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August 22, 2006


Observing the action over the last four days, one would think equity markets were being filibustered. Markets have been captive to very narrow and inactive trading, which has resulted in a net change of +3 points on the SPX and -6 on the NDX. Basically, we are in the midst of a grinding consolidation period around which traders anxiously await resolution. Like the previous three sessions, today's action left very little for either camp to hang their hats on.

The environment has been incredibly tricky for all traders. Whether the current consolidation results in a continued rally or a reversal, I remain firmly focused on capturing the next big downswing which is sure to come. When it begins, I suspect many traders, including bears, will be caught flat-footed. Consider that complacency is running rampant. The VIX is near all-time lows. Odd-lot short sales are near the low end of their trend, meaning the small guy is not anticipating a lower market. Option premiums, which of course are tied to volatility, are pricing in almost no downside risk. For example, today I purchased Motorola April 30 puts for $6.60... that's $6.50 of intrinsic value and only 10 cents of time premium!

The following two charts are also worthy of note. The first is a one year chart of the S&P 500, followed by a graph of the number of SPX stocks above their 200-day moving average. What these pictures tell us is that the recent advance, like most of the advance earlier this year, is being lead by an increasingly narrow group.

stock chart

stock chart

Optimists like to be called optimistic, while pessimists like to be called realistic. Realistically speaking, none of this data bodes well for stocks. When placed against the backdrop of a macro picture which suggests a not-so-soft economic slowdown looms, I can't help but believe a sharp drop in share prices is upon us. We are simply missing a catalyst to begin the cascade.

Disclosure: Long MOT Puts


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