Stocks Lower into Final Hour on Subprime Worries, Weakness in Europe

BOTTOM LINE: The Portfolio is higher into the final hour on gains in my (TLT) long, Semi longs, Computer longs, Biotech longs and Commodity shorts. I have not traded today, thus leaving the Portfolio 100% net long. The tone of the market is negative today as the advance/decline line is substantially lower, every sector is declining and volume is above average. Large speculators are the most net short the S&P 500 since June 2004. This also corresponds with SentimenTrader's All-Index, All-Product Dollar-Weighted Stochastic, which continued to move to an even more extreme reading this week at 99.2, which is right at the level seen during the trough of the February/March market pullback. Readings at or above 80 are historically followed by a 13.6% gain in the S&P 500 89% of the time on average over the next 12 months. This is especially noteworthy considering the major indices have moved back near highs, with a parabolic surge in short interest. I continue to believe that overall investor sentiment toward most U.S. stocks has never been this poor in history with the averages near records. This is a huge positive for stocks that continues to be underestimated by most market participants. I still believe this will eventually result in the "mother of all short-covering rallies" as large investors tire of the poor risk-adjusted returns associated with many low-correlation U.S. stock strategies and sentiment regarding the long-term prospects for U.S. equities improves. I expect US stocks to trade modestly higher into the close from current levels on bargain-hunting, lower long-term rates and short-covering.

Today's Headlines

Bloomberg:
- Hedge funds are short-selling S&P 500 futures by the most in three years, a Merrill Lynch analyst said. Short positions have reached “crowded levels” and “we view this as a contrary indicator and readings continue to be bullish for stocks.”
- Paulson & Co., the hedge-fund firm that tripled its assets in the past year with bets on the decline in subprime mortgages, returned 40% in its largest credit fund in June. The Paulson Credit Opportunities Funds soared 129% this year through June 30. Paulson, whose assets have increased to $15 billion from $4.7 billion in July 2006, speculated that securities based on home loans to US borrowers with poor credit histories would drop in value as defaults increased.
- Oil is rising above $73/bbl. in NY for the first time since August as speculators increase bets to record levels on further refinery “problems.”
- Copper is falling in NY after a report showed imports declined in China, the world’s largest consumer of the metal.
- A plunge in the price of sugar and the need to cut output costs will likely help drive mergers in Australia’s cane industry, Maryborough Sugar Factory Ltd. said.
- Nickel declined in London to the lowest in almost six months as rising stockpiles of the metal indicated a slowdown in demand growth.
- Federal Reserve Chairman Ben S. Bernanke said unexpected changes in inflation today are much more likely to be transitory than before 1980s and that energy price rise only leads to inflation if expectations rise, wage price spiral ensues.
- US treasuries advanced the most in more than a week after Standard & Poor’s said it may cut credit ratings on $12 billion of bonds backed by subprime mortgages and Fed chairman Bernanke’s speech was more dovish than expected.
- China executed its former chief drug regulator for taking bribes in a crackdown on fake medicine, a warning that the country intends to deal sternly with corruption.
- Apple Inc.(AAPL) may introduce a model of its iPhone this year that is 50% cheaper than the handsets that went on sale in the US last month, JPMorgan analyst Kevin Chang said.

Wall Street Journal:
- Dell Inc.(DELL) started an advertising campaign based on colors to boost sales, which have fallen since 2005.
- Short-sellers are targeting credit-ratings firm Moody’s Corp.(MCO).
- Exxon Mobil Corp.(XOM) and Enbridge’s pipelines, which used to carry Venezuelan and Mexican oil to the US, have been reversed to import Canadian oil after political instability in Latin America threatened US supplies.
- Linear Technology(LLTC), whose chips are used by Cisco Systems(CSCO) and Apple Inc.(AAPL), has found a profitable niche making unglamorous chips for a market where competition is limited and margins are high.

NY Times:
- Ryan Crocker, the US ambassador to Iraq, said violence in the country will increase if American troops are withdrawn. A US troop reduction may bring violence that results in thousands of deaths and heightened conflict with Iraq’s oil-producing neighbors.
- Scientific groups around the world are developing robotic devices designed to help stroke patients regain function in impaired limbs.

Lloyd’s List:
- A sea-traffic control system similar to that used for aviation should be introduced to cut accidents involving merchant ships, Circuit Court Judge Jon Newman said.

AP:
- Users of TiVo Inc.(TIVO) digital video recorders can, from today, order movies from Amazon.com Inc.(AMZN) over their television sets.
- Nielsen/Net Ratings plans to drop online measurements based on page views and start recording how long people stay on Web sites.
- Al-Qaeda’s second in command, Ayman al-Zawahiri, issued an audiotape in which the group threatens to attack the UK in retaliation for honoring novelist Salman Rushdie with a knighthood.

USA Today:
- FCC Chairman Kevin Martin plans new broadband rules to let consumers bypass a carrier’s pre-packaged wireless service and choose the mobile device and software they want.

Financial Times:
- Markit Group, the financial data provider, plans to offer real-time prices for credit-default swaps, citing Kevin Gould, head of data.

Nottingham Evening Post:
- Bank of England policy maker John Gieve said higher interest rates may be slowing segments of the UK economy.

Nepszabadsag:
- Hungarian Environment Minister Gabor Fodor opened the country’s first bioethanol station, with as many as 50 more planned for this year.

Le Monde:
- OPEC needs to raise output and could do this “discreetly” in the coming months, Claude Mandil, executive director of the International Energy Agency said. Oil prices are “worrying” and “catastrophic” for consumers in developing countries who have to spend a greater proportion of their disposable income on energy.

AFP:
- A man convicted of adultery was stoned to death in Iran earlier this month., citing judiciary spokesman Alireza Jamshidi.

Haaretz:
- Comverse Technology(CMVT) is up for sale after its board instructed management to liquidate the company and its subsidiaries.

Wholesaler Inventories-to-Sales Ratio Makes New Record Low

- Wholesale Inventories for May rose .5% versus estimates of a .4% gain and a .3% increase in April.

BOTTOM LINE: Sales at US wholesalers rose faster than inventories in May, making it more likely companies will place more orders and factories will increase production, Bloomberg said. Wholesaler sales surged 1.3% versus a 1.5% gain in April. The sales gain was pace by computer and furniture wholesalers, which each saw about 4% gains. The ratio of inventories to sales hit a new record low at 1.11 months’ supply at the current sales pace. Inventory de-stocking subtracted about 1 percentage point from GDP in the first quarter. The surge in furniture wholesaler sales is noteworthy considering the slowdown in housing. I continue to believe 2Q US growth will likely come in around 3%+ for 2Q before decelerating modestly this quarter.

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Tuesday Watch

Late-Night Headlines
Bloomberg:
- Shares of Cedar Fair LP(FUN) rose the most in 20 months after a report said the third-largest US theme-park operator hired Bear Stearns(BSC) to seek a buyer that will agree to keep the management team.
- Ford Motor(F) said it will team up with Southern California Edison to help develop rechargeable batteries for future plug-in vehicles.
- There is no evidence Turkey has massed troops on its border with Iraq, a Pentagon spokesman said.

NY Times:
- One of the suspects in the failed terror attempt in Glasgow, Scotland, worked as an aeronautical engineer for an Indian company that designs parts for Boeing Co.(BA) and Airbus SAS.

Financial Times:
- Chuck Prince, CEO of Citigroup(C), said turmoil in the US subprime-mortgage market is not so big a risk that it would slow down the company’s lending.

Commercial Times:
- Lee Chang Yung Chemical Industry Corp. plans to spend $1.6 billion over the next three years on alternative energy projects such as the production of methanol, ethanol and polysilicon.

Korea Economic Daily:
- SK Telecom Co. plans to acquire Sprint Nextel Corp.(S), the third-largest US mobile phone services business.

Bisnis Indonesia:
- At least 49 companies have received approval from Indonesia’s Investment Coordinating Board for plants that make biofuels.

Xinhua News Agency:
- The membership of China’s ruling Communist Party rose last year by 2.64 million to 72.39 million people.

Late Buy/Sell Recommendations
Citigroup:
- Financial players have now firmly moved ahead of refining as the main near-term driver of oil prices accounting for over $10 of the move higher since the start of the year versus over $7 for refining. Open interest increased 4% last week to a record 1.5 mm, while net speculators also reached an all-time high. We remain of the view that ex transitory factors, the upcoming shift to winter gasoline and restart of several major refineries are events that need to pass before adopting a more bullish stance on oil.
- Reiterated Buy on (GGC), target $23.
- Upgraded (DTV) to Buy, raised target to $30.

Citigroup:
- Rated (URBN) Underweight, target $18.
- Rated (ANF) Underweight, target $62.

Night Trading
Asian Indices are -.25% to +.25% on average.
S&P 500 indicated -.03%.
NASDAQ 100 indicated unch.

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Earnings of Note
Company/EPS Estimate
- (AYI)/.88
- (CHTT)/.77
- (ETP)/.69
- (ETE)/.34
- (GBX)/.45
- (HELE)/.30
- (PBG)/.63

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Economic Releases
10:00 am EST
- Wholesale Inventories for May are estimated to rise .4% versus a .3% gain in April.

Other Potential Market Movers
- The Fed’s Bernanke speaking, weekly retail sales reports, E3, CE Unterberg Towbin Emerging Growth Conference, CIBC Consumer Growth Conference, Roth Capital Semi Conference and Kaufman Brothers Defense Tech Conference could also impact trading today.

BOTTOM LINE: Asian indices are mostly lower, weighed down by automaker and commodity 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 Mildly Higher on Decline in Long-term Rates and Fall in Oil

Indices
S&P 500 1,531.85 +.09%
DJIA 13,649.97 +.28%
NASDAQ 2,670.02 +.13%
Russell 2000 853.24 +.11%
Wilshire 5000 15,471.17 +.10%
Russell 1000 Growth 609.55 +.06%
Russell 1000 Value 872.69 +.13%
Morgan Stanley Consumer 734.60 -.15%
Morgan Stanley Cyclical 1,104.40 +.35%
Morgan Stanley Technology 638.97 +.27%
Transports 5,279.32 +.92%
Utilities 506.46 +.26%
MSCI Emerging Markets 139.20 +1.16%

Sentiment/Internals
Total Put/Call .81 -5.81%
NYSE Arms 1.13 +82.11%
Volatility(VIX) 15.16 +2.99%
ISE Sentiment 171.0 +25.0%

Futures Spot Prices
Crude Oil 72.05 -1.04%
Reformulated Gasoline 234.50 +1.53%
Natural Gas 6.41 -.56%
Heating Oil 209.10 -.20%
Gold 662.30 +1.15%
Base Metals 260.37 +1.01%
Copper 362.40 +.82%

Economy
10-year US Treasury Yield 5.14% -4 basis points
US Dollar 81.45 -.01%
CRB Index 321.23 +.12%

Leading Sectors
Alternative Energy +3.86%
Engineering&Construction +1.47%
Biotech +.70%

Lagging Sectors
Restaurants -.72%
Computer Hardware -.81%
Homebuilders -1.23%

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Afternoon Recommendations
Bank of America:
- Rated (CVA) Buy, target $30.

Oppenheimer:
- Rated (SQNM) Buy, target $8.

BMO Capital:
- Rated (QLGC) Outperform, target $21.

Afternoon/Evening Headlines
Bloomberg:
- Alcoa Inc.(AA), bidding to require rival Alcan(AL) in a hostile takeover, said second-quarter profit fell 3.9% as costs for shutdowns at two US smelters eroded the benefit of rising prices. The shares fell .56 in after-hours trading to $41.79.
- Shares of Akamai Technologies(AKAM) will replace Biomet(BMET) in the S&P 500. The stock rose 4.6% in after-hours trading.
- The Cheesecake Factory(CAKE) reported total revenues increase approximately 15.7% in the second quarter. The stock rose 4.5% in after-hours trading.
- WD-40 Company(WDFC) reported net sales for the third quarter increased 6.2% over the third quarter of last year. The stock fell 10.3% in after-hours trading.

AP:
- The head of the US National Hurricane Center was reassigned after more than 20 of the center’s employees called for his ouster.

Reuters:
- Hedge fund Moore Capital Management LLC has taken a 5.08% stake in US home builder Beazer Home USA(BZH), according to a regulatory filing on Monday.

BOTTOM LINE: The Portfolio finished higher today on gains in my Internet longs, Biotech longs, Medical longs and Semi longs. I did not trade in the final hour, thus leaving the Portfolio 100% net long. The tone of the market was mixed today as the advance/decline line finished about even, sector performance was mixed and volume was about average. Measures of investor anxiety were about average into the close. Today's overall market action was mildly bullish. Over the weekend, Barron's had a positive mention on one of my longs, Gilead Sciences (GILD). I think that the recent pullback is over and the stock can be purchased around current levels. It remains my favorite biotech long. I went to the Apple (AAPL) store again over the weekend. It was even more crowded this time. About the same number of people were around the iPhone stand, however, more were looking at the computers. I suspect the "halo effect" is intensifying more than most analysts had expected. Just like last year before oil plunged $28 per barrel in six months, numerous investment managers have come on CNBC of late saying oil service is their favorite sector and has the largest weighting in their portfolios. I still believe this will be one of the worst performing sectors during the second half of the year as oil begins another substantial decline later this quarter. Semis have traded especially well of late. One of my longs, Broadcom (BRCM), has pulled back and in my opinion is providing investors an excellent entry point in the shares for strong outperformance through year-end. As has been the case often of late, many stocks substantially outperformed the major averages today. The 10-year yield finished near session lows, falling 4 basis points ahead of Bernanke's speech on inflation. I suspect the yield will fall further before week's end. One of the interesting things about the current rally is the lack of insider selling. Insider selling remained very muted again last week even as stocks approached highs. This is a big positive.