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September 19, 2006

Warning Shot

The PPI numbers published this morning were much lower than anticipated, showing a mere 0.1% gain for August producer prices. This report was followed by the Commerce Department's housing report, showing a 6% decline in housing starts, as well as the seventh consecutive monthly decline in building permits. Yesterday we learned that confidence among home builders is at a 16-year low, and a number of home builder CEOs have expressed surprise at the levels of speculation in the market and the rapidity of the market chill. There is no question that housing has more pain ahead.

These weak figures bolster the case for the end of rate hikes by the Fed, so the fact that stocks did not respond bullishly lends credence to my postulation that equities are simply tired.

The housing report took the wind out of the recent rally in homeys, knocking them for 2% in today's action. The biggest decliners included Centex, Toll Brothers, and Beazer. This news is hardly a cheery development for lenders, either, but most of them managed to recover early losses and close higher. I am still hunting for shorting points on this group, with my eyes on Novastar, New Century Financial, and Countrywide, as well as Washington Mutual.

Gold and silver, which tend to rise with inflation expectations, both slumped heavily after the PPI report. If there is no inflation, there is no future in gold and silver, right? This typically linear mode of thought is what traps most traders. In fact, the housing report is what deserves more attention, not only because it is more accurate than the fabricated PPI, but because it has been housing which drove our economy over the last cycle, and it is housing that will lead it down. We are only in the beginning stages of what is likely to be a severe downturn. In a quarter or two, when the scale of the carnage becomes more apparent, people will panic, and the Fed will trash the dollar in an attempt to hold things together. Therefore, these dips in metals prices will prove in hindsight to have been an even better buying opportunity than 2001.

Before rushing to stock up positions, however, gold bulls should take time for a history lesson. In the 1970s, gold's initial bullish surge saw the price nearly quintuple from around $40 to nearly $200 by the end of 1974. We all know that by 1980, gold's run peaked at $850. However, few remember that after 1974, its price fell nearly in half, bottoming in 1976 at $110 before starting its next surge. A severe recession could spell a replay of that 1974-6 action, so caution and patience are warranted.

The paragraphs above were mostly constructed early in today's session, and I was planning to close this post by speculating that a handful major earnings warnings were all we need to accelerate the selling. Then Yahoo stepped in about midday and got the party started, saying that its current quarter is looking soft. The news sent Yahoo shares tumbling 11%, and they were joined by large drops in other Internet shares such as Google, eBay, and Amazon. The development sent the NDX reeling 1.5% and the SPX nearly 1%. For a change, it seemed like bad news was not being treated as company-specific. I think the infectious nature of the Yahoo news is important because over the last year, the effects of bad news have been contained to the shares of the violating company. As we hear more of these warnings, the markets will be in for trouble.

Much to the chagrin of bears, however, the indices put in nice late-day recoveries. The end-of-day rally should not come as too much of a surprise considering there is a Fed meeting tomorrow. It is pretty much a given that rates will be held steady, and I suppose traders are banking on some soft language. Even so, I don't see much upside left in stocks, if any.

Disclosure: Long YHOO, AMZN Puts


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