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May 24, 2006

Reading Your Futures

Index futures threw traders yet another curve this morning by indicating nearly half-percent gains on the open. Big players had other ideas and sold stocks right out of the gate. Within five minutes of the open, major indices were sporting nearly half-percent losses. The selling wasn't ubiquitous, though. Several stocks showing limpness in recent days were firm, including Sandisk, Lam Research, Google, and Applied Materials. The strength in these recent losers turned out to be the important clue to today's action as the markets turned and headed quickly higher.

The buying spree lasted all of an hour until the new home sales number was published. A surprising increase the April new homes sold renewed fears that the Fed is not done hiking, and stock indices spiraled about 1%. However, the selling was pared late in the session as we saw the bulls, for the first day in quite some time, muster some decent strength in an impressive reversal of the midday slump. The bulls now have to prove they've regained some footing. I'll be on the lookout for an explosive rally tomorrow. If we don't see it, I will consider re-entering or adding to some short positions, depending on the overall feel of the action.

Surprisingly, the home builders did not rally on the new home sales report, which saw not only a higher level of sales than expected, but an increase in the median sales price. Perhaps the fact that unsold inventory lingers around 6 months has something to do with the lack of enthusiasm. The inventory glut is an even bigger problem for Building Materials Holding because it implies construction will slow rapidly. What may surprise my readers even more is the fact that I closed my BMHC short position along with all my put options today. Obviously, I don't think the environment has changed. I simply believe the chances of a large counter rally significantly outweigh the chances of a shaper breakdown at this juncture, so my moves are all about risk control. I may be proven wrong, but I have to trade things the way I see them.

Another litmus test for the current market environment came in the form of the Vonage IPO. The Vonage issue was priced at $17 and immediately plunged more than 10%. That a high-profile IPO failed so miserably is a telling sign of the current appetite for equities by those who drive the market. Granted, Vonage's business is more or less under siege by cheap... and even free... competition, but such nuisances have not stood in the way of rampant speculation in recent years. For the record, I was offered the opportunity to participate in the IPO, but passed.

Disclosure: Short SNDK; Long SNDK, GOOG Puts


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