Valentine Capital IPC Notes
by Valentine Capital's Investment Policy Committee

Valentine Capital Asset Management
Investment Policy Committee

WEEKLY MARKET and ECONOMIC OUTLOOK
May 20, 2010

“Flash Crash”
The sharp (and still unexplainable) drop May 6, followed by an almost immediate rebound, is known as the Flash Crash. It was the second largest point swing, 1,010.14 points, and the biggest one-day point decline, 998.5 points, on an intraday basis in Dow Jones Industrial Average history. The free fall occurred in just minutes and, temporarily, $1 trillion in market value disappeared. While speculation runs far and wide as to what sparked the dramatic market swing, both the regulatory agencies and the United States Congress are resolute in investigating the causes of the flash crash. A 151-page report on the causes of the May 6 disruption released by the SEC and the Commodity Futures Trading Commission offered preliminary hypotheses for what happened. As a result, the Securities and Exchange Commission (SEC) announced new trading curbs, also known as circuit breakers, will be tested during a six-month trial period ending on December 10th, 2010. These circuit breakers will halt trading for five minutes on any S&P 500 stock that rises or falls more than 10 percent in a five minute period. Volatility is certainly back, as we state in more detail below.

GLOBAL THEMATIC OBSERVATIONS
ECONOMIC UPDATES
MARKET ANALYSIS
EARNINGS DEVELOPMENTS

Japan said its industrial output soared in March but could not stave off an erosion in the Yr/Yr rate of growth. Output was up by 1.2% month-over-month across the major sectors. Additionally, Japan's economy grew at an annualized pace of 4.9% in the January-March quarter, the Cabinet Office said. However, The consensus estimate of economists surveyed by Nikkei and Dow Jones Newswires called for a 5.9% increase.
Germany said its investor confidence has dropped. The sentiment measure took a hit this month amid rising worries over the impact of the debt crisis in Southern Europe. The Mannheim-based Center for European Economic Research said its May economic expectations index fell to 45.8 from 53.0 in April, with the decline exceeding expectations for a drop to 47.0.
UK said its inflation is rising. British consumer price inflation accelerated to an annual rate of 3.7% in April, rising from 3.4% in March.
Source: Investor’s Business Daily, Wall St. Journal: May 13 – May 20.

U.S. Economic Events & Analysis:

POSITIVE INDICATORS:

Housing starts up: U.S. housing starts increased for the second straight month in April, the government estimated. Hitting an 18-month high, housing starts rose an estimated 5.8% to a seasonally adjusted annual rate of 672,000 from an upwardly revised 635,000 in March, the Commerce Department reported. April's starts marked the highest level of new construction since October 2008, when the financial crisis worsened. Housing starts are up 40.9% compared with the record low in April 2009, but they're down about 70% from the peak in 2006 and about 30% below the long-run level needed to meet the needs of a growing population, analysts say.
Home builder’s confidence up: U.S. home builders gained confidence in May in the market for new single-family homes, sending the monthly builder's index to the highest level in 33 months, according to the National Association of Home Builders. The housing market index rose three points in May to 22 after a four-point increase in April. At 22, the index is at its highest point since August 2007, but it's still very weak in historically. At 22, the index shows that about one in five builders thinks the market is good. At the peak in June 2005, the index reached 72. At its bottom in January 2009, it was 8. It's been below 50 for 49 consecutive months.
CPI down: Consumer prices in the U.S. fell 0.1% on a seasonally adjusted basis in April as energy, housing, auto and apparel prices declined, the Labor Department reported. It was the first decline in the consumer price index since March 2009. The consumer price index is up 2.2% in the past year. The core CPI, which excludes food and energy prices to get a better view of underlying inflation, was unchanged in April, lowering the year-over-year increase in core inflation to 0.9%, the lowest rate since January 1966. The inflation numbers were better than expected. Economists surveyed by nailed the 0.1% drop in the headline CPI, but were expecting a 0.1% gain in the core rate.
PPI down: U.S. wholesale prices fell slightly in April as the cost of energy and food eased, government data. The main producer price index fell 0.1%, seasonally adjusted. The more closely followed core rate, which excludes volatile energy and food prices, rose 0.2%, the Labor Department reported. Economists surveyed had predicted a 0.2% decline in overall produce prices and a 0.1% increase in the core rate.
CRB Index down: The Reuters-Jefferies Commodity Research Bureau is down -7.3% year-to-date. It is down further from -5.8% last week. The CRB has had one of its worst periods this month since March of ’09. It is down 9 of the last 12 sessions.
Benchmark interest rate down: Yesterday’s closing yield on the benchmark 10-year Treasury was 3.37%, down from 3.57% last week. Rates are now at the lowest level since mid-December.
Oil down: Crude for June delivery closed at $69.87 a barrel yesterday. This is down from $75.65 last week. The Energy Information Administration reported an increase of 200,000 barrels in crude-oil stockpiles, whereas analysts surveyed by Platts expected a rise of 950,000 barrels in crude supplies. However, concerns over demand for oil from southern Europe have knocked oil lower.
Sources: Economy.com, Bloomberg, MarketWatch, IBD, First Call: May 13 – May 20.

WEAK INDICATORS:

Jobless claims up: The number of people applying for unemployment benefits shot up 25,000 in the latest week, government data showed today. Initial jobless claims rose to 471,000 in the week ended May 15, the highest level in a month, according to the Labor Department. About one-third of the increase occurred in financially stressed California. Economists predicted initial claims would drop on the week, falling to a seasonally adjusted 440,000 from last week's reading of 446,000. While they've fallen 25% from 12 months ago, initial claims are now 3.6% higher compared with the end of 2009 in a reflection of the scarcity of new jobs.
Building permits down: Building permits fell 11.5% to a seasonally adjusted annual rate of 606,000, the lowest in six months. Permits for single-family homes, considered by many analysts to be the key number in the housing release, also dropped, down 10.7% to a 484,000 annual rate. Building permits are up 15.9% compared with a year earlier.
Empire State index drops: The Federal Reserve Bank of New York reported that its May Empire State Factory Index of General Business Conditions fell to 19.11, its lowest level this year. Nevertheless, the May level suggests positive growth in factory sector activity but it fell short of Consensus expectations for a reading of 30.0.
Mortgage delinquencies up: The Mortgage Bankers Association reported that as of last quarter, a record 10.1% of all mortgages were late. That's up from 9.5% at the end of last year and nearly double the rate before the last recession began. The record number of delinquencies is quite notable for those late by 90 days and over. The rise to 5.0% is up from 1.5% in 2007. For those late by 90 days or less, the figure actually is down from the peak in early 2009, though it's up since before the recession. No category of mortgages has seen delinquencies rise more than amongst subprime borrowers. Here, more than one-quarter of the loans were past due last quarter versus 7.3% for prime loans. The largest increase has occurred for those late by more than 90 days to 15.0% of loans from 3% in 2004.
Sources: Economy.com, Bloomberg, MarketWatch, IBD week of: May 13 – May 20.

· The Market: The US stock market quickly down shifted into correction mode since last week. Fear and uncertainty have investors in their grips. After losing nearly 1,000 points (the largest fall ever) intra-day last May 6, the market’s volatility has soared. The VIX, as referenced below, has shot up sharply week-over-week, indicating the increase in the market’s volatility. While corporate and economic -fundamentals have strengthened, weak European economies and terrorists scares in our homeland have caused a market sell-off from recent highs. As we have noted, the S & P 500 has not had a pullback exceeding 10% since the market rally began in early March (the S & P 500 is up 67% since the March 6th ’09 low). Year-to-date major index performance: S & P 500 0%, DJIA 0.2%, NASDAQ 1.3%, and the S & P 600 9.1%. Here are the past week’s results: May 13: 229 new highs & 14 new lows, May 14: 48 new highs & 40 new lows, May 17: 69 new highs & 70 new lows, May 18: 101 new highs & 53 new lows, and May 19: 28 new highs & 105 new lows. Industry Group analysis: year-to-date, 143 out of 197 groups we monitor are positive.
Source: Investors Business Daily. May 13 – May 20.
**The Standard & Poor’s 500 (S&P500) is unmanaged group of securities considered to be representative of the stock market in general.
**The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks.
**NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System.
**The Standard & Poor’s 600 (S&P600) is an unmanaged group of securities, relating to the small cap segment of the U.S. equities market, covering approximately 3% of the U.S. equities market.
***Indexes are unmanaged and cannot be invested into directly. Investing in limited sectors may increase the overall volatility of a portfolio.

Bull/Bear Barometer:
Market SHIFTS TO CORRECTION MODE: BEARISH
Industry group strength broad : BULLISH. 154 of the 197 industry groups we monitor are up year-to-date, down from last week’s 182.
Dow dividend yield: BULLISH. The current yield for the Dow Jones Industrial Average is 2.70%, up from 2.66% last week and down from 4.45% March 9, ‘09, which was a 5-year high.
Volatility index down: BULLISH. Also known as the ‘Fear index’, the VIX (volatility index) is 35.9, a sharp jump from 25.4 last week, but still down significantly from the last bear market highs. The VIX has dropped from over 50 near the market bottom in March. According to FactSet Research, the VIX spiked to record highs of between 81 and 96 in late October ‘08, then peaked at 103.4, as panic gripped markets worldwide. This contrarian indicator is considered bearish as it reads investors become less fearful. Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility.
Investors Intelligence survey shows rising optimism: BEARISH. The Investors Intelligence Advisors Sentiment index, which gauges the stock advice of about 150 newsletters and other paid market-advice outlets, is now at new extreme levels. The “Bearish” sentiment is 24.7%, the same as last week. “Bullish” professional sentiment is 43.8%, down from 47.2% last week ( and down from 56% 2-weeks ago). The 5-year high is 62.9. The index is considered normal at a measure of 45% bulls, 35% bears and 20% neutral.
Bear Perspective: Bull market or Bear market rally?? Both provide impressive gains, especially over the short-term. During the October of 1929 to July 1932 bear market the Dow lost 89% of its value. During that time there were 7 large rallies exceeding 27%. For example, the bear market rally that began in October 1931 lasted 35 calendar days and resulted in a gain of 35%. The Dow gained 15% in one day! Additionally, a more powerful bear market rally ensued in 1932 when an early August to late September advance exceeded 100% before another leg down, losing over 30%. Japan’s Nikkei showed 4 huge up moves of 50% or more during its prolonged bear market, losing 74% of its value. Japan’s stock market is still a fraction of its September 1989 peak near 40,000, as it is now about 10,000.
Sources: Wall St. Journal, IBD, Thompson First Call, Zacks, Stock Traders Almanac, AlphaTrends. May 13– May 20.


● Earnings & Company Developments: At this point it seems clear that we are going to have a stellar earnings season when all is said and done. So far 459 firms, or 88.4% have done reported. The results have been very positive, roughly in line with the great 4Q pace. According to Zacks Investment Research, there have been 341 positive earnings surprises so far, versus only 75 disappointments, for a ratio of 4.55:1. The median surprise is 6.81%, which is very strong. Historically, the surprise ratio tends to be around 3.0 and the median surprise at about 3.0%. The strong reporting season so far also applies to the top line as well as the bottom line, but to a lesser extent. Positive revenue surprises have topped revenue disappointments by a ratio of 2.12:1 and a median surprise of 1.25%. Positive revenue growth firms lead firms with falling revenues by 3.02, and 74.9% of all firms have higher revenues. Total revenues reported so far are 12.8% above the revenues those same firms had a year ago. Zacks states data shows S&P500 earned $547.1 billion in 2009, expected to earn $760.5 billion in 2010, $895.6 billion in 2011. Current “Top Down” earnings estimates for the S&P 500 are: $79.96 for 2010, $93.28 for 2011. Companies of interest: No companies to report.
Sources: Zacks Investment Research, Thompson Reuters, Earnings.com, TheStreet.com, FactSet. May 13 – May 20.

On This Day:
May 20, 1927 -- Charles Lindbergh took off for Paris from Roosevelt Field in Long Island, N.Y., aboard the Spirit of St. Louis on the first nonstop solo flight across the Atlantic Ocean.
Source: history; about.com

Notable & Quotable: on Behavior
“Don't reserve your best behavior for special occasions. You can't have two sets of manners, two social codes - one for those you admire and want to impress, another for those whom you consider unimportant. You must be the same to all people.”
Lillian Eichler Watson

Valentine Capital Asset Management, Inc.   

6111 Bollinger Canyon Rd. Ste 100, SAN RAMON, CA  94583

925.275.0200

Published by Valentine Capital Asset Management
Copyright © 2010 Genevieve Valentine Enterprises. All rights reserved.
All rights reserved. Valentine Capital Asset Management 6111 Bollinger Canyon Road #100 San Ramon, CA 94583 (925) 275-0200 Valentine Capital Asset Management is an SEC Registered Investment Advisory firm doing business in the State of California. John Valentine, Founder & President. Securities offered through Purshe Kaplan Sterling Investments, member FINRA/SIPC, Headquartered at 18 Corporate Woods Blvd, Albany, NY 12211 NOT FDIC INSURED. NOT BANK GUARANTEED. MAY LOSE VALUE, INCLUDING LOSS OF PRINCIPAL. NOT INSURED BY ANY STATE OR FEDERAL AGENCY.