Week In Review

Anxiety around the Fed and bad April same-store sales created a mixed market this week, with mainly the Dow moving higher:

Dow ……………. 13,326 +0.5%
Nasdaq …………. 2,562 -0.4%
Nasdaq 100 ……… 1,899 +0.2%
S&P; 500 ………… 1,506 0.0%
S&P; Midcap 400 ….. 894 +0.2%
S&P; Smallcap 600 … 431 -0.2%

MONDAY gave the floor to a host of voices claiming that the market was overbought and due for a pullback. As those voices rose higher, falling oil prices and new merger activity provided a counter argument.

Dow component Alcoa (AA) gained more than 8% when it announced a hostile bid to take over Alcan (AL) for $33 billion.

Another shopping announcement further spurred enthusiasm. Warren Buffett said last weekend at Berkshire Hathaway’s annual shareholder meeting in Omaha that the company is open to making a huge acquisition, valued somewhere between $40 and $60 billion. So far, he hasn’t contacted me here at The Kelly Letter, but I’m waiting by the phone just in case.

Mr. Buffett said on CNBC that it’s “hard to find big deals. We’re competing against private equity and other corporations.” He said he had “no idea” how the stock market would move in the short term. “I don’t look at the stock market at all as ridiculously priced. If you told me I had to buy a 20-year bond or make a 20-year investment in the stock market, I’d rather buy the stock market. It’s not cheap, but it’s not ridiculous.”

He said that he’s diversified his holdings to include companies that earn money in currencies other than the dollar. He predicted that the federal government’s “current account deficits” will cheapen the dollar and cause political trouble in the future.

He said that Berkshire Hathaway is looking for chief investment officers to replace him. He said there will be a number of candidates that he will test. “I’ll see how they play out over time — give them a block of money to run for a few years and look at who might scale up the best. That’s the real problem. Many can run $1 billion or $2 billion well, but they have to be able to run $100 billion well. It could end up that we end up with two or three for the job.”

The price of oil fell for the sixth session in a row, making it the longest losing streak since September. It dropped 0.7% to $61.47.

Kelly Letter holding Boston Scientific (BSX) gained 3.2% when Conor Medsystems, a stent maker recently acquired by Johnson & Johnson (JNJ), said its CoStar drug-coated stent failed in a clinical trial against Boston Scientific’s Taxus Express drug-coated stent. Conor said it would stop ongoing clinical trials and stop applying for FDA marketing approval. Further, J&J; will pull it from shelves in Asia, Europe, and Latin America where it’s already approved.

While good for Boston Scientific, the CoStar failure is by no means the end of the stent battle in the U.S. J&J; still has its Cypher stent that competes well with the Taxus, and Abbot Labs, Medtronic, and others are preparing to enter the market.

Also, we learned this week that Boston Scientific Chairman Peter Nicholas sold 365,100 shares at about $16.20 on May 4 and 7 for a total of $5.9 million. Director John Abele sold 67,100 shares at $16.19 on the same days for $1.1 million. While insider sales are not as strongly negative as insider buys are positive, these two are worth noting. With shares down some 46% in the past two years, a rush by insiders to buy value would be a welcome sight.

Kelly Letter Permanent Portfolios: Dow One -2.5%…Double The Dow +0.6%…Maximum Midcap 0.0%

The Dow gained 0.4% but the Nasdaq lost 0.1%. The advance/decline ratio came in at 52/43 on the NYSE and 45/51 on the Nasdaq. The NYSE high/low ratio was 300/15 and the Nasdaq’s was 167/51.

TUESDAY was flat ahead of Wednesday’s FOMC meeting, a common situation. Talk of an overbought market left many anticipating the Fed’s meeting as the catalyst that would finally send prices spiraling lower.

The price of oil finally rose after six days of falling. It closed at $62.26 per barrel, a gain of 1.3%. The supposed reason was that the Energy Information Administration (EIA) raised its demand forecasts for Q2 and Q3.

Kelly Letter Permanent Portfolios: Dow One -0.5%…Double The Dow +0.1%…Maximum Midcap +0.1%

Both the Dow and the Nasdaq ended flat. The advance/decline ratio came in at 39/56 on both the NYSE and the Nasdaq. The NYSE high/low ratio was 163/25 and the Nasdaq’s was 144/64.

WEDNESDAY was Fed day, and the market liked what it saw, pushing the Dow to another record high.

The FOMC left interest rates unchanged at 5.25% for the seventh time in a row, as expected. The attached statement was essentially the same, too, suggesting that rates will stay at this level for a while. The Fed noted that “economic growth slowed” at the beginning of the year, as opposed to its March 21 statement that “recent indicators have been mixed.”

Elsewhere, a rumor that BHP Billiton (BHP) would buy Rio Tinto (RTP) for $100 billion got the materials sector excited. Later, Rio Tinto denied the rumor.

Cisco (CSCO) beat earnings expectations the night before, but it didn’t raise Q4 forecasts enough to bring in the buyers. In fact, it sold off by 6.5%. However, IBM (IBM) received an upgrade to Buy from Goldman Sachs, balancing things out in the tech sector.

Oil resumed its downward path of late, this time falling 1.1% to a seven-week low of $61.55.

Kelly Letter Permanent Portfolios: Dow One -0.3%…Double The Dow +0.8%…Maximum Midcap +1.3%

The Dow gained 0.4% and the Nasdaq 0.2%. The advance/decline ratio was 60/35 on the NYSE and 52/43 on the Nasdaq. The NYSE high/low ratio was 278/18 and the Nasdaq’s was 172/54.

THURSDAY finally gave the bears what they’ve been looking for. With earnings season over, and a clear victory for the bulls, bears turned to economic data to find reasons that stocks are ripe for a downturn.

They found some.

April same-store sales figures, also called comps, were expected to be weak due to an early Easter, high gas prices, and bad weather. What even the most growling bear didn’t expect, however, was that it would be the worst April ever reported. According to the UBS International Council of Shopping Centers, April sales fell 2.3%.

Then it came to light that last month’s import prices rose 1.3%, more than expected, and another way to worry about inflation.

Finally, the trade deficit was worse than forecasted.

The market fell across the board, and pundits hiding after months of premature calls for the market to plunge emerged to declare themselves brilliant. And they were — for a day.

Our former watch list component, Cryptologic (CRYP), which we’d hoped to buy at $20 but watched rise beyond $30 before we had a chance to buy, reported that its Q1 sales were down on declining casino and poker business. That sent its stock down 15%, confirming our conclusion that it had risen too far to be worth buying. By the end of the week, Cryptologic would close at $23.28, a full 25.4% lower than its high of $31.20 made just two weeks prior.

Such a victory is not as psychologically sweet as buying something low and selling it high, but it is just as significant mathematically. Avoiding buying high and selling low, or waiting to buy as low as possible, is vital to investment success. We’re pretty good at it around here, and recent trends in our watch list have confirmed that. While I haven’t officially re-added Cryptologic to the compact watch list maint
ained in the letter each week, it’s on my extended list where I’m keeping it flagged for potential bargain hunting in the medium term.

The Kelly Letter’s scrappy little semiconductor maker Advanced Micro Devices (AMD) announced that it will cut jobs. One analyst quipped that such a restructuring might lift earnings, and the mood around AMD shares lifted, along with the price, up 4.5%. Our thesis of buying in the darkness at the end of Intel’s power play appears to be intact. The release of Barcelona is less than two months away. AMD’s restructuring activity along with the release of its impressive new processor should keep the shares climbing slowly higher for us.

Kelly Letter Permanent Portfolios: Dow One +4.4%…Double The Dow +0.3%…Maximum Midcap +0.5%

The Dow lost 1.1% and the Nasdaq 1.7%. The advance/decline ratio came in at 22/75 on the NYSE and 21/76 on the Nasdaq. The NYSE high/low ratio was 145/34 and the Nasdaq’s was 118/87.

FRIDAY saw the end of the bear party, if a one-day decline can be called a party. So far, my forecast of a rising market in the short term to be followed by lower prices in the medium term is playing out.

The pundit-fueled, soundbite-obsessed media is a constant source of fickle entertainment. On Wednesday, it told us that the market’s recent rise left it clearly overbought and ripe for a sell-off. After a one-day, one-percent downturn, it reported that Friday’s rise was due to the market having become oversold on Thursday. If all it took was a 1% sell-off to correct the supposed excess of the relentless rise of the past two months that took the Dow to record levels, how could it have been so “overbought” on Wednesday? The terms have lost all practical meaning.

The Labor Dept. reported that producer prices let up in April. The core rate went unchanged again, putting the year-over-year trend at 1.5%. That gave inflation worrywarts less to fret over, and even brought out the eternally hopeful whisper that an interest rate cut might happen sooner than everybody thinks.

This also re-cast Thursday’s soft same-store sales figures in a positive light. Now, instead of being bad for the economy, they are good for moderating inflation. With a strong earnings season behind it, and economic data looking more upbeat than frightening, the market rose.

Kelly Letter Applied Materials was upgraded by UBS from Neutral to Buy with a price target of $25.20. The firm thinks Applied will be the primary beneficiary of increased capital spending by Rexchip, a joint venture of Elpida (ELPDF) and Powerchip (PWSMF). UBS estimated that Applied’s shipments to Rexchip will total about $640 million in 2007, making it Applied’s second largest customer behind Samsung.

About Applied’s nascent solar-equipment business, UBS wrote that the company is “likely to succeed” and that the market should grow 20% to 30%, making a p/e multiple expansion probable. “While 2007 is only Applied Materials’ first year in solar equipment, our channel checks have found that Applied Materials is tracking well ahead of its targeted goal of having $200 million in solar equipment contracts and is likely to achieve closer to $350 million in only its first year. Our discussions with industry contacts suggest that the solar opportunity in calendar 2008 is likely to be $500 million.”

Kelly Letter Permanent Portfolios: Dow One +1.6%…Double The Dow +1.8%…Maximum Midcap +1.7%

The Dow gained 0.8% and Nasdaq 1.1%. The advance/decline ratio came in at 74/22 on the NYSE and 67/29 on the Nasdaq. The NYSE high/low ratio was 144/27 and the Nasdaq’s was 125/86.

Here’s Econoday’s recap of the week:

With the markets focusing on April’s dip in retail sales and the flat core PPI, the economy is probably a little stronger than markets believed at week end and inflation is probably still more of a problem than believed by many — the Fed notwithstanding. Nonetheless, the data still fit the soft landing scenario for now.

In this week’s Kelly Letter, I consider what’s in store for gasoline over the summer, and continue last week’s real estate discussion with a look at acquiring property for immediate income.

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