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The end of quarter tape painters should be proud. They managed to push the Dow to within nine points of its January 2000 all time high at 11750. This pushed the Dow's gains for Q3 to 4.7% and the best performance since 1995. The S&P posted its best third quarter since 1997 with a 5.2% gain. The Nasdaq ended the quarter with a 4.1% gain. The Dow transports failed to confirm the Dow industrials gains and lost -9.6% for the quarter. Unfortunately the painters ran out of paint Friday afternoon and the indexes slid back into the red. The decline was slight with the Dow ending only a few points below its highs.

Dow Chart - Daily

Nasdaq Chart - Daily

SPX Chart - Daily

The day started out well with the Chicago PMI jumping to 62.1 from last months 57.1. This was well over the consensus estimates of only 55.5. This was exactly opposite the trend we saw in the Philly Fed last week. Internal components of New Orders, Production, Order Backlog and Inventories all rose. The spike in new orders was significant with a gain of 7 points to 67.3. Prices Paid fell along with Employment, which fell sharply from 55.1 to 50.8. This unexpected strength in the Chicago manufacturing region suggests the national ISM due out on Monday may not be as bleak as analysts thought after the sharp drop in the Philly Fed survey. The current consensus is for a flat ISM at 54.0 for September. Over 50 is considered economic expansion and under 50 is a contraction. The PMI was met with surprise and also with a lot of disbelief. Many analysts thought it was an anomaly that would be corrected with next month's data. Time will tell.

The NAPM-NY also posted a gain for September but it was not as dramatic as the Chicago PMI. The NAPM rose to 421.0 from 416.8 but several internal components lost ground. The six-month outlook fell to 75.0 from 81.3 and the current conditions component fell to 58.5 from 65.0. This is not especially encouraging for traders. Inventory levels were up sharply with finished goods jumping to 67.0 fro 33.0. The NY NAPM has been climbing slowly for many months and the deterioration of those components follows the economic slowdown scenario and suggests next month could see a decline in the headline number.

Consumer sentiment rose from 82.0 to 85.4 in the final reading for September. The present conditions component fell to 96.6 from 103.8 but the expectations component jumped to 78.2 from 68.0. With gasoline prices dropping daily the fall in the present conditions component was surprising. Slower job growth was cited as a concern as well as the continued implosion in the housing sector.

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Personal Income rose 0.3% and right inline with consensus estimates but the core rate of inflation rose 0.2%. The Core PCE deflator, a primary concern for the Fed, showed a year over year inflation rate of 2.5% and the fastest core rate since 1995. The non-core PCE rose by 3.2%. The savings rate fell by -0.5% as consumers continue to be pressured by higher prices. The 0.3% growth in income was the slowest growth since last November. The slow growth in jobs is allowing employers to be choosy about their new hires and cheap when it comes to raises. Slowing income and rising inflation is not what the Fed wants to see. However, St. Louis Fed President William Poole spoke on Friday and repeated the Fed line that the worst was behind us. He also said that if inflation is only easing gradually there was no reason to hasten the decline by maintaining a restrictive Fed policy. He also said he would back a rate cut if both growth and price pressures were sufficiently weak over the coming months. However, nobody expects a rate cut or a rate hike for the rest of the year. The election cycle eliminates the October 24th meeting for political reasons and the next meeting is a week before Christmas and the Fed typically does not move around the holidays. Once into 2007 it is a different story with the majority of brokers now expecting a cut by the March meeting.

The calendar next week is chock full of major events led by the National ISM on Monday, three Fed speakers on Wednesday and the September Jobs report on Friday. The ISM is expected to be flat at 54 and a positive surprise there could be market friendly. A drop closer to 50 could create more fears about a hard landing and be market negative. Of the three Fed speakers on Wednesday Kohn is the one to watch. He is speaking on the economic outlook and does not have to remain as cautious as Bernanke in his comments. All the Fed speeches are at noon. The Jobs report on Friday is expected to show a gain of 125,000 jobs with whisper numbers rising to around 150,000. As long as the number is in those ranges everything will remain neutral and market positive. Over 150K is definitely not expected and could indicate a sudden and unexpected growth spurt in the economy, which could bring the Fed back into the picture. This would be especially true if the ISM surprised to the upside. A number slightly under 100K would be viewed as gentle economic slowing consistent with a soft landing. A number under 75K could cause alarm that the economy was spiraling down faster than expected and would be worse if the ISM fell several points as well. We already saw the GDP slip to 2.6% for Q2 and Q3 GDP due out in late October is expected to drop further to a range of 1.4% to 2.0%. The combination of all these events could produce some serious volatility next week.

Economic Calendar

Making news on the stock front was RIMM, which beat earnings estimates and guided sharply higher for the coming quarter. RIMM spiked $16.59 on the news and price targets from several brokers jumped by $40. The report was supposed to be released last Tuesday but it was delayed by their stock option review process. RIMM said it added 705,000 Blackberry subscribers during the quarter and expects to add another 800,000 in Q4. The new Pearl Blackberry is the company's first device targeted to the consumer market and expectations are very high. With an average volume of seven million shares RIMM traded 34 million at an all time high on Friday. I would be cautious of RIMM over the next couple weeks. That was a lot of people exiting on the good news. The new owners may have a low tolerance for risk at this level until we see some consolidation.

Merck (MRK) was watching nervously as a filing deadline for cases against its Vioxx drug approached. The deadline for filing cases is this weekend and more than 14,000 have already been filed. Some estimates suggest that number could hit 20,000 as those even remotely interested take a chance on a group payoff rather than litigate every case. Merck has been steadfast in their claims they will never pay and will fight every case. Unfortunately that would be terribly expensive and once the number of cases is capped we may see that stance changed to a class action payout.

Shutterfly (SFLY) and Bare Essentials (BARE) both came public on Friday and both ended the day with gains. Tech IPOs have done well recently as Riverbend (RVBD) and CommVault (CVLT) can attest.

FASB announced Friday a new set of reporting standards that will eventually cause extreme havoc in the stock market. The new standards require reporting of pension assets and liabilities on the company's balance sheet. This will provide another level of accountability for investors and illustrate the various problems the company may have with future pension obligations. According to preliminary estimates 47% of the S&P-100 will see their book value fall by more than -5%. 22% will drop by -15% and seven will drop more than -30%. The top five losers are probably companies you would have guessed with little effort. It is the amount of the drop that would surprise you with each company seeing their book value turn seriously negative. These rules will not take effect for sometime but you can bet the increased airtime from the rule change will create a drag on stock prices.

Negative Book Values

The Amaranth hedge fund announced late Friday that it was going to liquidate all positions and distribute the remaining funds to investors. Amaranth had tried to work a deal with Citigroup to generate some working capital in exchange for an ownership position in the company. That deal fell through on Friday and Amaranth announced after the bell it was shutting down once all positions were liquidated. Amaranth has several private equity positions that will require liquidation on a private offering basis and will take time to unload. Until it can do that they have suspended redemptions to keep extra cash for operating purposes as it liquidates. Amaranth had assets of $9.2 billion at the end of August and lost more than $6 billion in natural gas positions in only a matter of weeks. Unfortunately for Amaranth gas prices are poised to rally in October. Amaranth made $3 billion in profits in 2005. Big profits means big risk.

After the bell on Friday Keane (KEA) cut its earnings targets and fired the president of its North American Services division for misconduct. LCA Vison (LCAV) cut their expectations for the full year and announced the resignation of their president effective next week. LCAV dropped -$8 in after hours trading. A good rule of thumb is to avoid any stock that warns on a Friday night hoping to slip in unnoticed.

Oil prices continue to hover in the $63 range after a hard bounce off $60 earlier in the week. OPEC comments are starting to make the news with two members announcing voluntary production cuts to support prices. Nigeria said they would be cutting production by -120,000 bpd and Venezuela announced a cut of -50,000 bpd. This represents only 3.6% of the total production for those countries. Earlier in the morning OPEC had said it would be making an afternoon announcement about production cuts but Nigeria and Venezuela beat OPEC leadership to the punch. OPEC then cancelled their announcement. On Thursday there were rumors that an informal agreement had been made between Kuwait, Saudi Arabia and Nigeria to cut production. Nigerian oil minister Edmund Daukouru said he was unaware of any discussions on a joint cut. He told the Nigerian newspaper that consultations were still continuing among the 11 OPEC nations over what to do about the drop in prices. Obviously the mixed messages and flood of rumors is a sure sign OPEC members are concerned about prices and are willing to take steps to keep them from falling further. If you are OPEC sometimes you do not have to cut production but only act like cuts are imminent to achieve the desired result.

November Crude Oil Chart - Daily

November Natural Gas Futures Chart - Daily

Natural gas prices bumped up with the switch to the November contract and closed at $5.63 on Friday. There was another 77.0 BCF injection into storage last week and that pushed gas in storage to 3,254 BCF as of Sept 22nd and a 13-year high for this time of year. Assuming average injections for the rest of October we will begin the winter heating season, which starts on Nov-1st, with 3,543 BCF in storage assuming the storage locations can actually hold that record amount of gas. Because gas prices have been falling as storage locations fill up several gas producers have already started shutting in production rather than sell it for discount prices. Chesapeake Energy shut down 6% of their production or 100 million cubic feet per day and that will slow next week's injection rates. Chesapeake has more than 31,600 producing gas wells in the US. Other producers have said they would shut production below $5. Chesapeake has hedged 92% of its expected gas production at an average floor of $9.24 per mbtu. Obviously the price drop will not hurt them and by shutting in that portion not hedged they can wait for higher prices later this year. Ultra Petroleum and XTO Energy have done the same thing. Gas is going higher one way or another. September was 3.5 degrees cooler than normal producing expectations that this winter could be colder. However, forecasters claim El Nino is coming back this year and have predicted warmer weather for the southern US. These are the same forecasters that predicted a very heavy hurricane season for 2006 so I am not holding my breath. The Atlantic is still spawning storms with Isaac being the latest but all are headed north and well away from the oil fields. Whatever the outcome for weather it is unlikely we are going to have back-to-back record warm winters so expect some cold fronts to appear as usual. Once we start seeing inventory levels decline due to heating requirements natural gas prices will rise. Most analysts are expecting $7-$8 for a normal winter and over $10 if we suddenly start seeing North Pole conditions. The next couple of weeks may be a prime time to pick up some gas producers.

It was a banner month and quarter for the indexes if you believe the talking heads on stock TV. The major blue chip indexes rallied back to their highs and bulls were showing up on every corner. Personally I believe the rally was just a rebound since we were at these levels back in May before the summer crash began. We simply returned to the original levels. The fact that we did it in September is the amazing part given the history for the month. The problem now is of course October since it also has a record for major bottoms. I expect us to finish the year higher than we are now but I don't necessarily expect us to continue straight up. Friday's decline was not meaningful and it was expected. Over the last 26 quarters the last day was up only 25% of the time. The funds paint the tape into quarter end by keeping a bid under the winners hoping to go out strong. When there have been big gains the sellers are attracted to the last day like bears to honey. Those big gains are expected to evaporate next week and they want to be first in line. Friday was a textbook end of quarter event and nothing sinister should be read into the drop.

For next week we have several high profile economic events but Q3 earnings don't really kick into high gear until the week of Oct-16th. We will have a few earnings the week of the 9th but just a small sample. That means this coming week is warning week. Those companies who waited for the actual end of the quarter in hopes of an earnings miracle will have to face the music next week. That will give us some market news to digest along with the economics. Thomson is still predicting double digit earnings for Q3 and 13% for Q4. Those Q4 earnings are expected to be led by materials at 40%, financials 20% and industrials 17%. Laggards are expected to be utilities 4%, healthcare 3% and energy -2%. Energy has very tough comparisons with 2005.

Theoretically some funds will use next week to lighten up on their official Q3 statement positions to raise cash for future purchases should an October dip appear. My bias is slightly bearish for next week due to window undressing, potential earnings warnings and simply equalizing the overbought conditions. I think the economics could be better than expected and that would be a plus for the markets if that happens and a balance to those other negatives. Long term for Q4 I do expect a significant rally as long as the economy continues in slow growth mode. Historically the 4th quarter from the October lows produces above average double-digit gains for the S&P in the second year of a presidential election cycle. I would not bet on it happening but we can be prepared just in case.

The Dow rallied to 11741.67 to make the headlines but pulled back to close at 11679 on Friday. Support is weak at 11660 and a break there could quickly see us back at 11500 where we started the week. A move of that magnitude would be nothing to fear and that support at 11500 is fairly decent. It will depend on the external events for direction should 11500 be hit. Remember, this is the second longest streak on record (926 days as of Friday) without a -10% correction and it could happen at any time and triggered without warning by the slightest unexpected event. The longest streak was 1,767 days ending on October 7th, 1997. The key words there were "ending on October."

Russell-2000 Chart - Daily

Russell-2000 Chart - 15 min

The Nasdaq rallied about 60 points from Monday's lows but most of those points came on Mon/Tue. The rest of the week was spent in a narrow range from 2255-2275 with multiple swings. Techs were just not as excitable as blue chips. The SOX failed at resistance just over 460 and closed right on support on Friday. Warnings from several chip companies are weighing on techs in general. Since quite a few techs are small caps the performance of the Russell is always a support question. The Russell rallied 18 points to 733 by Tuesday but spent the rest of the week treading water only to collapse at Friday's close taking the Nasdaq with it. Support on the Russell is 715 and I would have no trouble imagining that level again early next week. Note in the table below that the Russell-2000 came very close to ending negative for the quarter with less than a point of gain. Normally the Russell is the strongest index going into year end but economic concerns are weighing heavily on small caps.

Index Gains

SPX Chart - Weekly

SPX Chart - 30 min

The S&P-500 rallied 30 points into Wednesday's open to tag 1340 and a new five-year high. Unfortunately that high became resistance and held like a brick wall the rest of the week. The close on Friday was negative but only to the tune of -3 points to 1335. The S&P was the best performer of the week and closed with the best relative strength. The game plan for the week was to remain long over 1315 and short below 1310. That gave us a dramatic rally and you should be long today at 1335 and ready for a new plan. Given the dead stop at 1340 that makes the plan very simple. Remain long over 1340 but reverse to a short or flat under initial support at 1333. If we do get an extended decline the 1310/1315 plan should be reactivated once those levels are reached. This is not complicated and nobody should make it any more complicated than it is. Having a dozen indicators and a myriad of shapes on your charts only gives you a good case of indecision. Monday's ISM at 10:00 should provide the spark for market direction and earnings warnings will provide the fuel. Just plan your trades and trade the plan and let the market make the decisions.
 

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