9-7-06 Keeping It Short!

Good Evening.

The markets gains that were racked up in August have been slowly slip sliding away over the past couple of days. Kcap readers who followed our recent advice to get defensive around 2185 - 2190 are finding much relief as it seems evident that a temporary top around NASDAQ 2200 seems to be in place. The slow volume drift higher that the market experienced in August dramatically increased the risk of a nasty pullback. This recent leg down has the potential to take the averages to new lows primarily due to seasonality.

In essence not much has changed with corporate fundamentals or the macro economic outlook to break the market out of its funk that it started experiencing in early May. Ultimately the August rally will seem more like a reflex bounce rather than anything more meaningful. The good news for the Bulls is that sustainable upside market action will come much later in the fall after the second wave of carnage wreaks havoc, but that's for a discussion at a later time.

Today's poor market action in the morning led to an intraday attempt to the upside in the afternoon. Rather than fresh buying from the Bulls it seemed more like some short covering from the Bears who caught the top of the trading range (Kcap anyone?) with some well placed shorts. Fortunately for the Bears the new downtrend resumed its course later in the day bursting the bubble of any bulls who were hoping to claim yesterday's carnage as a "one day Bear wonder". In fact the downside pressure was relentless between 2pm and4pm as opposed to the typical half hearted attempt in the final 20 minutes. Hawkish comments from Federal Reserve Governor Janet Yellen who is normally seen as a Dove provided a handy excuse for the Bulls to keep their wallets on the hip. This in turn allowed the Bears to re-short some of their positions that they covered earlier (Kcap anyone?)....now we sound obnoxious.

The Dow Jones Industrials also felt heavy today which kept further pressure on the NASDAQ despite the slight levitation in the SOX. Unfortunately for the SOX lovers, NSM guided revenues significantly lower after the close but what do you expect from NSM (Not Saying Much Semiconductor).

Your friendly neighborhood Kcap Team believes that a "sell the rally mentality" has kicked in. There are lots of gains to protect from the August rally and traders will be aggressive in locking them in now that the downtrend seems to have been confirmed. We also believe that the energy complex which has been acting terrible lately may have one more leg up before that party is fully over. There are plenty of catalysts that can still send Oil reaching for the highs over the next month or two. We will be watching XLE should the commodity take off in order to gauge the correlation of energy related equities to the actual price of Oil. Underperformance in XLE may be a signal that indeed a long term top in that complex may be forming. However declaring the death of this sector may be a little premature.

If You Held a Taser to Our Head:
We will be looking to add to our short exposure on any rallies. The likelihood is that the NASDAQ will find its way to 2125 over the next week. While we do not dismiss that a vicious upward Spike may take place once the NASDAQ reaches that level, we firmly believe that last week's highs will not be breached. In fact although NASDAQ 2125 would present a tradable long side rally, the smart money would be better served by shorting the pants off of that move especially near the upper end of the range.

Hope you did well.

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