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August 14, 2006

A Day for Bears to Salivate

There are few market performances that invoke Pavlovian hunger responses in bears than the type of massive reversal we witnessed today. Equities rocketed out of the gate, hit a brick wall mid-session, then dove into the close, going out on the lows. It would seem that bulls exasperated their last bit of stamina, but before getting too excited, we bears should remember to keep en eye on 1261 on the S&P 500, which has provided strong support on several runs lower.

To be honest, I have no idea where the early rally came from. The markets were not terribly oversold. Technical patterns were pointing to around a half percent of tolerable upside risk (from the bear's perspective), and other indicators such as odd-lot short sales and VIX were not indicative of a spent market. Headlines in financial media credited the rally to a cease-fire deal in Lebanon along with lower oil prices. While such news can be leveraged by those looking to push the market higher, I don't believe it fully explains the strength. After all, markets have been rallying for three years along with a doubling in the price of oil. Furthermore, the Lebanon situation appeared to do little damage to equities while it raged, so why should traders celebrate its end?

It is possible a surplus of liquidity was being played from one corner or another, but these types of theories are impossible to substantiate. Therefore, backed by the aforementioned lines of thought, I surmised the morning action was nothing more than frenetic folly, and I executed plan B: sit back and wait for the market to reveal its hand. And so, with the exception of covering Friday's Building Materials Holding short in the early going, I remained an observer.

Bonds fell across the board, bumping up yields 2 to 4 basis points, depending on duration. The short end saw the greatest yield increase, meaning the yield curve became more inverted. The latest pull-back in bonds may just be a blip, but it's worth keeping an eye on because a downward trend in bonds will ultimately weigh on stocks.

Looking forward, we receive more bogus inflation numbers this week, with the PPI published tomorrow and the CPI, Wednesday. Given the weakness on display today, the chances for a pop in equities on a tame inflation figure seems much lower than the chances for a swoon on a high one. We'll see.

Disclosure: None


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