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May 23, 2006

False Rally

Pre-market futures hinted that we may see the sharp reversal I've been anticipating. Indeed, the markets popped strongly on the open as if they would follow through with the threat, but the first 45 minutes contained all the rally the bulls could muster. By midday, equities were putting in a pretty weak showing for a rebound day. Counter-trend rallies in bear markets are typically violent. The meekness being displayed by bulls made me think today's rally would fail, so I jumped in and rebuilt some of my put positions.

In the last couple hours my read was validated as the major indices slumped heavily. The NDX fell 2% from its high with several of its component stocks falling dramatically. Check out the late day swoons in Sandisk, Amazon, Starbucks, Whole Foods, Yahoo, and Applied Materials. All this weak action does not bode well for the market's near-term outlook.

As expected, mining stocks put in a sharp rebound, fueled by solid gains in precious metals, but alas, their 4% gains were eliminated by the aforementioned weakness in equities. For those of you who wonder if a stock market slump would drag down mining shares with it, the answer is yes, at least in the short run.

The Office of Federal Housing Enterprise Oversight announced it would fine Fannie Mae $400 million as punishment for their fraudulent accounting practices. The size of the fine is barely punitive, but by fining the company, regulators are really only punishing current shareholders. If the U.S. Attorney General does not pursue criminal charges against previous management, no faith can be restored in our financial system. However, given that former CEO Raines is so well-connected politically, it is doubtful that he will ever face a court. Fannie Mae shares rallied on the news, likely in celebration of such a small fine. Freddie Mac shares were heavy before Fannie shares were allowed to open, but later recovered most of the loss.

Over the passed week, futures have consistently popped nicely before the market's open only to be negated during the course of regular trading. This pattern makes for the temptation to sell the futures in the morning, but such action would be risky... one of these days, the futures will be right! I believe a more prudent course of action would involve cherry picking some shorts and only getting more aggressive once we witness a counter-trend rally. Of course, there is some history to support an all-out freefall from here, and with both bulls and bears now anticipating a rebound, perhaps a freefall is what we'll get.

Disclosure: Short SNDK, FRE; Long SNDK, YHOO Puts


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