The Counterintuitive Stare Down. 5-18-06

Good Evening.

This has to be the most amazing cowardly display that we have seen from the Bulls in many many years. Even during times of disaster when the market was actually in the process of losing significantly more value there were at least a couple of up days. The fact that traders cannot even manage a flat close means, either that they have suddenly become great seers, forecasting a horrific Bear Market or that they are a new breed of Bulls unaccustomed to normal volatility within the markets.

We strongly believe that most market participants are of the tiny hedge fund variety and have not suddenly gained any new abilities to accurately predict the future. Furthermore the low volatility in the market over the past few years in combination with the thousands of hedge funds that have cropped up lends a credible argument to the fact that today's Bulls truly are inexperienced in dealing with normal market volatility. They all seem capable of handling intraday ups and downs but are completely inept at stepping into good stocks that have fallen for sequential days.

The VIX has appreciated to levels not seen in a long while and is further evidence of the emerging volatility that is slowly incorporating itself into the lives of market participants. Over time these newly minted hedge funds will learn to capitalize on these types of market swings as opposed to living under the day trading mantra. In other words, as long as the fundamentals remain solid (which they are), the lack of desire from the inept Bulls is not sufficient enough to have us abandon our favorite names and Bullish thesis at this time. While we do recognize that the market has suffered technical damage and will likely chop around for several weeks, we're cognizant of the fact that base building leads to better Bull markets. Don't get us wrong, we are certainly feeling our share of pain from this recent decline as many of our speculative positions have taken breath taking dives. While we took the opportunity to raise cash last week we were sufficiently long to still kick ourselves numerous times in the buttocks!

The market is poised for an imminent and breath taking Spike to the upside. The fact that a last minute shakeout was dealt to the Bulls in the final hour of trading today provides evidence of capitulation. In fact all of the major averages were down roughly the same across the board, further demonstrating the complete give up. Does the give up have more to run? Most likely just a little, however at this point in time every quarter percent loss in performance feels like a twisting knife in the gut of most money managers.

The handy excuse for the recent decline seems to be the reality of inflation and lack of credibility from the Fed to handle the dilemma. Surprisingly, the bond market vigilantes seem to be forcing the Fed to act more hawkish than Bernanke would like to be. The threat of long term inflation is real and bond market participants want it dealt with firmly and promptly. They are not interested in a pause anymore from the Fed and Bernanke's words of waiting for more data points are falling on deaf ears.
The lagged effect of past interest rate increases will likely provide the magic to slow the economy according to the Fed's prediction in their model. However, bond traders would rather take matters into their own hands by selling long term bonds, lifting yields in order to slow the economy in their own way. This is a clear attack on the credibility of Ben Bernanke and we strongly recommend that he not cave to the pressures of the bond market vigilantes. How beautiful will it be should the Fed still pause in June, only to have the economy soften greater than the bond vigilantes expect subsequent to the June meeting. Should that happen, Bernanke will have met his first major challenge and proven his ability, foresight, stamina and brilliance to make the right decisions in a complex no holds barred environment. Think about the next time a showdown were to materialize how much more clout and calm he would be able to exercise over the bond market and thus the stock market. What we have here folks is the reincarnation of Alan Greenspan in the making.

Cool Stuff.

If You Held a Taser to Our Head:
The NASDAQ is likely to get the biggest one day upward Spike in years sometime by the end of next week. Kcap will likely lighten some of our exposure into that Spike and not before. We intend on using the subsequent choppiness in the market after the upward Spike for trading opportunities while we await the congestion phase to play out.

Hope you traded well.

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