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Mid-Week Analysis

Mortgage Refinancing Applications
Mortgage Purchasing Index
California Electricity Prices

Trading centered on expectations on what the Federal Reserve will do and say next week. Credit markets were shocked Tuesday when a Market News report stated that the Fed might only be looking at a quarter-point cut. For the week the 10-year Treasury picked up 13 basis points to yield 5.303%, while the 5-year added 14 basis point yielding 4.946%.

The equity markets have traded higher this week as the S&P500 has added 1.6% and the NASDAQ Composite added 3.2%. Big cap tech stocks under-performed the smaller tech companies as the Morgan Stanley High Tech index was up 1.2%, this also diminished the return of the NASDAQ100, relative to the Composite, it increased 2.7%. After having a horrible Friday, retailers were recommended by Goldman Monday morning. The S&P retail index never looked back, adding 6% in three days. While, the 6% gain for retailers is impressive, TheStreet.com index added 11% and the biotechs increased a stellar 12% on the back of Amgen's recent court victory. The Morgan Stanley Cyclical index posted a 2% gain so far this week, while the Consumer index was the only loser for the week falling 0.3%. The Dow continued its range bound trading, only adding 0.6% and small cap Russell 2000 add almost 3%.

As alluded to above, the real news for the week happens tomorrow, when Greenspan testifies before the Senate Budget Committee. Fed watchers are hoping to get a glimpse of what will be decided at next week's much-anticipated two-day Fed meeting, which starts Tuesday.

The California power crisis is starting to cause concern in other parts of the country. The California crisis has dramatically increased the wholesale price of power. So any other power company that needs to buy additional power has to face this higher cost. That is because utilities have to tap into the wholesale market if maintenance and other improvements takes longer than expected and the utility is left without sufficient ability to generate enough power itself. Market News International discussed the situation regarding Seattle City Light and Nebraska Public Power District (NPPD) having to access the wholesale market. Seattle City Light is facing abnormally low water levels which are limiting the amount of power that its hydroelectric plants can produce. Moody's has cut the credit rating outlook to negative. The situation in Nebraska is less troublesome, but more likely to play out in other areas. NPPD was required to tap the wholesale power market after an environmental improvement project resulted in a longer than expected outage and reduced output. If more utilities run into problems during scheduled maintenance, more and more customers could face even greater increases.

Looks like yesterday was the day for a trial balloon. Investors woke up to reports that New York Fed President McDonough had reassured that "the financial system is the US is very solid and well capitalized" in news conference at the European Union headquarters. McDonough added, "I don't envisage any problems with it." Investors were then tested on the possibility of the Federal Reserve easing by only 25 basis points instead of the 50 bp that is widely assumed to be factored into the market currently. This idea was given credence as Redbook Research released its same-store sales estimates earlier that morning. For the week ending January 20, same-store sales rose 2.4% over December and 3.4% over the year ago period. This was marginally below last week's increase of 2.6%.

There seems to be growing concern that the U.S. economy is in fact not falling off a cliff as thought just a few short weeks ago. For those that insist the economy is heading for an immediate recession, or in one now, the Conference Boards index of leading indicators provides enough evidence to keep those forecasts alive. However, it should be noted that the index of leading indicators is weighted to depict what is happening in the manufacturing sector. And that is the source of the debate and confusion. Anirvan Banerji, director of research at the Economic Cycle Research Institute, portrayed the current economy as: "a two-speed economy, the manufacturing sector leading index looks even weaker than in the 1990-1991 business cycle recession, while the service sector is no weaker than in the 1995 growth recession or in 1998, which wasn't even a growth recession."

Even the pundits that are discussing the slowing economy are making a point to mention the weak manufacturing sector. This view was articulated by Gail Fosler, chief economist of the U.S. Conference Board, in yesterday's Financial Times Deutschland. Fosler expects U.S. GDP to grow 3.7% in 2001 as the economy heads into a hard landing in 2002 where GDP will only grow by 1.6%. Fosler argues that the while there is no doubt that the manufacturing sector is slowing down it only accounts for about a third of GDP. She contends, which we whole heartily agree with, that it is the consumer sector that has been driving the economy forward and still remains very healthy and "it is possible that growth has already accelerated to 3%."

Auto manufactures are seeing more demand in January then they initially forecasted. In fact, DaimlerChrysler has decided not to idle its Jeep Cherokee and minivan plants.

In its monthly report the Bank of Japan expressed concern as economic data continues to show a mixed picture. While corporate profits are rising and income levels of households have stabilized, industrial production, private consumption and net exports are all showing decelerating trends. The Bank is looking for the new government imposed stimulus package combined with an easy monetary stance to jump-start business to increase fixed investment outlays. The BOJ also expressed concern regarding the slowing U.S. economy, "Japan's economy continues to recover gradually, but the pace is slowing due to decelerating export growth." Since Japanese exports to the U.S. account for a large portion of their GDP, any prolonged slowdown in the U.S. economy would certainly ruin any plans for Japan crawling out of its now decade long economic slump.

Also out of Japan this week was data on Japanese bankruptcies. Teikoku Databank reported that total bankruptcies increased 23.4% to 19,071. However, the total amount of liabilities surged 77% to 23.99 trillion yen, eclipsing the previous record by 66%. The surge in liabilities was due to the dramatic increase in large-scale bankruptcies like retailers Nagasakiya and Sogo, and financial firms such as Nichiboshin and Life Co. Teikoku Databank's assessment of the future is not as rosy as the BOJ's. In The Japan Times article that discussed the bankruptcies, Teikoku forecasted:

"Looking ahead, consumer spending is slack and intensified deflationary trends are observed with slow demand and sharp price falls amid cutthroat competition. Reflecting these trends, the number of companies on the verge of collapse is on the rise as an increasing number of companies are faced with a sharp fall in sales and difficulties repaying their debt. The number of corporate failures is likely to increase further toward the end-of-fiscal year month of March."

In a sharp contrast to Japan, here in the U.S. corporations and consumers continue to borrow heavily. The LA Times reported that there has been $10.5 billion worth of high yield bonds issued so for this month. This was more than double the $4.16 billion issued in the whole fourth quarter of 2000. And there is another $2.4 billion already in the pipe. Global Crossing accounted for one of the ten billion and didn't even need it. Its CFO was quoted by Bloomberg, "We had no real need to raise money, but the market kept getting stronger and the rates kept coming down. It got to the point where it was compelling because it was so cheap."

Instead of excerpting the New York Times story "Equity Shrivels as Home Owners Borrow and Buy" that ran last Friday, I suggest reading it in its entirety to get an idea on the amount of leverage U.S. consumers are piling on. The story was included in our Bear in Mind section, so many of you have probably already read it.

The National Association of Realtors is expecting Greenspan to continue to work magic. On the heels of the recent rate cut and in anticipation of future rate cuts, the NAR has raised its forecast for the housing market. The number of existing-home sales for 2001 are forecasted to reach 5.14 million units, up from December's forecast of 4.94 million. Likewise forecast for new home sales and housing starts have recently been increased as well, from 861,000 to 894,000 and form 1.53 million to 1.62 million respectively. NAR's chief economist Dr. David Lereah admits, "the crystal ball is a little hazy this year." But, believes the housing market can lead the economy to a soft landing, "these strong housing numbers should help sustain related industries as people purchase a variety of goods and services that typically are needed when moving into a home." There is also the mentality that housing prices will be going up forever. A recent California homebuyer justified his purchase in a USAToday story, "We were afraid we'd get knocked out of the market by rising home prices. We either had to do it now or maybe never do it."

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