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February 21, 2006

Ugly Stick

Equities got beat with the ugly stick today, as they stumbled out of the gate and stayed down. The hardest-hit index on my screen was the Nasdaq 100, which is heavily weighted with drooping tech stocks such as Apple, Applied Materials, Dell, Juniper, and Yahoo, not to mention retailers Amazon and Whole Foods, all of which were down. Once again, the big damage was contained in the tech arena. The Dow and S&P 500 were both down less than a half percent.

A prominent financial news source (hint: it's owned by the mayor of a major north-eastern city) blamed Wal-Mart's earnings miss for today's weak action, but WMT was only down in-line with the market. If one is to place blame for market weakness on a single issue, at least pick an issue with an exacerbated move. The same news source also pointed to higher oil prices… crude was up 2%… but as I've pointed out before, oil and stocks have almost no correlation to each other in the short run. The truth is no one really knows why the market went down today, and it is a rare occasion that we can produce a direct explanation.

I have an age-old gripe against loose financial reporting. In recent years the shoddiness seems to have become more pronounced, and it is not limited to the source to which I alluded above. We traders have to read everything with a grain of salt and a resolve to filter facts from unsubstantiated opinion.

Back to the markets… bulls will be put to the test over the next few sessions. Last week saw the Dow break out to a multi-year high, and the S&P 500 is approaching the upper end of its trading channel. The next large move put in by the stock market will largely depend on the direction from which stocks exit this channel. You will notice in the chart below that equities are displaying a negative divergence with momentum, so it is unlikely that we are about to break out to the upside. We saw a similar divergence in late 2004 and into 2005, leading to last spring's wipeout. I would expect that, at a minimum, we will return to the lower trend line. Given the narrowness of the channel at this juncture, we will likely see it broken soon. The market will either start a powerful rally off the lower trend line or see it broken to the downside. Regular readers know I put higher odds on the latter.

stock chart

Metals started the day well, and silver stayed strong… up almost 2%… while gold backed off to finish flat. I'm having a hard time getting a beat on the metals action at the moment, though my inclination is to say they're going up from here. Bearishness is seeping from about every corner of the market. Most writers are playing it safe by saying they are long terms bulls, but expect a pull-back after the nice run we've had since August. I think we're in a stage of the bull market where anyone who sits around waiting for a bigger pull-back will be caught flat-footed.

Disclosure: Short AAPL; Long YHOO Puts


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