Educate Yourself

Week in Review
For the week 5/28/2007 - 6/1/2007
Brian Trumbore
President/Editor, StocksandNews.com

The equity markets resumed their rally after a brief respite and this time the S&P 500 joined the parade and hit a new all-time closing high. Stocks shrugged off the minutes from the Federal Reserve's May 9 meeting to focus instead on?..well, actually, I don't know what the market was focusing on, to tell you the truth, because one thing is for sure, the Fed is not about to lower interest rates, as many had hoped, despite the revision of first quarter GDP to a putrid 0.6% rate of growth. At the May confab, according to the minutes, the Fed observed:

"The correction of the housing sector was likely to continue to weigh heavily on economic activity through most of this year," or, "somewhat longer than previously expected."

Well, readers of this column certainly weren't surprised by the correction in housing. The Fed continued in the minutes that inflation remains "uncomfortably high" (though by the official numbers it isn't) and that it expects the economy to pick up in the second half, "a little below (its) trend rate of growth through the remainder of this year and then pick up to a rate broadly in line with the economy's trend rate in 2008," trend being defined as 3%.

On this last bit, GDP, we'll see. The first quarter is history and it wasn't good. But the economic numbers for April and May thus far have been pretty solid, I'll grant you, with manufacturing indices improving across the board and consumer sentiment looking as if it's bottomed, at least for the moment. So it's clear that while inventories in the first quarter were scaled back, there is some restocking going on in the second quarter. Thus GDP could rebound, though it will hardly be off to the races after that.

I do have to add that we've had some fairly high-profile layoff notices the past week?IBM another 1,500 (3,700 total thus far in '07), Motorola 4,000 (on top of 3,500 earlier), Pulte Homes, 2,000 (16% of their total work force), and Dell, 8,000.

Now with some of these it's not immediately clear just how many of the losses will be in the U.S., but they aren't the kind of headlines the average worker likes to see when they pick up the newspaper?.or read it splashed across Drudge next to "Kevorkian Out of Prison!"

You also have this issue of suddenly rising interest rates. I don't mean to beat a dead horse but, yes, while rates are still at historic lows, a 10-year at 5.00% doesn't bode well for any recovery in housing owing to the fact the vast majority of it, despite the recent price declines in some areas, is still unaffordable; or at least requires that the average American family stretch beyond their means?.which was the cause of most of our problems in the first place. And don't forget, we have this not so small issue of mortgage resets to deal with the next 12-24 months. That said, I continue to maintain that when it comes to the Federal Reserve, they have to understand this and thus won't raise interest rates the rest of 2007. It would kill a large group of Americans, which to me is far more important than concern over my beer or Chex Mix going up another 50 cents.

Both the S&P 500 and Dow Jones closed at all-time highs on Friday, a very positive sign, with the S&P having pushed through its March 24, 2000, high of 1527 to finish the week at 1536, while the Dow Jones motored to 13668. Certainly continued deal activity helped, as well as ongoing share buybacks and decent earnings out of the likes of Dell

Rates continued higher, despite the downward revision on GDP, because the other data, such as in manufacturing, was stronger than expected. Additionally, the May jobs report was solid (157,000 new non-farm jobs) and there is also continued pressure on bonds from those looking to diversify their holdings out of U.S. Treasuries.

--Toyota led the way yet again in U.S. auto sales for May, up 14% to its best monthly level ever. GM had a solid month with sales up 10%. Ford, however, which is continuing to cut sales to rental companies, saw a decline of 7%, while Chrysler's rose 4%.

--I found the following figures regarding foreign direct investment in the United States to be a bit startling, as reported by Barron's Jim McTague. Representing money that foreign companies invest in U.S. business operations, FDI peaked in 2000 at $321.3 billion, dropped to $64 billion by 2003, and has recovered to just $184 billion.

McTague further points out the troubling statistic that "The number of Americans employed at foreign-owned, non-banking firms in the U.S. declined from 5.7 million at the end of 2000 to 5.1 million at the end of 2005." Output also declined despite a fairly robust economy.

Bottom line, we continue to pay a big price for the Dubai Ports World fiasco. For foreign investors, we're often not worth the trouble.

--China's government came up with yet another measure in its attempt to ease speculation in the stock market by tripling a tax on share trades. The benchmark Shanghai Composite dropped 6.5% that day, Wednesday, though was basically flat the remainder of the week.

Meanwhile, a Beijing court sentenced the former head of China's food and drug administration to death for corruption and dereliction of duty. Zheng Xiaoyu, who was released from his post in 2005, was convicted of accepting about $600,000 in bribes to grant approvals on hundreds of medicines. Many of the drugs proved to be non-effective, if not lethal. On the tainted food front, however, another area in which Zheng had oversight, China has caught a small break in the disclosure by the U.S. FDA that melamine, the agent found in tainted pet food, was added by a Toledo, Ohio, company named Tembec to animal feed agents, so China can say it wasn't the only offender. But on Friday, the FDA also warned consumers to avoid using toothpaste made in China because it may contain a poisonous chemical used in antifreeze. So if your teeth suddenly turn green, well, you've got a problem. [If you use a name brand, not to worry.]

--India's economy grew at a 9.4% clip in the first quarter, the second fastest ever recorded there.

--Following is a tidbit from Lord Rees-Mogg and Strategic Investments. Referring to a book by Hugo Bouleau titled "The Final Crash," Rees-Mogg cites Bouleau's comments on the growth of derivatives.

"In 2004, the market in credit derivatives increased by 123%, creating an exposure of $8.4 trillion to these instruments of insurance. In 2005, they grew by 105%, such that their so-called notional value stood at $17.3 trillion, which is the excess of all outstanding corporate debt on the planet. The total derivatives market across all sectors is worth an incredible $298 trillion. To put this into context, the value of such instruments was equivalent to less than a third of the world economy in 1990 but equates to nearly 800% of global GDP in 2006. Much like Lloyd's re-insurers, someone somewhere must be exposing themselves to these credit risks."

"What is certain is that nobody has any real understanding of these risks, either in detail or globally. Their ultimate base, like that of any bookmaker, must be that the banks that issue derivatives keep their books balanced. In theory, as in other forms of banking, every liability is balanced against an asset. But - as we all know - bookmakers can go bust, and so can bankers. If the counterparty responsible for matching the risk becomes illiquid, then the whole system can be put at risk."

--Josh P. passed along this tidbit from the San Diego area real estate market. Foreclosures for the month of April 2007 were 525 vs. 85 for April 2006. And did you see the Sunday New York Times piece by Abby Goodnough on the collapsing Florida condo market? Goodness gracious; everyone and their mother is trying to get out of their contract. One attorney said a client of his abandoned a $340,000 deposit rather than close on a $1.6 million unit that lost its appeal.

"The numbers suggest that it will only get worse. In Miami- Dade County alone, 8,000 new condo units will be completed this year and nearly 12,000 more in 2008."

--John Henry, the owner of the Boston Red Sox, made his money trading commodities and futures as a large hedge fund operator. Remarkably, however, his firm's assets have plunged from $2.5 billion to about $500 million as his largest individual fund is off 24% over the past 12 months, during a time the S&P 500 was up 15%, as reported by Gregory Zuckerman of the Wall Street Journal. According to a survey by Barclay Group, the same fund has dropped 27% over the past three years while the average in his category is up 10%. As a result of this severe slump, disgruntled investors, including Merrill Lynch, are pulling out their money at light speed.

--John Henry's fund isn't the only high-profile offering having problems. Goldman Sachs' flagship hedge fund fell 3.4% over the first four months of this year, according to Bloomberg News, at a time when the average hedge fund gained 4.9%. Talk about overrated. Those wayward California humpback whales could have done better.

--Water?.can't live without it?as any whale could tell you. But with all my recent musings on the topic, I couldn't help but note that both Newsweek and U.S. News & World Report had big features this week on the world water crisis. Nothing I haven't already told you, but over the coming years, companies investing in water rights should do well?plus those making the pipes to carry it.

Incidentally, in yet another example of the severe issues facing China, authorities in Wuxi, Jiangsu province, face a crisis as the city of 5 million can't drink water that was contaminated by an algae bloom in heavily polluted Tai Lake. The locals are scared to take showers in it as well, for good reason.

--Staying on the topic, the New York Post reported that Mets All-Star David Wright may have earned up to $20 million when Glaceau - the company whose VitaminWater drinks he endorses - was acquired by Coca-Cola for $4.1 billion. Instead of taking cash, Wright took a 0.5 percent ownership stake in the company. Good for you, David, but just hit .300 and drive in 100 runs, know what I'm sayin'?

--In a big move for the brokerage industry, Wachovia acquired AG Edwards, thus giving the combined operation the second largest sales force at 15,000 financial advisers and $1.1 trillion in client assets. Wachovia is hoping the merger will allow it to tap into a larger segment of the affluent class.

--Health insurance giant WellPoint fired its CFO, David Colby, for violating the company's code of conduct. The CEO said swift action was required after "concerns were raised" about Colby's behavior. While WellPoint didn't enlighten us as to what that behavior was, except to say it was not illegal, I'll go with ye olde hanky panky.

--Because of bad behavior, Jack in the Box is being sued by CKE Restaurants, owners of Carl's Jr. and Hardee's, over Jack in the Box's characterization of Carl's and Hardee's Angus burgers. As reported by Alana Semuels (sic) of the Los Angeles Times:

"In one ad, Jack, the mascot whose head looks like an upside- down ice cream cone, is asked to point to a cow's 'angus area' on a diagram. He says sheepishly: 'I'd rather not.'?.

" 'While Defendant may find humorous the aural and phonetic similarities between the words 'Angus' and 'anus,'' the suit says, the link is made to create 'the erroneous notion that all cuts of Angus beef are derived from the anus of beef cattle.'"

--Lastly, the BBC reported "Experts at a biotechnology company in New Zealand have discovered that some cows have a gene giving them a natural ability to produce skimmed milk," specifically one that goes by the name of Marge, it seems.

So like I'm thinking this is potentially a classic private-equity deal, after which investment bankers could then merge NZSM (New Zealand Skimmed Milk) with Diversified Foods' Bordens division. Elsie the Cow, by the way, already has extensive experience dealing with investors. During World War II, she "helped raise 10 million dollars in war bonds." And you can look it up.

Iraq: We've heard these stories before, that some Sunni militants are cooperating with U.S. forces and that there are battles between Sunni units and al-Qaeda, but then at the end of the day actual progress is minimal. The month of May, after all, represented the second straight one with a death toll among U.S. forces exceeding 100 (at least 125). It was also distressing to see the kidnap card played anew with the capture of five Britons in central Baghdad; hauled away by men dressed in Iraqi police commando uniforms.

And Turkey has made it clear it is prepared to stage an offensive against the Kurdish rebel group, the PKK, as Ankara has sent large contingents to the border with Iraq. At the same time, Turkey is saying it will wait for the United States and the Iraqi Army to rein the PKK in before acting unilaterally. This past week, the Kurds are suspected in a bomb attack that killed six Turkish soldiers. Turkey must know, however, that the U.S. will not pressure the Kurds to cool it, and so this brewing crisis will at some point boil over.

Iran: Tehran is playing its own hostage card and it's time to call it what it is?another hostage crisis as four Iranian-Americans have now been placed under arrest by authorities for no other reason than their American connection. The mullahs call them spies, but as Sec. of State Condoleezza Rice says, this is nothing more than a "perversion of the rule of law."

The U.S. and Iran did hold direct talks in Baghdad this week, the first such interaction since 1979. There was no progress on the issue on the table, that being Iran's support for terrorists in Iraq, though none was expected.

Meanwhile, various news sources are talking about the ongoing CIA operation to harass, though not overthrow, the Iranian regime, in what has become a covert war between the CIA and Iran's elite Revolutionary Guard Unit, the Quds Force.

On the nuclear weapons program front, talks between Iran and the European Union were fruitless.

Internally in Iran, the price hike in gasoline for Iranian consumers is only 8 cents thus far (though that's a 25% increase) and there have been no real protests as yet. Actual fuel rationing, though, is slated to begin this coming week and I can't imagine the public will take kindly to it.

Iran's state bank, however, did something that one domestic newspaper called "Economic suicide," that being the move to cut interest rates to the 12% to 14% range from 17%, this despite the fact the Central Bank has predicted inflation will rise to 17% over the coming 12 months from the current 13% to 14%. The last thing you want to do is stoke it further. Said one official, "The economy minister and the head of the Central Bank have to explain this decision since this decree is incomprehensible for economists." [Daily Star]

Lebanon: Finally, some good news to report. Russia and China abstained from a UN Security Council vote on establishing an international criminal tribunal to examine the assassination of former prime minister Rafik Hariri. It was feared the two would veto the resolution. Lebanon's parliament must now adopt its own tribunal by June 10 or the UN-sanctioned one, complete with a majority of judges from outside Lebanon, will take over.

Of course pro-Syrian factions, such as Hizbullah, are not pleased and it's feared Lebanon will see yet another spasm of violence as Syrian agents attempt to intimidate the forces of good here. But it's important this all come to a head, just as it's vital the Lebanese Army crush the terrorists outside Tripoli.

Russia: The pictures out of this week's G-8 summit in Germany are going to be absurd, causing everyone to comment once more, "Remind me?just why is Russia a member of the club?" After all, relations with both the U.S. and Europe are at their worst level since the Cold War, and this week we learned that President Bush is hosting Russian President Vladimir Putin (who is devolving into Vlad the Impaler) in a tete-a-tete at the Bush family compound of Kennebunkport, Maine, July 1-2. It's not known if Vlad is bringing one of his spiffy new multiple warhead ICBMs with him, though after the U.S. customs agent let TB Man across the border the other week, one shouldn't be confident that customs will find Putin's missile, let alone the launcher. [Note to agents: If you see a 60-foot carryon bag, check to see what's inside.]

You see, this week Putin ratcheted up the rhetoric another sixteen notches when he warned the U.S. missile shield risked turning the European continent into a "powder keg" and would trigger a new arms race. Then he tested the ICBM, capable of carrying 10 warheads and overwhelming any missile shield.

"(Our partners) are stuffing Eastern Europe with new weapons," said Putin in defense of Russia's actions. "A new base in Bulgaria, another in Romania, a site in Poland, radar in the Czech Republic. What are we supposed to do? We cannot just observe all this?" [BBC News]

But the biggest immediate issue actually involves Kosovo. I wrote the following prediction for 2007 in my "Week in Review" of 12/30/06.

"Watch the Balkans as the issue of Kosovo gets center stage for a spell. Nothing too deadly, but between increasing concerns over Russia's intentions and the need for vigilance in the Balkans as well as what should be an increased presence in Afghanistan, NATO is going to have to confront the fact it is turning increasingly into a paper tiger and must, therefore, recommit itself to the security of Europe and beyond."

While a draft UN resolution on Kosovo will evidently soften the language on potential independence for the Albanian majority there, Russia continues to threaten to veto any Security Council act that calls for Kosovo to achieve statehood, allowing them to leave Russian ally Serbia's clutches.

China: Last week I wrote of the Pentagon's latest concerns with China's military program, which Beijing later blasted. An editorial in the May 28 issue of Defense News spells it out even further.

"Beijing is pursuing?single-minded policies in the military sphere. In the past year, (the Pentagon notes), China tested an anti-satellite weapon, accelerated development of land-and-sea- based ballistic missiles, and stepped up work on nuclear missile submarines and mobile launchers.

"Beijing also has probed U.S. defense computer networks for weaknesses, putting into action Chinese strategists' contentions that destroying an enemy's cyber-infrastructure is as important as physical attacks.

"A decade ago, only a handful in official Washington regarded China as an emerging threat. Two who did were Andrew Marshall, head of the Defense Department's Office of Net Assessment, and Michael Pillsbury, who wrote two books in the 1990s that argued that China was studying U.S. military vulnerabilities to draw its own modernization roadmap.

"Over the years, both have been derided as alarmists, especially by those who argued that military confrontation was unimaginable for close trading partners?.Besides, they said, Chinese defense spending was a fraction of the U.S. total.

"China is spending plenty - certainly more than it admits - to develop capabilities that go far beyond mere self-defense. It is militarizing commercial technologies - abetted by decades of close trade with European and other nations on 'non-lethal' defense systems - and embracing asymmetric approaches to future war?.

"As a nation known for detailing its strategic plans - for transport, for industry - China's silence on its military future sets the stage for a destabilizing arms race?.

"Does Beijing, as it claims, merely want a military commensurate to its rising global economic status? Or is it, as some fear, seeking the asymmetric teeth to secure economic resources or dictate global economic terms by force, if necessary?"

This last point is one I've been making for years, particularly with regards to the fate of Taiwan. Today, the U.S. would simply stand by while China moves in, and after, oh, about four weeks of worldwide condemnation and suspension of trade, the world, sans the U.S., would resume relations like nothing happened.

One other item on the China front, this from China Daily. According to a just released study by the Chinese Academy of Social Sciences, between 1978 and 2006 "about 1.06 million Chinese went to study overseas. Of those just 275,000 returned home during the period." The author of the report said:

"Against the backdrop of economic globalization, an excessive brain drain will inevitably threaten the human resources security and eventually the national economic and social security of any country."

The report "urged the establishment of a talent security alarm system to monitor the flow of domestic talent." Gee, I'd be kind of bummed if I wasn't given an ankle monitoring system of my own. 'Ya got no future, kid.'

North Korea: I wish there was something new to report here, but the bottom line is Pyongyang continues to jerk everyone around and get away with it.

Japan: Prime Minister Shinzo Abe is under intense pressure as a result of two suicides of high-profile government officials within days. Agricultural Minister Toshikatsu Matsuoka hung himself after he became the target of a corruption scandal, and then Shinichi Yamazaki threw himself from his apartment building amidst an investigation into bid rigging while he was the head of a government-affiliated company in charge of contracts for forestry work.

Where the prime minister suffers, particularly in the case of Matsuoka, is in his vocal support of a disgraced official which shows an incredible lack of judgment. Abe admitted responsibility for Matsuoka's death. "As the one who appointed minister Matsuoka to the post, I feel responsibility for the action taken." Abe's party's approval rating is now 36%, down 8% in just one week.

Thailand: Ousted Prime Minister Thaksin Shinawatra and 110 members of his party were banned from political office for five years. Thaksin was ousted in 2006 by a military coup on charges of massive corruption.

Separately, at least 10 Thai soldiers were killed in another bomb attack in southern Thailand by Islamic militants. I'm telling you, especially my European friends, think twice about vacationing here the next year or so.

Back to Thaksin, it hasn't been a great stretch for him. Earlier, he stopped for a meal at a Moscow McDonald's and had his briefcase stolen which contained his passport and $9,000.

Nigeria: The new president took over?Umaru Yar-Adua?and pledged to quell the violence. He also asked for the people to rally around his agenda for improving the infrastructure. But since a majority of the people don't believe the recent election was free and fair, there is little hope for lasting peace.

Sudan: President Bush ordered fresh sanctions on the Sudanese government in a final attempt to get it to stop the bloodshed in Darfur. The sanctions target 30 government-controlled companies and individuals accused of involvement in the genocide. The U.S. had been working with the United Nations, but with little movement on this front, Bush felt compelled to act more forcefully. Too little, too late for 200,000 who have died since 2003, but better than just sitting back and letting the likes of Russia and China dictate terms. In the case of the latter, Beijing continued to put up one roadblock after another because it needs Sudan's oil. As the Washington Post editorialized, "In a just-concluded tour of the region, Chinese ambassador Liu Guijin said he 'didn't see a desperate scenario of people dying of hunger.' He couldn't have been looking very hard."

Venezuela: Interesting development here as President Hugo Chavez shut down RCTV, the country's oldest private broadcaster first founded in 1953. RCTV was the only opposition network with national reach remaining. In 2002, it broadcast calls to overthrow Chavez.

The dictator's move is already backfiring on a broader front as lawmakers in Brazil and elsewhere in Latin America have criticized Chavez harshly. No one ever said the guy wasn't an idiot.

Mexico: No doubt, the treatment of Miss USA at the Miss Universe pageant in Mexico City wasn't good, but in a classic example of 'wait 24 hours,' in this instance for cooler heads to prevail, you have to focus on the Big Picture. Yes, Mexico has been a loser nation in many respects, having squandered its immense oil wealth, for starters. But while there are many in the U.S. who are tired of the anti-Americanism on display at every opportunity, this is the case throughout virtually all of Latin America these days.

The bottom line is we need both Mexico and Colombia, in the worst way, to balance out the likes of Venezuela and Bolivia, and Mexican President Felipe Calderon has thus far been a stalwart in the war against his nation's drug cartels. Calderon has already extradited 15 drug kingpins to the United States this year and unlike all his predecessors, he thus far has exhibited incredible courage in taking them on. In the first five months of 2007, 1,000 have died of drug-related violence and if Calderon is unsuccessful in his efforts, the tally will grow much higher. Tourism, for one, would dry up and we would have a totally failed state on our border exacerbating all the existing problems we have between our two countries. You think illegal immigration is bad today? Believe me, it can get much, much worse.

As it is, the Wall Street Journal reported that Acapulco already is becoming known "more for severed heads than for coconut-rum drinks." So while many in Mexico blow off steam at events like the Miss Universe pageant, the White House must bite its lip and support Calderon as much as possible?and quietly. We need him on our side, now more than ever.

Spain: Authorities arrested 15 North Africans, including 13 Moroccans, who were members of a cell that was allegedly sending money and fighters to different terrorist organizations in North Africa and the Middle East.

Ukraine: A crisis was averted, for now, as the two Viktors, President Yushchenko and Prime Minister Yanukovych, agreed on early elections for Sept. 30. We were just hours from probable bloodshed last weekend as thousands of Interior Ministry security forces were on the move to Kiev under the orders of Yushchenko. It was the Interior Ministry that had played a critical role in the 2004 Orange Revolution.

Dow Jones +1.2% [13668]
S&P 500 +1.4% [1536]
S&P MidCap +2.8%
Russell 2000 +2.8%
Nasdaq +2.2% [2613]

Next time?a "Black Diamond" commentary. What's a black diamond review? Let's just say you may want to have your security blanket handy.

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