FACTS TO CHEW ON

Consider this. On 10/13/05 the market low, S&P500 @ 1170, oil was at $63 and the 10yr note was at about 4.5%. At the market high on 1/11/06 S&P500 @1295, oil was at $64 and the 10yr note was at about 4.5%. In between we have had weak economic stats and strong, good earnings and bad. If oil, bond yields, don't matter and we've had 4th qtr GDP at 3.8% and 1st qtr GDP at 1.1%, high profile earnings misses by INTC,GOOG, YAHOO, upside surprises by XOM, BA, CAT, what's driving the market? It seems to me nothing moves the market like perceptions over Fed policy. It was perceptions of further tightening that drove the market down in September, and after Fed minutes were released on the first trading day of the year, it was perceptions that they were almost done that pushed the market up to 1294. So the lesson seems to be ignore the noise and watch how the market feels about the Fed.

JOBS

Wednesday's blog was somewhat prophetic. I said the market moves is bursts and I thought the next one would be down. I didn't think it would come so quickly. The move was surprising considering, auto sales and retail sales were very good. There was a lot of fleet sales in the auto numbers and a lot of gift card redemptions in the retail sales. I would suppose that is why they weren't taken seriously. The payroll number today was negative for the market, but the bond market rallied significantly. It's getting harder to read the tea leaves. Next week is a light data week and earnings are tapering off. We have Treasury auctions, which will be interesting in light of the fact that if prices hold here, buyers will have a negative carry. The Iran situation will also be front and center, so oil we be important. The last few days have seen a good sell off in both oil and gold. Both were overbought and up at resistance. I hope we have significant corrections so we can buy them again.

GOOGLE?

In spite of the fact that Google is down 35 pts and 7 out of 10 of the largest NASDAQ stocks are negative, the index trades around flat as I write, not bad at all. However the negatives continue to pile up. Oil is approaching $69, the bond market is down again with lots of supply coming next week, with Intel, 2 out of the big 3 have reported punk earnings, housing stocks are weak as both the MBA survey fell 5% and the NRA index of pending sales fell 3%. Lately I've also noticed a correlation, which makes sense, between housing stocks, retailers and the bank index. They are all weak today. Mortgage lending and home equity loans have been a big source of bank profits, and of course we all know how dependent retailers are on home prices.
The character of this market this year and maybe longer has been long periods of little volatility and then big bursts up and down, ala the first day of the year and the big swoon on Jan 20th. I think we are headed for another swoon, it is just a question of what sends it over the edge. If you would have told me about Google beforehand, I would have said that would have been enough. Maybe oil touching 70 or a bad auction next week . Stay tuned.

PINS AND NEEDLES

The market sits on pins and needles as well it should considering the surge the market got at the release of the last Fed minutes. My instincts tell me they will try it again. It is a perfect opportunity to squeeze the shorts as we are not far from the highs and a move above would run the stops. This time around I don't think it will be longlived. The fundamental background is quite different. Oil is near its highs. Real estate the locomotive of the economy the past few years is softening. Auto sales due out tomorrow, which bounced back in December but were blamed for the poor showing of GDP, are expected to show weakness. Finally, their is considerable doubt aver the strength of the consumer this year. Earnings, with the exception of Exxon, have also not blown anyone away particularly among the dow stocks. Greenspan the market's security blanket is also gone. Time to sell the rallies I think.

WALMART

In addition to Exxon's record profits, helping the market as well is Walmart saying it's same store sales will come in at the high end of it's 3-5% estimate at 4.7%. No doubt this is due somewhat to the redemption of gift cards, as they said sales were greater than expected last month. However, at 4.7% this is the best month they have had since a 5.9% showing in Mar of 04. Since last month was so dismal at 2.2% perhaps averaging the two months together is a more accurate picture of the underlying trend, and that comes in at 3.45%.
Walmart has been a weak stock since Feb of 04. Last week it got one upgrade and one down, by major firms. We all know that the low end consumer in the current economic climate is being hurt the worst, Walmart's bread and butter. What is not well appreciated is that prior to last month, they had been running positive comparisons in same store sales to last year for the past six months. This year may be the first year in 4, that they beat last years same store sales growth, albeit only marginally.
The question is, in a slowing economy, will they attract more move down consumers from higher end stores to make up for the shortfall in purchasing power of their traditional customer base. So far so good. Stay tuned.

BOUNCE

As I mentioned a couple of days ago, good earnings from CAT and HON in the dow was just what the doctor ordered and we had a triple digit increase in the dow. The market had a great rally to start the year and the bulls don't want to give up on it. Who can blame them. Every bit of good news is seized on with fervor. We will now pretty soon how this earnings season has come in, but of the 20 dow stocks that have reported, the bad still outnumber the good. Only 4 could characterized as unequivocally good. Not to say that is definitive, because some like AA and PFE are higher than when they reported because of favorable news flow, like higher aluminum prices and new drug announcements. The overall tone however is that the dow will be a lagger and revenue growth is hard to come by.

This morning, the lower than expected GDP report at 1.1% vs 2.8% expected is so far not doing much damage. To my mind, however, this is one more factor starting to deteriorate. Ten year yields are creeping up, the Fed is going to raise rates again next week, housing is slowing, the auto industry is in trouble and oil is getting close to $70 dollars again. Nothing is more lethal to the economy and the market than the combination of higher rates and energy. We have just to look back to Mar of 2000 to see what such a combination did.

MCDONALDS

Reading the footnotes of Mcdonalds press release, 2004 earnings had one time charges of .14 cents per share so the 1.79 reported for the year was 1.93 operating earnings adjusted. 2005 had one time benefits of .06 per share, so adjust the 2.04 reported down to 1.98. That's growth of 3%., a lot different than the headlines ballyhooed on the news wires and CNBC of "McDonalds profit jumps 53%, or McDonalds stock soars on 4th qtr earnings. What's more, revenue DECLINED sequentially. The 4th quarter had the slowest total sales growth in YEARS, averaging 2.5% vs 6% for the 3rd qtr and 6.3% 2nd qtr. Currency is starting to hurt them. Where are the analysts and reporters? Does anyone look behind the headlines any more.

DOW LAGGARDS

One reason the market has given up it's gains this year is the action of its generals. My count says we've had 14 Dow stocks report. All but three have been miserable. UTX is up two points on good earnings and AXP is slightly higher than when it reported. PFE loss was less than expected so it is trading higher. AA Alcoa's reported a fall of 16% in net income on higher energy costs. DD warned of a 200 mil revenue shortfall and issued very weak guidance. Big daddy INTC missed earnings badly and got clobbered. IBM earnings were OK but revenue was light and it is now trading lower. JPM had trading revenue disappoint and it has rolled over. GE was not impressive and its stock has traded consistently lower since reporting. C missed earnings by 2 cents and trading lower. MMM issued weak guidance and is down over a point. JNJ was light on sales, trading lower. MCD don't get me started, said their earnings were great but if you deduct one time factors from the comparisons, I think they were weak. MCD is up 1/4.

The good news is that most of the bad news should be out of the way for the remaining 16. Earnings for the rest should not be so lopsided. CAT, BA, HON should be good. As always forward guidance will be key. Good luck trading.

END OF YEAR DOLDRUMS

In the fall the S&p fell from 1240 to 1170 on the Fed inflation and tightening scare. In November the third quarter GDP coming in at 3.8% put to rest fears that hurricanes, energy costs and the Fed had harmed the economy and we ran from 1170 to 1270. From there, for the last five weeks we sit between 1250-1275. Volume is low and nothing substantial appears to be going on. Underneath the surface however, change is taking place. Yesterday's 100 point plunge was a dailykey reversal and may become a weekly. The bank index BKX, that led the Nov rally looks like it may be rolling over as RSI is dropping. Housing continues to soften as the MBA mortgage application survey showed today by dropping further. From 95 to 2000 it was the internet driving the economy, from 2000 to 2005 housing has driven the economy. The market trades as if people are more interested in protecting this years profits than marking them higher. Christmas was no blowout and earnings warning season is not far away. Retail reports are due next week and the chart of the RTH doesn't look too good. It's a good time to be careful and maybe put out some shorts. Happy New Year.

MCDONALD'S

McDonald's reported their monthly sales this morning. Of course they touted their same store sales rising 4%. Less heralded were their global system-wide sales up a paltry 1.7% , the lowest in YEARS! Those are what will be reflected in total revenues. Furthermore, at the end of their press release they state they are taking a 2 cent charge for asset impairment in Korea and that if the dollar stays where it is and mind you this is Dec 8 their earnings will be impacted negatively by at least a penny a share. None of the stories on Yahoo or Marketwatch mention this amazingly. Thomson has consensus earnings at $.47 for 4th qtr vs $.45 a year ago for a 4.4% increase. It sounds to me like they issued an earnings warning this morning that every one missed. Of course tout TV also never mentioned either fact. Has anyone noticed this kind of thing in other widely covered large caps?

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.

OIL OIL OIL

Boy was I wrong. My last post 10/10 the S&P closed at 1186, I expected an oversold bounce, instead we got further selling and didn't bounce until Friday. Here we are at 1186. I was right in pointing out that oil remains the wild card and heavily influences the movement of everything else. Today, another storm and accompaning oil price concerns. Stocks are down, dollar stronger. Oil, however is no longer a one way street. Signs of slower global growth and high prices has raised concerns of what they now call demand destruction. So we will now have tug of war. Economic data showing weakness will exert downward bias while supply disruption news will be positive. Let's not forget the weather which of course can go either way but will have more impact if it's colder than normal.
As I write, we are having an up day thanks to GM and MO which are up on GM's agreement with the UAW re health care costs, and MO's favorable ruling from the Supreme Court on tobacco litigation. Even so, I feel the bears have the upper hand in the intermediate term. As I've outlined before, the things we know augur badly for the market. The Fed will continue to tighten. Inflation continues to march higher as the higher energy prices grind their way through the economy. The budget deficits will continue to grow larger, not only because of the large expenditures lately due to hurricane relief, but now we have to worry that receipts may be lower due to a slowdown, a double whammy. Gas prices will stay high and be a drag on consumer confidence. We just don't have the refining capacity to bring them down. Outside of energy, earning are being squezzed by higher costs. It seems like everyone is blaming higher energy for earnings misses, even some that seem to have no connection. If there is a year-end rally I think we would have to see much lower oil prices for some reason and a friendlier Fed as a catalyst.

I haven't written much about the dollar lately, but we are now at an interesting juncture. The dollar has gained strength this year on higher interest rates. So far it has tested its July highs against the Euro twice at around 119 and held. Today I saw comments from both the ECB and the Bundesbank about higher interest rates down the road. Higher energy is causing inflation targets to be exceeded there also.This would of course be very supportive of the Euro, however, they have the same problem we do. Their think tanks last week lowered economic growth estimates. So the question will be, which economy slows sooner and farther and which central bank blinks first. We will trade back and forth on each data point pro or con. As the Euro is near one year lows and the U.S. capital markets are having problems, the best risk reward trade here is to go long the Euro, at least until support is broken. I like trades where the market doesn't have to move too far to let me know I'm wrong.

BOUNCE

The market was oversold. The payroll data was better then expected. Oil prices were dropping. Rally, rally, rally. The bullish argument to take away from the payroll numbers, where the previous two months were revised significantly higher, is that going into the hurricanes the economy was strong, strong , strong. With hurricane season almost over, and reconstruction money pouring into the gulf, it may have all been just a bump in the road with sunny skies ahead. Only a hawkish Fed and higher inflation are restraining prices.

Bears point out, you don't fight the Fed, much higher heating bills lie ahead, and Mutual Fund cash levels are at record lows.

I believe we are now going to test the upside. How far will this rally carry and with what kind of volume. 1210 seems like the first line of resistance in the S&P. Energy is still the wild card and the market will remain sensitive to it. This week we will have higher inflation readings and retail sales, continuing the worry over interest rates. Cold weather or large drawdowns of distillate inventories this week could halt the slide in energy.

WHAT NOW?

Yesterday the S&P finished down by 2 pts, the first down day in eight trading sessions.

True nothing much has happened in most of the last eight trading sessions, with the exception of the month-end window dressing rally. The bulls are looking for a year-end rally. Their argument is:

• The uptrend from the 03 low is intact.
• The market has absorbed all the bad news and remained resilient.
• Fiscal policy will support the economy and generate corporate profitability on Katrina spending. Yesterday's ISM index, certainly supports this.
  
• The Fed is almost done.
• We've seen the worst on oil prices.
  

The bearish argument is:

• The higher oil prices of the past year are working their way through consumer and corporate pocketbooks and will hurt spending and profits for the rest of the year.
• The Fed will continue tightening until they get mortgage rates up and slow housing. Greenspan is now concerned about inflating asset prices.
• Corporate profits while good, are slowing and are on a downward path. Earnings misses will be blamed on energy and Katrina.
• Inflation is in the pipeline.
• Energy prices will stay high particularly natural gas. This will significantly slow consumer spending which accounts for 70% of GDP. Evidence of stress is starting to show up in the higher percentage of consumers who are charging their gas purchases rather than paying cash. Also the percentage of consumers who are late on their credit cards has been increasing.
  

HALF FULL HALF EMPTY

Well, it's been crazy. Good news is bad news, bad news is good news. Many counter-intuitive moves in the market. In times like these I find it;s best to step back, reassess and try to find some anchors. For only with strong conviction can you ride out the short term swings. Some anchors or truths are:

• Gas prices are going to stay high. Even if Rita does minimal damage, we have enough production closed to keep things tight for some time.
• Budget deficits are going to grow significantly.
• Corporate earnings are being impacted by higher energy prices. AA today is only the latest.
• Inflation is in the pipeline
  
• Fed tightening will continue.

The question is, do current prices reflect optimism or have they priced in the worst? One thing seems obvious, the market likes deficit spending. The increased fiscal spending, means and economic boost now, while payback is down the road. The budget deficit is going to be huge, but the market will worry about that later. Both politicians and corporate America live in a current quarter mentality. Nothing gets done without a crises, and planning does not look far ahead. Whatever happened to the Social Security crises.

The dollar has been strengthening lately. A German political crises has helped. The increased fiscal spending, which I have read could amount to 1 1/2% of GDP has provided even more support. With no fiscal discipline, the Fed has to continue tightening. As I've said many time before though, any economic weakness will quickly spill over to the buck. We could see the economy weakening despite the fiscal laggress because of the housing bubble bursting, the consumer being tapped out, higher rates, loss of confidence by foreigners in our financial markets.

The bonds will be important to watch over the next few months. Before this all started, we were already borrowing 80% of the worlds savings. Should their supply or preferences change where will the money come from? Even if we print it long rates will rise. Like the 70's we could have weak growth and higher inflation ahead.

DOUBLE TOP?

The market has started to give back some gains it made, if you recall, first on Katrina not expected to be as bad as feared and then when it was actually worse, on the bump from rebuilding. The 40 pt rally in S&P is a perfect example of the old sayings, that the market can do anything, the market can stay irrational longer than you can stay solvent, the market cannot be predicted using rational means, etc. The rally looks like it was a bull trap, short and powerful. No volume on the downside yet, so they all got em. The market is supported by fiscal spending on Katrina, lower oil, and hope the Fed is done or close to it.

The bonds are coming under pressure. Last week's manufacturing surveys showed very large increases in the inflation indexes. We have also had many companies start to raise prices as their energy costs increase. Oil prices are starting to pass through. If the Fed blinks they may be seen as falling behind the inflation curve. That of course would be very negative for bonds and the dollar as well.

The dollar keeps getting bailed out. First there was the failure of the referendum on the European constitution and now the deadlocked German elections. The talk is, we won't know the election results for weeks. Eventually it will recede from the headlines and since nothing has dramatically changed the dollar will resume its underlying downward move. It's a choice between the lesser of two evils.

Gold is reflecting slower growth, higher inflation, increased demand from China and India, and lower production. Back to the 70's.