Growth Slows, Inflation Subsides, Consumption Strong, Confidence Rising

- Advance 3Q GDP rose 1.6% versus estimates of a 2.0% increase and a 2.6% gain in 2Q.
- Advance 3Q GDP Price Index rose 1.8% versus estimates of a 2.8% increase and a 3.3% gain in 2Q.
- Advance 3Q Personal Consumption rose 3.1% versus estimates of a 3.1% increase and a 2.6% gain in 2Q.
- Advance 3Q Core PCE rose 2.3% versus estimates of a 2.5% increase and a 2.7% gain in 2Q.
- Final Univ. of Mich. Consumer Confidence for October rose to 93.6 versus estimates of 92.7 and a prior reading of 92.3

BOTTOM LINE: The US economy grew less than economists forecast last quarter, Bloomberg reported. A 17.4% decline in residential housing construction was the main reason for the slower growth. Also hampering growth, companies added less to inventories during the quarter. There were several signs the slowdown may prove temporary. Consumer spending, which accounts for about 70% of the economy, increased 3.1% versus a 2.6% gain in the second quarter as rising incomes and lower energy prices helped offset the effects of the housing slowdown. The price of gas this month has averaged $2.25/gallon versus $3.00/gallon during July. Business spending on new equipment and software surged 6.4% during the quarter versus a 4.4% increase in the second quarter. The Core PCE Index, the Fed’s favorite inflation gauge, rose 2.3% during the quarter versus a 2.7% gain the prior quarter. The GDP Price Index rose 1.8% versus a 3.3% gain in the prior quarter. I expect US GDP Growth to bounce back to around 3% this quarter, while inflation continues to moderate.

Consumer Confidence in the US rose to the highest in 15 months in October as plunging gas prices, a strong job market and rising stock prices left more money in Americans’ pockets, Bloomberg reported. The current conditions component of the index, which reflects consumers attitude about their current financial situation and whether it’s a good time to buy big-ticket items, soared to 107.3 from 96.6 the prior month. Workers’ average hourly earnings rose 4% over the last 12 months, the largest gain in five years and unemployment is at a historically low 4.6%. I continue to believe consumer confidence will reach new cycle highs over the coming months as the job market remains healthy, housing stabilizes, interest rates remain low, inflation decelerates further, stocks continue to rise, irrational pessimism lifts and the mid-term election ends.

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Friday Watch

Late-Night Headlines
Bloomberg:
- Japan’s consumer price gains unexpectedly slowed in September, prompting speculation the central bank will refrain from raising interest rates until next year.
- The yen weakened to a record against the euro after a government report showed an unexpected slowing in the pace of consumer price gains, raising concern the nation hasn’t fully emerged from its seven-year battle with deflation.
- China Oilfield Services Ltd., a unit of the nation’s third-largest oil producer, drilled 13% more wells in the first nine months of this year as China intensifies its search for oil and gas.
- Islamist fighters in Somalia have sieged control of a trading town and are massing to the east of Baidoa, the seat of the interim government.
- Australia’s senior Muslim cleric’s assertion that women who dress immodestly invite sexual assault could do “lasting damage” to the country’s Islamic community, Prime Minister John Howard said. Egyptian-born Sheik Taj Din al-Hilali last month delivered a sermon in which he likened women who don’t wear the Islamic headscarf to “uncovered meat” that falls prey to alley cats.

Late Buy/Sell Recommendations
Citigroup:
- Reiterated Buy on (SFI), target $50.

Business Week:
- Solexa(SLXA), which makes DNA sequencing products, may rise as much as 50% on sales of its genome analysis system, citing Leerink Swann’s John Sullivan.
- Lazard Ltd.(LAZ), the investment bank that helped invent mergers and acquisitions as a specialty, has expanded in new areas in the face of competition, citing an interview with Chairman and CEO Wasserstein.

Night Trading
Asian Indices are -.50% to +.50% on average.
S&P 500 indicated -.14%.
NASDAQ 100 indicated -.04%.

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Earnings of Note
Company/EPS Estimate
- (ALEX)/.52
- (AT)/.64
- (BHI)/1.08
- (BC)/.46
- (CAH)/.76
- (CVX)/2.03
- (CEG)/1.28
- (EXC)/1.05
- (FO)/1.33
- (IR)/.86
- (ITT)/.76
- (NOV).96
- (TE)/.34

Upcoming Splits
- None of note

Economic Releases
8:30 am EST
- Advance 3Q GDP is estimated to rise 2.0% versus a 2.6% rise in 2Q.
- Advance 3Q GDP Price Index is estimated to rise 2.8% versus a 3.3% rise in 2Q.
- Advance 3Q Personal Consumption is estimated to rise 3.1% versus a 2.6% gain in 2Q.
- Advance 3Q Core PCE is estimates to rise 2.5% versus a 2.7% gain in 2Q.

9:45 am EST
- The Final Univ. of Mich. Consumer Confidence reading for October is estimated to rise to 92.7 versus a prior estimate of 92.3.

BOTTOM LINE: Asian indices are mostly lower, weighed down by financial shares 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 Surge on Heavy Volume as Energy Prices Fall, Profits Remain Strong and Long-term Rates Fall

Indices
S&P 500 1,389.08 +.50%
DJIA 12,163.66 +.24%
NASDAQ 2,379.10 +.96%
Russell 2000 776.02 +1.16%
Wilshire 5000 13,907.14 +1.02%
S&P Barra Growth 644.28 +.48%
S&P Barra Value 742.70 +.51%
Morgan Stanley Consumer 672.42 +.35%
Morgan Stanley Cyclical 866.75 +.62%
Morgan Stanley Technology 554.82 +.66%
Transports 4,788.72 +.14%
Utilities 450.44 -.41%
Put/Call .78 -7.14%
NYSE Arms 1.14 +7.80%
Volatility(VIX) 10.56 -.94%
ISE Sentiment 166.0 +9.93%
US Dollar 85.89 -.57%
CRB 311.78 -.32%

Futures Spot Prices
Crude Oil 60.29 -1.81%
Unleaded Gasoline 156.70 -1.59%
Natural Gas 7.47 -2.85%
Heating Oil 169.85 -2.33%
Gold 599.90 +.02%
Base Metals 243.97 +.07%
Copper 339.50 -.15%
10-year US Treasury Yield 4.72% -.97%

Leading Sectors
Airlines +2.44%
HMOs +2.17%
Retail +1.90%

Lagging Sectors
Oil Tankers -.52%
Steel -.68%
Drugs -.93%

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Afternoon Recommendations
Bank of America:
- Rate (PEIX) Sell, target $12.50

Afternoon/Evening Headlines
Bloomberg:
- US stocks extended a weeklong rally, pushing the S&P 500 toward its best month since 2003 and sending the DJIA to another all-time high.
- Gasoline futures fell more than 2%, the biggest drop in three weeks, on speculation current inventories did not justify yesterday’s 3.6% rise.
- Crude oil fell over $1/bbl. on speculation that US inventories are adequate to meet demand in coming weeks.
- Microsoft(MSFT) said first quarter profit rose 11%, helped by higher revenue from server software.
- Shares of Home Inns & Hotels Management(HMIN), China’s second-largest budget hotel chain, surged 63% in their fist day of trading on the Nasdaq Stock Market today.

Nikkei English News:
- The NYSE proposed a financial and operational partnership with the Tokyo Stock Exchange.

BOTTOM LINE: The Portfolio finished higher today on gains in my Semi longs, Medical longs, Retail longs and Biotech longs. I did not trade in the final hour, thus leaving the Portfolio 100% net long. The tone of the market was very positive today as the advance/decline line finished substantially higher, most sectors rose and volume was heavy. Measures of investor anxiety were mostly lower into the close. Today's overall market action was very bullish. I especially liked the slow grind higher throughout the day rather than a sharp compressed move. As well, the NYSE Arms was at above-average levels again throughout the day. Tomorrow's GDP report and inflation reading will likely result in another move lower in long rates. Natural gas gave up all of this morning's gains and is now down about 2.7%. The recent surge in prices was related more to another bout of record speculation by investment funds than fundamental improvements. Natural gas storage is at all-time high levels heading into the commodity's seasonally weak period which begins over the next couple of weeks. I suspect natural gas has made another meaningful top.

Nasdaq Surging on Heavy Volume as Corporate Profits Exceed Estimates, Energy Prices Fall and Long-term Rates Decline

BOTTOM LINE: The Portfolio is higher into the final hour on gains in my Semiconductor longs, Biotech longs, Retail longs and Computer longs. I have not traded today, thus leaving the Portfolio 100% net long. The tone of the market is very positive as the advance/decline line is substantially higher, most sectors are gaining and volume is heavy. Intuitive Surgical (ISRG) is rising 3.2% today ahead of its earnings report after the close, however the stock is still well off highs. I suspect the company will once again beat estimates and give conservative guidance. In the past, the always-conservative guidance has, at times, spooked investors. However, bullish sentiment is more subdued heading into this evening's report. The short interest ratio has increased from a low of 1.47 in February to 3.46 recently. The Open Interest Put/Call for ISRG is currently .93 vs. a low of .57 in March. Implied volatility has risen from 38% in September to 68% currently. HSBC recently initiated the stock with an overweight rating and put a $136 price target on the shares. I suspect that if the company is able to exceed estimates, which I expect, that investors will finally ignore the conservative guidance as the sentiment towards pure growth stocks continues to improve. I remain long the stock and still expect it to exceed its all-time high of $139.50 this quarter. I expect US stocks to trade modestly higher into the close from current levels on short-covering, strong profit reports, lower long-term rates, lower energy prices and investment manager performance anxiety.

Today's Headlines

Bloomberg:
- Natural gas is falling in NY, ending the recent rally, amid record inventories in underground storage.
- Crude oil is falling more than $1/bbl. on speculation that US stockpiles, near 7-year highs, are adequate to meet demand in coming weeks.
- The Dow Jones Industrial Average is making another all-time high on strong earnings reports and a better-than-expected new home sales report.
- Goldman Sachs(GS) promoted 262 executives to managing director a day after adding 115 partners, the firm’s top rank.
- Federal Reserve officials may leave interest rates alone until the middle of next year, confident of “moderate” economic growth and abating inflation.
- ExxonMobil(XOM) said third quarter profit rose 5.7% because crude prices climbed to an all-time high and production increased for a third straight quarter.
- China and Russia said they would oppose a draft resolution imposing UN sanctions on Iran over its nuclear program, as the Security Council’s five permanent members prepared for their first meeting on the text.

Wall Street Journal:
- Private-equity and hedge funds are considering taking stakes in the bankruptcy-plagued US auto-parts industry.
- Blackstone Group LP, which announced recently that it had raised the biggest-ever private-equity fund, with $15.6 billion, wants to increase that amount to $20 billion.
- Clear Channel Communications(CCU) may get bids from a group of investors led by Thomas H. Lee Partners that includes Texas Pacific Group and Bain Capital LLC.
- Wild Oats(OATS) has been a lackluster performer, with annual sales growth of 3-5% at established outlets, against 7-9% for the industry as a whole. That, however, could change under new leadership, and the company’s stock has risen twice in the past week, first on the news that CEO Odak’s contract wouldn’t be renewed, and again when it was announced that he’d resigned.
- Cold Stone Creamery, Marble Slab Creamery and MaggieMoo’s Intl. are trying to develop a niche within the ice cream market by offering high-end versions of a common product.

NY Times:
- Democratic bloggers are targeting about 50 Republican candidates in an effort to make particular articles or Web sites appear at the top of a Google search list. After embedding a candidate’s name with a hyperlink to a negative article about the person, blogger Chris Bowers, who devised the plan, has been distributing the links to others with left-wing blogs.

Boston Globe:
- McDonald’s(MCD) restaurants in New England are getting a makeover that features leather chairs, plasma televisions and wireless Internet access.