FEELIN HEAVY

An overbought market that can't rally on good news. that's the story today. New home sales, durable goods, consumer sentiment, all good. We are not going to fall off a cliff on that kind of news though. Look for choppy trade ahead. It definitely seems we have to consolidate the gains, before we decide where to go next.

The euro continues volatile around support at 117. It also is very oversold. As always I feel the dollar will follow the economy, and reflect its strength or weakness.

Bonds sold off on the strength of the new home sales and the fact that it will be hard for the curve to get much weaker without any signs of economic weakness.

GOLD

Very interesting action in gold this week. In spite of higher bond yields, lower oil, and a stronger dollar, all traditionally, bearish for gold, bullion kept marching higher. The inflation numbers both PPI and CPI were also pretty good with better numbers to come now that energy prices are receding. BCA research has a good analysis of this on their website today. That's not bullish either, so what's driving the price?

Kitco.com has the World Gold Council report for last quarter on their site and it says that while physical demand stayed strong especially in Asia and the Middle East, supply grew modestly as well. The biggest swing factor was increased investment demand from the growth in ETF's. So why the big rush into them now, after all they have been around awhile. GLD celebrated it's one year anniversary this week.
My take is that you may have several bearish factors mentioned above coming to and end. Oil may find support here as it sits on its 50day moving average and cold weather has begun. Bond yields fell after hitting resistance at close to one year highs and their 200 day moving avg. They also may not go higher again if inflation has indeed peaked and the economy slows. Finally, the dollar is testing resistance and may soon begin to fall. The ECB is talking about hiking rates today. That would narrow the interest rate spread currently in favor of the dollar. Also very importantly, the U.S. this week continues to press it's beggar thy neighbor polices, by pushing for a debasement of its currency. First, Greenspan in his latest speech made it explicit that a much weaker currency would have to be a large part of the solution of solving our huge current account deficit. Secondly, tomorrow, President Bush is again going to try to cajole China to revalue against us. In effect, you have the two most important men in the country, telling all the worldwide dollar holders, look out below. No wonder Russia, Argentina, and who knows who else, maybe China, want to double their Gold reserves.

SIDEWAYS

We are in our 5th day of sideways trading. A consolidation the bulls say. Never short a dull market says the axiom. Well perhaps, but if a market can"t make headway, it usually tests support. Fading concerns over the economy, pushed the market up and since then we have had a lack of catalysts. Tomorrow we get the trade figures and first look at Univ of Mich consumer sentiment readings, potential catalysts to be sure. The trade deficit could be a record, so it will be difficult to spin that one as bullish. On the other hand, if the consumer sentiment index shows a real bounce, that may be all the bulls need to go to higher ground. If we get a small bounce it will be important to see how the market reacts. A decline speaks for itself.

The dollar has been on a run and is somewhat overbought here. With the trade figures as catalyst, it seems an opportune time to play for a bounce in the Euro, gold or gold stocks. The wild card is how will bonds react. We are close to breaking the April highs in 10yr yields.

MCDONALD'S

MCD hit its lows in the spring of 2003. Same store sales were declining 4% a month. MCD had been a growth stock for decades. In an effort to keep the growth up, they started to diversify into other restaurant concepts in the late 90's as their markets became saturated and expansion opportunities waned. That strategy failed, as their forays into other businesses never reached critical mass to contribute significantly to the bottom line. Meanwhile, tastes were changing as the population aged and they had their eye off the ball and their core business faltered. New management was brought in, cutoff all the expansion and focused on their core business. They introduced new menu items such as salads to cater to older and healthier tastes, extended store hours, allowed credit cards for payment, etc. Essentially pushing more product through existing distribution channels. It worked. Same store sales started to improve peaking at 13.9% growth in the spring of 2004. So from its low of around $14 a share in 2/03, the stock rallied to 34 1/2 in 3/05. But then same store sales started to settle down, as the comparisons grew more difficult and the stock pulled back to $27. June and July SSS were better than April and May and so the stock bounced back a little to $31. The company itself is looking for mid single digit EPS growth. They fixed the business but are now in the same spot the old management was. How do you get growth out of a large, mature business going forward. They are already the biggest in every thing. They have the largest breakfast business, they expanded their menu, expanded their hours to get the late night crowd. By slowing international and domestic expansion, and eschewing other restaurant concepts, they are back to being a one trick pony, i.e. growing same store sales. This can be seen in the convergence of same store sales figures and total sales figures. The CEO has been quoted as saying that same store sales will be the driver of growth.

In August rumors started flying that Vornado the REIT was buying a stake in McDonald's. They had just done a secondary offering of 9 million shares raising about $800 million. It move the stock $4. At the time, I said it sounds like a lot but consider that in the last six months McDonald's bought back 33 million shares of it''s stock, approximately $1 billion dollars without much affect. I also said that they did not need the cash, that spinning them off into a REIT would provide. They have no major expansion plans. Well last week it finally came out that Vornado did indeed purchase a stake but even smaller than the initial rumors. According to AP they purchased a 1/2% stake amounting to 500 million dollars.

In September the stock was coming back down until it received a brokerage upgrade on rumors of it spinning off its Chipolte unit. I wrote at the time that while this was much more likely than spinning off the real estate, spinning off part of a 435 restaurant chain out of 30,000 was not that big a deal. More important I pointed out was the fact that total sales growth has been slowing on a quarterly basis since the 1st qtr of 04.

Today, they reported their Oct sales figures which were lauded for being better that the street expected, but look at the following table:

• Mthly SSS Total Sales Currency adj Total sales
• Jan 5.2 8.3 6.3
• Feb 1.6 4.4 2.7
• Mar 6.8 11.2 5.7
• Apr 2.8 6.7 3.9
• May 1.8 5.9 2.9
• Jun 3.8 6.2 4.9
• Jul 4.3 6.1 6.0
• Aug 3.4 5.7 4.4
• Sep 3.9 6.3 5.0

• Oct 3.4 3.9 4.4

What jumps out at me is that the trend in total sales growth, which is what correlates to total revenue growth, is really slowing. Secondly, that total sales growth is converging with SSS growth as I expected. Finally,most significantly, currency adjusted total sales were higher than total sales for the first time since I can remember. This means that the strong dollar is hurting total sales. According to their Website, a 10% move in the Euro equals a 6-7 cts per share on their earnings. This is significant considering that a 1% decrease in their SSS equals only a 2% decline in EPS. The dollar is about 13% higher than it was at the start of the year.

Finally both the CFO and CEO in the past couple of weeks have thrown cold water on any kind of REIT spinoff or restructuring. The CFO said it would be expensive and a distraction among other things. The CEO in a letter to employees said they had no intention of a spinoff or restructuring, that it would not serve the interest of their franchises or shareholders. I think he is exactly right. Do you want to lose control of your business by doing some financial engineering to get a one time pop. Spinning out the company owned restaurants so they can compete with the franchised one's is about as stupid idea as I've heard.

STRONG OR WEAK

As we wait for the Fed today, I must say it's been a while since I've read some many strong and contradictory opinions on the market. There is the Bill Gross and Steve Roach camp, that says a significant economic slowdown is just around the corner, which will weaken equity markets keep inflation under control and be good for long bonds. The opposing view, best personified by today's CNBC guest Brian Wesbury, is that GDP growth will remain strong and equities will rally, Inflation is the problem and interest rates will rise.
The big equity selloff in the first half of October certainly seemed to be driven by an inflation scare. Fed heads, one after the other proclaimed their fear of higher inflation and their intention to do something about it. Fears over a weak economy were also present as higher oil prices were seen as driving the consumer into hibernation.
Today, with the biggest two day rally in a year under our belts things look much better. Certainly the GDP report and today's ISM report show no sign of weakness. You have to admit, considering everything that has been thrown at it, high oil prices, plummeting consumer confidence, natural disasters, gargantuan trade and budget deficits, higher interest rates, high debt levels, low savings rates, that the economy can chug along at almost 4% is pretty amazing. You can appreciate the bulls point of view and see why the bears might want to throw in the towel, after all, what's it going to take.
The inflationists fear that inflation is already baked in the cake. Companies are finally raising prices, passing on costs that will find their way through to core price increases.

Which view will prevail? I expected a slowdown last year as the effects of the tax cuts wore off. I'm always too early. Going back to my trading notes, I wrote to myself , economic stats should start coming in weaker. Look for weakness in housing ,autos and retail sales. It never happened, but today, housing is slowing down, sales down inventories up, and Ford just announced a 25% decline in auto sales. That's two months in a row of lousy sales. While we are on the subject of auto sales, a lot of bounce in the 3.8% GDP was attributed to auto sales that occurred early in the quarter. As far as inflation goes, Victor Niederhofer reports that the Goldman Sachs commodity index fell some 10% in October from its Sep close, one of the biggest drops ever. So maybe down the road we will get some moderation in the PPI.