Bulls 'SPIT' in Our Face! 9-13-06

Good Evening.

Obviously we were wrong when we predicted that the NASDAQ had reached a temporary top around 2200. Just when we were feeling good about ourselves for calling the top within 1% and having the NASDAQ work its way down to 2147ish we and other poorly positioned traders were hit upside the head with a vicious spike higher. Perhaps it was a relief rally in celebration of the fact that September 11th passed without incident. Whatever the reason, the rally was noteworthy in how it caught so many people off guard. To add insult to injury, the breaching of the recent highs has added more complexities to the situation, essentially bringing back a "buy the dip" mentality just when a "sell the rally" mindset was kicking in. Your friendly neighborhood Kcap Team decided to cover much of our short exposure but still found ourselves severely underinvested on the long side. Oh well, this is not the first nor the last time that Kcap will be beaten with an ugly stick by Mr. Market. The good news is that we did not lose any money rather we did not participate to the upside in a manner that would make our clients proud. This too shall pass.

Does this mean that we have suddenly reversed course and have stuck a ring through our nostrils, snorting, grunting and drooling allover the marble floors? Come on, you know we don't have marble floors and we don’t' get scared by Mr. Market that easily. The problem with the recent spike is one that has been nagging at us for the entire climb off of the July lows. Seasonality is still very much in its infancy and the market internals such as decreasing new highs, low volume, unimpressive breadth, poor relative strength and other technical indicators are showing noticeable signs of deterioration. Furthermore, we are harboring serious concerns about the upcoming earnings season and how disappointments and poor guidance may become abundant. Early indicators such as commentary from the CEO of AN, reports from TXN, GS, LEH, XLNX, and our channel checks do not lend a comfy cozy feeling that inventory issues and margin pressures have been fully worked out.

Several weeks ago, we wrote a post outlining all of the issues plaguing the market which gave the Bear his ammunition. Miraculously all of these issues now have the perception of having been mended or resolved. Here's a wakeup call: NOTHING IS AS BAD AS IT SEEMS OR AS GOOD AS IT SEEMS and right now everything seems good. When the perception starts turning to a half empty environment, the deterioration of the internals of this market combined with its recent 10% lift off of the bottom, makes adding new long exposure here very dangerous indeed. We are not suggesting that the recent spike over the last few days can't continue a little further however, the risk vs. reward is very unfavorable in our beaten up and humble opinion.

Even today's action started to show signs of 'crackage' (we're thinking more of a plumber rather than Pamela Anderson in tight jeans). The momentum seemed to have slowed and the volume did not keep pace with yesterday's action. Semiconductor stocks pulled back and Energy stocks showed signs of a rebound. The low quality, low priced, high beta stocks which led this two day rally also showed signs of slippage. Basically the junk names led to the upside simply because portfolio managers were looking to play catch up after finding themselves so underinvested. Usually, in that type of scenario, these names come down dramatically faster than they went up.

If You Held a Taser to Our Head:
The problem with our Bearish view is that the recent Spike higher may have delayed the timing of our prediction. We are now faced with a market that contains a 'buy the dip' mentality which will need to be worked off with a couple of lower high failures. This may take a couple of weeks for there to be any payoff for the Bears. Even a 2% - 3% pullback from here would likely attract dip buyers who were just recently successful. The other problem for both Bulls and Bears is that nobody is brave enough to fully commit at this point in time due to the fear of being whipsawed. Therefore, choppy and sideways action for the immediate future might be the likely scenario. Either way, we will be trading with a short side bias every chance we can but a lot less aggressively until the market shows more signs of failure.

Hope you traded well.

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