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October 18, 2005

Lost in the Woods

Where to begin. The market is awash with interesting news, and its reactions are ambiguous. By now everyone is familiar with the debacle unfolding at Refco. This firm, which had a reputation solid enough to attract large accounts from people as savvy as Jim Rogers, announced bankruptcy out of the blue. The firm went public only a few short months ago, having to undergo intense financial audits and the scrutiny of the SEC. So, who dropped the ball in protecting shareholder interests? Granted, the SEC can only review what is presented to them. So were the auditors fraudulent? Did someone at Refco manage to fool them? Or did Refco really just mismanage their money so badly as to only turn sour in recent weeks?

Any way you cut it, this ordeal is bigger news than market performance would indicate. In usually form, the mass of traders treat this sorts of developments as isolated incidences, but I ask the question: how many other Refcos are out there, and at what point do they impact the financial markets. The risk is certainly out there, but doesn't seem to be reflected in prices, yet.

Turning to stocks, a few big names have delivered numbers to us this week. IBM delivered numbers that were in line with expectations, and most importantly showed a strong figure for new Global Services contracts. Given that IBM knew that the services number would be the focus of attention, I have to seriously question what types of deals they are cutting to get those contracts. Traders are celebrating the signings, but at this point all we really know is the top line. The next couple quarters could reveal these mechanics. My suspicion is that IBM accelerated contract acquisition by cutting sweet deals, so down the road they be forced to reveal lower margins and fewer contracts, both of which would devastate the stock.

In the hardware arena, Intel reported flat earnings disappointed a bit in their revenue forecasts. In the laughable department, they blamed the flat earnings on inability to meet demand for chipsets. Now if demand is so strong, why are companies at the end of the supply chains, like Dell and CDW, missing their earnings numbers? Shouldn't they be benefiting from pricing power in a strong demand environment? Something is amiss at Intel, and it isn't a supply problem.

Oil is dropped almost 3% today following a run-up attributed to a new hurricane in the Caribbean. Energy is a double-edged sword at this juncture. I continue to believe that the surprise in oil in the coming months will be lower prices. This conviction is a derivative of my view that China is cooling for the time being. However, given the political turmoil present in today's world, a crisis could pop up at any time and drive prices north of $100 per barrel. Having some sort of exposure to oil is prudent, and building it if and when prices subside will be my plan.

Disclosure: Short IBM, INTC; Long IBM, INTC, CDWC Puts


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