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October 4, 2005

Body Blow

As a bear on US equities, I thoroughly enjoyed watching today's action. The market experienced a sharp sell-off, starting at about 1:00 ET and lasting all the way until close. Although it's folly to try to pin one day's action on a specific bit of news, we writers always like to speculate, nonetheless. My speculation is that the stream of bad earnings reports that have been hitting the wire since July is starting to take its toll.

Today's prize winner was Lexmark, which sharply reduced its earnings estimate and missed big for the quarter. Traders pummeled the stock for a whopping 28.6%. Given the tide of reduced earnings estimate hitting the street, it would be a stretch to try to pin the problems Lexmark is experiencing on Lexmark alone. The odds are pretty high that more companies will begin revealing that business isn't as rosy as they all tried to pose earlier this summer.

Naturally, the lemmings who work in the analyst divisions of major brokerage houses won't admit there is a problem until after their clients have lost 20% or more of their invested capital. Until then, we'll probably continue to see buy recommendations on stocks that are on the verge of collapse. In one of the more laughable analyst revisions I've seen in quite some time, a firm named S.G. Cowen Securities changed their 2005 earnings estimate for XM Satellite Radio from a loss of $2.74 per share to a loss of $2.73 per share. Yes, folks, this firm has such a fine beat on XMSR that they think a 0.36% revision in their earnings estimate is noteworthy!

Turing to other markets 10-year Treasury yields were flat today, standing at 4.37%. However, yields have gone up about 25 basis points in the last few weeks. In conjunction with this bond decline, we've seen the dollar rally to near its 2005 high. It seems to me that this will be the last gasp for both the dollar and bonds, and I think the dollar is being supported for the time being by the rush by big companies with foreign operation to repatriate foreign earnings while they can take advantage of the temporary 5% tax rate for such earnings. This temporary rate expires on October 22. Naturally, repatriated earnings will have to be converted to dollars. If a repatriation rush is indeed what's holding up the dollar, we could see the next leg down start after mid-month.

On another interesting note, a chart of US Treasury holdings by country shows some interesting figures. First, net Chinese purchases of Treasuries has been flat over the passed four months. Japan's net purchases have been nearly flat since January. Korea's holding are about the same as they were in May. Bottom line: Asia has stopped soaking up U.S. bonds. Without the major funders of our deficit playing ball, we are looking at either 1) an economic crises or 2) sharply reduced government spending. With GW in office, the latter is not likely.

The second observation is to see what the "smart money" is doing. Now there are not many governments that can be considered smart money, but if I had to make a short list, Israel would be at the top of it. So what have they been doing? Selling, and selling a lot. Israel has reduced their U.S. Treasury holdings by a third since the beginning of the year. This data point could prove to be very telling. I wonder where they're moving the money? Gold, maybe?

Disclosure: Long XMSR Puts


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