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Market Wrap

Pause To Reflect

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Weak housing data was credited with pushing the market lower today but I doubt weak housing numbers actually surprised anyone. The pause today was more likely profit taking from Monday's short squeeze ahead of Friday's employment report. The major indexes may have been mixed with only fractional gains or losses but as I will explain later the real key to market sentiment was extremely bullish.

Dow Chart - Daily

Nasdaq Chart - 30 min

Pending home sales fell -6.5% in September as shown by the drop in the Pending Home Sales Index (PHSI) to 85.5. This was the lowest level since the index was created. The index fell -21.5% over September 2006, also the largest decline ever. The index is now -33.3% off its August 2005 peak. Existing home sales fell -23.7% from their Sept-2005 peak and -12.8% below Sept-2006. Since the September numbers are just the leading edge of the fallout in closings related to the August mortgage crash we are sure to see even lower sales numbers in the months ahead. The National Association of Realtors reported that more than 10% of closings were cancelled due to rescinded loan commitments and even more sales never got to that stage because buyers could not get an initial approval so they could move forward in the contract process. Estimates of existing home sales in September are for a -7% decline to 5.1 million units on an annualized basis. This decline is expected to bottom in Q4 at something under the 5 million rate for home sales.

Tomorrow's reports include the ISM Non-Mfg and the Challenger Employment report. Neither is expected to be market movers. The big report for the week is the Non-Farm Payrolls on Friday. Estimates are still holding for a gain of +115,000 as though last months -4000 loss never happened. Nearly everybody will be surprised with Friday's number since the unofficial whisper numbers are all over the map from -10,000 to +135,000 jobs. The potential today is for a positive surprise from an August revision. If they do revise sharply higher it would relieve a lot of recession talk in the markets. Assuming the September number is positive it would signal an all clear for the bulls to rally into year-end. It would also remove a lot of incentive for the Fed to cut rates again. I think the market would be fine with that if it thought the economy was not about to fall into a recession.


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The buyout of Sallie Mae (SLM) by private equity firm J.C. Flowers appears to be on life support. Flowers had agreed to pay $60 per share ($25 billion) back in April. Flowers sent SLM a revised offer saying a "material adverse change" or MAC had occurred due to changes in the credit markets and some legislation cutting subsidies to student lenders. The new offer is for $50 a share and some warrants that Flowers said could be worth $10. Analysts claim the warrants are more likely to be worth $1 instead. Sallie Mae said no thanks and told Flower to either follow through with the $60 offer or pay the $900 million breakup fee. SLM was up slightly to $50 on thoughts that either this deal or another deal would get done somewhere over the $50 price range. SLM had fallen off from the $58 high after the original announcement due to the credit crunch and expectations that the deal would not get done.

Garmin (GRMN) shareholders are in shock with the -$23 drop over the last two days. The challenge to the leader in navigation equipment came from Nokia's $8.1 billion ($78 per share) cash bid for Navteq (NVT). Nokia plans to integrate the GPS mapping technology into its phones and that suggests to the market for standalone GPS devices will shrink. Nokia paid more than 50 times earnings for NVT. Nokia actually acted in self-defense because an acquisition of NVT by Google, Microsoft or even Garmin could have taken Nokia out of the map market. Nokia currently uses NVT technology to power its GPS aware phones. Had someone else acquired NVT they could have decided not to renew Nokia's current license and kick them out of the mapping business. Nokia currently provides the mapping service, called Smart2Go, on its GPS phones for $13 a month. That is a strong and growing revenue stream and they did not want to give that up. Only 11% of the more than one billion cell phones sold last year had GPS capability. That number is expected to climb to 33% by 2011. The revenue stream can be expanded by selling advertising to local firms for consumer searches. If you are in an unfamiliar area and want Chinese food you check the list on your phone map. Restaurants that pay a fee to Nokia will appear on your list. Since GPS aware phones are always online Nokia can start implementing better real time traffic updates and weather services including alerts. Competitor TomTom is also on the move and will likely begin to insert cellular chips into other devices making them Internet capable. Analysts say this puts TomTom on a faster growth path that Garmin according to an analyst at Sanford Bernstein. Another problem Garmin faces is it's current license of NVT data to power its maps. Garmin is either going to have to make a higher bid for NVT, develop the database itself or worst case become a Nokia customer at a much higher cost. None of these are pleasant possibilities for Garmin. That suggests Garmin's days of high flying stock prices may be numbered without some news of a solution from Garmin. The play here would be to short Garmin and go long Navteq on thoughts that somebody will make a higher bid for NVT and it could be Garmin. Nokia's market cap is $146B and Garmin's only $21B. Hardly a fair fight but it could be a fight for survival for Garmin. Never bet against a smaller opponent who has been backed into a corner. Common sense tends to evaporate when a fight is the only alternative.

Navteq Chart - 30 min

Garmin Chart - Daily

Baidu.com Chart - 60 min

On the opposite side of the ledger Chinese search firm Baidu.com (BIDU) spiked +$36 to $320 after a JP Morgan analyst said BIDU was on the right track and could add another 100 million users over the next few years. He said BIDU could hit $400 by the end of 2008. From the +36 gain today it appears it could reach it by the end of 2007. I almost bought options on BIDU on Monday after 4 days of declines to just above $280. Unfortunately I never made any money with ALMOST trades. It only counts when you actually pull the trigger.

Gold dropped $17 on positive economics and a sharp rebound in the US dollar. That $755 level was too good to last for the gold bugs and today's close at 738 is recent support but a strong employment report on Friday could push it back to $715 on easing recession fears.

Morgan Stanley (MS) said it was cutting 600 jobs and shrinking its mortgage unit as the impact of the subprime crisis continues to be felt. MS missed estimates when it reported earnings and was forced to take nearly a $1 billion write down or corporate loans on its books.

Homebuilders are trading like the subprime problem is over thanks to the Citigroup attempt to again pick a bottom in the sector on Monday. Citigroup analyst Stephen Kim said the worst might be over and he saw little risk from here in the big cap builders. He cited the tendency for the builders to rally well before the fear subsided in past housing cycles. He upgraded Centex (CTX), D.R. Horton (DHI) and Ryland (RYL) to buy from hold. He raised his price target on Lennar (LEN) but cut his targets on Beazer (BZH), DHI, KBH, TOL and others. RYL, KBH, TOL and LEN all gained around a $1.50 on the continued bullishness today. Home supply stores did not benefit due to weakening consumer buying. In Florida for instance consumer sales fell -3.2% for the month as the drop in home prices, the inability to get loans and high gas prices kept shoppers at home.

Homebuilder SPDR Chart - Daily

Greenspan, speaking in London, said the long period of low prices and stable growth was coming to an end and central banks today will have to pay more attention to inflation pressures. He also said, "We are beginning to see this extraordinary period of disinflation and economic growth come to a halt and we have to be very sensitive to the fact inflationary pressures could well get out of hand." He also said Bernanke had a tougher task ahead than Greenspan had when he was Fed chairman. It is amazing what a book tour has done for Greenspan. You can actually understand what he is saying and he is in front of a microphone every day. In the CNBC interview two weeks ago he admitted he intentionally made up Greenspeak to confound the members of the house and senate committees whenever he gave testimony. He said he knew he was going to be asked questions he did not want to answer and so he made up the complicated and hard to understand Greenspeak so they would not understand his answers and continue to question him on the same subject. They did not want to look like fools for not understanding and would move on to other topics. Sounds to me like lying to congress and I thought that was illegal. However, I guess it is not a lie if you don't really answer the question with a false answer. I am sure Bernanke and probably quite a few other government officials wish Greenspan would simply ride off into the sunset never to be heard from again. But, fame is a funny thing even for a self confessed introvert. You get used to the spotlight and now that he is selling books he wants to grab all the attention he can before the current crisis fades.

Oil prices fell to $78.90 today on falling crude demand and a revised hurricane forecast. Hurricane forecasters revised their estimates to only 4 major storms this year now that the season is past its peak. All the recent storms have failed to venture towards the Gulf and are dissipating before nearing land. The season has been a flop in terms of a having a dangerous storm make landfall in the U.S. or blow through the oil patch. September 10th is the historic peak in the season although storms can still appear through November. The short covering bounce into the close was caused by a weather forecast suggesting a low-pressure area was forming 100-miles off the coast of Florida and cyclonic activity was possible. Traders short for the last three days were also covering before the inventory report tomorrow morning.

November Crude Chart - Daily

Russell 2000 Chart

The Dow closed down -40, Nasdaq +6 and the S&P flat but it was a bullish day for me. I say this because the Russell 2000 was up strong for the second straight day with nearly a +1% gain. You know I believe the Russell is the best indicator of fund manager sentiment and it appears they are buying again. The Russell is up +27 points for the week or +3.3% compared to only a 1.5%-1.9% gain for the other indexes. It appears the influx of quarter end retirement cash is being put to work in the small caps and that suggests fund managers are no longer afraid of another dip in October. This is a bullish signal and the bounce has put the Russell within 25 points of its July high at 856. If the Russell continues to outpace the rest of the indexes and we get good news on Friday we could see a breakout over that high and that would trigger a serious upward move in the broader market. The keyword in that sentence was of course "if."

The Dow rallied +190 on Monday and gave back -40 today. I would love to repeat that trend every two days for the rest of the year. The 14000 level was never in danger of being broken today and while the volume was light the buyers were waiting for every dip. Even Greenspan's inflation warning failed to cause any damage. It is possible we may still see some weakness ahead of the jobs report but it appears the tide has turned and the expectations for a better than expected report are providing support.

The Nasdaq rallied quickly from its intraday dip and managed to post a +6 point gain to a new high. Today it was the broader Nasdaq composite leading the way with the NDX or Nasdaq-100 closing down fractionally lower. The big cap techs rested with only Apple moving higher. RIMM, EBAY, DELL and MSFT all closed slightly lower. RIMM was weak on the PALM earnings and profit taking before it's own earnings on Thursday. The Nasdaq should find uptrend support at 2720 and we are in breakout mode as long as nothing appears in the form of a news event to trip the bulls.

Earnings officially begin next week but the calendar does not get really crowded until the week after that. Earnings warnings are running 2.8 to 1 over positive guidance and that is the worst quarterly ratio we have seen in several years. The subprime quarter as they are calling it saw broad dislocations of trends in almost every sector except tech. Banking, insurance, brokers, builders, retail, etc, all saw events that impacted earnings. According to Thomson Financial estimates for S&P 500 earnings have fallen to only +2% growth and the lowest quarterly growth in years but still growth. Citigroup said today that they felt the earnings markdown was over done and we should expect upside surprises. Their number for the S&P was +3.2% growth with upside potential. This is very bullish news for stocks and a series of positive surprises early in the earnings cycle could have a very positive impact on the markets. All the bad new is apparently priced in and the news is improving. Usually when things are looking up so favorably we will stumble over an event that nobody saw coming. The only thing I could imagine today would be a major sell off in the Chinese market when it reopens next week. If there is serious profit taking ahead of the National Congress convening in mid October that could ripple around the globe but it should only be temporary unless the Congress takes drastic action to cool the market. The Non-Farm payrolls should not be a problem unless we lost jobs in September and there is no upward revision to August. Get ready for earnings and start targeting those cheap October options ahead of their reports.

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