Betting on the next move: What's next for stocks?

A big rally gave the S&P 500 its best 3rd quarter in 9 years and pushed the Dow near record highs. Can investors keep it going?

What happened? The stock market was supposed to be all bad in the third quarter.

Terribly bad for the bulls. Wonderfully bad for the bears...

The quarter's was anything but bad for Wall Street. The S&P 500 is on track for a gain of 5.2%, which slowing a bit today, is the best third quarter in nine years for the broad index.

The third quarter is usually the worst of the year. And this year it was supposed to be especially bad since 2006 is a mid-term election year, and third quarters in those years tend to be the worst of the worst. Yet 2006 showed to be the best third-quarter in a mid-term election year since 1982, when the market rallied after hitting a bear market bottom in August, according to the Stock Trader's Almanac.
The rally has put the S&P 500 at another 5-1/2-year high and pushed the Dow near its record close set in January 2000, at the end of the 1990s boom. How did all this happen? And what's next for the market?

"A good third quarter in any year is unusual and one in a mid-term election year is even more unusual," said Jeffrey Hirsch, editor of Stock Trader's Almanac. "But there's no historical record of what it means for the fourth quarter."

That's a period that typically starts out weak on Wall Street but often ends up with a year-end "Santa Claus" rally. But will the showing so far this year, do the bulls need a rest?
The market got a boost this week from classic end-of-quarter moves by money managers who wanted to buy up winners before closing their books on the quarter.
When the quarter ends or even after the mid-term elections and all the heavy buying ends, we could still see a pullback. We can note the tendency for stocks to slip in early October, but then rally through the end of the year.

There are many reasons the market has been doing well. The economy's still growing, although more slowly than in recent quarters, and corporate profits remain robust. The economy and earnings have held up even after a two-year rate hiking campaign from the Federal Reserve, which is now apparently on hold. Then there's the steep decline in oil and gas prices that have taken the edge off inflation worries and put more money into the hands of consumers.

On the other side of the ledger, the bull market, at nearly four years old, is ancient compared to other bull runs. Plus the economy is slowing, sharply, though it is still growing. Plus the housing market is eroding.
Yet, stocks are doing well. Year-to-date, the S&P 500 is up 7.3%, the Dow is up 9.4% and the Nasdaq composite is up 2.6%. The strength has surprised investors and even some seasoned market professionals.

Like other market historians, Standard & Poor's chief strategist Sam Stovall thought the third quarter would be a weak one. "My feeling was, here we are in a mid-term election year and we haven't had a 10-plus percent bull market correction," he said.
Both Stovall and Hirsch said the second-quarter decline of 7.7% on the S&P 500 could have been the sell-off for this year, although it would be light compared to other mid-term election year dips.

Now what?

Just like in May, the Dow is currently nearing its record closing high and the S&P 500 is at a 5-1/2 year peak. Still, the Nasdaq remains buried 55% off its high hit in March 2000, when the Internet bubble peaked.
From such lofty heights, could stocks be primed to slump through the rest of the year?

That doesn't seem likely, most analysts said, but there are risks.

Investors seem to be back in a "Goldilocks" market, betting that growth is not too hot, not too cold, but just right. The economy is slowing, but not too much, and commodity prices are coming in, which means more money in consumer pockets going back to retail.

A slower economy would hurt corporate profits, drive up price-to-earnings ratios, which would then make stocks seem less attractively valued. In fact, earnings disappointments are probably the biggest threat as investors move into October and third-quarter reports start rolling in.

The concern is, that profit forecasts are too optimistic if the economy is going to slow to about a 2% growth rate next year from an expected 3.5% in 2006.
On Thursday, second-quarter gross domestic product growth was revised down to a slower-than-expected 2.6% rate. And on Wednesday, a monthly read showed a surprise slip in August durable goods orders.

But the market barely noticed either report, a sign investors are not yet factoring in the impact of a slowing economy on stocks.

Housing Market: What´s going on??

Anyone who reads the newspaper knows that these are interesting times for real estate watchers. Day after day more grim statistics emerge: Housing starts fell 2.5% in July. Giant homebuilder KB Home says its 3rd-quarter orders are down 43%. The National Association of Home Builders reports that its index of builder optimism is at its lowest level in 15 years. What to make, then, of last month's release from the Office of Federal Housing Enterprise Oversight, which shows that nationwide, home prices rose about 10% from spring 2005 to spring 2006?

The slowdown was particularly acute in what's been one of the nation's hottest markets, Arizona. While prices rose 24% for the 12-month period, they climbed just 2.9% in the most recent quarter. If you're finding it hard to make sense of the conflicting signals on the housing market, you're not alone.

Summing up the report, OFHEO director James Lockhart concluded, "These data are a strong indication that the housing market is cooling in a very significant way. Indeed, the deceleration appears in almost every region of the country."

But in an interview with Fortune, OFHEO chief economist Patrick Lawler seemed to take a different tack. "The big theme is that prices are still going up in most of the country," he says. "Housing is different from stocks. We wouldn't expect huge drops." What does it mean for you?

If you want to sell your house, local conditions mean much more than national stats. But there's little point in holding out for the kinds of prices your neighbors were getting last year. In the current environment, chances are that the longer you wait to sell, the less money you'll get. But if you've owned your home more than a year or two, chances are also good you'll end up with a nice profit.

U.K.: slowly going under

UK economic growth was unexpectedly revised down to 0.7% in the three months to June, official figures show.

An overestimation of the impact of the World Cup on the UK's gambling industry partly led to the downwards revision in gross domestic product (GDP).
The Office for National Statistics (ONS) had previously estimated growth of 0.8% for the second quarter.
However, the year-on-year rate of GDP growth remained at 2.6%.
The ONS said the downwards revision in second-quarter growth was also a result of new health service figures, which showed that hospital admissions had been lower than expected.

'Marginal revision'

The downwards revision came as a surprise to economists, many of whom had expected the second-quarter figure to remain unchanged.
The ONS also revised down the GDP deflator, which is a key measure of inflation, to an annual rate of 2.2% from 3.4%.
"The marginal downward revision to quarter-on-quarter growth does not materially change the outlook for interest rates," said Howard Archer, chief UK and European economist at Global Insight.
"However, we believe that growth is likely to lose some momentum over the coming months as consumers continue to face significant headwinds and exports are limited by a slowdown in global growth."
Separately, the ONS said Britain's balance of payments deficit reached £6.986bn in the second quarter, lower than forecasts for a deficit of £8.0bn.

US loses top competitiveness spot

The U.S. has lost its status as the world's most competitive economy, according to the World Economic Forum. The U.S. now ranks only sixth in the body's league table of global competitiveness, behind Switzerland, Finland, Sweden, Denmark and Singapore.

Risks attached to the large U.S. trade and fiscal deficits prompted its fall. The UK has retained its place among the world's 10 most competitive economies but China, Russia and Brazil have all fallen down the rankings.

Imbalances

Countries were judged on how conducive their business climates are to sustaining economic growth.
Publishing its Global Competitiveness Index, the World Economic Forum (WEF) said the best performing countries were distinguished by their competent economic stewardship, investment in higher education and a emphasis on technological development and innovation.
Although the U.S. remained the global engine of technology, WEF said its business environment was being endangered by the fragile state of its public finances.
The U.S. has seen its budget and trade deficits spiral in the past few years as a result of heavy government spending and rising trade imbalances with countries such as China and Japan.
The U.S. trade deficit is expected to top last year's record level of $717 bn ( £378 bn; 565 bn euros) in 2006, while the budget shortfall, although expected to be significantly lower than last year, is still forecast to be close to $300 bn.

U.S. competitiveness is threatened by large macroeconomic imbalances, particularly rising levels of public indebtedness associated with repeated fiscal deficits. Its relative ranking remains vulnerable to a possible disorderly adjustment of such imbalances.

World Economic Forum, Global Competitiveness Index´s report

Swiss peak

Switzerland is now regarded as the world's most competitive economy, with Nordic countries holding three of the five top rankings.
The WEF praised the UK for its flexible labour markets and low unemployment rate compared to the rest of continental Europe. But it said the UK, in common with Germany and Italy, was afflicted by public sector deficits and rising levels of public indebtedness.
China, Russia and Brazil, among the world's fastest growing economies, all suffered a decline in their relative competitiveness.
China fell from 48 to 54 in the ranking, its rapid economic growth and low inflation offset by an over-regulated banking sector and low penetration of mobile and internet technology outside urban areas.
Russia slipped from 53 to 62, with concerns over the independence of the country's legal system and safeguarding of property rights singled out as key concerns, the WEF.

"The private sector in Russia has serious misgivings about the independence of the judiciary and the administration of justice," it said.

OPEC is watching... closely

"OPEC is watching prices closely. They could cut production if the drop continues and falls below $55 a barrel."

Moncef Kaabi, director of research at Ixis Corporate & Investment Bank in Paris.

An OPEC production cut may push crude prices lower... let´s see how could that happen.

Oil bulls have harped on a lack of spare capacity during the run-up in crude over the last three of four years as being the key driver, if OPEC cuts production, there will be, by definition, more spare capacity.'' In London, Brent crude oil for November settlement rose 29 cents, or 0.5 percent, to $60.70 a barrel on the ICE Futures exchange. Rising winter demand may drive crude oil prices higher in the coming months, said Mike Wittner, global head of energy market research at Calyon London. He expects oil futures to reach $70 a barrel by the end of the year.

Demand will rise

What's going on right now is seasonal, between October and the end of the year, global oil product demand is going to go up. As the wolrd grind our way through the next couple of weeks and stabilize with the help of OPEC, there is upside after that. Gasoline for October delivery rose 2.68 cents, or 1.8 percent, to $1.498 a gallon on the Nymex.

The average price for unleaded gasoline at the pump in the U.S. was $2.384 a gallon, 17 percent lower than a month earlier, according to the American Automobile Association, the U.S. largest car club. Oil fell earlier in the day after BP said it plans to resume output at the eastern side of its Prudhoe Bay oil field later this week.

"There is a lot of crude that was purchased to go to the West Coast to fill in for this shortage in Alaska... that crude is available", said Andy Lipow, president of Lipow Oil Associates LLC, a Houston-based consulting firm.

The eastern part of Prudhoe Bay, the biggest oil field in the U.S., has been offline since early August, when a corroded pipeline leaked oil. BP is producing 250,000 barrels of oil a day from the western side of the field. Most of Prudhoe Bay's crude supplies U.S. West Coast refineries. U.S. Energy Secretary Samuel Bodman said on Aug. 8 that BP may be unable to return Prudhoe Bay to its full output for six months.

Open for Discussions

Iran, OPEC's second-biggest oil producer, is open to discuss "everything" with the U.S. regarding its nuclear program if the U.S. stops threatening sanctions, President Mahmoud Ahmadinejad said in a Washington Post interview published yesterday.

Iran believes that "talks are much better than threats and confrontation," Ahmadinejad, pronounced ah-ma-deen-ah-ZHAD, said in the interview. The Islamic republic, which holds the world's second-largest oil reserves, ignored a United Nations deadline in August to stop uranium enrichment. Traders have expressed concern Iran will cut oil exports if it is punished.

Emerging market currencies slump

Emerging market currencies tumbled Friday, weighed by continued geopolitical worries and on concerns that a sharp slowdown in the U.S. will undermine global demand for commodities.

The South African rand tumbled to a more than three-year low versus the U.S. dollar. The Brazilian real dropped to its lowest level in almost three months. Elsewhere, the Turkish lira and the Iceland krona were both sold off sharply.

"Fear of a deeper-than-expected slowdown in the U.S. is having knock-on effects for oil prices and for emerging markets."

Paul Guest, senior economist at Moody's Economy.com.

"The drop in commodities compounds the impact on some of the emerging market currencies like the South African rand, which is associated with growing deficits"

Amarjit Sahota, a currency strategist at HIFX.

In the U.S., the odds of an interest rate cut continued to rise, as a scenario for a hard-landing for the U.S. economy continued to take shape after data showing manufacturing activity in the Philadelphia region contracted in September for the first time in 3 1/2 years.
The fed funds futures market is now pricing in a 26% chance that the Fed will lower its target for overnight rates to 5% from 5.25% this year. The Federal Reserve held overnight interest rates steady at 5.25% on Wednesday and said inflation remains a risk, but added that it expects a slower economy to reduce inflationary pressures.
Adding to the rand's woes Friday is a report that showed the nation's current account deficit remained at elevated levels.
The South African deficit declined just slightly to 101.7 billion rand, or 6.1% of gross domestic product in the second-quarter, from a record 103.1 billion rand, or 6.4% of GDP in the opening three months this year.
Analysts say while the deficit was still fully financed by capital inflows, the growing negative sentiment regarding many emerging market assets will continue to pressure those countries with large current account shortfalls.
"There is clear evidence that the current account deficit has peaked but underlying trends continue to suggest that it will remain around 5.5-6% of GDP until the end of the year," said Rory MacFarquhar, an analyst at Goldman Sachs, in a note. "This continues to weigh on the rand which so far has weakened by about 3% since the release of the data."

Political woes

Compounding the pessimism regarding the U.S. outlook, "emerging market currencies ran into heavy selling as political troubles in Poland added to the recent events in Thailand, Brazil, and Hungary," Moody's Guest said.
The baht tumbled more than 1.3% to a low of 37.9 versus the greenback Tuesday, posting its biggest one-day loss in three years, after news that Thailand's military staged a coup against the nation's prime minister.
The Polish zloty was a touch weaker against the euro Friday after a dispute over government spending caused the collapse of the country's ruling coalition, possibly triggering a new general election.
The rand last traded down 0.3% at 7.6086 per U.S. dollar. The Turkish lira was off 1.2% at 1.5085; The Hungarian forint was off 0.3% at 216.45. The Iceland krona was down 1% at 70.57. The Brazilian real was off 1.7% at 2.2101.
The Thai baht bucked the downward trend, trading at 37.3040 versus the greenback, up 0.4%.

Interest rates steady... another Fed´s "move"

Federal Reserve policymakers left interest rates unchanged Wednesday for a second straight meeting, as a sharp drop in oil prices helped ease inflation concerns.

The central bank left the benchmark overnight lending rate at 5.25 percent, exactly where it has been since June 29, when the Fed halted a two-year stretch of 17 consecutive rate hikes.
The long rate-hike campaign was intended to keep the economy from overheating and sparking a damaging run-up in inflation. But with the economy showing clear signs of slowing, and energy prices plummeting, Fed Chairman Ben Bernanke and his colleagues have gotten some major breathing room in their effort to keep inflation contained.

Traders and analysts looked for some insight into the Fed’s next move by reading the tea leaves of the Fed’s comments on Wednesday’s decision.

The moderation in economic growth appears to be continuing, partly reflecting a cooling of the housing market.

Extract from the Fed’s Open Market Committee' statement.

The group cautioned that some inflation risks remain, noting that readings on core inflation have been elevated, and the high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures.
But it said that inflation pressures seem likely to moderate over time, reflecting reduced impetus from energy prices, contained inflation expectations, and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.

As for future rate changes, the FOMC said the extent and timing of those moves “will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”

No time for generals

Neither the months-long political impasse that preceded it nor Tuesday's so-far bloodless coup have done much to dent Thailand's status as a star economic performer in Southeast Asia. But lasting harm could come if the current situation descends into a political struggle between the country's new military leadership and the former prime minister, billionaire Thaksin Shinawatra.

If democratic rule is not quickly restored, the resulting political instability could crimp domestic consumption, delay needed spending on infrastructure and scare off foreign investors.
On Wednesday, Gen. Sondhi Boonyaratklin, the leader of the Thai army, assured the nation in a televised address: "We don't have any intention to rule the country and will return power to the Thai people as soon as possible." Sondhi said the country would be returned to civilian rule within two weeks.

Tim Condon, Singapore-based head of Asia research with ING, said he expected a sharp decline on the Thai stock market, particularly shares held by the Thaksin family. He also sees weakness in the baht until the political situation stabilizes.

The Thai stock market was ordered closed by the military on Wednesday, though trading is expected to resume on Thursday. After news of the coup spread in New York on Tuesday, two closed-end funds specializing in Thailand fell about 4%, presaging weakness when Bangkok trading resumes.

The baht fell 2% against the dollar, a large decline for what had been a strong currency this year, but not a fall that indicated a total collapse in investor confidence. Given the country has foreign reserves of $59.6 billion, fast-growing exports and improved public finance, there does not seem to be much chance that the economy will suffer the way it did in 1997, when foreign investors suddenly pulled out of Thailand, setting off an economic crisis across Asia.

After rising to 37.95 baht in New York late Tuesday, the dollar stabilized against the Thai currency in London, slipping to 37.70.

Moody's Investors Service, the bond-rating agency, told clients it considered the coup as "primarily a domestic political development, rather than as a financial development." It suggested the political situation could rapidly normalize if the coup clears the way for elections. A vote had been scheduled for November before the military action, but it was unclear if it could be arranged that quickly.
Moody's noted that Thaksin's administration was generally friendly to foreign investors, which might not be the case among the major opposition parties.

A rival rating agency, Standard & Poor's, was less optimistic. Ping Chew, a credit analyst, said the political impasse already has taken a toll on domestic consumption and investment interest in the country, and that a continuing of current impasse would affect the country's investment climate. Standard & Poor's put Thailand's triple-B-plus debt on its Credit Watch list of issues whose ratings might change, with negative implications.

The political paralysis in the past few months has claimed casualties in a projected $7 billion spending on public infrastructure projects, which is critical to Thailand's economic growth in the next few years. Already, the political uncertainty has halted the extension of Bangkok metro line and new highway plans.

More immediately, the automobile industry, which has drawn significant foreign investment, is suffering from plant closures on Wednesday at Nissan Motor and Mazda Motor in what has been declared as a day of "public holiday."

Another casualty will likely be Thailand's plans to become a regional transportation hub. The government had planned to use the Sept. 28 opening of Suvarnabhumi, or Golden Land, airport in Bangkok as a showcase. The airport has been touted as the most modern in Asia, but the plans to draw international traffic will probably have to wait for a while.

India attacks 'flawed' IMF reform

India has attacked changes to the voting structure of the International Monetary Fund (IMF) after it saw its share of the vote decrease.

Its comments came after the 184 IMF nations agreed a deal on Monday to give some emerging economies a bigger vote.
While China, South Korea, Turkey and Mexico all saw their voting quotas rise, India's declined.
India said the reforms were "hopelessly flawed". The IMF has now pledged to overhaul its voting system by 2008.

New formula

Indian Finance Minister Palaniappan Chidambaram said it would "hold the IMF to its promise" of a complete reform of the voting system within two years.

"We may have lost the vote but we have not lost the argument," ,he said.

Under the temporary reforms agreed at the IMF's annual meetings in Singapore on Monday, India saw its voting quota drop slightly to 1.91% from 1.95%.
Mr Chidambaram said the reform formula used to determine Monday's changes - including a country's GDP and market openness - did not accurately reflect the economic might of emerging economies such as India.
India wants the next formula to take into account the need of large developing economies to protect their farmers and young industries from foreign competition

.

Economic growth: What the game's about

OPEC has steadfastly refused to set a formal price target, but is on alert for any signals that oil's slide could be prolonged by fundamental market imbalances or by an economic slowdown.

U.S. industrial output fell last month for the first time since January, providing fresh evidence of a cooling economy.

"We are following (U.S. economic growth) with a lot of attention, because this element is critical for petroleum demand in the next few years,"

Algerian Oil Minister Chakib Khelil

But there is a chance for the prices to stay above $50 in the coming years. No new risks to supply emerged over the weekend.

China urged Iran to be more flexible about its atomic work after a week of European Union talks left officials upbeat that a row between Tehran and the West could be resolved.

Weather concerns were also on the backburner, with the fourth storm of the Atlantic hurricane season - Helene - churning over the open seas but posing no immediate threat to land, U.S. forecasters said.

U.S. recession on the horizon

The U.S. economy may fall into recession in 2008 as "inflation pressure'' drives up borrowing costs next year.

U.S. Federal Reserve policy makers have so far persuaded investors that they will contain inflation, helping keep yields on 10-year notes below 5 percent. U.S. consumer prices will increase more than expected, prompting a bond market selloff.

The view is darker than the predictions published yesterday by the IMF, which also expects a slowdown in the U.S. Inflation will persist because of rising prices in Asia, whose growth will fuel the global expansion next year.

Inflation is not going away at all, it's coming from land
prices in Asia, and hat's feeding into production costs."

The IMF yesterday said that inflation, oil prices and the risk of an abrupt drop in U.S. housing prices the strongest global expansion in three decades. The fund cut its prediction for U.S. growth next year to 2.9 percent from the 3.3 percent it forecast in April. That would be the weakest since 2003.
Morgan Stanley's New York-based chief economist, Stephen Roach, said that while he didn't share such type of view, the "odds of a U.S.-led global recession are rising in the 2007-08 period and cannot be taken lightly.'' David Rosenberg, chief North America economist at Merrill Lynch & Co., forecasts a 45 percent risk of a U.S. recession next year.
U.S. government 10-year bonds are yielding 4.77 percent and consumer prices rose 4.1 percent in July from a year earlier. The average rate on a 30-year fixed mortgage was 6.32 percent last week, close to the lowest since March.

Chinese Growth

Asia may be insulated from a U.S. recession at first, as China's high savings rate could fund continued investment in the world's fourth-largest economy.

If the U.S. stays down for several years then China will also slow down,
because in the end Chinese liquidity is based on exports."

The IMF forecasts the global economy will expand 5.1 percent this year, slowing to 4.9 percent in 2007. Both forecasts are 0.2 percentage points higher than its April estimates. Growth was 4.9 percent last year.
U.S. economic growth slowed to an annualized rate of 2.9 percent in the second quarter, after expanding 5.6 percent in the first quarter. China's economy advanced 11.3 percent in the quarter from a year earlier.

Record clip of metals mergers: chasing fool's gold?

Forget prospecting. By the time the next rich vein of gold is found, the blistering rally in prices might be over. The much quicker road to today's Klondike is to leverage assets and jump someone else's claim.

Evidence of this fast-forward approach to mining is piling up in the number of mergers seen so far this year. Mining companies worldwide have announced 737 deals so far this year, closing in on the record high of 763 unveiled in 2005, according to Dealogic, a merger-tracking research firm. Already, their combined price tags have surpassed last year's by $34 billion.

"The pace is continuing to be quite robust, and there are a number of active deals in the pipeline," said Gordon Bell, managing director and head of the global mining and metals group at RBC Capital Markets. Joining oil and natural gas, metals is the latest commodity sector to undergo a massive consolidation in the wake of steep price increases.

The incentive is simple. Mining companies need reserves, and it's faster to buy them than do the prospecting. And with stock prices for many buyers at all-time highs, they can offer hefty premiums to their targets' share prices. In the last few months, major gold companies including Goldcorp Inc. Barrick Gold Corp. and NovaGold Resources Inc. have all launched deals to buy other gold miners.

Not even a recent sell-off in gold and other metals prices, which has hurt shares in mining companies, has dulled executives' appetite for the next takeover target. Gold futures have dropped by about $120 an ounce since hitting a mid-May high of $717, with over $40 of that lost in the last week. Silver has fallen $3.70 an ounce, or 25%, to $11.20. And copper futures have dropped about 13%. Those declines have dragged down publicly traded mining companies.

The Amex Gold Miners Index has dropped 13% in the last week and over 4% in the past month. Still, the broader Dow Jones U.S. General Mining Index boasts a 17% advance in just the past three months.The recent sell-off underscores how volatile the fortunes of any company involved in the commodity sector can be. Indeed, not all deals get the gold seal from investors.

M&A gold rush

Consider Goldcorp's Aug. 31 offer for Glamis Gold Ltd. of Reno, Nev. Goldcorp offered a 33% premium for Glamis' stock, motivated in large part by a mine that isn't even producing gold yet. Vancouver-based Goldcorp has set its sights on Glamis' developing Penasquito mine in Zacatecas, Mexico. The site should produce 400,000 ounces of gold a year once it starts up in 2009, which would raise the company's annual production to about 3.5 million ounces from about 1.8 million ounces today. "That's the main asset that Glamis has and the reason we're so excited," said Goldcorp Chief Executive Ian Telfer of Penasquito.

With Telfer expecting already lofty gold prices to rise another $200 an ounce in the next two years, those additional gold deposits will come in handy.

Oil bulls are defiant

Oil is under pressure, but both bulls and bears seem skeptical.

First, an oil bear and stock bull.

Don Hays of the respected institutional service Hays Advisory put out this powerfully incisive comment :

"It is very hard for any of us in the Strategy Business to say the word recession, but the yield curve has now been saying that was in the cards for the last few weeks. The Dow Transportation Index is certainly confirming economic weakness."

Side note: Hays is being commendably frank here. Wall Street-oriented services know their clients want to be bullish. Independent investment letters, in contrast, aren't afraid of bad news.

Hayes continued:

"So far, the industrial commodity prices have not confirmed it, but we are seeing [Friday] morning ... the price of oil is just barely penetrating its 55-week moving average at $66.90. Some very talented technicians believe a significant penetration of this moving average price would be the 'breaking point' for the price of oil and would put the downside target at the 200-week moving average which is at $47.35 today. An examination of the massive inventory glut gives similar potential."

However, Hays went on, again with welcome candor:

"The slight break is not yet sufficient to turn the full red light on. It is important to note that energy bulls would consider the pull-back to this important support area as a screaming buy. Each time it has pulled back here for the last three years it has bounced and returned to a very bullish trend of higher highs. With my bearish bias, of course you know how my odds are placed, but my bearish bias hasn't done a lot for me in the last 18 months, so please be forewarned."

Economists have been following two very articulate oil bulls, both of which have been beating the stock market recently according to the Hulbert Financial Digest: Sound Advice and Outstanding Investments.
Sound Advice usually comes across as more moderate. But its editor, Steve Horwitz, has been sounding positively vengeful:

"Talk about not being able to chew gum and walk down the street at the same time. The financial media seem incapable of keeping more than one story alive at any one time, and invariably, wherever that story line might be, the tone verges on lunatic panic. ... The excitement surrounding the drop of oil prices below $70 a barrel had the hosts on CNBC almost too giddy to bloviate. But they fail to ask whether there is any substantial reason for the drop other than the diminishing threat to the Gulf Coast from the season's first noticeable hurricane. We can't wait for them to fall into deep depression when the energy prices again rise above $70."

Horwitz concluded: "We are still betting that inflation is building, that natural resource stocks remain a good hedge against inflation, while defensive sectors such as food and [health care] as well as exposure for foreign equities are also timely, and that the slowdown in the U.S. economy does not preclude further inflation (a.k.a., as Sound Advice notes, 1970s-style "stagflation.")

Outstanding Investment's Justin Litle remains equally convinced of the "secular bull market commodities thesis" with a peak "some 5-10 years from now."

But he is advocating "getting tactical" in the face of "the likelihood, and maybe the inevitability of a drawn-out correction." That means looking at "temporary discounts", such as he currently sees in natural gas and coal, and also at SEC 13-F filings (which show the holdings of maybe money managers).

Watch out for the oil trap

Energy stocks are great long-term investments, but you should buy them very carefully.

Seems like only a couple of weeks ago, everyone was worried that oil was on its way to $100 a barrel. Since then, the oil price has fallen 15 percent to below $66.
It's fairly clear that the cost of energy will rise over the next couple of decades. And top-quality oil & gas stocks figure to be excellent long-term investments. But you have to be careful about when you buy them. Even if the value of oil reserves rises considerably in the years to come, oil prices - and energy stocks - could still go a lot lower in the short run. The greatest success will go to investors who buy slowly and shrewdly.

There are a variety of forces driving oil prices.

The oil market has been tight over the past year or so. Demand has been strong. And there hasn't been a lot of unused capacity that could be tapped. And the problem hasn't been only at the level of crude production. The U.S. doesn't have spare refining capacity. So shortages can occur in refined products even when there's crude oil available. This climate has led to buying by traders and speculators that has bid up the price higher than pure economics would require.
In addition, fears of escalating conflict in the Middle East has added a risk premium - more than $10 a barrel by some counts - to the price of oil. Estimates of the fair price of oil in the absence of all speculative and risk premiums range anywhere from $45 to $65 a barrel.
An outbreak of war or terrorism in the Middle East could send the price right back toward $100 a barrel. On the other hand, a period of stability could allow oil to drift down further from today's level.

Watch the overshoot

It may seem like a no-brainer that if the oil price drops to $55 a barrel, say, you should move all you spare cash into energy stocks. Either those shares will soar during the next crisis or you'll have a great buy price for long-term investment. There's a catch, however. Historically, once a price spike has ended, oil has overshot on the downside.
It's very instructive to look back at the 1970s and 1980s using inflation-adjusted prices.
In 1970, oil was trading at less than $18 a barrel (in today's dollars). In 1980, the price peaked above $89. By 1985, the price had fallen to around $50 a barrel. But that wasn't the end of the decline. Between 1986 and 1999, oil traded for less than $30 a barrel in 12 of those 14 years. And as recently as 1998 and 1999, the price of oil was below $20 a barrel.
I'm not saying that the Middle East will stabilize and the price of oil will plummet to $20. But the range of possible prices is far greater than one might expect. And while the long-term prospects for reserve-rich oil producers is very positive, you could load up on those stocks and watch them lag the market for a year or longer. So accumulate your holdings slowly. As the 1980s show, it can take five to 10 years for a price trend to run its course.
Recent expensive oil has called forth a lot of exploration and we could see a mini-glut of oil production at some point in the next few years. That excess will be absorbed by an oil-thirsty world, but it may take a couple of years beyond that. I'm in favor of having a sizable chunk of money - possibly more than 25 percent - in inflation-hedge investments.

Above all, be prepared to be surprised if the oil price goes down much further than seems possible. If there's a global recession that chokes off energy demand and the oil price drops well below $50 a barrel, you could become a more aggressive buyer.

But until such a recession hits, the slower you buy, the better.

U.S. Growth: inflation should ease

The U.S. economy will likely slow, helping to bring down core inflation, Boston Federal Reserve Bank President Cathy Minehan said Monday.Speaking to the National Association for Business Economics, Minehan said the risks to her forecast have grown on both sides in recent months. "I see growth for the next year or so in the high 2s, approximately full employment, and core inflation subsiding," she said. "Not a bad picture."

Housing is an obvious concern for growth. While she expects the slowdown to be moderate, "recent data on declines in starts and permits, gloomy assessments by builders, the potential for higher mortgage rates, and increased inventories of unsold homes, remind me that this assessment could well be optimistic," she said.

The new types of mortgages could contain "some nasty surprises" for some borrowers and lenders. The economy could slow too much if housing prices actually decline, Minehan said. However, a decline in prices "would be quite an unusual event." And she said moderately rising income and financial wealth will "buoy household spending."

Business investment in structures and equipment should offset some of the headwinds from housing. And global trade is now "marginally supportive of growth," Minehan said.

Another risk is that "inflation will continue to rise or persist at high levels and embed itself in consumer and business plans," she said. She said she's reassured that inflation expectations remain restrained. Much of her speech revolved around the need to raise U.S. savings rates, including reducing the federal deficit and boosting private savings for retirement.

Unit labor costs up at a 16-year high

U.S. workers have been more productive, but have also been paid more than previously believed, figures on Wednesday showed.
Revisions to quarterly nonfarm business productivity data show unit labor costs rose 5% in the past year, matching the fastest pace since 1990, the Labor Department reported.

Higher unit labor costs could fuel inflationary pressures as firms struggle to recover their labor costs, and that could push the Federal Reserve to resume raising interest rates.
Unit labor costs -- the cost of the labor needed to produce one unit of output -- had been subdued in the past few years, but now workers are capturing more of their share of the productivity bonanza.
"We now unquestionably have an issue with wage growth," said Stephen Stanley, chief economist for RBS Greenwich. Higher wages mean consumer spending should hold up, but it raises troubling issues about whether a new inflationary spiral is beginning.
The figures "will keep the Fed in an uncomfortable position regarding the inflation outlook," said Michael Englund, chief economist for Action Economics.
Productivity increased 1.6% annualized in the second quarter, up from 1.1% reported a month ago, the Labor Department said. Unit labor costs increased 4.9% annualized, revised from 4.2% earlier. Real hourly compensation increased 1.6% annualized.
But the big revisions came in the first quarter with the introduction of updated data on compensation. Unit labor costs rose a staggering 9.0% annualized in the first quarter, the most since the third quarter of 2001.
In the past year, productivity of the nonfarm business sector increased 2.5%, compared with an average of 3.2% since the recession ended. Meanwhile, real hourly compensation increased 3.6% in the past year, nearly double the 1.9% average gain since the recession ended in 2001.
Unit labor costs rose 5% in the past year, the most since 1990. A month ago, the government was reporting that unit labor costs had risen 3.2% in the past year.
Economists were expecting productivity to be revised up to 1.5% and unit labor costs to be unrevised at 4.2%, according to a survey conducted by MarketWatch.
Markets took the news hard. The yield on the 10-year note rose to 4.83% from 4.78%. Stocks opened lower.

In a separate report, the Institute for Supply Management said its nonmanufacturing sentiment index rose to 57% from 54.8%, indicating healthy growth in the economy.
The federal funds futures markets showed investors were not persuaded the figures would force the Fed to resume hiking interest rates. The odds of a rate hike by the end of the year rose to 20% from 13% earlier.
One economist said the numbers made no sense.
"The problem we have with all these data is that there is no way that corporate profitability could be as strong as it is if unit labor costs were really growing at a 7% annualized rate in the first half of the year," said Joshua Shapiro, chief economist for MFR. "Profit margins continue to expand and profits as a share of national income are in the stratosphere."
It's better to watch the nonfinancial corporate sector, as the Fed does, Shapiro said.
Unit labor costs in the nonfinancial sector are up just 2.6% in the past year, compared with 5% for the nonfarm sector.
The revisions to the second-quarter data reflect new estimates of output, hours worked and compensation. The revisions to the first quarter mainly reflect better estimates of compensation, which was higher than initially reported.
Productivity, defined as output per hour worked, is perhaps the most important long-term variable in economics. But it also the most difficult to define and to measure.
Higher productivity can mean higher profits, wages and living standards. Productivity gains reduce inflationary pressures. But the concept is difficult to measure, especially in financial services where the concept of a "unit" of output is murky.
Therefore, Fed officials watch nonfinancial productivity most carefully.
Productivity in the nonfinancial corporate sector increased at a 2.2% annual pace in the second quarter, while unit labor costs increased 4.2% annualized. Real hourly compensation in the nonfinancial corporate sector rose 1.4%. Unit profits fell 1.2% in the second quarter.
In the first quarter, revisions show nonfinancial productivity increased a stunning 11.1%, the most since 1971. Unit labor costs increased 1.2% in the nonfinancial sector in the first quarter, compared with 9% in the nonfarm business sector as a whole.
In the past year, productivity in the nonfinancial corporate sector rose 4.8%, unit labor costs rose 2.6% and real hourly compensation increased 3.4%. Unit profits are up 8.4% in the past year, a reflection of the favorable environment for profits.

The U.K. growth story: an unhappy ending?

With sterling trading near levels not seen in 16 months against the dollar, investors are beginning to fret about a foreign-exchange trend they fear may spell an unhappy end to the growth story for U.K. shares.
The U.K. currency briefly touched $1.90 in May and had held around that level for around the last month. Compare that with five years back: sterling hit a low of around $1.3678 against the dollar in June 2001, and has staged a steady recovery since.
If this strengthening trend continues, it could significantly impact revenues at some of Britain's biggest and best-known companies. And it would threaten to undermine the M&A story that's been helping to drive U.K. equities since 2003.
"In the case of the U.K., there is a significantly large proportion of companies in the benchmark FTSE 100 index whose receipts are denominated in dollars -- when (those dollars are) converted back into sterling (for instance to pay costs or dividends), they'll have less sterling receipts to show for it," said Mike Lenhoff, chief equity strategist at London-based stockbrokers Brewin Dolphin Securities.

Robert Parkes, a U.K. equity strategist at HSBC Bank, said that around 25% of sales from U.K. companies are into the U.S, which, when coupled with the high dollar exposure of the commodity sector, brings the total dollar exposure of the FTSE to between 35% and 40%..

Feeling the pinch

Central banks and interest rates have largely been behind the currency moves.
"Interest rates are the dominant driver in the (currency) markets at the moment," said Geoff Kendrick, a senior currency strategist at Australia's Westpac Bank.

"The key in the short term is whether or not the Federal Reserve is really finished (tightening rates) now, or whether they'll need to tighten again," Kendrick says.

The U.S. rate now stands at 5.25%, while in the U.K. it's 4.75%.

The Bank of England surprised investors with a rate hike in early August of a quarter percentage point, which sent sterling spiking upward. The central bank said the pace of economic activity had quickened, with higher energy prices sparking greater inflationary pressures.
If the Bank of England tightens rates again, it raises the possibility sterling could strengthen towards the magic $2 mark. That's when the impact would really kick in, experts say.
"If you're aiming for a target like $2 in cable (as the cross rate is known), you'll probably need the Federal Reserve to stop (raising rates), the market to think about current account balances and the Bank of England to hike again. Then you may start getting close," said Kendrick.
The pound at $2 could undermine the export position of many U.K. companies, which earn revenues in dollars that would be subject to a negative translation effect. And it could knock about 1% off earnings for U.K. companies, said Richard Batty, investment director at Standard Life Investments.
HSBC's Parkes said of all the companies in the U.K. stock market, pharmaceuticals record the most sales in the U.S market at about 44%. Following close behind are aerospace, with 41% sales exposure, and general industrials, with 37% of sales in the U.S.

How much movement's ahead?

However, a move to $2 probably isn't coming anytime soon: the consensus twelve-month view on dollar/sterling is for a level of $1.8734, according to FX Week.
Dresdner Kleinwort heads up that list, forecasting $2 in twelve months, while Westpac expects the dollar to hit $1.97 and HSBC sees it at $1.86. HBOS Treasury Services has the lowest forecast, with a twelve-month view of $1.68.
And even if the cross rate reached $2, the move would have to be sudden and sharp to have a significant detrimental effect, Lenhoff said.
"The trigger would be if the market is convinced that the Fed has stopped tightening, and not only stopped tightening, but that the next move in interest rates would be downward," he said.
If earnings started to fall off, it could be critical for merger and acquisition activity in London. Many companies traded on the London Stock Exchange, and on European exchanges too, have been the subject of intense M&A speculation and deals.

Since May 2005, the FTSE 100 index has increased in value by around 20%, rising from 4,986 points at the close of trade on May 27 last year to 5,959 points on Monday. It's a gain to which "M&A has definitely contributed," said Parkes.
Year-to-date in 2006, a total of 8,231 deals worth $987 million have involved European companies, according to data supplied by Thomson Financial. Separate figures were not supplied for the U.K.
Many of these deals have involved company buyouts by private-equity consortiums, which rely on using high earnings yields to repay debt used to fund acquisitions.
"If the equity market were to weaken because earnings are no longer reckoned to be as forthcoming now that the dollar has weakened... the idea of borrowing in sterling to finance acquisitions and to use earnings to pay off loans and service debt is no longer quite as attractive a proposition as it once was," said Lenhoff.