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May 10, 2006


Readers of these pages will have received no great shock to hear the FOMC state that more interest rate hikes may be needed after today's quarter-point hike. With the dollar tanking, the Fed simply cannot come out and say they are done or even near done with rate hikes. We all know the dollar is doomed, but the Fed, as well as other major central banks, do not want it to go down too quickly.

Reactions in the markets were surprisingly muted. I had perceived that a premium had been built into prices around expectations for Big Ben to turn dovish. Apparently, such expectations were not so ubiquitous after all. Any traders straddling or straggling asset prices around this Fed meeting are seeing the worst possible outcome: sideways movement. Granted, there have often been delayed reactions to Fed announcements, but at this point the markets are making the May meeting look like a non-event.

Whether the Fed does indeed raise rates again, I don't know. When they say future decisions will be "data dependent," they simply mean they will keep raising rates as long as they think they can get away with it. The one-and-done crowd has been cheering loudly through at least four hikes now. I've been saying for months that the Fed will keep hiking until forced to stop by the will of the market gods, most likely manifested as some sort of crisis. The pertinent question now is whether the markets keep responding to the one-and-done cheerleading or finally capitulate in defeat of that belief. Ironically, a general rejection of the one-and-done theme may be what finally causes it to come true.

Last night, Cisco held an earnings conference call during which Mr. Chambers pulled off a classic bait and switch tactic. Their latest quarter hit estimates squarely on the nose, and Chambers gleefully claimed that the recent woes of competitors did not apply to Cisco. Indeed, based on recent reports from Juniper, F5 Networks, and others, traders were expecting Cisco to come in a bit low, so when they didn't, the stock popped a couple percent. Then came fourth quarter guidance. It was unimpressive, especially on margins, and Cisco tried to blame the margin shortfall on problems with its Scientific-Atlanta acquisition. Traders didn't buy it, sending Cisco shares reeling. They closed today with about a 2.5% loss.

Whether related to Cisco's problems or other reasons, semiconductor stocks were very soft today. The SOX lost 2.5%, with players such as Broadcom and AMD off 3.3% and 4%, respectively. Intel also had a weak showing, falling 1.3%, and Lam Research, a big supplier to the semis, was weaker by about 3%. The weight of inventory and excess capacity problems may finally be about to make its way into stock prices. Many of these companies are ambiguously blaming revenue shortfalls on capacity problems, but as a good friend of mine cleverly points out, the only capacity problem they are suffering is the capacity to sell their inventory.

Disclosure: Short INTC; Long INTC, LRCX Puts


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