Tuesday Watch

Late-Night Headlines
Bloomberg:
- Citadel Limited Partnership added 208,891 shares of Google Inc.(GOOG) last quarter, making the stock its largest equity position worth $329,326,090.
- Starbucks Corp.(SBUX) will sell a new line of premium packaged coffees and add supermarket kiosks for its Seattle’s Best Coffee brand as the company seeks to expand sales beyond cafes.
- EMC Corp.’s(EMC) VMware software business raised $957 million in an IPO today, at the top end of the forecasted range.
- Demand for services in Japan unexpectedly rose in June as the best job prospects in nine years encouraged consumers to spend.
- Radian Group(RDN), which protects against defaults on mortgages and bonds, said it guaranteed collateralized debt obligations worth about $47 billion.
- Sales of bonds backed by European commercial property loans may reach a record this year, even if turmoil in global credit markets curbs the pace of issuance in the second half, Moody’s Investors Service said.
- China’s retail sales grew at the fastest pace in more than three years as rising stock prices and wages left consumers in the world’s most populous country with more money to spend.

Wall Street Journal:
- Best Buy(BBY) will begin selling Liz Claiborne(LIZ)-designed accessory bags for laptop computers, digital cameras, iPod music players and other products.
- Rule Change Ticks Off Some Traders.

MarketWatch.com:
- Quant quake shakes hedge-fund giants. Goldman, Renaissance, AQR see losses, but also sense opportunity.

CNNMoney.com:
- An electric car for the common man. One company is hoping to bring a $30,000, 80-mph battery-powered sedan to the market by 2009.

Late Buy/Sell Recommendations
- None of note

Night Trading
Asian Indices are -.50% to +.25% on average.
S&P 500 futures -.05%.
NASDAQ 100 futures -.03%

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Earnings of Note
Company/EPS Estimate
- (A)/.48
- (AMAT)/.32
- (DDS)/.02
- (FIG)/.27
- (FOSL)/.19
- (HAR)/1.23
- (HD)/.73
- (LZB)/.02
- (LWAY)/.07
- (SCHS)/1.75
- (TJX)/.37
- (WMT)/.76

Upcoming Splits
- (SHEN) 3-for-1

Economic Releases
8:30 am EST
- The Trade Deficit for June is estimated to widen to -$61.0 billion versus -$60.0 billion in May.
- The Producer Price Index for July is estimated to rise .2% versus a -.2% decline in June.
- The PPI Ex Food & Energy for July is estimated to rise .2% versus a -.2% decline in June.

Other Potential Market Movers
- The weekly retail sales reports, (SE) Analyst Meeting, (ABI) Analyst Meeting, Keefe Bruyette & Woods Bank Conference, CSFB Communications Conference, Jeffries Industrial Conference and the UBS Engineering & Construction Conference could also impact trading today.

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

Stocks Finish Mixed as Lingering Credit Fears Offset Healthy Retail Sales

Indices
S&P 500 1,452.92 -.05%
DJIA 13,236.53 -.02%
NASDAQ 2,542.24 -.10%
Russell 2000 779.81 -1.14%
Wilshire 5000 14,590.18 -.07%
Russell 1000 Growth 586.06 +.17%
Russell 1000 Value 812.20 -.15%
Morgan Stanley Consumer 715.56 +.28%
Morgan Stanley Cyclical 1,025.10 +1.48%
Morgan Stanley Technology 623.73 +.42%
Transports 5,011.49 +1.0%
Utilities 493.50 +.44%
MSCI Emerging Markets 129.61 +.60%

Sentiment/Internals
Total Put/Call 1.0 -8.26%
NYSE Arms .85 +16.09%
Volatility(VIX) 26.57 -6.11%
ISE Sentiment 107.0 +.94%

Futures Spot Prices
Crude Oil 71.53 +.08%
Reformulated Gasoline 193.45 -1.04%
Natural Gas 6.83 +.10%
Heating Oil 196.75 -.19%
Gold 679.90 -.25%
Base Metals 242.0 +2.51%
Copper 342.20 +1.86%

Economy
10-year US Treasury Yield 4.76% -5 basis points
US Dollar 81.10 +.53%
CRB Index 311.57 +.21%

Leading Sectors
Wireless +1.78%
HMOs +1.43%
Computer Hardware +1.31%

Lagging Sectors
Alternative Energy -2.78%
Homebuilders -3.23%
Coal -3.42%

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Afternoon Recommendations
- None of note

Afternoon/Evening Headlines
Bloomberg:
- Aegon NV, the second-largest Dutch insurer, said it agreed to buy two life insurance units from Merrill Lynch(MER) for $1.3 billion in cash.
- Smokers are four times more likely to develop macular degeneration, the leading cause of blindness in the elderly, compared with people who never puffed a cigarette, Australian researchers said.
- Johnson & Johnson(JNJ) returned to the bond market after a four-year absence, raising $2.6 billion in its largest ever debt offering.
- Time Warner Cable Inc., the second-largest US cable company, plans to expand a service that lets viewers watch shows when they want as long as they sit through the commercials.
- Chinese toothpaste distributed to hotels worldwide by a US company has been recalled because it may contain a chemical used in antifreeze, adding to recent cases of unsafe food and drug imports.

Wall Street Journal:
- US retail gasoline fell another 6.7 cents/gallon to $2.77/gallon in the latest week, the lowest since April 9.

CNNMoney.com:
- Credit crunch: Blackstone smells opportunity. President Tony James says the private equity firm has an eye on debt that has been oversold in the market.

Times Online:
- Almost every big quantitative fund using a strategy similar to Goldman’s(GS) – known as equity market neutral (EMN) strategy – was suffering in its own way. The result has been a rout of one of the most popular types of quant fund. Hedge Fund Research’s EMN Index had lost 7.6% by last Thursday.

BOTTOM LINE: The Portfolio finished higher today on gains in my Computer longs, Biotech longs and Medical longs. I did not trade in the final hour, thus leaving the Portfolio 75% net long. The tone of the market was slightly negative today as the advance/decline line finished mildly lower, sector performance was mixed and volume was above average. Measures of investor anxiety were elevated into the close. Today's overall market action was neutral. Growth outperformed value again today, with growth stock leaders especially strong. Areas of weakness were once again homebuilders, financials and commodities. Oil continues to trade very poorly. The long natural gas/short oil trade I suggested a couple of weeks ago has worked very well so far. I still think oil has put in place a major double top and will begin an accelerated downward move within the month. I would take off the long natural gas hedge as that move commences. The Nikkei, which barely rose last night, is indicated down about 60 on the open in Japan. While today's performance was likely frustrating for the bulls and bears, given the news after the close on Friday, I think a mixed performance was pretty good. Every day that goes by without another dip lower and more uncertainty lifting puts more pressure on the many bearishly positioned investors, in my opinion. For some time I have argued that the extreme popularity of the market neutral hedge fund strategy has been a large contributing force to the current US negativity bubble, helping to send short interest into the stratosphere. There are always exceptions, but in general this strategy has performed very poorly on a risk-adjusted basis for years. Last week, I wondered whether market neutral funds had really been run in a net short manner during this bull market. Then on Thursday when the market fell almost 3%, market neutral funds still fell 1.8%, according to Dow Jones. They are now down -5.3% for the month and -3.5% for the year. They had only returned an annualized 2.8% over the last 3 years even before the recent carnage. I continue to believe this strategy has seen its peak in popularity and that a majority of the vast amount of capital that has been deployed into these funds since the bubble burst in 2000 will begin to find its way into more positively correlated US stock strategies.

Stocks Slightly Higher into Final Hour on Less Economic Pessimism

BOTTOM LINE: The Portfolio is higher into the final hour on gains in my Computer longs, Biotech longs and Medical longs. I have not traded today, thus leaving the Portfolio 75% net long. The overall tone of the market is neutral today as the advance/decline line is slightly lower, sector performance is mixed and volume is above average. My intraday gauge of investor angst is elevated again. Investor angst is still levels normally associated with meaningful market bottoms. I had thought that, given recent stock declines and hedge fund de-leveraging, we would see diminished short selling. However, last week saw a massive spike in short sales by the public and total short sales. As well, the specialist short sales/total short sales ratio continues to move lower as it has since near the major market bottom in 2002. SentimenTrader's All-Index, All-Product Stochastic remains near levels normally associated with a meaningful market bottom. The Rydex Nova/Ursa Ratio also recently hit levels not seen since the depths of the 2000-2002 bear market. This also corresponds with the recent pessimistic extreme readings in the 10-day total put/call ratio, 10-day ISE Sentiment Index and highest VIX since early 2003. Let's also not forget that insiders are buying at levels not seen since right before the 2002 bottom. Goldman Sachs (GS) said this morning that non-financial companies in the S&P 500 have $800 billion in cash, or 10% of their market cap, which is double the historical average. This is one of the many large positives that continue to be ignored in the current climate of fear. A U.S. recession is a foregone conclusion in many circles, even as little evidence suggests this, and it has mostly been priced into stocks at current levels, in my opinion. I suspect with so many investors positioned so bearishly that we have to see significant economic weakness very soon or a substantial market rally is in the cards from current levels. I expect US stocks to trade mixed-to-higher into the close from current levels on short-covering, less economic pessimism and bargain hunting.

Today's Headlines

Bloomberg:
- The European Central Bank may have “overreacted” last week when it poured money into the banking system to avert a crisis of confidence in the credit market, said Paul de Grauwe, an academic at Belgium’s University of Leuven.
- Yield premiums on AAA and AA rated securities backed by US subprime or second mortgages have widened enough to make the bonds attractive, analysts at JPMorgan said.
- Sears Holdings(SHLD) rose the most in more than a year after the biggest US dept.-store company said it plans to buy back $1.5 billion in stock.
- Goldman Sachs(GS) will invest about $2 billion to shore up its Global Equity Opportunities Fund after a 28% decline this month.

Wall Street Journal:
- Former Fed Chairman Greenspan has been hired by Deutsche Bank AG as a consultant for its corporate and investment banking unit, Deutsche Bank Securities.
- Pakistani voters would be eager to take a stand against violent radicals and militants if they were given a chance to vote with their conscience, said Benazir Bhutto, the country’s main opposition leader and a former prime minister.
- Karl Rove, President Bush’s longtime political adviser, is resigning as White House deputy chief of staff effective Aug. 31, and returning to Texas, marking a turning point for the Bush presidency.

NY Times:
- Two of the three leading US automakers are being run by industry outsiders as the traditional notion of “car guys” take a back seat to broader pragmatic knowledge.
- Pack Mentality Among Hedge Funds Fuels Market Volatility.

Business Week:
- After the Drop, It’s Time to Stock-Shop.

USA Today:
- High-profile attacks in Iraq dropped almost 50% to about 70 in July from a 12-month peak of about 130 in March because of higher troop levels, citing the US military command in Iraq.

Handelsblatt:
- Jean-Michel Six, chief European economist at S&P in London, expects interest rates in the 13 countries sharing the euro to peak at 4.25%.

Retail Sales Bounce Back, Inventories Still Low

- Advance Retail Sales for July rose .3% versus estimates of a .2% gain and an upwardly revised -.7% decline in June.

- Retail Sales Less Autos for July rose .4% versus estimates of a .4% increase and an upwardly revised -.2% decline in June.

- Business Inventories for June rose .4% versus estimates of a .4% gain and a .5% increase in May.

BOTTOM LINE: US retail sales rose more than expected in July, a sign that consumer spending is accelerating into the important back-to-school selling season, Bloomberg reported. Moreover, excluding autos and gas station receipts, retail sales rose a healthy .6%. This data bear out the Fed’s forecast, reiterated last week, that the economy will grow at a “moderate” pace through year-end. Sales of electronics were especially strong, boosted by Apple’s(AAPL) iPhone release, rising 1%. Filling station sales fell .8% last month, as gas prices declined. Finally, furniture sales rose .5%. Wages in July rose 3.9%, well above recent inflation readings, which helped boost the Conference Board’s Consumer Confidence Index to a six-year high during July. I continue to believe retail sales will accelerate into the fall as energy prices continue to fall meaningfully, inflation decelerates further, wages continue to substantially outpace inflation, unemployment remains historically low, housing fears subside, stocks resume their major uptrend and confidence improves.

US businesses took advantage of slower sales in June to rebuild depleted inventories, suggesting orders and production will keep growing in coming months, Bloomberg said. Businesses had enough goods on hand to last 1.27 months at June’s sales pace, near the lowest in 12 months. I continue to believe inventory rebuilding will help boost US economic growth through year-end as companies gain confidence in the sustainability in the current expansion.

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