Sitting in the Corner, Not Eating our Pie. 10-6-06

Good Afternoon.

Like good little machines, the dip buyers have been falling into place robotically buying every shallow pullback. The Dow's ‘perceived” convincing break above the all time record finally managed to pull the NASDAQ along for the ride. The Hedge Fund community is writhing in pain as all the major averages are far outperforming the typical Hedge Fund manager, especially the long/short variety. The nerves of these managers are so frayed that they are now throwing caution to the wind and adding more long side exposure. In order to avoid being whipsawed, many of our brothers are seeking out long side exposure in names that offer decent upside potential but have lagged other sectors. The Bio-Tech group comes to mind…BBH anyone? This is not a terrible idea but would require very tight stops. Furthermore, this is usually a sign that the end is near…although if we hold our breath any longer we'll be bluer than David Blain when he emerged from the tank. Has anybody heard from David Blain recently?... Just wondering…

The emotions are running high as everyone feels that the long awaited Bull market has finally arrived and they are missing out. Please remember that psychology changes on a dime but fundamentals do not. Currently the universe is beautiful and if it feels good 'just do it'. Unfortunately the fundamentals do not share such euphoria. The recent earnings miss from MU adds more confirmation to the fact that Semiconductor stocks and OEM's are still carrying significant inventory which is not as of yet being sopped up by demand. MRVL and NSM were the first major Semiconductor companies to show that the sector is in trouble and MU put the fundamental icing on the cake. We can not wait to hear from INTC, although they will probably do a decent spin job.

What is even worse is that stock prices in technology land have more than priced in strong end user demand for the next few quarters despite plenty of signs that the economy is cooling faster than is comfortable. Even today's sharp decline in new jobs added versus August payrolls demonstrates how caution has broken out among corporate CEO's in the past month. Furthermore, recent polls taken of corporate CEO's intermediate term future outlook for their companies are showing an extreme drop-off compared to several months ago. This means that capital expenditures as well as hiring are suspect in the near future. This is but one reason why Kcap expects continued soft guidance when corporate earnings season kicks into overdrive over the next few weeks. Heck, if you were a CEO with a new found lofty stock price and signs of a slowing economy that might accelerate to the downside, wouldn't you sand bag just a little when delivering guidance to the analyst community later this month?

The Bulls will spin any soft guidance claiming that CEO's are playing it conservative. However, what happens when some of the current psychology of today's issues, i.e. Iran, contained inflation, North Korea, low energy prices, etc. suddenly start to flip in a more ominous way? After all, it has only been a few months since every one of these issues were scary front page news and most of them remain very much unresolved. More importantly, how will Bears in Bull suits react to new doses of bad news that the market has yet to grapple with in 2006? We are not trying to predict what that news might be, but are only suggesting that Murphy's Law is a force to recon with.

If You Held a Taser to Our Head:
In essence, the market has priced in a host of positives and is unprepared for anything else. The risk reward setup continues to be unfavorable and we are refusing to cave in to the emotions of the moment. Don't get us wrong, we are carrying plenty of longs in boring defensive names and lots of shorts in Semiconductor land. We are occasionally covering our short positions and remounting at higher prices to better our cost basis. We are also holding plenty of trash ..er.. cash. We are finding it very difficult to find stocks to go long that are not severely extended. Therefore, not forcing trades seems like the smart thing to do, despite the dunce cap so many of you would like us to wear at this point in time!

Have a good weekend.

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