Saturday, September 02, 2006

Market Week in Review

S&P 500 1,311.01 +1.23%*

Photobucket - Video and Image Hosting

Click here for the Weekly Wrap by Briefing.com.

BOTTOM LINE: Overall, last week's market performance was bullish. The advance/decline line rose, almost every sector rose and volume was light on the week. Measures of investor anxiety were mixed. The AAII percentage of Bulls rose to 41.57% this week from 39.35% the prior week. This reading is now slightly below-average levels. The AAII percentage of Bears fell to 25.84% this week from 37.42% the prior week. This reading is now slightly below above-average levels. The 10-week moving average of the percent Bears is currently 42.6%. The 10-week moving-average of percent Bears was 43.0% at the major bear market lows during 2002. The only other time it has been higher than these levels, since record keeping began in 1987, was the significant market bottom during the 1990 recession and Gulf War. I continue to believe the “irrational pessimism” aimed towards most US stocks has never been this great in history given the positive macro backdrop.

The average 30-year mortgage rate fell 4 basis points to 6.48%, which is 32 basis points below July highs. I still believe housing is in the process of slowing to more healthy sustainable levels. Mortgage rates have likely begun an intermediate-term move lower, which should help stabilize housing over the next few months. The Case-Shiller housing futures are projecting a 5.0% decline in the average home price over the next 9 months. Considering the average house has appreciated over 50% during the last few years, this would be considered a “soft landing.” The overall negative effects of housing on the US economy are currently being exaggerated, in my opinion.

The benchmark 10-year T-note yield fell another 6 basis points on the week on diminishing inflation worries. I still believe inflation concerns have peaked for the year as economic growth moderates to around average levels, unit labor costs remain subdued and the mania for commodities continues to reverse course.

The EIA reported this week that gasoline supplies rose more than expectations as refinery utilization increased. Unleaded Gasoline futures dropped substantially and are now 40.3% below September 2005 highs even as refinery utilization remains below normal as a result of the hurricanes last year, some Gulf of Mexico oil production remains shut-in and fears over future production disruptions persist. Gasoline demand is estimated to rise .8% this year versus a 20-year average of 1.7% demand growth. According to TradeSports.com, the percent chance of a US and/or Israeli strike on Iran this year has fallen to 12.8% from 36% late last year. The elevated level of gas prices related to crude oil production disruption speculation is further dampening fuel demand, which is beginning to send gas prices back to reasonable levels.

US oil inventories are near 7-year highs. Since December 2003, global oil demand is only up .1%, while global supplies have increased 5.3%, according to the Energy Intelligence Group. Moreover, worldwide inventories are poised to begin increasing at an accelerated rate over the next year. I continue to believe oil is priced at extremely elevated levels on fear and record speculation by investment funds, not fundamentals. Oil will likely test its major uptrend at $66.33 in the near-term, barring the formation of a new hurricane. Escalating tensions with Iran and a Gulf hurricane will likely lead to a major top in oil over the next six weeks as demand destruction further accelerates. As the fear premium in oil dissipates back to more reasonable levels, global growth slows and supplies continue to rise, crude oil should head meaningfully lower over the intermediate-term.

Natural gas inventories rose more than expectations this week, sending prices for the commodity plunging. Supplies are now 12.4% above the 5-year average, a record high level for this time of year, even as some daily Gulf of Mexico production remains shut-in. Natural gas prices have collapsed 62.4% since December 2005 highs. It is very likely US natural gas storage will become full during October, creating the distinct possibility of a “no-bid” situation for the physical commodity. Colorado State recently reduced its forecast from three to two major hurricanes for this season versus seven last year. Natural gas made new cycle lows this week despite the fact that the commodity is in its seasonally strong period.

Gold was about unchanged on the week as US dollar weakness offset diminishing inflation fears. The US dollar fell on declining expectations for further Fed interest rate increases. I continue to believe there is almost zero chance of a Fed rate hike at the September meeting and very little chance of another hike this year.

Technology stocks outperformed for the week on increasing optimism ahead of a seasonally strong period for the sector. Energy stocks underperformed as the mania for these shares continues to subside in the face of falling commodity prices and declining inflation worries. S&P 500 profit growth for the second quarter is coming in a strong 13.2% versus a long-term historical average of 7%, according to Reuters. This would mark the 16th straight quarter of double-digit profit growth, the best streak since recording keeping began in 1936. Moreover, another double-digit gain is likely in the third quarter. Despite a 75.8% total return for the S&P 500 since the October 2002 bottom, its forward p/e has contracted relentlessly and now stands at a very reasonable 15.0. The 20-year average p/e for the S&P 500 is 24.4. The S&P 500 is up 6.4% and the Russell 2000 Index is up 8.0% year-to-date, notwithstanding the recent correction.

The current pullback is still providing longer-term investors very attractive opportunities in many stocks that have been punished indiscriminately. In my entire investment career, I have never seen the best “growth” companies in the world priced as cheaply as they are now relative to the broad market. By contrast, “value” stocks are quite expensive in many cases. A recent CSFB report confirmed this view. The report said that on a price-to-cash flow basis growth stocks are now cheaper than value stocks for the first time since at least 1977. The entire decline in the S&P 500’s p/e, since the bubble burst in 2000, is a function of growth stock multiple contraction. The p/e on value stocks is back near historically high levels. I still expect the most overvalued economically sensitive and emerging market stocks to continue underperforming over the intermediate-term as the manias for those shares subside. I still believe a chain reaction of events has begun that will eventually result in a substantial increase in demand for US stocks.

In my opinion, the market is still factoring in way too much bad news at current levels. One of the characteristics of the current “negativity bubble” is that most potential positives are undermined, downplayed or completely ignored, while almost every potential negative is exaggerated and promptly priced in to stock prices. Problematic inflation, substantially higher long-term rates, a significant US dollar decline, a “hard-landing” in housing, a plunge in consumer spending and ever higher oil prices appear to be mostly factored into stock prices at this point. I view any one of these as unlikely and the occurrence of all as highly unlikely. This “irrational pessimism” by investors is resulting in a dramatic decrease in the supply of stock as companies buy back shares, IPOs are pulled and secondary stock offerings are canceled.

Over the coming months, an end to the Fed rate hikes, lower commodity prices, seasonal strength, the November election, decelerating inflation readings, lower long-term rates, increased consumer/investor confidence, rising demand for US stocks and the realization that economic growth is only slowing to around average levels should provide the catalysts for another substantial push higher in the major averages through year-end as p/e multiples begin to expand. I still believe the S&P 500 will return a total of around 15% for the year. The ECRI Weekly Leading Index was unchanged this week and is forecasting healthy, but decelerating, US economic activity.


*5-day % Change

Friday, September 01, 2006

Weekly Scoreboard*

Indices
S&P 500 1,311.01 +1.23%
DJIA 11,464.15 +1.60%
NASDAQ 2,193.16 +2.47%
Russell 2000 721.56 +3.19%
Wilshire 5000 13,117.19 +1.52%
S&P Barra Growth 608.89 +1.40%
S&P Barra Value 700.03 +1.06%
Morgan Stanley Consumer 646.45 +2.34%
Morgan Stanley Cyclical 810.09 +2.78%
Morgan Stanley Technology 509.52 +2.92%
Transports 4,310.38 +1.67%
Utilities 441.39 +.48%
MSCI Emerging Markets 98.90 +2.98%
S&P 500 Cum A/D Line 7,067 +6.0%
Bloomberg Oil % Bulls 38.0 +7.6%
CFTC Oil Large Speculative Longs 179,681 -2.0%
Put/Call .99 +22.2%
NYSE Arms .75 -33.6%
Volatility(VIX) 11.96 -2.84%
ISE Sentiment 65.0 -56.95%
AAII % Bulls 41.57 +5.6%
AAII % Bears 25.84 -30.9%
US Dollar 84.95 -.49%
CRB 325.42 -3.2%
ECRI Weekly Leading Index 135.10 unch.

Futures Spot Prices
Crude Oil 69.24 -4.48%
Unleaded Gasoline 173.60 -7.2%
Natural Gas 5.94 -19.6%
Heating Oil 196.75 -5.04%
Gold 632.70 +.24%
Base Metals 230.35 -.10%
Copper 346.75 +1.69%
10-year US Treasury Yield 4.72% -1.25%
Average 30-year Mortgage Rate 6.48% -.61%

Leading Sectors
Disk Drives +6.31%
Restaurants +4.80%
Airlines +4.45%
Internet +3.8%
Networking +3.7%

Lagging Sectors
Banks +.24%
Coal -.88%
Oil Service -1.44%
Oil Tankers -2.42%
Energy -2.97%

One-Week High-Volume Gainers
One-Week High-Volume Losers

*5-Day % Change

Stocks Higher into Final Hour on Another Fall in Energy Prices and Rising Economic Optimism

BOTTOM LINE: The Portfolio is slightly higher into the final hour on gains in my Retail longs, Medical longs and Computer longs. I have not traded today, thus leaving the Portfolio 100% net long. The tone of the market is positive as the advance/decline line is higher, most sectors are rising and volume is light. Oil is trading near session lows, down $1.07 to $69.19, notwithstanding the Iranian situation and the potential for hurricanes this month. Barring the formation of a new tropical storm over the holiday weekend, I suspect oil will test its major uptrend line around the 50-week moving-average at $66.30 next week. Overall, commodities continue to weaken. The CRB Index already broke its key uptrend a couple of weeks ago and is now making another weekly lower low. I normally pay some attention to technicals. However, given the fact that a large majority of commodity traders overwhelmingly use technical analysis I am more focused than usual on these key levels. I continue to believe the negative effects oil has had on the U.S. economy and stock market are vastly underestimated. An oil breakdown into the $50s would have hugely positive implications for the broad market. I expect US stocks to trade mixed-to-higher into the close from current levels on short-covering, more economic optimism, declining energy prices and lower long-term rates.

Today's Headlines

Bloomberg:
- McDonald’s(MCD) said activist investor Bill Ackman plans to buy more than $793.8 million of McDonald’s shares.
- Crude oil is falling to a two-month low on less speculation for hurricane-related production disruptions and a declining fear premium.
- Gas prices across the US are likely to fall further this month as demand from motorists slows.
- Colorado State University hurricane forecasters trimmed the number of storms they expect to form in the Atlantic Ocean this year for a second time. They now expect 5 more hurricanes with two being major.
- Ford Motor(F) said US sales fell 12% in August as purchases of gas guzzling SUVs and trucks continued to decline.

Wall Street Journal:
- US retailers are part of a large increase in the number of approved retail projects in China after the government removed restrictions governing the entry of foreign firms.
- Immigration has become critical to maintaining population levels in many countries as birth rates decline worldwide, Gary S. Becker writes.
- Advanced Cell Technology’s report last week of success in creating stem cells without harming embryos has come under scrutiny over the accuracy of its statements.

NY Times:
- Shanghai high-school educators will reduce the emphasis on socialism and Mao Zedong in their history courses in an effort to prepare students better for current society.

- Starting pay at large NYC law firms has reached $145,000, after a California firm with NY offices boosted salaries for first-year associates.

Business Week:
- Scholastic Corp.(SCHL) could be a takeover target, citing Michael Metz of Oppenheimer.

Washington Post:
- Iraq television stations are broadcasting reality shows ranging from an “American Idol”-like talent contest to one inspired by “Extreme Makeover: Home Edition.”

NY Daily News:
- Fast Retailing, Japan’s biggest casual-clothing retailer, will use portable stores built into cargo containers to promote its first Uniqlo store in NY.

NY Post:
- The number of passengers using the NY area’s three major airports hit a record 50.6 million in the first six months of this year, citing Port Authority of NY and NJ.

Star-Ledger of Newark:
- Comcast(CMCSA), buoyed by sales of packages that bundle phone, video, and Internet services, expects to hire 552 new employees in NJ by year’s end.

Business Day:
- A Nigerian refinery that’s been out of production since militant attacks destroyed a pumping station is now importing crude oil from Iraq so it can resume operations.

USA Today:
- Golf courses across the country are being replaced by housing and other real estate projects, as land becomes more valuable and owners seek higher returns.

Financial Times:
- Ford Motor’s(F) Aston Martin sports-car unit may be sold for as much as $2 billion.

Reuters:
- BP Plc expects to restart production in the eastern section of its Alaskan Prudhoe Bay oil field as early as the end of this month.

Toronto Sun:
- A fictional-documentary, the “Death of a President,” that portrays the assassination of President Bush has drawn “outrage” in some circles.

AFP:
- Syrian President al-Assad agreed to deploy more border guards and set up a “liason mechanism” with the Lebanese army and UN troops to enforce a weapons embargo against Hezbollah.

Unemployment Falls Again, Consumer Confidence Rebounds Slightly, Residential Construction Slows, Manufacturing Healthy, Prices Paid Falls

- The Change in Non-farm Payrolls for August was 128K versus estimates of 125K and an upwardly revised 121K in July.
- The Change in Manufacturing Payrolls for August was -11K versus estimates of 0K and a downwardly revised -23K in July.
- Average Hourly Earnings for August rose .1% versus estimates of a .3% gain and an upwardly revised .5% increase in July.
- The Final Univ. of Mich. Consumer Confidence reading for August rose to 82.0 versus estimates of 79.0 and a prior forecast of 78.7.
- Construction Spending for July fell 1.2% versus estimates of a .1% decline and a .4% increase in June.
- ISM Manufacturing for August fell to 54.5 versus estimates of 54.5 and a reading of 54.7 in July.
- ISM Prices Paid for August fell to 73.0 versus estimates of 76.0 and a reading of 78.5 in July.
- Pending Home Sales for July fell 7.0% versus estimates of a 1.5% decline and unchanged in June.
BOTTOM LINE: Job growth in the US picked up in August and the unemployment rate approached a five-year low, the latest in a string of reports to show the economy will avoid a sharp downturn, Bloomberg said. Employment in service-producing industries rose 118,000, boosted by a 60,000 job increase in education and heath service jobs. Builders add 17,000 jobs, the most since February, led by commercial construction. Average hourly earnings rose 3.9% year-over-year, the best in five years. Most economists believe the economy needs to create about 100,000 jobs a month to keep unemployment from rising. I continue to believe the job market will remain healthy over the intermediate-term without generating substantial unit labor cost increases.

Confidence among US consumers was higher than forecast in August as gas prices fell in the final two weeks of the month and incomes grew, Bloomberg said. The current conditions index, which is a gauge of Americans’ perceptions of their financial situation and whether they should buy big-ticket items rose to 103.8 versus a prior estimate of 100.8. Consumers’ inflation concerns eased in August as gas prices fell. I continue to believe consumer sentiment will make new cycle highs over the intermediate-term as stocks rise, energy prices fall, interest rates remain relatively low, inflation decelerates, housing stabilizes, the job market remains healthy and irrational pessimism lifts further.

US construction spending fell in July by the most since 2001 as the housing market weakened after five years of record sales, Bloomberg said. Private-non-residential construction surged 22% from last year as companies spent more on offices, healthy-care facilities and transportation projects. I expect construction to remain well-below recent levels, but commercial building to somewhat cushion the deceleration.

Growth in US manufacturing eased slightly last month, Bloomberg reported. The prices paid component of the index fell to 73.0 from 78.5 the prior month. The closing price of a barrel of oil fell below $70 for the first time in two months on Aug. 29 as production disruption speculation subsided. The new orders component of the index fell to 54.2 versus 56.1 in July. The employment component of the index rose to 54.0 versus a reading of 50.7 the prior month. I continue expect manufacturing to remain around average levels as companies gain confidence in the sustainability of the expansion, thus rebuilding near-record low inventories.

Contracts to buy previously owned homes in the US fell in July, Bloomberg reported. The decline should ensure the Fed remains on hold. Pending home sales fell 9% in the Midwest, 7.7% in the Northeast, 6.4% in the South and 5.5% in the West. The average 30-year mortgage rate has declined 32 basis points since July 21. As well, the homebuilding stocks(HGX Index) have begun ignoring negative data points, rising 8.7% since July 21. I continue to believe housing is in the process of slowing to more healthy sustainable levels. Home inventories should begin heading lower from current levels over the next few months.

Links of Interest

Market Snapshot
Detailed Market Summary
Market Internals
Economic Commentary
Movers & Shakers
Today in IBD
NYSE OrderTrac
I-Watch Sector Overview
NYSE Unusual Volume
NASDAQ Unusual Volume
Hot Spots
NASDAQ 100 Heatmap
DJIA Quick Charts
Chart Toppers
Option Dragon
Real-time Intraday Chart/Quote