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May 5, 2006

Reward Ratio

Any day now, stock trading textbooks will drop "risk" from the term "risk-reward ratio" since the former no longer seems to apply to decision-making in the markets. The playbook these days simply calls for determining which sector will go up the most. On the heels of this morning's jobs numbers, traders, for the third time in a little over a week, flipped their opinions on the immediate future of Fed policy. Equities discounted a Bernanke put and leaped about one percent across the board. The S&P 500 now looks to be putting in a major upside breakout while the Dow Jones Industrial Average is within a whisper of its .

Earlier this week I did something I said I wouldn't do, and that is go long Home Depot. I have highlighted this stock's bullish rising wedge on my stock charts page, and commented that although the technicals pointed toward a major upside breakout, I was hesitant to play it due to my overall market outlook. However, given the short positions I've put on recently, I decided that having a long, particularly one that looked so compelling, would provide a much-needed hedge to being wrong about the direction of the market. HD shares did their job today, jumping about 2.5%.

Toll Brothers trimmed its 2006 sales target this morning in a preliminary Q2 report. The sales adjustment was a mere 200 homes lower than the previous forecast, and this minimal revision sparked a 4% rally in TOL shares. I doubt that the data itself is responsible for today's pop, but rather that home builders in general were oversold, and Toll's news provided a catalyst. Across the board, the homeys were up about 3%. I was fortunate to close my put position in TOL yesterday afternoon, and I will look to possibly re-establish that position before their official earnings report on May 23. My only open play on the housing story, Building Materials Holding, slipped a couple percent, showing weakness not only in light of the S&P breakout, but in the face of the home builder rally, as well.

Gold managed to finish the day at a new high of $682 while silver edged up a dime to approach $14 again. The miners, though, failed to participate, with the Amex Gold Bugs Index down almost a percent. Pan American Silver slipped 2%, but still doesn't look compelling to me.

Expectations of easy money also sent the dollar to a new one-year low. As many other writers have pointed out, we now seem destined for a test of long-term support around the 81 area on the Dollar Index. I continue to believe Bernanke & Co. will make an effort to help the dollar pass that test by talking tougher than expected in next week's meeting.

Just in case no one has noticed, the Dow Jones Transportation Average put in one of its largest weekly gains ever this week, rallying 6.5%. It has now officially doubled from its 2003 low... a doubling that occurred while the price of oil went up nearly three-fold. Consider that equities in general also have experienced an unusual positive correlation with commodity prices and, it makes a rather compelling case for hyperinflation, doesn't it?

Disclosure: Long HD; Short INTC, BMHC; Long INTC, BMHC Puts


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