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January 27, 2006


Bulls bid the market higher right out of the gate this morning, but it appeared most of the serious buying occurred in the first 45 minutes or so of trading. The major indices drifted sideways or down the rest of the day, depending on which one you consider. Nevertheless, it was a strong showing for a Friday, considering all the concerns with which the geopolitical landscape presented us this week. I had expected traders to show a little more caution going into the weekend.

The GDP number released this morning may have had something to do with trader exuberance. The 1.1% growth number for Q4 2005 was much weaker than anticipated. In some circumstances, such a weak showing would hammer markets because of earnings concerns. However, earnings are not forefront on traders' minds these days. Interest rates are, and an especially weak GDP number is interpreted as creating pressure on the Fed to stop raising rates, if not cut them.

People who step back and look a the macro picture, though, see this number for what it is: another step toward the trap the Fed has been setting for itself in recent years, especially when taken in light of the fact that the weak number was blamed on slow consumption last quarter. A weakening economy, weighted by dramatically slowing consumption, is exactly what many of us have been anticipating. The Fed's customary response to recession, at least under Sir Alan, has been to print money like crazy. However, the Fed has already been flooding the economy with liquidity despite a rising Fed Funds rate. To cut rates now, the Fed would have to take the money supply vertical! To not cut rates would mean to risk a substantial recession. Neither scenario is tenable for the Fed, hence their trap.

How all this plays out is difficult to predict, but ultimately I believe the stock market will have the wind knocked out of it in a big way. The market can be thought of as a grand risk discounting mechanism... the more risk that is perceived, the lower the market's price. Until a broader base of traders perceive these risks, the risks won't be discounted into the market price.

Back to today's action... consumer stocks faired well despite the consumer being blamed for a decelerating economic growth rate. At some point I intend to have some significant shorts in this group, but for now I am only dabbling to get my feet wet. The companies that I suspect will see the most trouble are the ones that have been beneficiaries of the housing ATM via big-ticket items. These companies would include Best Buy and Circuit City (appliances and flat panel TVs) and perhaps Home Depot and Lowes (appliances and remodeling).

Silver pretended like it would have another big day, having popped 15c in the early going, but finished flat. Gold has yet to participate in the breakout. I don't know if these actions signify the end of the current run in metals, but it is clear that buyers are having a tough time pushing prices higher here. I reduced my Newmont Mining calls in light of the mixed signals and may pull the rug from under the rest of my NEM and PAAS calls if things begin to deteriorate. I already have large profits in these positions and wouldn't mind waiting for a clearer point to be holding them, even if it ultimately turns out to be at higher prices.

Disclosure: Short CC; Long NEM, PAAS Calls


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