Friday's Brew - Feb 23

Enjoy your fresh coffee with our summary and analysis of the market activity of the day and a medley of important information you should find useful. Outside of energy shares, and surprisingly a few semiconductor stocks, equities are broadly lower today across the U.S. Clearly, increased uncertainty surrounding an intensifying situation in the Middle East has investors wary of holding stock through the weekend.

OVERSEAS MARKETS

Markets in mainland China and Taiwan will reopen on Monday after a full week's celebration of the lunar new year. Shares in Hong Kong have traded most of the week, and the Hang Seng concluded the week with a decline of 0.47%, likely reflecting global volatility caused by geopolitical concerns. The NIKKEI 225 rose 0.44%, the second day of increase since a weak performance that followed the Bank of Japan's decision to boost rates.

Indian markets were the sharpest movers on the downside today. The BSE SENSEX 30 fell 2.77% on concerns that the government may announce steps to curb inflation when it makes its budget plans public next week. Specifically, there is speculation that the government could ban cement exports.

German business confidence fell in February. Still, the IFO Institute's Sentiment Index, which measures responses of 7,000 executives, declined to a still strong 107, compared to 107.9 in January. If we get away from the catchy headlines focused on the decline, we notice that February's reading was not far off from December historical high of 108.7, and still reflects a high level of confidence. The DAX rose 0.27% on the day.

Tony Blair openly raised concerns about military confrontation with Iran, not long after announcing he was getting his guys out of there. We go into great detail about how we think Iran will play out in the special geopolitical section within today's article. It's not out of the question that Blair does not know about the plan we theorize below, and it might explain his actions. The FTSE 100 rose 0.32% today, as perhaps Blair's actions appease and relieve a concerned populous. However, the move was not dramatic enough to be explainable, in our view. In fact, European markets were relatively quiet today on the whole. An outlier, the Russian RTS Index was up 1.5%, likely due to oil's recent climb.

ECONOMIC DATA & ANALYSIS

There was not much on the economic slate today. Dallas Fed President Richard Fisher addressed the topic of the U.S. economy in a global context. He said he remains vigilant on inflation, and that there are signs that inflation could abate, but there were also worrying factors. He indicated that he would be more comfortable if the growth rate of core prices were to moderate to below 2.0%. San Francisco Fed President Janet Yellen is also speaking today on the subject of the economic outlook.

GEOPOLITICAL ISSUES

Surprise surprise, Iran is on the radar again, after yesterday's IAEA report that the Persian nation had stepped up its uranium enrichment efforts since being sanctioned by the United Nations in December. World powers are now scheduled to meet on Monday in London to discuss a new, harsher set of sanctions against Iran.

After North Korea agreed to back off its nuclear program, Iran has shown interest in what it might be offered as compensation for compliance to U.N. requests. However, Iran refuses to halt enrichment, the prerequisite laid before it for moving forward. Time and again, Iranian officials have publicly stated that they would not submit to the "bullying" of the U.S., just to reach the negotiating table. At the same time, the United States has no confidence that Iran is sincere in its offers to appease the world community's concerns about its "peaceful nuclear program." In other words, the U.S. is sure that Iran's statements are pure stalling tactics.

China brokered the North Korean deal, and it is likely necessary that a third-party nation play a significant role in the Iranian negotiations. In this case, we believe it would have to be Russia, Iran's closest partner in its nuclear efforts.

I believe it will ironically become more and more complicated for the U.S. to use force against Iran as the negotiating process progresses. I believe that as a result of the Iraq campaign, and due to concerns that Iran could more significantly impact the global economy if confronted militarily, America is handcuffed. Also, I believe that as diplomatic process progresses, it becomes more likely that Russia and China could present a serious obstacle to the use of military force on Iran. It is likely in America's best interest to provoke Iran into a mistake that would allow for retribution. Otherwise, the paralysis of analysis, and diplomacy, could position Russia into a more significant alliance with Iran. Considering Vladimir Putin's recent comments and actions, we do not view it out of the question for Russia to stand for Iran, depending on Iran's actions and statements during the process. This is why we fully expect Israel to act on its own at a time when least expected, and not long from today.

We believe the positioning of increased American troops in Iraq, along with the addition of a second aircraft carrier fleet, are indicative of information sharing between Israel and America. We expect that the recent travels of Israeli and U.S. officials, including Condoleeza Rice, Dick Cheney and Negroponte, are indicative of more preparations and communications with allies. We anticipate that American forces are being positioned to contain an Iran that will undoubtedly lash out after it is bombed by Israeli forces, possibly aided covertly by the United States. It is in the United States' interest to protect vital petroleum producers and routes in the region and our own forces in Iraq. In plain English, we believe an Israeli led bombing attack of Iran may be imminent, meaning within weeks or a few months.

COMMODITY MARKETS

Shocker! Brent crude broke $61 today and was just below that mark in mid-afternoon trade, up 0.56%. The confrontation with Iran is clearly driving energy commodities again today. Natural gas is down 1.09%, however, as unseasonable temperatures warm the northeast. Natural gas prices should be volatile in the months ahead, as the Iranian issue and global warming jostle to impact the price in either direction. Gold, another beneficiary of the uncertain future of the Middle East, is up another 0.67% at this hour.

STOCK SPECIFIC NEWS
Earnings reporters today include Clear Channel Communications, Nicor, Inc. and Lowe's Company. Lowe's beat EPS estimates today, while posting an EPS decrease compared to its prior year result. Same-store sales fell 5.3% in the quarter, but LOW shares are up 4.0% today on the result and the company's 2007 growth forecast.

KL A-Tencor announced a large share buyback plan and its shares are up 4.3% today, perhaps partly behind the reason the SOX Index is defying the broader market move.

We have not reviewed the K.B. Homes situation in depth, but based on what I have read so far, it appears that the company has taken appropriate steps with its old CEO and the H.R. representative involved. I would expect that any decline in the price that creates a valuation differential between the firm and its peers, outside of any other important fundamental difference I may not be aware of, should create an opportunity for arbitrage as that difference is recovered. However, any naked long position is subject to the effects of a weak housing market, in my view, and should also be hedged against. This is not a recommendation, just an opinion, and please read my disclosure statement below.

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