David Moenning's Daily State of the Markets:

Subprime Decline Part II

Good morning. The popular press blamed rising interest rates for the sudden and sharp drop of nearly 150 points yesterday afternoon. And while it is true that rates did indeed rise - the yield on the 10-year closed at 5.12% - an increase of less than four basis points is hardly a good reason for stocks to plunge into the close.

No, the real story here is tied to the inner workings of Wall Street and the blow up of two Bear Stearns hedge funds. While everyone knows that the two funds were "done" what we didn\'t know is whether or not the assets, which involve sophisticated debt instruments called CDO\'s, would be liquidated in a forced sale situation (think margin call) or if some negotiated deal could be reached.

At issue here is the problem that is created when a billion here and a billion there of lower quality debt obligations is dumped on an already skittish bond market. You know as well as I do that whenever someone is forced to sell a large amount of anything, buyers aren\'t usually quick to step up to the plate. And if the bears get a whiff of what\'s going on, it can get ugly in a hurry.

Up until yesterday afternoon, the thinking was that there would be some sort of bailout created for the two funds so that the assets would not have to be dumped on the bond market all at once. However, once Merrill Lynch started making noise yesterday about liquidating the assets, people started to get nervous. And in fact, CNBC confirmed after the bell that Merrill had seized $850 million in assets and had begun to auction them off.

So, what does almost billion in CDO\'s have to do with the stock market, you ask? In short, the worry is that there will be a ripple effect. If more hedge funds begin to have problems with their subprime holdings, then more assets will have to be sold. This, of course, would bring the subprime financial nightmare that the bears were screaming about back in March back into play.

To be sure, this is not the first time the stock market has had to deal with "structural issues" of a fund going belly up. And what the past has taught us is that things can and do get nasty for a short period of time as assets are liquidated and fear runs amuck.

However, unless we see more funds imploding or the Fed starting to fret over the financial system, we\'d bet on the fact that this worry will pass within a few weeks and that hindsight will show any further selling will have been a buying opportunity.

Turning to this morning, the major economic news of the day will come after the opening bell as we will get reports on the Index of Leading Economic Indicators at 10:00 and then the Philadelphia Fed at noon.

Running through the rest of the pre-game indicators, the foreign markets are mixed with Asian markets higher while Europe is lower across the board. Gold futures are moving down this morning by $2.40 to $657.60. In the oil pits, crude futures are moving up again by $0.60 with the latest quote at $69.46.
Interest rates are also moving up this morning with the yield on the 10-year currently trading at 5.13%. And finally, with about an hour before the bell, stock futures in the U.S. are pointing to a slightly lower open. The Dow futures are currently off by about 15 points; the S&P\'s are about 2 points underwater, while the NASDAQ looks to be about 4 points below fair value at the moment.

Stocks "In Play" This Morning:

Today\'s Earnings Before the Bell:

H&R Block (NYSE: HRB) - Reported $1.81 vs. $1.88
AG Edwards (NYSE: AGE) - Reported $1.18 vs. $1.12

News, Upgrades/Downgrades/Brokerage Research:*

Sybase (NYSE: SY) - Upgraded at Banc of America
Cheesecake Factory (NASDAQ: CAKE) - Downgraded at Bear Stearns
Motorola (NYSE: MOT) - Bear Stearns reduces estimates
United Auto Group (NYSE: UAG) - Upgraded at Bear Stearns
Prudential (NYSE: PRU) - Upgraded at Citigroup
Nokia (NYSE: NOK) - Downgraded at Goldman Sachs
Nvidia (NASDAQ: NVDA) - Upgraded at Lehman Brothers
Alltel (NYSE: AT) - Downgraded at Lehman Brothers
Home Depot (NYSE: HD) - Downgraded at Piper Jaffray
Symantec (NASDAQ: SYMC) - Upgraded at RW Baird

Mr. Moenning holds Long positions in stocks mentioned: GS, MER

Note: All earnings reports compared to Reuter\'s consensus estimates

** For More of David Moenning\'s Market Analysis, Stock Portfolios, and Trading Ideas, visit: www.TopGunsTrading.com


The opinions and forecasts expressed are those of David Moenning, President of Heritage Capital Management and Co-Founder of TopGunsTrading.com and may not actually come to pass. Mr. Moenning\'s opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security or Heritage Capital program. No part of this material is intended as an investment recommendation. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any of HCM\'s programs. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that investment objectives outlined will actually come to pass. Investors should consult an Investment Professional before investing in any investment program. Neither Mr. Moenning or Heritage Capital Management nor any of their employees shall have any liability for any loss sustained by anyone who has relied on the information contained herein. Mr. Moenning and employees of HCM may at times have positions in the securities referred to and may make purchases or sales of these securities while this publication is in circulation. The analysis contained is based on both technical and fundamental research. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

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