Thursday's Brew - Jan 25

Enjoy your fresh coffee with our summary of the market outlook and activity for the day and a medley of important information you should find useful. U.S. markets are broadly lower today, after an increase in weekly jobless claims and greater than expected decrease in existing home sales in December.

OVERSEAS MARKETS

Shares in China were impacted by economic data. A government report showed that GDP grew 10.7% for the year, exceeding the 10.4% rate of growth in 2005. However, during the fourth quarter, growth slowed to a 10.4% rate, while consumer prices in December were 2.8% higher than the prior year. The combination of price inflation and a slowing economy concerned traders, in our view. The recently strong Shanghai and Shenzhen 300 Index fell 3.3%, as all of the mainland's indices collapsed. The Hang Seng Index dipped 0.73% on the day, as Chinese investors found no safe haven. We reiterate a recently stated recommendation that investors should consider taking money off the table from the high-flying and relatively more expensive Chinese markets.

In Japan, the NIKKEI 225 edged lower 0.28%, as the Japanese trade surplus increased less than was expected. The surplus increased 22.8% on strong import growth and amid speculation that U.S. market demand weakness played a role. Japan, as a developed market, is finding increasing export competition from emerging markets in its region, and import growth of 7.6% is undeniable and should grow over time, despite blame being attributed to commodity prices. In the future, automobile exports may be cannibalized some by Toyota's efforts to shift more production to U.S.-based assembly plants. India's market was one of few Asian markets to show strength today, as the BSE SENSEX rose 1.2%.

Europe was weak today as well, and the DJ STOXX 50 declined 0.25%. Germany's DAX dipped 0.43%, as business optimism in the world's third largest economy decreased in January. However, January's measure was not far off December's mark, which was the highest since German reunification began in 1991. Still, directional change matters in moving markets, maybe more than anything else, in our view.

ECONOMIC DATA & ANALYSIS

December existing home sales fell 0.8% to an annual rate of $6.22 million homes, lower than Bloomberg's consensus view for 6.25 million and below the 6.27 million measure in November. Indications have been that the housing market had strengthened in early 2007, but we have been stating our view that housing should weaken further this year. We continue to theorize that new home sales will outpace existing home sales, as home builders accept the reality of necessary price cutting at a faster pace then home owners, and as they sell through their inventory. Also, home builders are adept at providing incentives to prospective purchasers, where existing owners are much less active despite the desperate pushing of commission hungry real estate agents. New home sales will be reported tomorrow. What we found surprising was that the median price of a home was unchanged at $222,000.

Weekly jobless claims were reported at 325,000, well above expectations for 305,000. Seasonal factors may have come to play since last week was holiday shortened. Data before today had been very strong, and even this measure is not alarming in our view.

The Kansas City Federal Reserve Bank will report on the state of its manufacturing sector on Thursday. Finally, the help-wanted advertising index will be posted, but this metric is in need of a makeover, as it excludes on-line services like Monster and Career Builder.

COMMODITY MARKETS

The EIA inventory report on natural gas was released this morning. Yesterday, natural gas prices fell in sympathy with heating oil, as the distillates report indicated growth in supply. However, growth in distillates was greatly driven by a strong build in gasoline stocks, as heating oil inventory decreased. We advised traders to take a short-term long position in natural gas. Well, we got one right and one wrong, after predicting the buy entry point for oil on last week's inventory report.

The EIA's report on natural gas showed a seasonal draw of 179 bcf, in line with expectations but surpassing last year's draw of 76 bcf and the historical five-year average drop of 160 bcf for the calendar period. Traders are arguing that natural gas was over-bought, and analysts are arguing that there is not much winter left to eat into the nations supply. This view is driving natural gas prices lower 3.4% today. Despite our admitted error on the short-term trade idea, there are a few reasons why we remain positive on natural gas and oil.

A severe cold front is going to freeze traders in Chicago and New York over the next week, and the forecast into February is for continued normal winter weather patterns. El Nino was suppose to cause a mild winter this year, but NOAA recently adjusted their forecast, indicating El Nino would make less of an impact. Al Gore's film, An Inconvenient Truth, and the views of most scientists globally, indicate that global warming could eventually lead to a dramatic and swift shift in temperatures colder. Reason being, the polar ice caps are melting, bringing fresh water levels up within the ocean and impacting the gulf stream and other warming currents. Eventually, the impact of this change is expected to put North America and Europe into a deep freeze. This is not happening now, but perhaps the unexpected easing of El Nino this year is an indication of such pending impact over the next few years. The rate of melting is dramatic enough to make that statement. I highly recommend readers see the documentary. Before I saw it, I was like most of you who just raised an eyebrow as I suggested renting the film. Now, I might vote for Al Gore if he were to run for president, and I am a republican who favors confronting Iran.

The second reason I favor remaining long energy is the announcement from the government two days ago that it would begin refilling the strategic oil reserve. We calculated how long it should take the government to do so at the rate it stated, and it comes to 360 days. Did you know the U.S. government filled the strategic reserve before bombing Iraq and liberating Kuwait? Did you also know the U.S. government filled the reserve just before invading Iraq again a few years ago? So, I do not think it is coincidence that we are filling the strategic reserve now, ahead of the confrontation I anticipate with Iran in 2007/2008. According to the timeline created by the reserve build schedule, which is to start in the spring, the event would take place in early 2008. However, we anticipate an earlier war, possibly even begun with a preemptive strike by Iran and allies.

As natural gas is increasingly becoming more and more a substitute for oil, it should rise along with it as tensions escalate toward conflict. Natural gas already competes with heating oil to warm homes and it provides an increasing portion of the nations electricity. Hydrogen powered fuel cells, which use natural gas as an input, could eventually supplant some of the country's gasoline demand. However, currently, hybrid engines, ethanol and bio-fuel are more effective in doing so. Still, hydrogen fueled distributed power plants are taking share of the generation market, especially where energy independence is important for strategic reasons or where industrial waste can be used to generate hydrogen, like in water treatment facilities and breweries for instance. So, for these reasons, I believe investors should retain long-term positions in natural gas stocks, or build them during the summer should prices decline into the summer as some analysts are predicting.

STOCK SPECIFIC NEWS
This mornings earnings headliners were Ford, AT&T, Dow Chemical, Bristol-Myers Squibb, Cardinal Health, Lockheed Martin, Baxter International, Kimberly-Clark, Southern Company and Occidental Petroleum. Today's afternoon schedule includes Microsoft, Amgen, Franklin Resources and Hartford Financial Services.

Expectations based on Thomson Financial:

Company / EPS estimate for quarter

Microsoft (MSFT) $0.23

Amgen (AMGN) $0.95

Franklin Resources (BEN) $1.51

Hartford Financial (HIG) $2.26

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