Stockscom Report for Sunday May 22 2005

Publisher: Colin Alexander Editor: Ken Wilson (450-691-4617)

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• Economy sending mixed signals but not Sino-US trade wars

Market Synopsis

There may be mixed signals on the economy as we outlined last week but the signals on Sino-US trade are anything but mixed. The political wrangling has only begun, but what is truly frightening, is the loud rhetoric that threatens to place each side in an uncomfortable position with no room for possible compromise. Each of the combatants has managed to plant themselves into a corner and the objective now is to wait and see which one blinks first.

This untenable position has been activated through the combination of an export-oriented economy and the principle nation-destination of its exports and a government-controlled financial sector. For over a year now, the trade deficit with China has been rising at an inexorable rate and while the normal exchange rate mechanism would see the deficit-riddled economy’s currency depreciating and the surplus-fed economy’s currency appreciating, this relationship is not the case here. Instead China, in a bid to ensure employment for the massive migration toward cities of rural people, has steadfastly refused to re-evaluate its currency, which has been pegged at 8.28 yuan to the dollar for over a decade. Last week, things got a little dirtier though.

Washington, under pressure from Congress and loud, upset industry-people, applied restrictions on Chinese textile imports, namely pants, shirts and underwear as the surge in imports over the first four months of the year placed the very survival of the US textile industry in question and consequently these same companies sought protection from the avalanche of imports. China, in response, argued that their exports were being reduced from the initial volumes at the beginning of the year and pointed out that importing countries had a decade to prepare for this WTO initiative.

But Washington wasn’t through yet. Earlier this past week, they gave an ultimatum to China – let your currency appreciate within six months or face sanctions. The Chinese still reeling from the first blow have been quick to defend their policies based on the fact that their banking system is in no position to be freed up as few banks if any meet the BIS (Bank of International Settlements) standard for capital adequacy. The capital adequacy of a bank is the margin by which creditors are covered in the event of an asset liquidation. In general terms, the margin, measured as a ratio of total capital to total risk-weighted risk exposures should not be less than 8%.

Perhaps more importantly, this conflict is a clash of titans where each is accusing the other of nasty deeds. The US accuses China of dumping their exports on American shores and managing the currency in a manner unbecoming of an emerging economic power. China meanwhile accuses the US of not putting their own financial house in order, running large unmanageable fiscal and trade deficits to the detriment of the global economy. Both have painted themselves into a corner where they stand to lose face if they reverse from their extreme positions. While we have no magic solution for the two parties, we do know that cooler heads must prevail if some resolution is to be found.

Ironically, the issues that they present are unlikely to be resolved under the current situation and, in fact, could be alleviated if both parties stuck to free market principles. The textile industry in the US isn’t best served by sustaining jobs at wages ten times the wages of East Asian countries. Thus singling out Chinese textiles as the target for trade action will only allow other Asian countries to take up the slack. Specifically, the Indo-Pakistanian textile industry will surely plug the demand gap left by the Chinese. Will the Republican Administration take exception to these countries’ textile exports then?

In China’s case, the possibility of bank failure (or any failure for that matter) is tantamount to disaster yet an appreciation of their currency could serve them well in the long run. One of the biggest problems in China now is that domestic demand is abysmally low at 42% of GDP, the lowest consumption of any major economy. Allowing the currency to appreciate would induce a higher level of consumption and an economy that was less dependent on exports than it is now. It would also put sizable pressure on the other Asian tigers, equally dependent on weak currencies, to allow their currencies to appreciate in similar fashion with one net effect being rising interest rates in the US, which hitherto have been kept artificially low. True, a recession would probably result but it would wring out the surplus capacity in many industries and allow real capital investment to form.

Technically Speaking

A buying surge this week in equities gave a boost to bulls and affirmed the change in sentiment that was felt by the end of last week. Despite the weak economic signals offered by everything from the ISM survey of purchasing managers to factory orders to industrial production to the Federal Reserve’s own regional surveys (such as the Philly Fed Index), the equities markets are not being coy. They are emphatically endorsing the economy and signaling that investors should be buying. Though we may have been less than certain at the end of last week, by mid-week we were convinced and sent an Alert to warn traders to cover shorts.

Similar to last week, the Nasdaq continues to lead this parade, but for the moment, this market and its brethren are well into overbought territory and traders should expect markets to move little for a few sessions after having sprung significantly higher.

Of our recommendations, AIRT stands out, as a jump on Friday on substantially higher volume, sets this one up to move much higher this week. Price has been compressing for weeks and while jumps higher have been made on large volume days, the drops have occurred on lower volumes. But Friday’s action changed this by moving above the falling trendline that had limited the upside of AIRT for many weeks.

New Buy Recommendations:

Captiva Software (CPTV) – The weekly chart of CPTV piqued our interest as this week resulted in a breakout from the sideways range that had limited price since May/04. A year-long consolidation that results in a break is always worthy of our collective attention. On the daily chart, the move above $13 on Wednesday on heavy volume was confirmed on Friday after a small bout of digestion on Thursday. Though overbought, there is a strong likelihood of support at or just below the $13 level where several sessions since late April had their highs on a daily basis.

New Short Sales

None.

Stock Positions to Sell/Exit:

None.

Portfolio Comments:

New stops have been added to the list while others have been modified. Those that have blanks, are being carried unstopped for now. Please see our complete list of stops in the table below.

List of Current Stock Recommendations:

Action Ratings. The following is the legend for designating immediate action
for our stock recommendations. The first is B, meaning the stock is timely
to buy but the case for doing so right here is not overwhelming. Either the
stock may have gotten ahead of itself and may be vulnerable to a retracement or
else the stock has been performing disappointingly but may simply be
regrouping. B+ and B++ indicate stocks for which there is a technical case
to buy now, with plusses adding weight according to how many there are, up
to a maximum of two. Stocks rated H are ones to hold, awaiting confirmation
to buy more or to sell. SELL, of course, means what it says. It seldom pays
to override this designation. In the case of stocks held short, the rating is S where positions should be retained. S+ and S++ indicate stocks for which there is a technical case to add to the positions with plusses adding weight similar to long positions. The maximum number of plus signs is 2.

Please take note that the following clause is being removed under the assumption that the aforementioned federal budget in Canada will be accepted into law. From the budget date forward, there are no longer restrictions on foreign stocks held in Canadian retirement accounts. Furthermore we will no longer mark stocks with # to indicate such.
[Stocks marked # are eligible as Canadian content in Canadian RSP funds. Otherwise there is a 30 percent restriction on foreign stocks held in these accounts.]

Date of Entry	Name	Symbol	Entry Price	Current Price	Stop	Action Rating
01/31/05	Air T Inc	AIRT	17.63	17.88	13.64	B+
05/08/05	Canadian Nat Res.	CNQ	56.94	53.00		H
04/25/05	Gilead Sciences	GILD	39.58	40.18	34.50	B
05/10/05	Humana	HUM	36.30	36.30		H
04/25/05	Hutchinson Tech	HTCH	37.00	40.18	32.00	B
05/10/05	Pacificare Health	PHS	62.60	61.50		H
03/08/04	Transcanada Corp	TRP	21.34	24.42	23.25	H
04/25/05	Verisign Inc	VRSN	29.24	29.92	24.60	B

Short Sales

Date of Entry	Name	Symbol	Entry Price	Current Price	Stop	Action Rating
04/25/05	3M	MMM	77.67	78.10	78.40	Covered
04/25/05	Wal-Mart	WMT	47.05	47.83	50.00	Covered
04/25/05	Yellow Roadway	YELL	50.62	52.02	55.00	Covered

New stops in BOLD

* Stop on a closing basis

** Buy if above entry price