component of the index fell to 56.2 from 58.4 in August. The inventories component fell to 38.2 from 44.6 the prior month. The order backlogs component jumped to 50.5 from 38.8 in August. The prices paid component plunged to 59.0 from 71.8 the prior month. Moreover, the NAPM-Milwaukee Index soared to 70, the highest on record going back to 1998. As well, the New Orders component of this index jumped to 81, also the highest on record. I continue to believe manufacturing will help boost overall US growth over the intermediate-term as companies gain confidence in the sustainability of the current expansion and rebuild depleted inventories.

The final reading on consumer confidence for September came in slightly below estimates, Bloomberg reported. I expect consumer sentiment to rebound sharply during the fourth quarter as stocks make new record highs, energy prices fall and housing fears subside to an extent. I still expect both main gauges of sentiment to rebound back near cycle highs over the intermediate-term.

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Friday Watch

Late-Night Headlines
Bloomberg:
- Sharp Corp., Japan’s biggest maker of liquid-crystal display televisions, climbed to the higher in more than a month on the Tokyo Stock Exchange after UBS AG raised its rating to “buy,” citing demand for large panels.
- Investors added $466 million to high-yield corporate bond funds, the biggest inflow in more than two years, JPMorgan Chase(JPM) said, citing figures from AMG Data Services. Net inflows in the week ended September 26 compared with net outflows of $32 million a week earlier and withdrawals of $154 million in the week ended September 12, according to a JPMorgan report yesterday.
- Blackstone Group LP(BX) and other private-equity firms will accumulate more pension-fund money than real-estate and hedge funds within three years, a Citigroup survey showed.
- Japan’s industrial output surged at the fastest pace in almost four years and household spending rebounded, signaling the economy may weather a US slowdown.

MarketWatch.com:
- Lenders are back in business after winning concessions.

NY Times:
- Bush Moves to Ease Flight Delays.

CNNMoney.com:
- Real estate investors are betting on bargains in depressed markets they think are ready to bounce back.

CNBC.com:
- Fed’s Mishkin Says Inflation Is Low Thanks to Policy.

Late Buy/Sell Recommendations
Citigroup:
- Reiterated Buy on (VZ), target $49.
- Reiterated Buy on (DVA), target $75.
- Reiterated Buy on (ZION), target $89.

BMO Capital:
- Rated (GILD) Outperform, target $51.
- Rated (VRTX) Outperform, target $44.
- Rated (PHRM) Outperform, target $57.
- Rated (MOGN) Outperform, target $33.
- Rated (MEDX) Underperform, target $11.

Business Week:
- Time Warner Telecom(TWTC), a provider of voice and Internet services for businesses, shows potential for “fast growth,” citing Joan Lappin, president of Gramercy Capital Management. She bought the stock at $5 and expects it to reach $35 in 18 months.
- Plum Creek Timber(PCL), a real estate investment trust that owns US timberland, could reach $60 a share after land purchases in Montana and Wisconsin, citing Benjamin Segal, president of Winchester Capital Management.
- Universal Electronics(UEIC), the maker of remote controls for TVs and other appliances, is likely to expand in Asia after signing a contract with PCCW Ltd. Investment firm B. Riley’s Michael Coady said the company, which is a client, may see its stock increase 31% within a year.

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Asian Indices are unch. to +.75% on average.
S&P 500 futures -.11%.
NASDAQ 100 futures -.21%.

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Economic Releases
8:30 am EST
- Personal Income for August is estimated to rise .4% versus a .5% gain in July.
- Personal Spending for August is estimated to rise .4% versus a .4% increase in July.
- The PCE Core for August is estimated to rise .1% versus a .1% gain in July.

9:45 am EST
-The Chicago Purchasing Manager Index for September is estimated to fall to 53.0 versus 53.8 in August.

10:00 am EST
- Construction Spending for August is estimated to fall .3% versus a .4% decline in July.
- Final Univ. of Mich. Consumer Confidence for September is estimated at 84.0 versus a prior estimate of 83.8.

Other Potential Market Movers
- The Fed’s Lockhart speaking, Fed’s Yellen speaking, Fed’s Poole speaking, Fed’s Mishkin speaking, NAPM-Milwaukee, (PRX) analyst meeting and JPMorgan Federal IT Services Forum could also impact trading today.

BOTTOM LINE: Asian indices are higher, boosted by commodity and technology stocks in the region. I expect US equities to open modestly lower and to rally into the afternoon, finishing modestly higher. The Portfolio is 100% net long heading into the day.

Stocks Finish Higher, Led by Technology and Commodity Shares

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Stocks Slightly Higher into Final Hour, Building on Recent Gains

BOTTOM LINE: The Portfolio is slightly higher into the final hour on gains in my Computer longs, Medical longs and Biotech 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, sector performance is positive and volume is below average. The market continues to mostly ignore negative news and reward positive news, which should worry the many "crash-callers." Nasdaq reported recently that short interest on the exchange from mid-August through mid-September fell 7.4%, from 8.99 billion shares to 8.32 billion shares. However, as on the NYSE, over the last seven months, Nasdaq short interest has rocketed 18.2%, the largest seven-month percentage gain since at least 1991, according to Bloomberg. Here are the 25 Nasdaq stocks with the largest percentage increase in their short interest relative to their float from mid-August through mid-September:

1. Global Crossing (GLBC, +34.9%)
2. Lululemon Athletica (LULU, +18.9%)
3. Triad Guaranty (TGIC, +17.5%)
4. Superconductor Technologies (SCON, +12.4%)
5. Infinity Property and Casualty (IPCC, +11.5%)
6. Take-Two Interactive Software (TTWO, +9.1%)
7. Fuel-Tech (FTEK, +9.0%)
8. Bankrate (RATE, +9.0%)
9. Crocs (CROX, +8.6%)
10. Horsehead Holding (ZINC, +8.4%)
11. NutriSystem (NTRI, +8.3%)
12. Conns (CONN, +7.5%)
13. Tuesday Morning (TUES, +5.7%)
14. Corcept Therapeutics (CORT, +5.7%)
15. RF Micro Devices (RFMD, +5.5%)
16. Vineyard National Bancorp (VNBC, +5.4%)
17. Hoku Scientific (HOKU, +5.4%)
18. Theravance (THRX, +5.3%)
19. Synchronoss Technologies (SNCR, +5.0%)
20. Vermillion (VRML, +5.0%)
21. Silverstar Holdings (SSTR, +4.9%)
22. Atmel (ATML, +4.8%)
23. California Coastal Communities (CALC, +4.7%)
24. Salix Pharmaceuticals (SLXP, +4.5%)
25. True Religion Apparel (TRLG, +4.4%)

The S&P 500 also reported short interest data. Only two industries reported an increase in short interest, materials (+6.8%) and consumer discretionary (+0.3%) Here are the 25 S&P 500 stocks with the largest percentage increase in short interest relative to their float from mid-August through mid-September:

1. Jones Apparel (JNY, +18.5%)
2. Rohm & Haas (ROH, +11.6%)
3. W.W. Grainger (GWW, +7.4%)
4. Parker-Hannifin (PH, +3.9%)
5. Archstone-Smith Trust (ASN, +3.8%)
6. Marsh & McLennan (MMC, +3.8%)
7. Dillard's (DDS, +3.6%)
8. UST Incorporated (UST, +3.4%)
9 Bear Stearns (BSC, +3.4%)
10. MBIA (MBI, +3.4%)
11. DR Horton (DHI, +3.1%)
12. Verisign (VRSN, +2.8%)
13. Network Appliance (NTAP, +2.7%)
14. Ryder System (R, +2.4%)
15. Clorox (CLX, +2.2%)
16. Black & Decker (BDK, +2.1%)
17. Ambac Financial Group (ABK, +2.0%)
18. Big Lots (BIG, +1.9%)
19. RadioShack (RSH, +1.9%)
20. Sears Holdings (SHLD, +1.8%)
21. Family Dollar Stores (FDO, +1.6%)
22. Centurytel (CTL, +1.5%)
23. Masco (MAS, +1.3%)
24. Harrah's Entertainment (HET, +1.3%)
25. Circuit City (CC, +1.3%)

I expect US stocks to trade mixed-to-higher into the close from current levels on short-covering, lower long-term rates and investment manager performance anxiety.