Monday Markets

Happy Monday everybody!

Asia did NOT melt down, the Shanghai stock exchange fell 3% at the open but made a spectacular recovery to end the day up 1%, setting yet another new record.  The macro picture in  China is that the rapidly expanding middle class (we used to have one of those) is faced with the choice of bank interest rates that do not keep up with inflation or a market that looks like this.

China is a nation of savers and the people have $2.5 Trillion dollars, 88% of their GDP in cash and bank deposits.  8.6M new equity accounts were opening in the first quarter of this year compared with 5.4M opened in all of 2006, when the market rose from 1,150 to 2,674.  With the market now standing around 4,100 it’s no wonder the Chinese are making a bull run to the brokers.  While we may feel they must be heading into some kind of bursting bubble, the fact is that earnings on the Shanghai Composite Index grew 44% in 2006 and year-over-year growth MORE THAN DOUBLED in Q1 ’07 while the overall economy grew 11% (that’s 4 years of US growth).

Even Hong Kong tycoon Li Ka-shing, one of the richest people in Asia, expressed concerns this week over the stock gains, saying he is worried about high price-to-earnings ratios that have created a "bubble." What is troubling is that most of these investors are new to trading stocks, yet they are going after lower-quality shares without considering the downside risk. "In the case of a severe correction, this could lead to social instability," warned Credit Suisse economist Dong Tao, in a report to the investment firm’s clients this week.

Over 560 trading days, from early 1998 to April 2000, the Nasdaq rose 212 percent and crossed 5,000 before plunging to half of that today.  The Shanghai Composite Index has seen almost identical gains since the start of 2005 over the same number of trading days. Maybe that is just pure coincidence, but it sure looks like a red flag but, then again, you know how bulls react to red flags!

Japan’s Nikkei never faltered today as it rose 157 points as exporters (including our SNE and TM!) as the "carry trade" marches on thanks to the BOJ’s continued loose money policies which dropped the yen to new lows as China tries to pull back the reigns on their markets by tightening lending requirements over there.  China is putting $3Bn to work with the Blackstone group, an interesting way to buy US companies without actually buying them directly.  China’s foreign exchage reserves have now climbed to $1.2 Trillion, up $200Bn from October when everyone freaked out that they had $1 Trillion.  Putting it simlply, this country is kicking our assets!

As China seeks to more actively manage its burgeoning reserves, the U.S. is still likely to be the destination for most of its investment. But instead of steering the vast majority to the U.S. Treasurys market, Beijing is likely to seek higher-returning vehicles that promise profit rather than safety.  Blackstone, which announced its IPO plans in April, is expected to expand its stock-market offer, scheduled for June, to $7 billion from around $4 billion to accommodate the Chinese.

Europe is having a pretty good day ahead of our open spurred on by Unicredit’s $29.7Bn deal to buy Capitalia (great name!), suddenly creating the World’s 5th largest bank.  Unlike the US markets, other banks traded down on this news as investors worried about the sudden creation of an 800-pound gorilla so the EU numbers are muted today.  Lloyds is selling something for $1Bn and Norsk is selling something for $1Bn but these "little deals" hardly seem worth mentioning anymore in this Mega Merger environment.

What is worth mentioning is the $27.5Bn deal for AT, who are being snapped up by GS and TPG Capital.  This should be great for our T shares as we have June $40s and Jan ’09 $40s with a pretty perfect entry at the end of April!  That’s another $27Bn of stock that you can’t have anymore and this little merry-go-round isn’t likely to stop until we get a $100Bn takeout or two.  While Alltel (a favorite of ours last fall) may have seemed a little toppy at $65, the 10% jump in this stock give the bears yet another reason to hibernate as no stock seems safe from the rampaging private equity firms.  In another deal hardly worth mentioning, HOLX is spending $6.2Bn to buy CYTC at a 50% premium to create another health care giant.  Did CYTC look toppy to you up 50% from October?  Well ha ha ha ha, you silly old bear…  Go on – short something – I dare you!

With that challenge in mind, lets see how our markets are looking today:

Congrats to the Dow for being our first US index to break out but it’s crunch time for the SOX as they are pooping the whole party this month.  Transports will have a tough time with oil up at $70 in Europe and over $65 here as well so we need to watch those levels closely.  A continued rally in the energy sector may be more than our markets can take but, then again, what are you going to short?  Way too scary, which is why we took a lot of cash off the table but it sure would be painful to sit on the sidelines during another breakout.  It’s all about the S&P though with that all-time high just 7 points away.

Happy Trading sees bullish signals on the Nasdaq as well, which is critical for a continued rally but we’re going nowhere without our SOX and 490 is the line in the sand for the week there.  We are in agreement that the OIH looks toppy at $170 but it was TOT’s turn to have a visit from Nigerian rebels according to Criminal Narrators Boosting Crude this morning. but I see no confirmation of this actually happening.

We’re all going to be kicking ourselves today for day trading ELN on Friday when it now turns out we should have stuck with them as the company announces great progress on an Alzheimer’s drug.  This is one great little company and I won’t be so foolish as to miss out on the next dip!

The dollar is critical at 82.50 and gold is critical at $660 the other way but a drout in Australia is hurting mining production and should lend some general support to metals.  We’ve been adding to our miner positions on the dips but let’s keep in mind our rule to reduce on the way up, especially if the dollar shows continued strength.  I certainly wouldn’t want to head into the holiday auction short on gold!

Our economics calendar is very light this week with nothing until Durable Goods on Thursday (should be BTE) and Home Sales (how could they get worse?) on Friday.  The G8 meeting went without much event (as usual) but the Fed is out of their "quiet period" after a meeting so expect to hear from the Governors and Uncle Ben this week.

A week of consolidation into the holidays would be a very good thing, let’s see if we get it!