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February 2, 2006

What Bulls?

For all the credit given to the bulls for their recent fortitude, they sure looked weak today. Major indices went out near their lows, and were down around 1%. The Nasdaq 100 fell nearly 2% on continued weakness in tech. Today's sell-off seems to be sparked by this morning's labor reports. Index futures fell immediately after the report revealed accelerating labor costs from last quarter. The trail of thought: higher labor costs means higher inflation means higher interest rates. As we all know, interest rates are forefront on traders' minds these days.

Even with a slump, the bulls managed to hold the line at key support levels today. As we can see in the chart below, the S&P 500 held right at its moving average (I've found a 55-day MA to work much better for this index than the commonly accepted 50-day MA), as well as its trend line for the 2006 rally (which I do not show):

stock index chart

Also, the NDX held a support line for the 2006 rally, as well as its MA:

stock index chart

A significant breach of these support levels could result in an elongated spill for stocks, perhaps down to the lower trend lines.

Although tech lead the way down today, weakness was across the board. The only strong gain on my screen was posted by Pan-American Silver, which soared another 4.5% despite its underlying metal trading a bit lower. Perhaps today's move was a follow-thru on the Cramer Effect. In any case, I took advantage of the strength to reduce my position a bit. I am still bullish on the company, but after a 38% rise in two weeks, my exposure to PAAS became large enough to dictate a bit of prudent trimming, especially since the position consists entirely of call options.

Despite firmness in the bond market and a decent report from Pulte Homes, home builders got smashed today to the tune of 2-4% across the board. I put a short on PHM in the early going. They showed initial strength off their report while the rest of the homeys were careening. Indeed, PHM eventually capitulated and fell in line with the sector. As I pointed out in yesterday's post, the home builder sector is showing signs of technical weakness. I see the odds being in favor of a test of the November lows. However, this group threw some nasty curves in 2005, so I will be wary and follow my trade with a reasonable stop.

As I conclude today's write-up, I see that Amazon missed with its earnings and is off 11% after-hours. Let's call it a bit of unwinding of that mystical Internet premium these online retail stocks keep enjoying. This play is one that I saw coming, but got shaken out of early. That's the life of a trader. In any case, their drop may make it difficult for bulls to hold the support lines tomorrow.

Disclosure: Long PAAS Calls; Short PHM

 

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