Equityletter 12/18/06

I. Key Events to Watch In the Week Ahead

The economic calendar in the week ahead contains a few highlights that shall be noted. On Tuesday, Dec.19^th, PPI (Producer Price Index) is due to be reported. The consensus estimate for PPI is for a rise of 0.5%, with the Core PPI to have risen 0.2%. On Thursday, Dec.21^st, we have the third quarter GDP (Gross Domestic Product) report. The consensus estimate is for GDP to have grown at a rate of 2.2%. Finally, on Friday, Dec.22^nd, the Durable Orders report for November is estimated to come in at a gain of +1.2%.

The earnings picture this week will continue to be very minimal. On Monday, Dec.18^th, after the market close, Oracle Corp. (ORCL) will report earnings. On Tuesday, Dec.19^th, we will get reports from Circuit City (CC) and Morgan Stanley (MS). This Wednesday, Dec.20^th, brings earnings reports from Federal Express (FDX), Bed Bath & Beyond (BBBY) and Nike (NKE). The earnings highlights for Thursday, Dec.21^st, will come from Carnival Cruise (CCL), Commercial Metals (CMC), ConAgra (CAG), General Mills (GIS) and Micron Technology (MU).

II. General Market Overview

The major indices (S&P, Russell 2000, Nasdaq Composite) continue to reach multi-year highs. It is our belief that this market strength can be attributed to a few different factors. The first contributor is that fact that the Federal Reserve is in pause mode in regards to their removal of over accommodative interest rates. In fact, the consensus opinion is that the next move by the Federal Reserve will be to lower interest rates. The second factor is what we like to call “performance chasing performance”. Many fund managers (Hedge and Mutual) are underperforming their benchmarks. As this year winds down, these fund managers are frantically chasing strong upside momentum in an attempt to improve their lagging returns. The final factor is the large sums of capital now dedicated to “private equity”. The private equity of today is reminiscent of the “junk bond” era of the early 1980’s. There is a perception in the market place that many companies are now vulnerable to being taken private. This perception has caused many short sellers to cover their positions or at the very least refrain from instituting short positions at all. While we believe that private equity is not going to go away anytime soon, we do believe that the other two factors mentioned above will be in a state of flux shortly. The end to this calendar year will also bring an end to what we consider to “performance chasing“. The recent chain of strong economic reports (Retail Sales, Unemployment) may shift the apparent market opinion that the Federal Reserve will lower rates in the near future. Is it really all about earnings and interest rates?

The financial sector displayed strong upside momentum last week. Three major brokerage firms, Goldman Sachs, Lehman, and Bear Stearns all reported good earnings. Interestingly, only the stock of Bear Stearns rose on the week. The tepid price action in the brokerage group last week (XBD-242.93) is the reflection of the heightened earnings expectations for the sector. While the performance of the group as a whole lagged last week, the overall trend remains to the upside. The real strength in finance came from the money center bank stocks. In particular, Citibank (C-54.07), which has enjoyed an estimated 10% gain in two weeks. Our work has identified Wells Fargo-(WFC-35.65) as a potential laggard in the group.

We remain negative on the Pharmaceutical Group (PPH-77.13) as a whole. Drug behemoths Pfizer (PFE-25.64), Merck (44.00) and Johnson& Johnson (JNJ-66.29) continue to act poorly. Despite this negative view, we continue to like to technical patterns of Abbott Labs (ABT-48.47) and Wyeth (WYE-51.17).

It is beginning to become apparent that the correction in Managed Care companies is coming to an end. Whatever reason one must choose, the Democratic election victories or the stock option back- dating scandal at United Healthcare, the group has underperformed the market. Our weekly technical work is indicating renewed strength in companies such as UNH-50.09, HUM-55.11, and WLP-77.13. Look to buy extreme weakness in these names.

Four weeks ago we upgraded our view on the Semiconductor (SMH-34.26) group from negative to neutral. Last week the SMH index was essentially unchanged for the week, closing at 34.26 +.06. It is our view 33.15 is a key price support level for this index. We mentioned MU-14.47(Micron Technology) as a potential low risk trade. On 12/01/06 we went long MU at 14.38. We decided to exit our MU long position on the close of trading on Monday, Dec.11^th, at a price of 14.22, for a loss of .16 or 1%. The reasoning behind the exit was the fact that a major Wall Street brokerage firm downgraded the stock to a “sell” rating. A “sell” rating is very rare on Wall Street, therefore we decided to jettison the position. We will continue to monitor the sector for potential long positions.

Take note that the VIX-10.05 (CBOE Volatility Index) declined from a reading of 12.05 the previous week. Part of this decline can be attributed to the expiration of December options. Whatever the reason, this fear index is sitting at three year lows and reflects extreme investor complacency.

III. GOLD

GLD (streetTracks gold index) – In our 10-1-06 letter we announced our change of opinion regarding Gold. We said to cover all short positions and look to institute a long position around the $58.00 level using the GLD (gold index fund) as our trading vehicle. On 10-04-06 we went long the GLD on the close of trading at $56.37. We decided to take our profit on the close, Friday, Nov. 3^rd at a price of 62.30, a gain of 10.5%. Last week we mentioned that our technical work was indicating short term weakness in the GLD. The GLD declined from 62.05 to 61.00 or 1.7% for the week. We continue to believe that the 58.00-60.00 price level to be a critical support area for this index. Therefore we will be looking to institute a long position upon a price decline to this area.

IV. Energy

The energy complex (oil, oil service, natural gas, coal) put in a mixed performance for the week. Oil refiners and Oil Service stocks enjoyed a small advance while Natural Gas and Coal stocks displayed relative weakness. It appears that the stock market has already priced in the proposed production cuts that were announced last week by OPEC. Although our weekly technical work continues to remain positive, we are still of the view that the energy complex is in a short term overbought stage. Therefore, it would be our recommendation that long positions tighten up sell-stops to protect profits. We will continue to wait for an optimal entry point for initiating new long positions.

V. Dow 30 Analysis

Our Weekly Trend Indicator (WTI) measures in at +14, a strong increase from the previous week reading of +2. The bullish upside momentum resumed during this past weeks option expiration. Our weekly support level for the DIA-124.15 (Dow Industrial Diamonds) has been raised to 122.05. A weekly close below 122.05 will raise warning flags for the DIA. The five strongest stocks in the Dow 30 are the following; AIG, AXP, BA, DIS, and IBM. The five weakest stocks in the Dow-30 are as follows, CAT, GM, JNJ, PFE, and WMT.

Dow 30 stocks with positive weekly signals:

AA, AIG, AXP, BA, C, DD, DIS, GE, HD, HON, HPQ, IBM, INTC, JPM, KO, MCD, MO, MSFT, PG, T, VZ, and XOM

Dow 30 stocks with negative weekly signals: CAT, GM, JNJ, MMM, MRK, PFE, UTX, WMT

* Underline names have changed from previous week*

VI. OPEN POSITIONS

NO OPEN POSITIONS

* The following information has been provided for informational purposes only and should not be used or construed as an offer to sell, a solicitation, or an offer to buy, or a recommendation for any security. EquityLetter does not guarantee that the information supplied is accurate, complete, or timely, or make any warranties with regard to the results obtained from its use.