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September 14, 2005

Tug O' War

Bulls and Bears have their guns loaded, as one of the greatest battles the market has seen in decades continues to unfold. Mortars are flying in each direction, bulls citing the likelihood of a cessation in rate hikes by the Fed, bears countering with missed results in consumer bellwethers like Best Buy and Dell. The bears took the day, dropping the Nasdaq Composite a little over 1% and the S&P almost a half percent. On the forefront are a peculiar quadruple-witching Friday (more below) and a Fed meeting next week. Whatever is baked in, the next 4-6 trading days are apt to be volatile.

Today's action provides a few interesting notes. First, Fannie Mae set yet another brand new low for the year. I've commented several times on my belief that the GSEs would be leading indicators to the eventual bust in housing stocks, and I still believe that to be true. Regardless of what the Fed does, I believe the homeys are done for.

Second, AMD is very close to passing Intel's share price. At the beginning of May, when I mentioned an arbitrage play of short Intel / long AMD, AMD was priced at $14.30, Intel at $23.50. Today, AMD is $23.50 and Intel is $24.50. Inversion in the "CPU-manufacturer stock price curve" is inevitable.

Both AMD and Fannie Mae show textbook cases of when fundamentals can overpower technicals, even in the short run. For over a month AMD has been technically overbought (to an extreme, actually), yet has continued to break upward. Fannie Mae has likewise been extremely oversold, yet has continued to break downward. This type of action is why no one should rely on solely technical indicators. There are times when it is too risky to fight the underlying story, even for a short-term for a trade. I have a name for these casesÂ… "Reality Re-alignments".

Regarding the quadruple witching mentioned above, Standard & Poors will be updating its stock weightings for the S&P500 at the close of business Friday. The change will implement what they call "full-float" weighting. What this boils down to is ignoring stock held by insiders who are not likely to sell their stake any time soon. Therefore, companies with heavy insider ownership will lose weighting. The stock most affected by this change is Wal-Mart, of which 40% of the shares outstanding are owned by insiders. WMT will drop from the 7th largest stock in the S&P by weight to the 16th.

This change likely explains WMT's weakness this week. Index fund managers will have to dump WMT shares to re-weight their holdings accordingly. An interesting trade may be to purchase WMT late Friday for a pop Monday. I've never followed such an update in an index closely enough to know the risk/reward ratio of such a trade. I already own a small position in WMT for technical reasons.

Disclosure: Short BBY, INTC; Long WMT; Long INTC Puts


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