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April 25, 2006

Second Thoughts

Building Materials Holding reported earnings this morning which included spectacular year-over-year gains. Prior to regular trading hours, the shares were showing a $2.70 (7%) gain. A few minutes into regular trading, we were sitting at about a $1.50 gain, and not long after the first hour had passed, BMHC had plunged to a $1.50 loss. I've noticed this behavior of reversal arising frequently this quarter. Take Broadcom, for example, which reported earnings last Thursday afternoon. In after-hours trading Thursday, BRCM was showing a $1.50 pop, but Friday's market punished the shares to the tune of about $2 (that is $3.50 below the after-hours level). Intel also saw an initial 2% pop on its earnings report only to cough it all up, plus much more over the next three trading days.

What's going on?

At first glance it would seem that traders are simply having second thoughts about earnings reports. However, this explanation seems too simplistic. A more plausible explanation would involve manipulation by fund managers who take advantage of thin off-hours trading to ramp a stock and give the illusion of a positive earnings reaction. They would hope that their imposed reaction would take hold, perhaps by squeezing the shorts or drawing in momentum players. The hole in this theory is that such action is obviously a quick way to forfeit your fund's capital. Of course, such risks have rarely deterred eager fund managers from frivolous action. If anyone else has a theory on these reversals, please let me know.

BMHC finished the day down 10%, which means I've made out pretty well with my positions. Given the deteriorating condition of the housing market and the weakness being displayed by BMHC's chart, I decided not to reduce my positions in the wake of this pummeling. I don't know whether this decision will prove wise, but I have a feeling there are far darker days ahead for the homeys. I am simply going with my instinct on this one and may very well change my mind tomorrow.

A figure for existing home sales for the month of March was published today, showing an unexpected increase. Chief economists from several large brokerage firms immediately jumped on the news to proclaim that the March figure was a clear sign the housing market would slow gradually, not crash. Once again these meatheads are taking one data point and extrapolating it ad infinitum. Should the April figure show a sharp drop, these same economists would immediately flip their outlook and pretend they knew what was going on all along.

Consumer confidence also clocked in a bit higher than expected. Whether in reaction to these two data points or due to more compelling macro factors, bonds took it on the chin today. The 10-year Treasury climbed to its highest yield of the year at 5.08%. This move in long yields has to be discouraging to bulls who were looking at bond charts which were appearing ready for at least an interim rally. At some point... I don't know when... these rising yields will matter to equities. When that point arrives, I believe things will get very messy, very quickly.

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


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