9-29-06 Teddy Bear Growing Claws.

Good Evening.

This week, market participants were obsessed (thanks mainly to CNBC) with closing the Dow at a new all time high. Unfortunately for the Bulls, the prize was not delivered. Even if it were delivered the absolute return on the Dow over the past decade has been completely pathetic. No one has made any real money on the Dow even if it were 500 points higher than todays close. However, psychology is an important aspect to the market and perhaps closing over 11,722 portends better times ahead, at least that's what the Bulls are convincing themselves of. In our humble opinion, new highs on the Dow would need to be accompanied with better performance from the other averages. In fact, large cap growth stocks are astronomically far away from anything close to their highs. Market internals are pathetic and most smart institutions know that this is a suckers rally.

Economic news this week was mixed and didn't deviate enough from expectations to provide fuel for either Bears or Bulls. Essentially, the Dow has been running on its own price momentum with the help of "end of the quarter markup games" and forced excitement in its quest for a new high. Whether or not the failure for the Dow to close over 11,722 for the second day in a row means anything, remains to be seen. Certainly should the market pullback next week and potentially morph into a down trend, people will look at the non-confirmation in the Dow as an indication that something negative was brewing. In other words, the Bears have a small window of opportunity to create this scenario by leaning on any profit-taking next week. We are not suggesting that a downtrend is imminent, rather that we would not be surprised for this to develop from this juncture.

Notably, Gold and Oil seem to have regained their footing which may continue to pressure the major averages. Presumably many traders have started to rotate back into the commodity complex in order to get ahead of their fellow traders who might be thinking the same. All in all, it is difficult to make any bold predictions about the near term direction of the market. What we do know is that the air is very thin up here and the risk reward ratio is unfavorable for the Bulls.

The market has rallied nicely in September, primarily from the decline in rates and Oil. We believe that current levels of rates and Oil are not enough to keep the Major Indexes powering forward despite their relatively low levels versus one month ago. The downward momentum in rates and Oil is important for the continuation of the Dow's rally more so than their absolute level. Try to imagine what would happen to the market should it become the consensus that both rates and Oil are heading higher in something more than a dead-cat bounce. We doubt very much that the support underneath the Dow and NASDAQ is sufficient enough to keep them aloft. Furthermore, earnings will be the next catalyst and that should not give Bulls a comfy, cozy feeling based on the few reports that have been received so far in conjunction with the evidence that the economy is slowing. Few companies are likely to deliver solid earnings and guidance. You may get one but not the other.

If You Held a Taser to Our Head:
Please do not listen to arguments that the market is still cheap after this rally. We will not know how to value the market until we hear the majority of companies collected guidance for 2007 earnings. Kcap is continuing to use strength to build our short positions and dips for partial covers. However, we plan on doing heavier shorting into rallies and lighter covering now that the artificial support has ended. We are Bears slowly on the prowl and our appetite is growing.

Have a good weekend.

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