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July 18, 2006

Short the Mall

Target lowered July same-store sales forecast, and the news dealt a blow to retail stocks across the board. Target, Best Buy, and Nordstrom, just to name a few, were all down around 4%. JC Penney was down more than 6% at one point on the heels of a downgrade by AG Edwards. The process of consumer stocks following homeys into the abyss is well underway. The Consumer Discretionary SPDR has fallen 6% in the last five sessions and about 12% since early May. This ETF experienced a similar slide nearly a year ago, and it remains to be seen if new lows will be set. Given that household debt service ratios have spiked in recent quarters, I simply don't see how consumers avoid pulling back. So in my view, these shares will likely trend lower for quite some time.

Watching the first half of today's session, I couldn't shake the feeling that the big boys wanted to move the market higher. Major indices have been bluffing rally for two days, and short-term momentum indicators have been turning positive. At the same time, the action has been fractious at best. A backdrop of pessimism pervades on all frontsÂ… fear of higher interest rates, earnings jitters, and concern over geopolitical eventsÂ… and all these concerns were exacerbated in today's news.

Despite this undertow, the pessimism seemed overdone, and the scent of a snap counter-rally wafted across my trading desk. Not long after mid-session, with the S&P 500 off three-quarters of a percent and the tech-heavy Nasdaq 100 down twice as much, I significantly reduced my short exposure by repurchasing some index futures I had sold a couple weeks ago. As luck would have it, both indices rallied strongly into the close, finishing up for the day.

At least for a few hours, the move looks prescient. However, we are heading into a week of earnings reports from heavy hitters, and anything can happen. The fun begins with IBM and Yahoo this afternoon. I do have the impression, though, that the near-term oversold environment lends an upward bias to the reactions to these reports. I'm not saying the stocks will rally after their reports, but rather that the oversold environment lends some degree of support.

Metals were bashed again today bring their two-day losses to 90 cents for silver and $33 for gold. A strong PPI figure published this morning renewed fears of a tough Fed, though at least in the case of stocks, these fears were a distant memory by afternoon. While the volatility may cause a smattering of dismay among metals bulls, the action is hardly unusual for a corrective period. For those of you who fancy trading such swings, the next few months should prove quite accommodating. For my part, I simply intend to wait until I sense a new bull run upon us and then get aggressively long.

Disclosure: Short XLY; Long YHOO Puts


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