Wednesday Watch

Late-Night Headlines
Bloomberg:
- Bill Gross said on CNBC that Federal Reserve Chairman Bernanke’s decision to say the central bank will “carefully monitor” the dollar was intended to stabilize the relationship between oil and the currency. Pimco is avoiding US government debt and is instead investing in bonds sold by “banks and investment banks that have come under the guarantee – quote, unquote – of the Fed’s discount window,” Gross said.
- Yahoo Inc.(YHOO) CEO Yang is facing increasing shareholder pressure to sell the Internet company he helped found or step aside.
- Moody’s Investors Service, S&P and Fitch Ratings are near an agreement with NY Attorney General Andrew Cuomo to end an investigation into the credit-rating companies’ role in the subprime-mortgage crisis.
- Trichet Foiled as European Consumers Reduce Spending, Except on Lipstick.
- New Zealand central bank Governor Alan Bollard may be pushing the economy into a recession by keeping interest rates at a record to fight inflation, ignoring factory closures and slumping consumer spending.
- Lehman Brothers(LEH) denied borrowing from the Federal Reserve today and said the firm’s cash holdings have increased.
- Barack Obama was poised to clinch the Democratic presidential nomination tonight as Hillary Clinton told colleagues she is open to running as the party’s vice presidential candidate.

Wall Street Journal:
- Is there an oil bubble that is about to burst? Some big voices on Wall Street think so, predicting the oil market could tilt sharply south soon if the US dollar strengthens and demand for crude oil weakens in some key consuming countries. Tightness on the supply side could also ease, they say, as some big refineries and new oil fields come onstream over the next few months and the outlook for the Chinese economy clouds over.
- China Restricts Protests And Media in Quake Zone.
- Lehman Brothers(LEH), facing a sharp decline in its stock that will make it more difficult to raise fresh capital, did an about-face and began using its own money to buy back its plummeting shares.

MarketWatch.com:
- The investment flood into commodity indexes bears eerie similarities to the craze for portfolio insurance that led to the stock-market crash of 1987, according to hedge fund investor George Soros, who warned that the rush into oil has created a “bubble.” “In both cases, the institutions are piling in on one side of the market and they have sufficient weight to unbalance it,” said Soros. “If the trend were reversed and the institutions as a group headed for the exit as they did in 1987, there would be a crash.” Traders took today’s moves by the CFTC, which will make it more difficult for financial investors to sidestep limits on speculation, as possibly curbing demand. “These kinds of dramatic moves” surprised traders, said Mike Zuzolo, senior analyst at brokerage Risk Management Commodities. “At first glance it looks like they’re targeting long-only index funds.”

CNBC.com:
- Dennis Gartman, of the Gartman Letter, thinks the CFTC will change the definition of “hedger”, which could send oil to $100 "so fast it will make your head spin." Gartman would be very careful about being outright long commodities. (video)

c/net:
- Shell station in LA to offer hydrogen.

NY Times:
- In Hiring, Europeans Go Global. As pressure grows on European businesses to go global, European companies are breaking down the glass ceiling that has long reserved their top spots for a local.

FinancialWeek:
- The SEC announced two new deputy enforcement directors on Tuesday, bolstering the division’s management as it grapples with subprime mortgage-related fraud and continues to crack down on insider trading. SEC Chairman Christopher Cox said the enforcement division is putting a special focus on subprime-related investigations, as well as illegal hedge fund activity and insider trading.

AM New York:
- Former President Carter said Tuesday he will endorse Democrat Barack Obama. “The fact is the Obama people already know they have my vote when the polls close tonight,” Carter said.

Reuters:
- With oil prices at historic highs, China is moving full steam ahead with a controversial process to turn its vast coal reserves into barrels of oil. Known as coal-to-liquid (CTL), the process is reviled by environmentalists who say it causes excessive greenhouse gases.
- The market for large leveraged buyouts, virtually stalled by a Wall Street credit crisis, may take a year or more to revive itself, but buyout executives said at a conference on Tuesday they are finding new strategies to deploy cash.
- McCain launches general election bid with eye on oil. “The next president must be willing to break completely with the energy policies not just of the Bush Administration, but the administration that preceded his, and lead a great national campaign to put us on a course to energy independence,” McCain said.

Financial Times:
- Lehman Brothers(LEH) lost $500 million to $700 million on certain hedging positions in the second quarter. The hedging failures will increase overall losses at the bank, which may lead to Lehman raising capital by selling a stake to an outside investor. Insiders said Lehman had opened talks with potential investors including asset managers and Asian banks.

Late Buy/Sell Recommendations
Citigroup:
- Reiterated Buy on (AMAT), target $25.

Morgan Stanley:
- Reiterated Overweight on (ALTR), boosted estimates, target $26.

Night Trading
Asian Indices are -.50% to +.75% on average.
S&P 500 futures -.03%.
NASDAQ 100 futures +.01%.

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Earnings of Note
Company/EPS Estimate
- (WSM)/.01
- (MATK)/.25
- (ADCT)/.30
- (CMTL)/.56
- (BLUD)/.23
- (VIP)/.49

Upcoming Splits
- None of note

Economic Releases
8:30 am EST
- Final 1Q Non-farm Productivity is estimated to rise 2.5% versus a prior estimate of a 2.2% increase.
- Final 1Q Unit Labor Costs are estimated to rise 2.0% versus prior estimates of a 2.2% gain.

10:00 am EST:
- The ISM Non-Manufacturing Composite for May is estimated to fall to 51.0 versus a reading of 52.0 in April.

10:30 am EST:
- Bloomberg consensus estimates call for a weekly crude oil inventory build of 400,000 barrels versus an 8,883,000 barrel decline the prior week. Gasoline supplies are expected to rise by 825,000 barrels versus a 3,258,000 decline the prior week. Distillate inventories are estimated to rise by 1,675,000 barrels versus a 1,641,000 barrel increase the prior week. Finally, Refinery Utilization is expected to rise by .50% versus a -.2% decline the prior week.

Other Potential Market Movers
- The Fed’s Lockhart speaking, (NFP) analyst meeting, (SPR) investor day, (BOBE) analyst meeting, ADP Employment Change report, Challenger Job Cuts report, weekly MBA mortgage applications report, Keefe Bruyette Woods Financial Services Conference, JPMorgan Basics/Industrials Conference, KeyBanc Transports Conference, Stephens Investment Conference, Oppenheimer Communications/Tech Conference and UBS Electronic Payments Summit could also impact trading today.

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

Stocks Finish Lower, Weighed Down by Defense, Commodity, Financial and Gaming Shares

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In Play

Stocks Lower into Final Hour on Financial Sector Worries

BOTTOM LINE: The Portfolio is slightly lower into the final hour on losses in my Software longs and Medical longs. I have not traded today, thus leaving the Portfolio 75% net long. The tone of the market is slightly bearish as the advance/decline line is lower, most sectors are declining and volume is about average. Investor anxiety is slightly above average. Today’s overall market action is mildly bearish. The VIX is rising 1.92% and remains above average at 20.2. The ISE Sentiment Index is low at 110.0 and the total put/call is above average at 1.14. Finally, the NYSE Arms has been running above average most of the day and is currently 1.06. The (XLF) is only down .12% today, notwithstanding rising worries about Lehman(LEH). The European Financial Sector Credit Default Swap Index is increasing another 2.1% today to 72.44 basis points. As well, the TED spread is falling 2.3% today to .83. The 10-year TIPS spread, a good gauge of inflation expectations, is declining to 2.45% on the fall in commodity prices, which is down from 2.59% nine days ago. The decline in commodity prices is a major US broad market positive, however further declines are likely necessary before investors begin to anticipate these positives. A number of sectors are rising today, despite the losses in the major averages. Tech stocks are relatively strong again. One of my longs, (GILD), made a new all-time high today and is up 20.2% year-to-date. This company remains my favorite biotech and the sector should do well going forward given the macro backdrop. Nikkei futures indicate a +6 open in Japan and DAX futures indicate a -28 open in Germany tomorrow. I expect US stocks to trade modestly higher into the close from current levels on bargain-hunting and short-covering.

Today's Headlines

Bloomberg:
- Lehman Brothers(LEH) may report its first quarterly loss since going public in 1994, increasing pressure on the company to raise more capital, according to analysts.
- Intercontinental Exchange Inc.(ICE) agreed to buy Creditex Group for $625 million in a deal it says will help to improve processing in the market for credit derivatives.
- Banks in Europe are lagging behind US lenders in disclosing risk, damaging investor confidence, according to Svein Andresen, secretary general of the Financial Stability Forum.
- The US dollar rose to a two-week high against the euro and increased versus the yen after Fed Chairman Bernanke said the central bank is “attentive” to the implications of the currency’s decline. ``It could be a turning point for the dollar,'' said Michael Woolfolk, senior currency strategist in New York at Bank of New York Mellon, the world's largest custodial bank, with more than $20 trillion in assets under administration. ``It's very unusual for a sitting Fed chairman to talk about the dollar explicitly.''
- North Dakota Oil Fields of Saudi-Sized Reserves Make Farmers Oil Drillers.
- Crude oil is falling more than $3/bbl. on signs that the US will stop cutting interest rates to bolster the US dollar and worries over a potential bursting of the oil bubble intensified.
- Copper fell for a second session on speculation that consumption may cool in China, the world’s biggest user of the metal. Stockpiles of the metal monitored by the Shanghai Futures Exchange have surged 85% this year.
- Corn fell for the first time in three sessions on speculation that a government investigation of US futures trading may result in rule changes that will halt the surge in commodity investment. ``The investigation into the commodity index-fund investments is going to reduce buying interest today,'' said Don Roose, president of U.S. Commodities Inc. in West Des Moines, Iowa. ``Commodities have been dominated by increased index-fund buying that might be at risk.''
- US gasoline demand fell 4.7% during the Memorial Day holiday last week, a sign that motorists are cutting consumption because of record prices, MasterCard(MA) said. Demand for the motor fuel fell 3.6% from the previous week. Consumption nationwide is down 1.8% year-to-date. Demand based on the four-week average dropped 6% from a year earlier, indicating “Americans are changing driving habits,” the credit-card company said.
- Ford Motor(F) said May sales fell 16% as gasoline near $4 a gallon steered US consumers from pickups and sport-utility vehicles.

Wall Street Journal:
- We Don’t Need a Climate Tax on the Poor. With average gas prices across the country approaching $4 a gallon, it may be hard to believe, but the US Senate is considering legislation this week that will further drive up the cost at the pump. The Senate is debating a global warming bill that will create the largest expansion of the federal government since FDR’s New Deal, complete with a brand new, unelected bureaucracy.

NY Times:
- Regulators of the nation’s commodity markets will demand more information about investors to determine whether they are evading market limits on speculation and artificially driving up world food prices. Billions of dollars have poured into the commodity futures market – from pension funds, endowments and a host of other institutional investors – through the new conduit of commodity index funds. They believe this flood of new money from swaps and index funds is undermining confidence in the market’s role in setting prices and managing risk. The commission will start requiring more information about index funds and, more significantly, about the clients on the other side of the unregulated swaps deals that are being hedged on the regulated futures exchanges. The swaps market has traditionally been seen as off limits for federal commodity regulators, but the commission clearly is responding to concern that investors may be using swaps dealers to evade rules that limit the size of their speculative role in regulated markets. The commission is also putting brakes on granting waivers that have exempted some commodity index funds from speculative limits. In recent years, more than a dozen commodity index fund companies have been granted individual waivers.
- Putin Critics Disappear From Television, Talk Shows.
- US Senator Joseph Lieberman is creating a bill to make investments in commodity markets by institutional investors taxable. The bill would amend the ERISA Act.

AP:
- AP tally: Obama clinches Democratic nomination.

PCMag.com:
- Sanford C. Bernstein analyst Jeffrey Lindsay argues in a new 310-page report that Google Inc.(GOOG) and Amazon.com(AMZN) will be long-term winners, while Yahoo(YHOO) and IAC InterActiveCorp(IACI) fall by the wayside and eBay(EBAY) becomes a merger target.

Earth2tech:
- 11 Companies Racing to Build US Cellulosic Ethanol Plants. The plants will be built all over the US and will churn out biofuels made from waste, plant byproducts and woody energy crops.

FINalternatives:
- According to a Goldman Sachs analysis of 755 hedge funds, with $833 billion of long equity positions, hedge funds now appear net short financials compared with 14% net long at year-end and 26% at the end of the third quarter. Long holdings in financials fell by $20 billion in the first quarter, and hedge fund short positions rose by an estimated $7 billion, suggesting funds were 9% net short the sector.

Financial Times:
- Billionaire investors George Soros is to tell US lawmakers on Tuesday that “a bubbe in the making” is under way in oil and other commodities and that commodity indices are not a legitimate asset class for institutional investors. “I find commodity index buying eerily reminiscent of a similar craze for portfolio insurance which led to the stock market crash of 1987,” Soros will say. "In both cases, the institutions are piling in on one side of the market and they have sufficient weight to unbalance it. If the trend were reversed and the institutions as a group headed for the exit as they did in 1987 there would be a crash." "Nevertheless, the asset class continues to attract additional investment just because it has turned out to be more profitable than other asset classes. It is a classic case of a misconception that is liable to be self-reinforcing in both directions."

Bear Radar

Style Underperformer:

Large-cap Value -.39%

Sector Underperformers:

Gamingirlind (-2.13%), Defense (-1.62%) and Banks (-1.42%)

Stocks Falling on Unusual Volume:

MDCI, CHU, CHA, GR, WB, MIND, LAYN, AVAN, LULU, RECN, BEXP, GYMB and LEH

Stocks With Unusual Put Option Activity:

1) MVL 2) RHT 3) NSM 4) NMX 5) AMT

Factory Orders Jump

- Factory Orders for April rose 1.1% versus estimates of a .1% decline and an upwardly revised 1.5% gain in March.

BOTTOM LINE: Orders to US manufacturers unexpectedly jumped in April, Bloomberg reported. Bookings excluding cars and airplanes, surged 2.6% for a second month. Bookings for non-defense capital goods excluding aircraft, a gauge of future business spending, jumped 4% in April. Shipments of those goods, which are used to compute GDP, rose .2% after a .8% increase in March. Total shipments in April rose 2.2%, the most since December 2006. That left the amount of goods on hand at 1.23 months’ worth at the current sales pace versus 1.26 months in March. Federal Reserve Chairman Bernanke said today that rates are “well positioned” to promote growth and stable prices, and that policy makers are “attentive” to the impact of the falling dollar. The second quarter is “likely to be relatively weak,” he said, omitting his mention in the April speech of a possible contraction. The second half may have “somewhat better economic conditions,” and growth may pick up further in 2009, Bernanke said. The US Dollar Index is jumping .52% and the 10-year yield is rising 4 basis points to 4.0% on today’s news. I expect Factory Orders to trend higher through year-end.