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December 4, 2006

Bad News Bears

The bears are starting to act like John Kerry in a presidential election. They are taking what should be a slam dunk victory and blowing it. Bearish blogs such as the one you are now reading have been ranting since early 2005… against popular opinion… about how the unwinding of rampant speculation in the housing market would drag on consumerism and the U.S. economy. We have been warning that the Fed has severely damaged the natural and efficient mechanisms for resource allocation built into the capitalist system via their incessant tinkering and money printing. We have been pounding the table about how the next round of rate cuts would be aimed at mitigating a severe recession and would ultimately serve only to fuel inflation and further damage to the economy. Given the deteriorating news out of the housing market and the fact that precious metals are on a tear again, the veracity of our views is finally dawning on the masses.

Last week the market took its biggest stumble since early summer. With momentum and news on our side, what did the markets do today? NDX up 1.5%. SPX up 1% to new multi-year highs. Some of the most over-priced equities on the planet, including Research in Motion, CDW, Nvidia, and Lam Research, were all up sharply. The SOX, a widely-watched barometer for the health of the market, exploded for nearly 2%.

Financial media are crediting today's rally on the Bank of New York's bid for Mellon and the dollar dip in oil. However, I see those as just coincident events. The bottom line is that the idea of risk aversion is still vacant from trader mentalities. Buyers are undeterred, and potential sellers are not concerned enough to cash out. In other words, the latest news has not been scary enough to push concerns to a tipping point.

I continue to believe the falling dollar will provide a catalyst for a market downswing, but timing when such things will matter is always the challenge. Looking back at the spring swoon, the dollar started plunging in early April. Meanwhile, the SPX managed a last-ditch push to the upside before seeing heavy selling in early May. The current sharp weakness in the dollar began in mid-October, and I had expected the failure of the May lows to be an important trigger for equities. Last week's action seemed to reinforce that concept, but with the new highs seen today, we bears have to exercise extreme caution and wait for more information.

Disclosure: Long RIMM, LRCX Puts; Short NVDA

Disclosure: None


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