Week in Review 
For the week 10/22/2007 - 10/26/2007
Brian Trumbore
President/Editor, StocksandNews.com

Wall Street

"In issuing its earnings report, Merrill Lynch said its subprime mortgage positions were 'appropriately marked.' Ha!"
--Week in Review, 7/21/07

Nailed that one, it's safe to say. This week Merrill finally fessed up, at least partially, to having some rather severe issues when it comes to its books. Like up to $8.4 billion worth, or another $3.4 billion more than it had preannounced just three weeks earlier. It remains all about the housing sector and efforts to securitize same; as in with Merrill, its many bets on subprime mortgages and collateralized debt obligations didn't exactly go as planned. They might have been better off going to the casino and putting all their chips on 'red.'

Merrill's problems, which as I go to post reportedly will cost CEO Stan O'Neal his job, are related to two common themes around here, as espoused for years in this space.

"These guys don't know what they own, and, they aren't as smart as you think."

The word 'transparency' has also become part of our lexicon once again, just as it did at the height of all the Enron-type accounting debacles, and it is a huge black mark on America's reputation.

Even I used to say, how could you possibly want to invest in many of the hot overseas markets when there is no transparency? Well you know what? Wall Street has been the biggest offender.

And when it comes to smarts, in the same "Week in Review" cited above, 7/21/07, I discussed Federal Reserve Chairman Ben Bernanke's congressional testimony, wherein he was asked his estimation for the total losses in the mortgage sector and he replied $50 billion to $100 billion. I made fun of the chairman then because I knew exactly where he got that answer. He was just parroting what he read in the Wall Street Journal and on Bloomberg. I myself said it would exceed $200 billion. Now it turns out it's probably going to be closer to $400 billion.

But to those who keep saying this is an isolated event, they're nuts. This isn't a stock we're talking about, where the pain can be swift and sure; it's real estate. It takes time before the negative wealth effect seeps into the psyche of homeowners, at which point it will finally impact consumer spending. Morgan Stanley's Stephen Roach, who admittedly has been too bearish for far too long when it comes to Americans' penchant for spending, said this week the "American consumer is toast." While on the other side of the debate, economist Ed Yardeni points to the fact any negative wealth effect has been offset by a positive one from stocks. I can't deny this, plus, critically, the jobs picture is still solid, but you shouldn't be surprised I remain in the Roach camp.

After all, anxiety is building. I'm not a big proponent of the sentiment indicators, but when a Bloomberg / Los Angeles Times survey has Americans expecting a recession in the next year by a 65 to 29 margin, at some point it's meaningful.

The New York Times' Vikas Baja and Edmund Andrews had a story on the broader implication of the mortgage debacle, aside from the gigantic hits the financial firms are taking. State and local governments could face a loss of $917 million in lost property tax revenue, for example, just off the number of foreclosures. For the hardest hit states like Florida, California, Michigan and Ohio, that's significant. In many it's certainly not a great time to have a government job.

This past week we had more data on home sales that was far from encouraging, for those desperately searching for a bottom. Existing home sales for September fell more than expected, while new home sales came in exactly as estimated. [This fact was misreported, incidentally.] But what made the new home figure worse was a huge downward revision for the month of August.

On the overall health of the economy, outside real estate, the news isn't much better. Durable goods, big-ticket items, fell for a second consecutive month when a rise was forecast, and even when the likes of DuPont and Dow Chemical had something good to say, growth in their overseas businesses continues to be offset by softening in the U.S. One company after another in the industrial sector has said the same thing for three weeks now.

Outside of China, as well, growth is slowing and I had to grin when on Monday the Wall Street Journal ran the headline:

"Europe Feels Pinch As Housing Boom Slows"

"The housing boom was a global phenomena, affecting virtually every developed country outside of Japan during the past 10 to 15 years."

Nothing you didn't already read here, going back years. And in a separate piece for the Journal, David Wessel correctly reminded everyone that today's recessions, more often than not, "are triggered more by collapsing asset prices - the bursting tech-stock bubble in 2001, for instance - than by the old cycle of retailers and factories reacting to rising inventories of unsold goods by curtailing orders and production."

Lastly, as if we didn't already have enough problems, we have this other bogeyman out there, oil. Last week I said I wasn't too concerned until gasoline futures began to run, specifically to the $2.30+ level which would over time translate into the psychologically important $3.00 at the pump in most parts of the country. Gas futures did indeed begin to advance and are now at $2.27. Yes, $90 oil grabs the immediate headlines, but, again, if the price at the pump climbs above $3.00 this holiday season, score one for the Grinch.

Street Bytes

--The market managed solid gains after the previous week's debacle, particularly in the area of tech with great earnings reports from heavyweights Apple and Microsoft leading the way, bookending the week as it turned out. But am I allowed to rain on even this parade? Or rather, am I the only one bemused by the fact that we aren't inventing anything great these days, but we consume a lot of gadgets and new versions of old products that were pretty effective in their own right; Microsoft Vista being an example of the latter.

And of all stocks, Countrywide Financial added to the mirth and merriment on Friday when it reported a $1 billion plus loss for the quarter, but added the mortgage giant would not only return to profitability in the fourth quarter, but it would be profitable for all of 2008. So some took this to mean the worst is over in housing. Well bless their misguided souls.

Back to oil, it closed at a record high of $91.86 yet the Street rallied in the face of it. But the price wasn't just the result of speculators, as has been the case some weeks recently. The inventory picture simply isn't good and global demand, thanks to China and India, as you all know by now, has yet to decline. Plus tensions on the Iraq-Turkey border don't help any. More on this in a bit.

For the week the Dow Jones regained 2.1% to 13806, the S&P 500 added 2.3% to 1535, and Nasdaq rose 2.9% to 2804 on the heels of Microsoft and Apple.

--U.S. Treasury Yields

6-mo. 4.03% 2-yr. 3.76% 10-yr. 4.39% 30-yr. 4.69%

Rates were largely unchanged as the market waits for the Fed's decision on how far to lower, Wednesday, as well as Friday's always key employment report.

--To our friends in southern California, you were in our thoughts and prayers all week. The damage estimate now exceeds $2.5 billion. It also goes without saying there is a special place in Hell reserved for those who may have been involved in arson.

--China's economy is going to continue to run at an 11.5% clip for the foreseeable future, especially with the Olympics around the corner. But consumer inflation is running above 4%, of major concern. Also, pollution was so bad in Beijing the other day that visibility was reduced to zero and every flight in the region was delayed.

--Warren Buffett addressed the China bubble. "We never buy stocks when we see prices soaring. We buy stocks because we are confident of the company's growth. People should be cautious when they see prices rising as they are here."

--But Bear Stearns and China's Citic Securities inked an historic deal to invest $1 billion in each other. Both sides, though, should scan all the bills involved and make sure it's not Monopoly money being exchanged for securities in Baltic Ave.

--Bank of America said it was eliminating 3,000 jobs after its miserable earnings release of the prior week. CEO Kenneth Lewis added "I've had all of the fun I can stand in investment banking at the moment."

--Heating oil futures continue to hit record highs on the back of soaring crude prices, thus creating major concerns for consumers this winter, though the forecasts I follow for the key Northeast and Midwest regions say it will be a warm one.

--Congressman Charlie Rangel has proposed to eliminate the alternative minimum tax but in return he would levy a surcharge on incomes of over $150,000 ($200,000 for couples). The corporate tax rate would be reduced, however, under his plan.

But while there is much discussion of this, we are still at the talking point stage; so it's far from hitting the floor for a vote and I'm not going to spend too much time on it until then.

--Inflation is such a concern in Russia, especially ahead of December's parliamentary elections, that the government and food retailers have agreed to freeze prices on some types of bread, milk, cheese, eggs and vegetable oil until the end of the year. China is doing the same with certain products, while other governments have been increasing subsidies. Inflation in Russia is now approaching 10%. The price freezes hearken back to Soviet-era solutions.

--Bird flu claimed an 89th victim in Indonesia, out of 110 infected with the H5N1 virus there. But here in the States, as my brother commented the other day, who would have thought staph would suddenly become so much of a concern? In the New York area, we have had a number of children die from it, similar to other parts of the country. Very scary.

--Apple Inc. once again blew away expectations as it announced fiscal fourth quarter profits soared 67% on the heels of record Mac sales, up 34% over a year ago, as well as iPods (up 17%) and iPhones. Regarding this last one, Apple says it has sold 1.39 million since the product introduction June 29.

--Microsoft acquired a 1.6% stake in social networking site Facebook for $240 million, beating out Google and placing a $15 billion valuation on the startup. Microsoft is concerned that sites such as Facebook will become the new portal used by consumers to access the Web and is determined not to miss out.

--Prior to its earnings release, Countrywide Financial had agreed to rework some $16 billion in home loans, a move that could affect 82,000 borrowers. The focus is on those with adjustable- rate mortgages that were slated to reset after the initial two- and three-year teaser rates.

--Research In Motion has shipped its first BlackBerry to China, a big breakthrough as it struck a Chinese distribution deal with Alcatel-Lucent. Obviously, with its booming mobile phone market, China could contribute millions of subscribers to RIM and its shares soared anew on the announcement.

--Wal-Mart announced it was reducing capital spending and scaling back its superstore expansion plans for a second time this year.

--Amazon reported strong sales and profit growth, but after hitting $100, the stock dropped below $90 over concerns the gross margins were slipping. But there is another reason why profit takers finally entered the market. Amazon is grossly overvalued! I can't make that statement about Apple or Google, given their success, but here? I mean for crying out loud, Amazon is still trading at about a 60 multiple off of next year's profit forecasts.

--Once again, college tuition and fees rose at twice the rate of inflation, up 6.6% this year at public colleges and up 6.3% at private institutions. I also have to note I received more feedback on my bit last time on endowments than on any topic in quite a while. Yes, it's outrageous that the dollars aren't being spent to reduce the tuition burden.

--Crain's New York Business reported that the number of personal bankruptcy filings in New York City soared 70% in the past year.

--Scientists have concluded carbon dioxide levels are increasing much faster and will be harder to control. An international team reports that since 2000, the rate at which CO2 has entered the atmosphere is 35% greater than models called for. The chief culprit is of course China and its soaring number of coal-fired power plants. [One is built every five days on average!] Germany's Foreign Minister Steinmeier said "Climate change is not a faraway problem. It's dramatic and our window to act is even smaller than we thought just a few weeks ago." Steinmeier also spoke of a Cold War at the North Pole that must be prevented. "We have to make sure that Arctic treaties are respected and upheld."

But back to China, there is another school of thought, this one out of Sussex University, that concludes:

"A focus on emissions within national borders may miss the point. While the nation state is at the heart of most international negotiations and treaties, global trade means that a country's carbon footprint is international?.

"Without this demand, China would not have developed so rapidly, and its emissions would not have risen so sharply," the study said, proposing that so-called imported carbon be included in national emission calculations. [South China Morning Post]

And this, sports fans, is why they're called think tanks.

Foreign Affairs

Iran: Secretary of State Condoleezza Rice, in setting the stage for a new round of sanctions on Iran, including the designation of the Revolutionary Guard Corps as proliferators of weapons of mass destruction, told the House Foreign Affairs Committee:

"The policies of Iran constitute perhaps the single greatest challenge for American security interests in the Middle East, and possibly around the world, because the combination of Iranian terrorism, Iranian repression at home and the pursuit of nuclear weapons technology - technologies that could lead to a nuclear weapon - is a very dangerous mix."

In his first major speech since leaving office, former British Prime Minister Tony Blair talked of Iran and Islamic extremism in general.

"Out there in the Middle East, we've seen?the ideology driving this extremism and terror is not exhausted. On the contrary it believes it can and will exhaust us first.

"Analogies with the past are never properly accurate, and analogies especially with the rising fascism can be easily misleading but, in pure chronology, I sometimes wonder if we're not in the 1920s or 1930s again.

"This ideology now has a state, Iran, that is prepared to back and finance terror in the pursuit of destabilizing countries whose people wish to live in peace?.

"There is a tendency even now, even in some of our own circles, to believe that they are as they are because we have provoked them and if we left them alone they would leave us alone.

"I fear this is mistaken. They have no intention of leaving us alone. They have made their choice and leave us with only one to make - to be forced into retreat or to exhibit even greater determination and belief in standing up for our values than they do in standing up for theirs." [London Times]

[Blair these days heads up the Quartet of the U.S., Europe, Russia and the United Nations on the Middle East.]

Of course many read the above and say, we've been down this road before, and such an argument by detractors certainly can't be dismissed out of hand. But it's not as if the Bush administration hasn't been giving negotiations a chance. I would just add, as I've written before, that the foreign policy of the White House has been both unimaginative (as in not talking to the right people, as well as not cutting some old-fashioned dirty deals) and almost criminal (as in our treatment of Lebanon right after the Hariri assassination in Feb. 2005 and then the war in '06).

But the facts are Iran is bound and determined to get the bomb and the U.S. and its few allies are running out of time. It was indeed worrisome when President Ahmadinejad fired his chief nuclear negotiator, Ali Larijani, and replaced him with someone even more conservative.

It's complicated, though, even on this last issue. Over 180 members of Iran's parliament signed a letter signaling support for Larijani, including Rafsanjani's brother, a former vice president; Rafsanjani being the man I thought the White House should have been conversing with all these years in an end-run of Ahmadinejad.

And I saw another report, an intriguing one at that, that Ayatollah Khamenai, who has the ultimate say in all matters, is actually trying to isolate Ahmadinejad so he can blame him for the new sanctions; thus his allowing the president to fire Larijani. The majority, though, says that Khamenai is simply supporting Ahmadinejad. I kind of like the other theory.

But here's the bottom line. You either believe Iran is close to obtaining the bomb, or you fall into the International Atomic Energy Agency / CIA camp that says Iran is still another 3-8 years away. I believe they are closer than this, but I do not associate myself as yet with the bombs away crowd.

Then there is Russian President Vladimir Putin, who said of the new U.S. moves against Tehran, "Why worsen the situation and bring it to a dead end by threatening sanctions or military action. Running around like a madman with a razor blade, waving it around, is not the best way to resolve the situation." Vlad has always been a most helpful sort, hasn't he?

Iraq / Turkey: From an editorial in the Washington Post on the standoff between these two over the disposition of the PKK, the Kurdish insurgents that keep crossing the border to wreak havoc in Turkey.

"What Turkey really wants is to pressure the United States and Iraq into taking action against the PKK. Diplomats argue that the regional government of Iraqi Kurdistan and the U.S. military are responsible for curbing the Kurdish insurgents and have the means to do so. The first part of that argument is certainly true, and some U.S. officials concede that the Bush administration has probably not put enough pressure on its Iraqi Kurdish allies to move against the PKK. Unfortunately, the second part of the Turkish argument is questionable. It's not clear that Kurdish forces in northern Iraq are strong enough to take on the PKK guerrillas, and U.S. commanders in Baghdad are understandably loath to divert hard-pressed American units from operations against al-Qaeda and Shiite militias to yet another front."

It's so frustrating. The U.S. has had years to get in the Kurds' faces and say, 'Enough. We've helped you attain your autonomy, now behave and we'll continue to protect you. Over time we can all work on the politics of the region.' Instead it's been hands off, just as it was in Lebanon.

And because the White House hasn't been putting any pressure on the Kurds, you get Iraq's president, Jalal Talabani, a Kurd, saying "We will not hand any Kurdish man to Turkey, even a Kurdish cat." But, incredibly, Turkey remains patient outside of a few bombing runs along the border, and Prime Minister Erdogan said he will not launch a full-scale invasion until his visit with President Bush, November 5.

On the issue of Iraq itself, former national security adviser (under Jimmy Carter), Zbigniew Brzezinski, told the Financial Times "There has been an effort to change the subject. It is not so much that Iraq has been replaced by Iran as that the Bush administration has successfully broadened the Iraq debate to include Iran."

Maybe so, but the facts on the ground in Iraq continue to at least speak of an improved security situation. Maj. Gen. Rick Lynch told the AP's Steven Hurst, "I've never been more optimistic than I am right now with the progress we've made in Iraq. The only people who are going to win this counterinsurgency project are the people of Iraq. We've said that all along. And now they're coming forward in masses."

Lt. Col. Val Keaveny said his unit has lost only one soldier in the past four months despite intensified operations against both Shiite and Sunni extremists.

"People are fed up with fear, intimidation and being brutalized. Once they hit that tipping point, they come to realize we truly do provide them better hope for the future. What we're seeing now is the beginning of a snowball."

We pray he's right.

Pakistan: Benazir Bhutto is no saint and far from someone to be admired, despite the glowing press coverage accorded her on what turned out to be a bloody return after eight years in exile.

Of more import these days is the security of Pakistan's nuclear weapons and weapons grade material. For now, President Musharraf has been doing all he can to reassure the U.S. that the safeguards are in place, even as the Taliban and al-Qaeda solidify recent gains.

China: President Hu Jintao unveiled a new leadership lineup at the just concluded national party congress and of the four new faces on the Politburo Standing Committee, two are in their 50s and the frontrunners to succeed Hu in 2012?a Mr. Xi and Mr. Li, if you must know. But in the televised appearance of the new order, it was Xi who walked ahead of Li?which is your first clue as to Hu's on second?

Meanwhile, in the latest census data, 56% of China's population still lives in rural areas, or 737 million. As recently as 1990, this figure was 74%.

But as the research chief at the World Bank noted the other day, China has seen "the most dramatic increase in inequality that I've seen in any data anywhere," said Dr. Ravallion. In a piece for the Sydney Morning Herald, a 57-year-old factory worker told the paper her pay had risen from 46.50 yuan a month to 1300 yuan in 20 years. "But all that extra money was worthless, she said."

" 'When I used to make [dumplings] everyone in the building would smell the fragrance and want to come over,' she said. 'But these days the meat you buy smells and tastes bad.'

"She said modern furniture was junk and she was too scared to go to hospital because it cost too much. 'So we are actually very, very poor.'"

And over on Taiwan, the government denied rumors it was developing nuclear weapons or cruise missiles with nuclear warheads.

Russia: The Bush administration may delay activation of its missile defense shield in Europe until it has "definitive proof" that Iran poses a missile threat in an effort to appease Russia. The bottom line, though, is that the White House has not really gained approval from both the Czech Republic and Poland; the latter where there has been a change in government. Russia insists North Korea poses a fundamental threat, Iran does not, as put forth by Foreign Minister Sergei Lavrov. Then on Friday, Putin said if the U.S. deployed the shield it could precipitate a situation similar to the Cuban missile crisis. I'll reserve further comment for today.

Lebanon: Troops fired on Israeli warplanes invading Lebanon's airspace for the first time since the August 2006 cease-fire, as is their right. No damage was done.

Israel / Syria: As reported by the Washington Post, satellite imagery of the area bombed by Israel last month "shows buildings under construction roughly similar in design to a North Korean reactor capable of producing nuclear material for one bomb a year," according to experts. Syria has since bulldozed any remaining evidence.

India: Not only has the government of Prime Minister Manmohan Singh been unable to gain approval for the joint U.S.-India nuclear cooperation agreement, but now Washington is upset India appears ready to build an oil and gas pipeline in Iran [which would pass thru Pakistan.]

Switzerland: The anti-immigrant Swiss People's Party won a record 28.8% of the vote in parliamentary elections - the largest share any party had won since proportional voting came into being here in 1919. The People's Party claims foreigners, which make up 20% of the 7.5 million in the country, are the source of much of the surge in crime. The party is also against joining the European Union.

Cuba: President Bush blasted the leadership here, saying the administration would not accept a political transition from Fidel to Raul Castro. But the fact is the transition to Raul thus far has been smooth, and U.S. policy, under every president since JFK, has been truly pitiful.

Colombia: At least 21 politicians have been killed during the run-up to Sunday's regional and municipal elections.

Zimbabwe: Inflation here has reached 8,000 percent. Were this the case here in the U.S., next week the Federal Reserve would be hiking the funds rate from 4.75% to 83.50%...thus roiling markets somewhat.

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Pray for the men and women of our armed forces.

God bless America.

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Gold closed at $787
Oil, $91.86

Returns for the week 10/22-10/26

Dow Jones +2.1% [13806]
S&P 500 +2.3% [1535]
S&P MidCap +1.9%
Russell 2000 +2.8%
Nasdaq +2.9% [2804]

Returns for the period 1/1/07-10/26/07

Dow Jones +10.8%
S&P 500 +8.2%
S&P MidCap +11.3%
Russell 2000 +4.3%
Nasdaq +16.1%

Bulls 56.5
Bears 22.9 [Source: Chartcraft / Investors Intelligence?as you can see a big drop in the number of bulls after peaking at 62.0 the week before, following the big swoon.]

Have a great week. I appreciate your support.

Brian Trumbore

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