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Mid-Week Analysis

Total Auto Sales
Treasury Bill Future
Construction Spending
NAPM Index - Prices Paid

In the first such move since the panic days of the 1998 financial crisis, the Federal Reserve today lowered interest rates between meetings. It was a dramatic 50 basis point move, sending a strong signal to the begging marketplace that the Fed is ready and willing to take strong action to sustain the faltering boom. Interestingly, this aggressive rate cut comes just one day after financial markets traded in an extraordinary manner uncomfortably reminiscent of 1998. Throughout the Treasury, agency and mortgage-backed marketplace, yesterday was a virtual buyers' panic. Two-year Treasury yields sank an eye-opening 23 basis points to 4.93%, while 10-year Treasury yields jumped 19 basis points. The implied yield on the agency futures contract also collapsed 23 basis points, with mortgage-back yields generally dropping about 22 basis points. It looked like derivative trades run-amok. Ominously, NASDAQ was in severe decline and many key financial stocks were coming under heavy selling pressure as well. In both the stock and credit markets, it certainly had the appearance of an unfolding market dislocation - a 1998-style "seizing" of the markets caused by "deleveraging" and derivative problems.

Today's Fed announcement created an abrupt market response, inciting panic buying throughout the stock market. The NASDAQ100 ended the day with a stunning 19% advance, while the NASDAQ Telecommunications index surged 18% and the AMEX Broker/Dealer index rose 13%. The Street.com Internet index gained 20% today, while the Semiconductors added 18%, and the Morgan Stanley High Tech index jumped 17%. The NASDAQ Composite gained a record 325 points, besting the 274 points gained on the 5th of last month. The 14.17% gain surpasses the 10.48% record gain set on December 5th as well. It was a record day of volume on NASDAQ with more than 3.1 billion shares traded. This surpassed the previous record established on April 4th, 2000, by 240 million. All of the top ten volume days have been within that past nine months.

For the week, the Dow, S&P500, Transports, and the Morgan Stanley Cyclical index, have all gained 2%. The Morgan Stanley Consumer index has declined 3% and the Utilities 8%. The NASDAQ100 has gained 8%, the Morgan Stanley High Tech index 10%, and the Semiconductors 16%. The Street.com Internet Index and the NASDAQ Telecommunications index have gained 9%. The Biotechs, small cap Russell 2000, and S&P400 Mid-Cap indices are largely unchanged. The AMEX Securities Broker/Dealer index has gained 9% and the S&P Bank index 3%. The dollar rallied strongly on the Fed announcement, gaining better than 2% against the euro.

Panic buying in the stock market was the mirror image of the heated selling in key sectors of the credit market. For the day, the benchmark 10-year Treasury yields jumped 25 basis points and 5-year yields surged 22 basis points. Agency yields jumped 17 basis points and mortgage-backs 15 basis points. In short, dislocated conditions prevail throughout the credit market, with such an environment quite a challenge for the leveraged player and derivative players. We are left to ponder if some type of derivative problem and/or hedge fund troubles was a factor in the Fed's surprise decision. Clearly, all is not well in the U.S. financial system.

Things are not well in Corporate America either. The Bloomberg headline read "GM, Ford Dec. Auto Sales Fall 15% on Weather, Economy." For U.S. manufacturers, December auto sales reports make for some bleak reading. Ford's American-built sales dropped 15%, with auto sales declining 24% and truck sales 7%. It was, however, a record year with sales increasing 1%. At General Motors, December total vehicle sales dropped 18%, with car sales down 15% and truck sales declining 20%. For the year, total vehicle sales at GM declined 1%, with car sales declining 1% and truck sales flat. Chrysler division December sales dropped 15%, with year-2000 sales down 4%. DaimlerChrysler announced that it would idle five plants next week in an effort to trim oversized inventories.

Interestingly, industry sales for December are being called down about 8%, as foreign manufacturers continue to benefit from strong sales. At Toyota, December sales were up 14% from last year. For the year, Toyota sales jumped almost 10%, to a record 1.62 million units. The Camry was the best-selling car in the U.S. for the fourth year in a row. December Camry sales were 23% above year ago levels, and the luxury Lexus unit saw sales jump 31%. Honda's December sales were 3% above last year, with year-2000 sales up 8%. Volkswagen December sales were 12% above 1999, and full year sales increased almost 13%. BMW enjoyed a record December, with sales jumping 40%. It was also a record year at BMW with sales surging 22%. SAAB also had a record December, with sales 29% above year ago levels. Audi December sales were 15% above last year and up 22% for the full year. Nissan's year-2000 sales increased 11% from last year, with truck sales jumping 21%. Mazda sales jumped 16% for the year. Sales at Ford's Jaguar and Volvo divisions both set new records, with Jaguar sales jumping 25% during 2000. Mercedes-Benz's established a new U.S. sales record, up 9% from last year. December sales, 6% above 1999, were also a new record. Kia also enjoyed a record year-2000, with sales increasing 19%. It was a record year as well for Mitsubishi, with sales jumping 20%.

We have over the past months highlighted auto sales on an almost monthly basis for the reason that we see them basically as a "microcosm" of the unfolding problems for the entire U.S. economy. Importantly, foreign manufacturers are "kicking our butts." Wall Street and the media can present the weak showing of the U.S. manufactures, as indicative of a very weak consumer sector, but this is a distortion of reality. If consumer spending was so weak and the negative NASDAQ wealth effect so powerful, would BMW and Lexus sales be at record levels?

Much was made of yesterday's sharp decline in the National Association of Purchasing Manager's Index. And while the media focus was on the "NAPM Drops to Lowest in 9 Years," there was little mention that the prices paid component jumped to 61 from 56.6. The prices paid component was 32.2 in December 1998 and has remained very stubborn despite the sharp downturn in new orders and production. We believe this is indicative of strong underlying inflationary pressures that will only gain additional momentum from lower interest rates.

Interestingly, November construction spending data was released today. Year-over-year, total construction spending was 5% above a very strong November of 1999 and 11% above November of 1998. Nonresidential spending ran 11% above last year, with spending on industrial structures rising 44%, office buildings 15% and hospitals 11%. Residential spending was 3% below very strong levels from last year. There are currently few indications of any significant downturn in the construction sector, with lower interest rates certainly a continuing benefit for this key sector.

And while the focus will be on the Fed and how their rate cuts will ensure the continuation of solid economic growth, - "permanent prosperity" - the "real story" remains an acutely maladjusted economy and unstable financial system. Today's stock market reaction is just confirmation of how dysfunctional and distorted market dynamics have become. Such wild moves in equity and credit market prices are indicative of serious financial imbalances, with the U.S. financial system clearly an accident waiting to happen.

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