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No Fly Zone

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Venezuela banned flights into the country by Continental and Delta and restricted American Airlines to only three flights originating from Miami. This move was planned to further punish the U.S. for restricting Venezuelan flights into the U.S. airspace and to stick it to the U.S. one more time. Venezuelan airlines are rated a class two for safety and cannot add any new flights into the U.S. at that level. Only class one airlines can increase flights into the U.S. market. Class three airlines, the lowest safety level, are prohibited from entering U.S. airspace at all. President Chavez, never known for calm and rational actions, took the step to punish the U.S. for its long standing policy of only allowing those airlines with a strong safety record to access U.S. markets. Venezuela is the fifth largest destination in South America and the loss of these flights will hurt the American carriers but don't look for U.S. officials to relax their rules, especially for Chavez. Over the last two years Chavez has attacked the energy sector by imposing billions in new taxes and making them retroactive. He also changed the royalty schedule for oil produced in VZ and changed the ownership rules for oil facilities in his country transferring ownership of the properties to VZ. He also attacked the mining companies and food service companies who export to America. Last week he ordered the central bank of VZ to turn over more than $5 billion in reserves to the government thus weakening the bank and the countries currency. Chavez said the funds would be used for "off budget" expenditures. Chavez also aggravated the U.S. administration by offering millions of gallons of heating oil to northeastern users at below market rates as another stab at the administration. He has repeatedly said he wants to sell his oil to other nations rather than America and has inked deals with China to start those plans in motion. I seriously doubt U.S. officials will be willing to negotiate with VZ over the flight restrictions given his recent list of attacks on us. Nobody should want to fly on an airplane with substandard maintenance procedures and bad safety records and that makes VZ a no fly zone unless you can get one of the 900 daily seats allowed on remaining the American Airlines flights. While this new flight restriction spat made the news on Friday it was far from the lead story.

Dow Chart - Daily

Nasdaq Chart - Daily

Wilshire 5000 Chart - Daily

Friday was a heavy news day for the energy sector. The morning started off with news that Saudi Arabia foiled a terrorist attack on a facility at the Abqaiq Center. That facility handles about six million bbls per day of Saudi output. Vehicles loaded with explosives attempted to crash through the security gates into the facility but exploded when guards opened fire on the bombers. No material damage was reported to the oil facility but three guards were killed and ten injured in the battle and explosions. Saudi has been hardening their security after Osama called for attacks on oil infrastructure as a way of penalizing the United States with higher prices. Many facilities have tanks guarding the approaches and bunkers with heavy caliber weapons to thwart just such an attack as we saw on Friday.

In Nigeria attacks continued on oil facilities with 455,000 bbls of daily output already offline. Rebels said they would continue the attacks until one third of the 2.5 mbpd of production was stopped or roughly another 400,000 bbls. Rebels are now attacking oil rigs and taking hostages right off the platforms. Nigeria is the fifth largest exporter to the U.S. and exports the light sweet crude strongly demanded by refiners.

Indonesia thwarted an attempted coup attempt this week and had to disperse troops to sensitive locations including gold mines and oil facilities in a state of heightened alert as instability loomed. Late Friday the conditions appeared to be under control and tensions eased. Indonesia exports approximately 1 mbpd.

Earlier this week Ecuador was also in the headlines as protestors staged violent demonstrations with many causalities. The president, Alfredo Palacio, suspended civil rights and ordered police and the military to regain control. Protestors had damaged pipelines and roads necessary to transport crude to the coast for export. The conditions appeared to have calmed late in the week but tensions were still high.

The combination of those events showed just how fragile the oil situation really is. Crude oil prices soared +2.37 on Friday to close at 62.91. This was above the resistance set earlier in the week and erased the drop back to $59.65 we saw on Thursday. The continued news events surrounding black gold are preventing it from making its normal historical lows for this time of year. Typically oil prices fall in late February and early March and then rally into the summer driving season with highs in the May/June period. In 21 of the last 22 years gasoline has set lows in the last two weeks of February and highs in the first two weeks of May. This is because of a buildup of crude inventories as refineries go offline to switch from winter products to summer products. Crude supplies rise with prices dropping while gasoline supplies moderate. Once the refinery maintenance is over they race to catch up with rising demand for gasoline, diesel and jet fuel. The maintenance schedule puts them behind the demand curve causing prices to rise. This year the maintenance schedule is especially tough given the extended run at nearly 100% capacity by many refiners to compensate for those refiners knocked out in the gulf. It is also going to take longer due to the new rules on lower sulphur emissions. Those rules require extensive modifications to refineries making the conversions to low emission fuel. The new rules are expected to remove -500,000 bpd of diesel from the market on a permanent basis due to some older refineries choosing to halt production rather than spend the money necessary for the conversion. The elimination of MTBE as a fuel additive is also expected to remove nearly 300,000 bpd of gasoline from the market. For refiners who have already made the conversions this represents an opportunity for wider margins and stronger earnings. Valero is best positioned to profit from this trend.

April Crude Chart - Daily

The problem of geopolitical pressures on oil prices is not expected to change. The Iran problem is expected to heat up over the next two weeks as the date for the next UN action draws near. Nigeria is not expected to improve and it is only a matter of time before some new hot spot appears or a terrorist is successful in crippling Saudi production. We saw the price of crude drop back to our target of $58 in Mid February, which gave us a strong buying opportunity. It is entirely possible we could see another pullback to that area but these geopolitical events are making that less likely as each day passes. This is the period where the price normally declines but the time is growing short based on the historical patterns. Once into March the bias is going to shift to the upside ahead of the summer driving season. Bottom line, buy any dip over the next two weeks.

RIMM got a reprieve on Friday as the Federal Patent Office invalidated the final patent under litigation. As of Friday ALL of the NTP patents have been ruled invalid and the NTP/RIMM case is rapidly approaching a conclusion. The judge on the case warned both parties on Friday that they had better reach a settlement quickly or he was going to issue a ruling that neither party would like. The judge has been growing increasingly frustrated with the lack of a settlement or even the lack of meaningful settlement talks. Friday's final patent ruling should slam the door on NTP and their hopes of a large cash payment. The RIMM CEO said on CNBC there is no reason to settle with NTP given the patent ruling. He said the only reason to settle at all was to keep NTP from attacking their partners in an effort to produce some blackmail proceeds. RIMM said it was willing to discuss a settlement if access providers, manufacturers, users, software providers, etc, were also protected from future NTP action. The clock is clearly running out on the battle yet the judge refuses to acknowledge that the patents have been ruled invalid. It produces a conundrum for RIMM because they have been vindicated by the patent office but still have a judgment pending by the court as though the patents were still in force. Deal or no deal, that is the NTP question this weekend. Facing the potential for zero compensation if the case turns against them NTP lawyers better start making a settlement decision quickly. RIMM has been escrowing money for a settlement every quarter since the case began and reportedly has a cash hoard of more than $2 billion. They have got to be breathing easier today with plans for putting that money back to work very soon.

RIMM Chart - Daily

LEH Chart - Monthly

Lehman (LEH) continues to push higher with a close at $148 on Friday. For long-term holders this is a +1300% gain from the split adjusted $11.31 low we saw back in 1999. Lehman last split 2:1 in October 2000 after a high of $160 was posted in September. This puts Lehman well within range for another split announcement soon. One broker raised their price target for Lehman to $173 saying business was hot and profitability was growing. However options activity suggests traders are more bearish than bullish on LEH and short interest accounts for more than five days of volume. This is a recipe for another move higher on any good news or continued bullishness in the sector. Other brokers with highflying stock prices include BSC $135, GS $144 and LM $136. The Broker Dealer Index (XBD.x) hit a new historic high at 225 on Friday on the rising strength in the sector.

Last week produced some rocky economics despite the Fed's stand that the recovery is gaining strength. Friday was no exception to the headliner rule. The headline number for January Durable Goods showed a -10.2% drop in orders and more than ten times worse than consensus estimates for a -1.0% drop. This is astounding on surface as the biggest drop in more than five years but we always want to look beyond the headline number for the real news. Excluding the volatile aircraft component orders actually rose +0.6% and right inline with many analyst estimates. The other components showed only a minor decrease in activity and a small rise in inventory levels. There was nothing in this report to worry the Fed contrary to the CPI released on Wednesday showing a +0.7% increase. Again, removing the +5% jump in energy prices the core CPI rose only +0.2% and less than the consensus estimate of +0.4%. For the last week economics produces lots of flash but no real substance in the way of Fed damaging numbers. That flash of strong headline numbers did manage to push the Fed funds futures to nearly a 100% chance of a 5.25% rate and analysts are still whispering that 5.5% is likely to be the real target. With the rate target slipping farther out into the future it is amazing the markets can maintain their current bullish bias.

Next week there are some major economic reports on tap with GDP, NAPM, PMI and ISM the ones to watch. These reports should give us a better idea of what the Fed will do as the year progresses. Missing from next week's schedule is the Employment report for February, which is normally on the first Friday of the month. Because month end is not until Tuesday it was moved to the following Friday March 10th. That puts it only about two weeks before the next Fed meeting. Sure seems like those meetings are popping up more often. Seems like Greenspan's last meeting was just last week but it has been nearly a month.

Economic Schedule Week of Feb-27th

Fed Governor Poole said on Friday that a sustained expansion is in place and proceeding well. He also said he was comfortable with the current rate program BUT even if the Fed did go too far the economy can rebound from that event. If the Fed governors are worried about going too far then it is less likely it will happen. Let's hope the meeting in March confirms that fact.

Several indexes set new multiyear highs last week including the Dow, NYSE Composite, Wilshire 5000 and Russell 2000. The Dow was the leader again with the other indexes breaking prior highs by only fractional amounts. For instance the Russell broke its January high of 736.45 with a high on Friday of 737.21 or only a .76 point difference. The NYSE composite broke its high of 8130 with a brief spike to 8140 intraday but fell at the close back to 8126. The Wilshire 5000, an index trading at the lofty level of 13,000 managed only a +15 point breakout intraday over its previous 13030 high posted in early January and closed back at 13009 at Friday's close.


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While those breakouts are tentative at best there is still no help from the bearish Nasdaq. The Nasdaq is still well below its January high of 2332 and struggling with downtrend resistance at 2286. The index did show a little more life this week but it could not muster an intraday breakout above the short-term resistance at 2295. We did get some higher lows and that gives us a little hope that techs may be finding some reluctant buyers.

The Nasdaq is the only thing keeping the markets from a real rally as February closes. If the six major indexes were all members of a six-horse team pulling a heavily loaded wagon uphill then the Nasdaq would be the horse passed out in its harness and being dragged along with the wagon by the other five horses. It is going to be very difficult to gain any substantial ground until the Nasdaq wakes up and at lease walks along with the rest of the team. Not having to drag the horse as well as the wagon would be a major relief for the rest of the indexes. The virus affecting the Nasdaq and producing the weakness is the semiconductor flu. Led lower by INTC, TXN, AMAT, MRVL, NVLS, STM, TSM and XLNX the SOX is testing support at 520 and well off its 560 highs set in late January. Merrill analyst Joe Osha reported potential price cuts on processors, DRAM and NAND supply for all of 2006. AMD slashed prices for Opteron processors and Osha thinks Intel will follow suit and slash its dual core processors in April. Osha said Intel has an inventory problem ahead of its release of the Woodcrest and Conroe products later this year. Channel checks on NAND chips showed a ramp in inventory levels in Q4 that could slow production in Q1/Q2 until the inventory is absorbed. He also expects Q2 price cuts by SanDisk and others. To put is simply there is no joy in Chipville after Intel struck out. Depression has settled over chip investors and there appears to be no desire to hunt for bargains. Next weeks semiconductor billings on Thursday might provide a spark but first quarter semi sales are normally weak.

SPX Chart - 180 min

That leaves us with a SPX that gained a whopping +2 points for the week to close at 1289 and a dead stop under the 1295 resistance that held back in early January. The NYSE, Wilshire and the Transports were the only indexes to post double-digit gains for the week and all three were only able to make it into the +30s despite their efforts. It is remarkable that the transports were able to gain at all given the spike in oil to $63.25 from the prior weeks $59.15 low. (April contract) The March contract that ceased trading on Tuesday hit $57.40 and the low for 2006. If you were comparing apples to apples that was an oil spike of nearly $6 as the contracts changed and geopolitical considerations mounted. This makes the +31 point gain in the transports even more surprising. I mentioned last Sunday that I thought the extreme volatility in oil prices ahead of the weekend was due mostly to options/futures expiration and the three-day weekend rather than the $58 level being seen as a good buy on Thursday. The two-day drop, which began on Wednesday, proved that point with oil returning to $59 and change but after the Saudi attack we may have seen the lows for spring. Oil prices did not appear to impact the equity indexes despite their volatility. Traders appear to be more focused on the Fed than oil. Bernanke gave a speech on Friday at Princeton where he taught for 17 years and said the Fed is not seeing any material inflation as a result of higher energy prices. I think he must have been reliving his college days and a possible flash back to some sort of chemical induced mental haze to make that statement. Anyone that has bought gas for their SUV or paid their heating bills over the last three months knows that prices have risen even if the Fed does not count energy as an inflation factor. It appears I digressed but that is a pet peeve of mine that they don't count food or energy.

Next week will be data dependant with a strong calendar on Tuesday likely to decide our fate followed by the ISM trump card on Wednesday. As boring as it is we should still be cautiously long over SPX 1275 but I would be cinching my stops really tight on any new bounce to 1295. This is month end and we should see some minimal benefit from cash flows into funds but we are rapidly running out of reasons to remain long. Earnings are over and we have seen a constant parade bad guidance recently and much of it from the consumer sector. Earnings for Q1 are expected to slow drastically except for energy and banking and we should be very close to single digit mode after 14 quarters of double-digit earnings growth. Without the energy sector Q4 would have come in around +4% rather than another double-digit quarter around +15%. Thomson First Call is still stubbornly holding on to barely double digit estimates of +10.8% growth in Q1 and +10.9% growth in Q2. Clearly we are right on the edge of that single digit cliff.

While investors should be pleased to maintain that sort of growth we are way out on that earnings limb and stretching for all it is worth. A couple more double cheeseburgers and we could hear a sharp crack as the streak ends and we tumble back to earth. No earnings growth cycle lasts forever and a retracement in earnings and the markets is only normal. The second year of a second term president is also problematic and history is clearly against a large market gain. Add in the Fed stretching out its rate hike cycle and the market has a nice wall of worry to climb. This is exactly the kind of circumstance that sometimes produces big gains. Fundamentals line up on the side of the bears and short positions increase. A set of positive economic numbers shocks the markets and a new round of short covering, shorting, short covering, shorting begins.

The long-term bullish view about the markets offsets the short-term fears about an earnings decline. Last week the SPX broke $800 billion for the forward earnings consensus. That is the first time ever and suggests that despite the earnings growth decline companies are still far better off than they were in 2000 at the height of the bubble. The forward earnings at the top of that bubble were only $556 billion. Today's numbers represent a +44% increase in real earnings. Interest rates were higher, 6.0% compared to only 4.5% today. Yes, the Fed is on track to hit 5.25% by summer but you get the idea. The clincher is the 1552 high on the SPX back in March of 2000. Earnings are up +44% while stock prices are down -17% and interest rates are more favorable. Inflation is almost nonexistent at 2% according to the Fed and the economy is gaining strength, also according to the Fed. In reality we could be in a stealth bull market and the last three months of sideways movement on the S&P is just consolidation before the next move higher.

I wish I could predict that higher spiral for the next couple weeks but unfortunately my crystal ball is out for repair. Until we actually see a break from this range we need to remain guided by our long/short indicators at 1275/1270. As long as we remain over 1275 we should remain cautiously long. Let the day traders fight it out in cyberspace and we will wait patiently for the next market move to confirm a direction. A convincing move over SPX 1295 would cause me to add to longs but keep my stops below 1295 to avoid the expected volatility. I would also want to see some life return to the Nasdaq but you can't have everything in life.

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