Stocks Finish Slightly Higher on Rising Anxiety Ahead of Tomorrow's Employment Report

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Stocks Mixed into Final Hour Ahead of Tomorrow's Employment Report

BOTTOM LINE: The Portfolio is mixed into the final hour as losses in my Internet longs and Computer longs are offset by gains in my Medical longs and Biotech longs. I have not traded today, thus leaving the Portfolio 100% net long. The overall tone of the market is slightly positive today as the advance/decline line is mildly higher, most sectors are gaining and volume is below average. I suspect that tomorrow's jobs report will come in modestly below estimates of 100,000. As long as we don't see another negative number, investors will likely be OK with a mild disappointment. A negative number would likely produce a negative market reaction initially, but would ensure another Fed rate cut, in my opinion, which could boost stocks later in the day. A number above 175,000 may result in initial market strength, but would significantly lower the odds of a fed funds rate cut at the upcoming meeting. Fed fund futures now imply a 70% chance for a 25-basis-point cut at the upcoming meeting, down from 86% a week ago. I still think the Fed hasn't made up its mind yet and the odds are closer to 50/50. The AAII percentage of bulls rose to 51.8% last week from 49.4% the prior week. This reading is still modestly above average levels. The AAII percentage of bears fell to 25.3% last week from 34.2% the prior week. This reading is now modestly below average levels. However, the 10-week moving average of the percentage of bears is currently at 38.3%, 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 36.7%, 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. The S&P 500 is 110% higher from October 2002 lows and is only 0.4% lower from its recent record set in July. While bullishness has rebounded recently, I would have to see several readings in the high 50s/low 60s before becoming concerned. We are just now getting back to normal bull market levels in most gauges of investor sentiment. I see no signs of excessive optimism in our market, outside of the Chinese ADRs. Moreover, U.S. stock mutual funds have seen outflows for most of the past five years; there has been an explosion in low correlation/negative correlation U.S. stock strategies; there have been huge spikes in gauges of investor anxiety over the last couple of years on relatively mild market pullbacks; permabear pundits are more popular than ever; a fairly large chunk of the public generally hates U.S. stocks and says it won't ever invest in them again; public short-selling continues to set new records; index futures traders are positioned near historically net short levels; short interest on the major exchanges has exploded higher this year; the mainstream press obsesses with what is wrong and 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 that overall investor sentiment regarding U.S. 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 mixed-to-higher into the close from current levels on less economic pessimism and short-covering.

Today's Headlines

Bloomberg:
- The risk of owning corporate debt fell for a fourth day as signs that the credit rout has passes lured investors back to the market, according to credit-default swap traders who bet on creditworthiness.
- Bear Stearns(BSC), the securities firm hit hardest by the collapse of the subprime mortgage market, said it will “weather the storm” and isn’t looking for a cash infusion from an outside investors.
- European Central Bank President Trichet signaled the bank is in no rush to raised interest rates as higher credit costs threaten to slow economic growth.
- Fed district bank presidents are expressing skepticism about the need for further rate cuts, and some investors agree.
- The market where companies routinely borrow for periods of three months or less expanded for the first time in eight weeks as investors regained their appetite for some asset-backed debt.

NY Times:
- Thousands of software developers are creating features for Facebook, the rapidly growing social network, many hoping to strike it rich alongside Facebook’s own employees.

USAToday.com:
- Boom in high-rise developments reflects cultural change reshaping downtown areas across the USA.

Detroit News:
- Ford Motor(F) will push the UAW union for a less-expensive labor agreement than one reached with General Motors(GM).

Financial Times:
- Facebook Inc., the social-networking Web site, may not be worth $10 billion, as has been touted, except to a company such as Microsoft Corp.(MSFT), which doesn’t want to miss out on the next big thing.

Job Market Still Healthy, Factory Orders Decline After Large Jump

- Initial Jobless Claims rose to 317K versus estimates of 310K and 301K the prior week.

- Continuing Claims fell to 2541K versus estimates of 2550K and 2551K prior.

- Factory Orders for August fell 3.3% versus estimates of a 2.8% decline and a 3.4% increase in July.

BOTTOM LINE: The number of US workers filing first-time claims for unemployment benefits last week remained near the average for the year, showing companies are holding on to their employees, Bloomberg reported. The four-week moving-average of claims increased to 312,750 from 312,250. The unemployment rate among those eligible for jobless benefits, which tracks the US unemployment rate, held steady at a historically low 1.9%. I continue to believe the job market will remain healthy over the intermediate-term without generating substantial unit labor cost increases.

Orders placed with US factories fell in August after a large jump in July, Bloomberg reported. Excluding transports, factory orders fell 1.7%. Bookings in August for capital goods excluding aircraft and military equipment, a gauge of future business investment, fell .5% versus a .9% increase the prior month. Shipments of non-defense capital goods excluding aircraft, which the government uses to compute GDP, rose 1% versus unch. in July. Orders for petroleum and coal products fell 7.4% in August. Factory inventories fell .1%, the first decline since February 2006. I continue to believe manufacturing will help boost overall US growth as companies gain confidence in the sustainability of the current expansion and rebuild depleted inventories.

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Thursday Watch

Late-Night Headlines
Bloomberg:
- Elpida Memory Inc., Japan’s largest computer memory-chip maker, will reduce the number of chips it sells on the spot market to match a new strategy by Hynix Semiconductor.
- A new version of the benchmark loan derivatives index, which added the leveraged buyout debt of First Data Corp.(FDC) and Tribune Co.(TRB), rallied on its first day of trading in a sign that demand for the debt is returning.

Wall Street Journal:
- The FDA may establish a “behind the counter” system allowing more drugs that currently require a prescription to be sold without one.

MarketWatch.com:
- Delta(DAL) flying high after bankruptcy.
- Newsletters remain largely in cash, despite Dow’s record high. That’s bullish from a contrarian point of view.

CNNMoney.com:
- Some of the year’s hottest toys could be sold out weeks before Christmas, industry watchers warned.

Financial Times:
- Citigroup(C) is in talks with KKR to provide financing to buy some of the leveraged loans on its balance sheet. It has also talked to other private equity firms about providing such funding.
- A price war aimed at Japan’s 100 million mobile phone users could have a significant impact on the core consumer price index, potentially prolonging the country’s brush with deflation, economists warned on Wednesday.
- Walt Disney(DIS) has acquired a parcel of beachfront land in Hawaii to develop a hotel resort, part of a new strategy to expand its theme-parks business through smaller, mixed used sites.

Reuters:
- United Auto Workers members at several locals have backed a ground-breaking tentative contract with General Motors(GM) that may serve as a pattern for talks with Ford Motor(F) and Chrysler LLC.

Ming Pao Daily:
- Funds in China may invest more than $18 billion in Hong Kong’s stock market in the next two months. Funds to be raised under China’s qualified domestic institutional investor, or QDII, program, in the next two months will be $36 billion. The funds may allocate half of the money for Hong Kong stocks.

Late Buy/Sell Recommendations
Citigroup:
- Rated (MTG) Buy, target $63.
- Reiterated Buy on (EL), target $48.
- Reiterated Buy on (PX), target raised to $93.

Morgan Stanley:
- We are initiating coverage of the North American steel industry with a Cautious view. Steel stocks do not appear to be discounting the one-two punch of a deteriorating supply-demand balance and slowing global growth that we expect next year. Our top short idea is US Steel(X).
- Although we are long-term bulls on oil prices, tactically we think energy stocks will underperform in the coming three to six months. Relative valuations are unattractive – in the last month the sector offered a yield below the market for only the second time in history. Sentiment on the stock is very bullish, which we take as a good contrarian sell signal. Earnings growth in the next few years will be sub-par while free cash flow is falling and the free cash flow yield is the second lowest of the ten big sectors. In the short-term, we think consistently weak seasonality(energy underperformed by 6.7% on average in the last ten 4Qs), falling dollar and high expectations for 4Q represent headwinds.

Wachovia:
- Rated (MU), (NOK), (XLNX), (MSCC), (DELL), (ADI), (INTC), (HPQ), (CAMD) and (BRCM) Outperform.

BMO Capital:
- Rated (AAPL) Outperform, target $182.

Night Trading
Asian Indices are -1.0% to -.75% on average.
S&P 500 futures +.10%.
NASDAQ 100 futures +.11%.

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Earnings of Note
Company/EPS Estimate
- (AYI)/1.18
- (STZ)/.33
- (FDO)/.25
- (ISCA)/.56
- (MAR)/.30
- (PLL)/.55
- (CMN)/.16
- (LWSN)/.04
- (SLR)/.05

Upcoming Splits
- (PCAR) 3-for-2
- (RUSHA) 3-for-2

Economic Releases
8:30 am EST
- Initial Jobless Claims for last week are estimated to rise to 310K versus 298K the prior week.
- Continuing Claims are estimated to fall to 2550K versus 2551K prior.

10:00 am EST:
- Factory Orders for August are estimated to fall 2.8% versus a 3.7% rise in July.

Other Potential Market Movers
- The Fed’s Mishkin speaking, Fed’s Fisher speaking, ECB policy meeting, weekly EIA natural gas inventory data report, (FLO) analyst meeting, (PRX) analyst meeting, (AEP) analyst meeting, (NSTK) analyst meeting and Deutsche Bank Leveraged Finance Conference could also impact trading today.

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