Inflation is clearly moderating and will likely continue to do so if consumer spending remains erratic and gasoline prices stay soft.

The Federal Reserve's favorite inflation indicator, the core Personal Consumption Expenditure (PCE) index, has climbed only 1.9% in the past 12 months and is now running at its lowest rate in over three years. The core PCE rose 0.1% in June, which was the lowest monthly inflation since last November.

Under Ben Bernanke, the Fed unofficially targets inflation within a range of 1% to 2%. So as the core PCE falls, it sets up the Fed for an interest rate cut sometime this fall.

There's also been a dramatic decline in long-term bond yields to 4.8% for the 10-year Treasury bond, which was over 5.2% not too long ago. This was obviously caused by a flight to quality during the sell-off in late July. Short-term yields, however, have also declined and are now well below the Federal Funds rate.

The Fed doesn't like to fight market rates and the fact that core inflation continues to moderate is very bullish. The real reason why the Fed may want to cut rates is to shore up consumer spending and help the battered housing market, which could cause economic growth to struggle.

Today's weak payroll report will put the stock market in a grumpy mood, especially since it's a Friday.

The job market lost some of its punch last month as employers added 92,000 jobs -- the fewest number in five months, the Labor Department said today.

In a further sign that hiring has slackened somewhat, the government also reported that job growth in May and June was slower than first estimated and that the unemployment rate edged up last month to 4.6 percent from 4.5 percent.

The percentage of working-age Americans who were employed in July fell to 63 percent from 63.1 percent.

If payrolls are truly slowing--we'll need more data to see if it's a trend--then it's another reason for the Federal Reserve to cut interest rates.

USA Today compares today's Fed statement with the from six weeks ago:

June 28: Economic growth appears to have been moderate during the first half of this year, despite the ongoing adjustment in the housing sector. The economy seems likely to continue to expand at a moderate pace over coming quarters.
Aug. 7: Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.

June 28: Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.
Aug. 7: Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

June 28: In these circumstances, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.
Aug. 7: Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.

The stock market got rocked today on the news that the largest bank in France, BNP Paribas, is halting withdrawals from three of its investment funds. The reason for the halt is that the bank can no longer fairly value its holdings. Yikes!

Let me explain. Hedge funds like to make money, but what they love to do is make money steadily. James Altucher, at Stockpickr, described the hedgies' goal of making, say, 2% a month, every single month rain or shine. If you're a hedgie and you can knock out 2% a month all the time, investors will adore you and you'll soon find yourself in the Grand Caymans managing a gazillion dollars. I wish I were exaggerating.

When the Federal Reserve lowered interest rates, many hedgies thought they had found the Holy Grail. They could borrow at short-term rates for next-to-nothing, then turn around and buy mortgage-backed securities for a lot more than they had originally borrowed. Presto, instant money! Best of all, it was so easy. The housing market was booming, and there was tons of money just lying around. Soon funds were using their collateral to leverage up 5-to-1 or even 10-to-1 at times.

Hey, what's to worry about? Everybody's doing it.

Now that the housing market is taking it on the chin, those mortgage-backed securities are getting walloped, and the subprime sector has been hurt the most. So the problem these hedge funds are having is that they can't unload their mortgage-backed bonds because no one will buy them.

In an interview today, Timothy Ghriskey, chief investment officer at Solaris Asset Management LLC in Bedford Hills, New York, said, "There are no bids for them. Asset-backed securities, mortgage loans, especially subprime loans, don't have any buyers."

This means they really don't know the price of the bonds--and that means they have no idea how much collateral they really have. So instead of "only" being leveraged 5-to-1 or 10-to-1, they're really leveraged...ugh, I don't even want to think about it!

So now you can see the problem BNP Paribas faces. Think about that in global macro-economic terms. A hedge fund in France gets a super-atomic wedgie because some schmoe in Sheboygan can't pay his mortgage! Paribas said that the funds lost 20% in the last two weeks and are now down to two billion euros.

This is almost an exact repeat of what's happening at Bear Stearns (BSC). As the crises hits at Bear, two of its top executives were at an important engagement in Nashville--a national bridge tournament. Again, I wish I was exaggerating.

Well, I'm glad to see they're not worried, unlike this guy.

So now that we know what isn't working on Wall Street, let's turn our attention to what is working--namely, earnings. And by earnings, I mean real actual profits, not bought for, or highly leveraged money, just real earnings.

Last week, I highlighted one of my favorite Emerging Growth energy stocks, Holly Corp. (HOC), an independent petroleum refiner. I said that I thought the company's next earnings report would be quite good. Well, the earnings report came today and I was wrong--the report wasn't good, it was fantastic.

Holly is a perfect example of a company that's still able to generate strong earnings in a difficult environment. For the second quarter, Holly earned $2.84 a share, which creamed Wall Street's consensus estimate by 41 cents a share. Revenues jumped to $1.22 billion which topped estimates by over 20%. The shares shot up 8% today before pulling down some this afternoon. The stock is now up over 400% since I first recommended it to members of my Emerging Growth service less than three years ago.

Don't be fooled by any of the talking heads on TV--there are plenty of stocks like Holly out there. In fact, I think the next candidate for an earnings surprise is Guess (GES), the teen jean store. I currently recommend the stock in my Emerging Growth service.

The company is due to report its second-quarter earnings soon, although the company hasn't given us a specific date yet, I suggest you keep an eye out. Guess has made a nice habit of creaming Wall Street's predictions for the past several quarters. Last quarter, the Street was expecting EPS of 28 cents, Guess earned 38 cents. In February, Guess beat earnings by six cents a share and the stock vaulted 12%. In a year-and-a-half, Emerging Growth members have made over 180% in shares of GES. I currently rate Guess a buy anytime the price is below $50 a share.

I want to give you an overview of the entire situation surrounding the "credit crunch crisis," so that you don't become confused by all the bits and pieces you may hear in the media.

Collateralized Mortgage Obligations (CMOs) have been around for decades. They have blown up like this before--first in the early 1980s, and then in the early 1990s. In fact, I bet that this crisis will strike again in another decade or so, after a new generation of inexperienced fixed-income traders emerge on Wall Street. The fact that Bear Stearns' hedge funds and other hedge funds leveraged these CMOs to get higher yields and subsequently blew up is, well...too bad for those investors. They obviously did not assess the risks in their quest to get a higher yield. However, now that the CMO credit crisis has hit big European banks, too, the pain is obviously hurting other investors.

Complicating matters this time around is a newer high-yield debt instrument, the Collateralized Debt Obligation (CDO). These are risky new high-yield investments that were packaged to boost yields. Structured CDO products totaled $3.3 trillion last year! Hedge funds struggling with lower returns leveraged themselves deeply in these CDOs in an attempt to get higher returns.

Sadly though, the resale market for CDOs has now collapsed, due to the fact that no one trusts any CDO until they break it apart to see what's inside. In fact, the Securities & Exchange Commission (SEC) is now investigating whether major Wall Street brokerage firms are using consistent methods to calculate the value of their CMOs and CDOs, as well as the assets they hold for large customers, such as hedge funds. If it turns out that some firms are valuing these assets differently, you can kiss the hedge fund industry goodbye! The SEC demands full disclosure and transparency, so if you cannot properly price a security, then chaos will reign. In the interim, help may be coming, since Goldman Sachs and other smart players are nibbling at the subprime and high-yield investments, when they can get a big enough discount, so some CMOs and CDOs actually have a consistent "bid" price. At least, that is what the Wall Street firms (and probably the SEC) are hoping to see.

In the interim, chaos will continue to reign for a few weeks. Treasury Secretary Hank Paulsen (former head of Goldman Sachs) and Fed Chairman Ben Bernanke are mandated to protect our standard fixed-income investments, such as Treasuries and certificates of deposits (i.e., CDs) at banks. Now that the U.S. banking industry is at risk for investing in CMOs and CDOs, potentially putting your CDs at risk as well, the Fed had to intervene last week to reassure everybody that it would be "providing liquidity to facilitate the orderly functioning of financial markets."

However, the situation got more complicated last week, as the hedge fund meltdown spread more widely. Specifically, many equity hedge funds, especially those that short stocks, were squeezed on August 6, when the Dow Industrials staged their biggest one-day rally this year, led by the battered financial stocks. This short-covering rally, combined with excessive stock market volatility (the Dow's swings averaged 400 points a day - much wider than usual), caused great confusion among some "market-neutral" hedge fund managers. Black Mesa Capital, for instance, has a hedge fund with about $1.9 billion in long positions and $1.9 billion sold short. But they told investors that market-neutral hedge funds had suffered losses of 5% to 15% so far in August.

According to The Wall Street Journal, a hedge fund run by Goldman Sachs - the North American Equity Opportunities market-neutral fund, with $767 million invested - was down 15% year-to-date through July 27th and has sold some of its positions recently. Goldman Sachs' largest hedge fund, the Global Alpha fund, suffered potentially bigger losses and may also be selling positions, according to other published reports. According to John Mauldin's August 11th weekly e-letter, Goldman Sach's $8 billion Global Alpha fund "has been losing money for two years, is down 26% for the year and down almost 40% since the end of July." On Saturday, MarketWatch said that the Global Alpha fund has "fallen 26% so far this year." These depressing performance reports only add to the chaos. No wonder Goldman Sachs is being hit with redemptions!

Another hedge fund, the $29 billion Renaissance Institutional Equities Fund, led by a famous mathematics professor, also reported significant losses in August as their computer models were overwhelmed by the wide stock price swings. Many such "quant" funds analyze the historical relationships between related securities and trade when those relationships get out of alignment. Unfortunately, trading ranges have since widened, throwing their models off kilter.

This is what happens when Wall Street lets the math professors play with the money, instead of letting the finance guys run the show! I cannot tell you how many knock-down drag-out fights I have had with some pretty big players on Wall Street who no longer believe in fundamental analysis, like I use each week on ProfolioGrader Pro. These math wizards were not trained in finance. This is what happened to Long-Term Capital Management (LTCM) in 1998 when some Nobel Prize-winning mathematicians profited from the "normal" trading ranges, then along came an abnormal move (devaluation) in the Russian ruble, and they had no idea how to stop the bleeding.

The use of leverage turns a small, normal loss into a massive loss that threatens bankruptcy in a hedge fund. Some of these hedge funds also have permissive redemption periods, allowing their investors to take their money out every month, with 30 days' notice or less, which exaggerates the selling pressure. Naturally, this puts more pressure on selected securities, such as financial stocks, and escalates the losses at other hedge funds that made the same bet through a chain reaction.

I'd say the current situation is best described as "the blind leading the blind." Too many hedge funds made the same bet and ended up on the wrong side of the trade. Back in 1998, the giant LTCM made bets on the relationship between the prices of government securities from around the world. When Russia defaulted and devalued its currency, there was a flight to quality that caused the prices of U.S. Treasuries to spike up and the Japanese yen to jump 12%, causing a massive financial earthquake around the globe. The LTCM collapse caused the Fed to intervene and bail out several of the world's largest investment banks. From last week's actions by the Fed and other central banks, we may be in the process of repeating the 1998-style bailout.

Here's an interesting article I noticed on coal-to-liquids:

It's largely escaped notice, but there's already a dozen or so coal-to-liquids plants in various stages of development around the country.

While most are years away from construction, supporters of converting coal to motor fuels say at least some are a certainty - even if Congress doesn't approve incentives sought by coal-to-liquids supporters. Yet supporters consider some form of subsidy vital if the nation is going to build enough coal-to-liquid plants to dent its reliance on foreign oil.

"You're going to have a coal-to-liquds industry in the United States," said John Ward, vice president for marketing and government relations for Headwaters Inc.

Among other things, the South Jordan, Utah, company is working on a coal-to-gasoline plant proposed for North Dakota and researching the feasibility of coal-to-liquids for Pittsburgh-based Consol Energy. "The question is how fast will it happen," he said.

One plant is fairly far along. Rentech Inc. bought a natural gas-fed fertilizer plant in East Dubuque, Ill., and hopes to convert to using coal by the end of 2009 or 2010. Production would start low - 920 tons of fertilizer and 1,800 barrels of diesel a day.

Read the whole thing.

When the European Central Bank first intervened in the credit markets, on the morning of Thursday, August 9, they also took the bold step of telling banks that they could have as much money as they wanted at the central bank's current 4% base rate - without any restrictions or limits. The ECB had never done that before. This was a big gamble, but so far, it has worked. Previously, the ECB had sent signals that it intended to raise key interest rates further, so promising unlimited money at 4% seems risky. However, the continuing intervention by other central banks and the Fed's big (50 basis-point) Discount Rate cut may cause the ECB to postpone or shelve its upcoming rate hike.

After a confluence of factors - namely the crisis in the credit markets, tumbling stock markets, a sharp drop in British inflation and disappointingly slow economic growth in the euro-zone's three largest economies - many ECB observers are now questioning how much further central banks need to go. On Tuesday, data showed that the economies of Germany, France and Italy all grew less than expected in the second quarter, with the growth rate slowing in all three nations. But there is hope: Euro-zone GDP growth is still above its recent trend line, so it's possible that the ECB may stubbornly raise key interest rates anyway, which would likely strengthen the euro.

On Tuesday, Britain released its July inflation figures, which fell much faster than economists' expectations, down to an annualized rate of 1.9%. This marked the first time in over a year that inflation figures fell below the British government's long-term target. The fact that U.S. inflation (the July CPI) also fell to its lowest level in 8 months is indicative that inflation may be cooling in many nations. Euro-zone inflation is likely moderating, especially in light of softer GDP growth in Germany, France and Italy. Complicating matters further, economists now expect the Bank of England and the Fed to cut interest rates soon, so it would be a bit odd if the ECB raised interest rates.

From Bloomberg:

Bertrand Des Pallieres, founder of the SPQR Capital LLP hedge fund, said he was so focused on the swings in financial markets that he didn't notice his 80,000-pound ($160,000) sports car had been impounded by London authorities.

The 39-year-old, who quit Deutsche Bank AG in April to set up the fund, said in a telephone interview he amassed "thousands of pounds" in fines from unpaid congestion-charge fees and taxes. Authorities seized the blue Maserati Cambiocorsa in late May. Des Pallieres didn't realize it had been taken until this month.

More good economic news. The government reported that July was the strongest month for durable goods in two years.

Orders for U.S.-made durable goods jumped 5.9% in July on higher demand for airplanes, vehicles, computers, machinery, steel and most other kinds of long-lasting manufactured goods, the Commerce Department reported Friday.

Excluding the 10.8% increase in transportation goods, orders rose 3.7%, the fastest gain in two years.

The increase far exceeded the expected 1.5% gain forecast by economists surveyed by MarketWatch. It was the largest gain in total orders in nearly a year.

This means that exports are continuing to boom thanks to the weak U.S. dollar. This is especially good news for my favorite defense stocks like Precisions Castparts (PCP), and other aviation suppliers. I currently recommend Precisions Castparts in both my Blue Chip Growth and Emerging Growth services.

It's not just Cramer and Trump. Now Alan Mulally, the head of Ford, is calling for the Fed to emphasize growth.

Wherever housing has crashed (like Southern Florida or Southern California), vehicle sales have also crashed.

The chief executive of Ford has joined calls for the Federal Reserve to stimulate the economy, saying the housing crisis and credit turmoil has made sustaining economic growth a "priority".

In an indication of the growing pressure on the Fed to cut rates, Alan Mulally said economic and credit conditions were a "big headwind" to his plan to turn round the carmaker, which last year lost $12.65bn.

"Something we are all concerned about is the macro-economy," he said. "Especially right now in the US with subprime and [higher] fuel prices."

Do you remember when the French bank BNP Paribas said that it could no longer assign a fair price to its troubled hedge funds? Since then, the European Central Bank (ECB) has pumped $300 billion in liquidity to help stabilize the banking industry in the euro-zone.

Well guess what? On Thursday, BNP Paribas announced that its executives have changed their minds! They're going to reopen these controversial funds, which are expected to be valued at 2% to 5% lower when trading resumes.

Wait a minute--does this mean that the whole panic and massive liquidity injection was over a measly 2% to 5% reduction in principal? Sheesh, high-yield bonds can lose that in a day, and central banks never intervene! I have a sneaky suspicion that some BNP Paribas executives wanted to go on vacation in August and just closed the redemption window.

I find it odd that as they now return from vacation the redemption window is suddenly being reopened. It's a simple fact that the markets tend to lose their liquidity in August because everyone goes on vacation. In retrospect, these gyrations in August were unquestionably due to these seasonal effects.

The fact that the U.S. dollar has been very resilient during the subprime crisis also seems a bit unusual. Didn't the subprime crisis originate in the U.S. due to aggressive mortgage lending? Or were U.S. banks smart enough to get other banks around the world to buy all this subprime paper?

During this month's credit crunch, the dollar emerged as an oasis, especially our Treasury bills, which benefited immensely during last week's flight to quality. Short-term Treasury yields just had their biggest drop in 19 years. As the yield on Treasury bills falls, it makes the stock market look even more undervalued, so last week's rebound, in my opinion, is definitely not a head fake but it's the "real deal." As trading volume picks up after Labor Day, I expect that institutional buying in my recommended stocks will become even stronger.

If you turn on CNBC they keep telling you how weak the economy is and how it continues to soften. The problem is that the folks on CNBC are Wall Street people who are stressed out about their shrinking year-end bonuses, their over-priced Manhattan real estate and generally outrageous cost of living.

Well guess what? The entire U.S. economy is not based solely in Manhattan!!

As soon as you head to the heartland, business is booming. Why the disparity? It's very simple. The weak dollar has fueled an export boom that's responsible for strong economic growth. Remember that the United States is the equivalent of Saudi Arabia for corn, coal and even high-grade iron ore.

Second-quarter GDP estimate will almost certainly be revised higher this week. The reason for the revision is due to June's surprisingly strong trade deficit, which narrowed by 1.7% due to soaring exports. Trade typically contributes about one-third of the economy's growth, but due to the housing market woes, trade now has a much larger role in the economy.

The fact that export growth dramatically outpaced imports in June is a sign of robust activity overseas. Obviously, this is a good sign for continued growth, which is why Treasury Secretary Paulson recently said, "this is the strongest global economy we've had." Adjusted for inflation, the June trade deficit was at its lowest level in almost three years.

So far the third quarter is also looking quite strong. The Commerce Department recently reported that orders for U.S.-made durable goods jumped 5.9% in July. Looking even further out, crude oil prices should continue to fall due to lower demand from seasonal pressures (the summer driving season is almost over), which should help the trade deficit shrink even further.

China has emerged as a temporary oasis amid the "credit crunch" going on in the rest of the world. With the Beijing Olympics now less than a year away, the Chinese economy is experiencing an Olympic-sized adrenaline rush. The Chinese economy keeps soaring, no matter what its central bank does. Last Tuesday, the People's Bank of China hiked its key interest rate by 0.27% for the fourth hike this year. The People's Bank of China's deposit rate is now 3.6%, while its lending rate rose 0.18% to 7.02%.

This latest move was widely expected due to the fact that China's GDP grew at an 11.9% annual pace in the second quarter and inflation surged to an annual pace of 5.6% in July. The fact that China's trade surplus has risen 85% so far this year and its economy continues to boom means that the Chinese yuan should continue to slowly but steadily appreciate against the U.S. dollar, which is very good news for the China-based stocks I recommend in my Global Growth service.

Mt top-rated China stock right now is China Southern Airlines (ZNH). Second-quarter revenue grew by 19.2% from the same period last year, the company said, citing a "strong national economy, a stable increase of market demand and an appreciation of the Chinese yuan against major currencies such as the U.S. dollar."

During the first half of 2007, China Southern launched 56 new flight routes, including nine international routes. As of June 30, the airline operated a total of 592 routes, of which 478 were domestic, 21 were Hong Kong and Macau, and 93 were international, to 154 cities, using a fleet of 318 aircraft (with an average age of 6.89 years). Last week, the company also said it plans to buy 55 Boeing (BA) B737 aircraft for delivery between May 2011 and October 2013.