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Market Wrap

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Confusion appears to be the condition of the market since the Thanksgiving holiday. Friday was also the lowest volume day since Thanksgiving. We saw a week of very strong volatility and a sharp drop followed by a sharp rebound (11/27-12/1) and then a week of very low volatility. Investors bought the dip but then did not know what to do next. Each day brings another view of the economy and many times the opposite view from the day before. To say the market and traders in general were confused would be an understatement.

Dow Chart - Daily

Nasdaq Chart - Daily

Friday started off with the Non-farm Payrolls and economists were greeted with a decent surprise. According to the report 132,000 jobs were created in November. That is +40,000 over the October gain of +92,000. The consensus estimates for +110,000 had been raised by some analysts after the strong comments from ADP earlier in the week. ADP, a large payroll processor, said on Wednesday as many as 158,000 new private sector jobs were created in November. The non-farm payroll report failed to reflect as many as the ADP survey but much better than consensus. The report also showed revisions to both the September and October numbers. October job gains were revised down by -13,000 from 92,000 to 79,000. The September gains were revised higher from 148,000 to 203,000 or +55,000. The net gain including the revisions was +174,000 jobs. Despite the job gains the unemployment rate rose to 4.5% from last months cycle low of 4.4%.

Jobs Table

The manufacturing sector lost -15,000 jobs and construction lost -15,000. The service sector showed a monster gain of +172,000 jobs, led by +43,000 professional jobs, +41,000 in education/healthcare and +31,000 in the hospitality sector. Retail additions were minimal, only +20,000, suggesting retailers were trying to get by with fewer to compensate for door buster specials. Since the US economy has morphed to a 70% service, 20% manufacturing, 10% other split the spike in service jobs is right inline. The better than expected jobs number failed to impress many analysts who point to the earlier than normal survey week as potentially skewing the numbers. The survey was done earlier in November to avoid the Thanksgiving holiday. Some analysts point to weakening indicators as November drew to a close and suggest the December report could be a shocker.

The report was strong enough to take the Fed rate cut expectations for March off the table once again. The markets reacted sharply to the announcement and saw their lows of the day by 10:AM. Bonds hit the skids with the yield on the ten-year note rocketing higher to close at a fresh two week high of 4.55%. Remember, it was just last week we were talking about the potential for a yield under 4% by January. That seems like a slim chance now with the Fed back in the picture. You see the jobs gains were right inline with the last six-month average of +138,000 and showed no further weakening that would have hastened a Fed change soon.

Ten-Year Note Yield Chart - 30 min

The December Fed meeting is next Tuesday and after this week's data we can expect them to maintain a tightening bias and that will help dampen the markets. Also putting a negative spin on next week's Fed meeting was comments from Treasury Secretary Paulson on CNBC. He was very upbeat about the economy saying he was confident it was on track for a sustainable rate of growth. He also reiterated his stance for a strong dollar and his thoughts about next week's China trip. He said everything you would expect from a Treasury Secretary but he brings a lot of credibility to the position from his prior life. His views are bullish for the market long term but negative for the Fed in the short term. With the Fed meeting next week the markets turned sour on the job news and failed to post any material gains.

The only other report on Friday was Consumer Sentiment, which fell to 90.2 from 92.1 and well below the consensus estimate of 92.5. The present conditions component rose to 108.2 from 106.0 but the expectations component fell sharply to 78.6 from 83.2. Evidently the constant talk about weakening economy and possible recession in 2007 is having a negative impact on consumers. Climbing gasoline prices from the fall lows and the weak housing market were given as factors.

Next week the two most important economic events are the FOMC meeting on Tuesday and the Consumer Price Index on Friday. There are a lot of other reports but they are mostly just filler and not normally market movers. The FOMC will be the focal point and it has the potential to be a negative turning point. Hopefully they will stick to the script and not deviate only two weeks before Christmas. Just repeating their prior statement would be best for the markets. Any further elaboration about risks weighted toward inflation would not be viewed positively. The markets need to remain focused on the potential for a rate cut regardless of how far in the future it might be. Should the focus revert back to worrying about a rate hike it could be detrimental to the markets. Personally I would rather have a booming economy and slightly higher rates but the housing market is showing signs of a rebound and rates need to remain low to feed that bounce.

Economic Calendar

Rumors were running rampant on Friday with Citicorp at the top of the list. There were rumors Citigroup might be announcing a breakup to release value by spinning off one of its units. There was also a rumor that the departing CFO from Bank of America, Al De Molina would be replacing Chuck Prince as CEO of Citigroup. It was also rumored that Citigroup CFO Sally Krawcheck was leaving. While Citigroup said they do not comment on rumors a spokesman did say Sally was not leaving. When asked if she would remain in her present position they declined comment. Citigroup traded 54 million shares and was the second highest volume on the NYSE. They normally trade 16 million shares. The rumors did push the stock to a new two-year high at $52.70 and I am sure many long time holders were happy to exit. Citigroup stock has provided lackluster performance for years.

Another rumor making the rounds was that Bank of America (BAC) was going to make an offer for Barclays (BCS). This sent the stock of Barclays to a new historic high over $61 before falling back to close at $58.25 (+2.46) as analysts scoffed at the rumors. BCS began to rise on Wednesday as the rumors began to slip out but Friday's intraday gain came after several noted analysts said the deal would be a good fit. A Merrill Lynch analyst, Edward Najarian, wrote to clients on Friday that Merrill believes BAC is very interested in acquiring Barclays. Both BAC and BCS declined to comment on the rumors. One analyst pointed out that the rumors are not likely to be true because the Chairman of Barclays, Matthew Barrett, had sold almost his entire stake of 2.3 million shares over the last several weeks and he would not have done that if BAC was talking to the board about an offer. However, even if BAC was not looking at BCS before last week all the good press about the synergies of a wedding might cause BAC to pop the question anyway. Time will tell.

Rating agency Fitch placed Ameriquest Mortgage on "rating watch evolving" due to the deteriorating condition of its subprime mortgage portfolio. Ameriquest's portfolio has shrink by -15% in loan volume and now has risen +9.4% in unpaid principal balances since their prior review. They currently have 437,000 loans for more than $71.2 billion. UBS recently said 8% of all subprime mortgages are in default nationwide, up from 4.5% last November. Fitch has also noted that numerous consumers have filed class action lawsuits against Ameriquest claiming improper loan procedures. I can see it now, "You loaned me more money than I could repay so I am suing you." Other public lenders under the subprime gun today include Accredited (LEND), Countrywide (CFC) and New Century (NEW). On Wednesday Ownit Mortgage closed their doors, an $8 billion casualty of the subprime collapse. Sebring Capital also closed its doors on Dec-1st but said it would honor any existing loan commitments if those loans could be closed by Dec-15th. Sebring had 325 employees and averaged about $250 million in loans per quarter, down from $450 million in 2003. Atlanta based NetBank closed its subprime operation in November. H&R Block is trying to find a takeout buyer for its Option One Mortgage Corp subprime business to stop the bleeding. Key Corp is also dumping its subprime Champion Mortgage business.

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Expedia (EXPE) surprised the markets with an announcement they would be buying back 30 million shares or roughly 10% of their outstanding shares. This sent the price of Expedia shares spiking to $21 from yesterday's close of $18.59. Expedia will make a tender offer between $18.50 and $22 between Dec-11th and Jan-10th. Moody's Investor Services immediately lowered its outlook on the company to negative saying this reduced Expedia's financial flexibility. Investors should wonder why Expedia can't find some place better to spend the money to increase earnings.

Ford was the largest volume mover on the NYSE with 195 million shares traded. Ford just announced $4.5 billion of 4.25% convertible bonds due in 2036 and investors are dumping the common stock in favor of the bonds. If Ford does manage a turnaround then the bonds can be converted. If they don't manage a recovery the bonds offer some level of security since they have priority over common stock. Those currently holding the stock will see their interests diluted at some point in the future by the debt conversion. The bonds can be converted at $9.20 per share. I guess those still holding the stock would be glad to have their stock diluted if it rises from the current $7.20 to more than $9.25 per share. The offering was so successful Ford doubled the initial amount. Ford already has 1.9 billion shares outstanding.

Two IPOs soared on their debut on Friday. Allegiant (ALGT) spiked +$7.10 or +39% to $25.10. Allegiant, based in Las Vegas, operates a low cost airline offering non-stop flights from smaller markets to popular vacation destinations. It also offers hotel rooms, rental cars and other travel services. Heelys (HLYS) jumped +11.60 or 55% to close at $32.60. Heelys makes a popular brand of shoes for kids with wheels in the heels allowing them to double as roller skates.

Chesapeake Energy surprised investors with a 30 million share offering which was snapped up by Deutsche Bank at $31.85 per share. DB said they would sell it at the public offering price of $32.15. That is a pretty small profit margin for DB but you can bet they placed most of it before it was announced. You can probably guess what price CHK fell to during the day, yes, $32.15. More than 31 million shares traded compared to the average of 7.5 million. I would be a buyer of CHK at this level not only because that 30 million share block at $32 should provide solid support but CHK is also moving to convert most of its 16.4 TCF of undeveloped and unproven reserves to proven and developed. When added to their 8.4 TCF of already proven reserves this will provide them nearly 25 TCFe to produce worth about $200 billion. This is a monster amount of gas and CHK already has 33,700 producing wells making them the 3rd largest independent US producer. They are currently valued ($14B) for something less than their 8.4 TCF of proved reserves because CHK has quietly grown from only 1.2 TCF in late 1999. They currently have more than a 10-year backlog of drilling prospects on the board. This is not a fast moving stock but one you could buy and forget. As gas prices continue to rise between now and 2010 you can bet CHK will rise as well. CHK has no foreign exposure and therefore is a safe play with little geopolitical risk. Gas prices will rise with mid double digit prices the norm by 2010. North America gas production has already peaked and begun its permanent decline.

CHK Chart - Weekly

The SOX continued to weaken as the list of chip problems grows. Over the last week National Semi (NSM), Altera (ALTR) and Xilinx (XLNX) led a list of companies posting weaker guidance for the current quarter. It appears the PC slump while waiting on Vista and a slowing in wireless sales has led to an inventory surplus. The SOX has stubbornly clung to its recent range at the top of a six-month high but that grip may be slipping. Next week Texas Instruments (TXN) will give us its mid quarter update and analysts have their fingers crossed. With comments from Motorola and Nokia making them nervous about wireless sales they fear TXN could disappoint. Others claim TXN is very diversified but has little exposure to the current PC sales slowdown. Either way the Texas Instruments update will be critical for any continued chip rally.

Oil prices imploded at the close to hit $62 after trading as high as $63.65 intraday. I know I use the term imploded more than I should but today's drop in oil definitely fit the term. After holding most of the day over $63.25 it took only about 45 min to make the plunge. With an OPEC meeting next Thursday and almost a guarantee of another production cut many traders were scratching their heads in disbelief. Personally I think it is simply profit taking with a little more than a week left on the January contract. After spiking from a low of $57.80 in late November the price had rebounded to $63 and has held in the $61.50-$63.50 range for more than a week. With no further gains Friday turned into a ka-ching for those who had been long. Comments out of Saudi on Thursday also removed confidence from traders. The Saudi ambassador to the US, Prince Turki al-Faisal, said current prices were "acceptable and imminently fair." This is an offset to the comments from the OPEC president that prices were not yet back in an acceptable range. Phil Flynn from Alaron Trading said the conflicting remarks were just to keep the market off balance and give Saudi the appearance of being friendly to the US concerns over prices. For whatever reason the price fell back to support with only 6 trading days left on the January contract. I suspect we will see another sell the news dip after the OPEC meeting just before the contract expires. That would be another buying opportunity for me. OPEC keeps saying there is a surplus of 100 million bbls in the market. While that sounds like a lot it is only a little more than the 85 million bbls we consume every day. Having an extra day's supply lying around does not sound like a bunch to me.

January Crude Oil Chart - 2 min

January Crude Oil Chart - Daily

Dow Transports Chart - Daily

The transports also took a header on the morning spike in oil prices and slipping consumer sentiment. We have a troubling pattern appearing on the TRAN chart that looks a lot like a head and shoulders. If the transports move below 4700 again it could be trouble for the broader market because of the economic doubt falling transports imply.

The Dow rocketed back to its resistance highs on Monday and then failed hold any new gains for the rest of the week. We saw opening spike to 12360 on Thursday to equal the all time high set back on Oct-22nd. Both highs were very short lived opening spikes and neither held for more than a few minutes. Both were followed by declines to a multi-day low in the following session. It appears there is a considerable amount of supply waiting at that 12350 level and conditions are worsening as December passes.

The Nasdaq has been weaker than the Dow and put in a lower high last week. With weakness in the chip sector we could see a further move down if Texas Instruments disappoints. Support remains 2400 with 14 trading days left in 2006.

The S&P-500 showed the least volatility of the three major indexes. After a major spike from 1390 to 1415 early this week it fought very hard to hold the high ground. 1410 appeared as initial support and that is where we closed on Friday. No harm, no foul but we are on the cliff edge once again.

S&P-500 Chart - Daily

Next week is expiration week and Thursday's decline could have been expiration related. However, with the FOMC meeting on Tuesday we could see quite a few positions being held on the hopes that the meeting produces a result favorable to those positions. After Friday's jobs report the odds of a favorable statement have slipped. That means anyone holding now is probably hoping for a more hawkish statement to push the markets lower. All of this is simply speculation but we need to be aware of potential potholes. My recommendations for last week were to remain long over 1405 and reverse to a short under 1400. I am going to change that to reverse to a short under 1405. That level was dip support on Friday morning so a break there next week could signal a sharper plunge. The biggest event for the week will be the FOMC meeting on Tuesday followed by the OPEC meeting on the 14th (Wednesday night for us) and the CPI on Friday. We are still a week or so away from the warning cycle for Q4 but that does not prevent anyone from confessing early to avoid the holidays. We are in the period of December where funds sometimes shuffle portfolios to offset losers by selling some winners. That could continue to dilute any positive news. Bottom line; don't just expect the market to continue blindly higher. Be prepared for range bound volatility over the next week.
 

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