Perception is Reality. 9-22-06

Good Evening

There are quite a few things that make us doubt the potential for significant upside in the market at this juncture. We have explored our concerns on prior posts but will use this opportunity to list some of them again. In essence, all that were perceived to be wrong with the market a few months ago have reversed course and are now perceived to be just what the doctor ordered. Fear of inflation from strong growth has been turned into talk of soft landing and benign inflation. Dramatic questions about the credibility of Ben Bernanke, especially during his Maria Bartiromo episode, have been answered with a new found respect for the man who may have engineered the so called "soft landing".
Geopolitical tensions around the world are now on the back burner except for the recent entertainment that has been provided at the United Nations. Oil reaching the stratosphere a few months ago is now considered a "bubble that burst" despite having yet to break key technical levels. Even the failure of a major institution specifically Amaranth, has signaled to the Bulls that the worst is behind them.

Unfortunately, your friendly neighborhood Kcap Team is not convinced. All of the above issues are fluent and perception based and can flair up at anytime in a negative direction. In addition, there are real concerns from specific data points recently that show things are not so rosy in corporate and economic land. Specifically, the Philly Fed Index that was released yesterday showed signs of a potential hard landing. Another economic report that confirms this next week could be just enough to disrubt the "soft landing cheerleading crowd". The Semiconductor Book/Bill ratio showed continued weakness in that complex which flies in the face of the recent rally in the Sox over the past couple of weeks. The few key companies that have reported earnings have been underwhelming in their outlooks. YHOO comes to mind and the 12% - 13% clubbing that it was recently given does not bode well for any other companies that disappoint. The market is in the infancy of preannouncement season and should fully expect at least a few more Yahoo!'s in its path.

The Fed is in a quandary. Too many are convinced they are done raising rates and will actually lower the Fed Funds target in the next 3-6 months. Unfortunately for the Bulls, the Fed does not want to cut rates too soon for fear of acknowledging that they overshot. Furthermore, cutting rates at this juncture would damage Bernanke's new found credibility as an inflation fighter. On the other hand, should inflation pick up its ugly head in the form of higher energy prices, the Fed will be unlikely to raise rates for fear of exasperating a potential hard landing. The accelerating pace of the cooling housing sector is starting to become problematic. All in all, there is not enough data to determine a proper course of action for the Fed at this time despite the fact that the market has already priced in a cut in the not too distant future. Imagine how the market will react when it becomes clear that the Fed is reverting back to data dependency that might last well into 2007.

The market will not take kindly to the fact that technology stocks in the NASDAQ are sitting at the upper end of their range thanks to the recent rotation out of the oil complex. What will happen to the NASDAQ when the Oil complex reasserts itself to the upside due to further inevitable geo-political tensions? Unfortunately, there is a ton of hot money with quick trigger hands in the high beta tech stocks at this delicate moment.

The market is also overextended on a technical basis and its internals are very unimpressive. Despite higher levels on the averages the new low list is expanding and the new high list is contracting. Volume was heavier yesterday on a down day than it was the day before when the Market was up. In addition the all important mighty Sox Index seems to have failed at its 200 day Simple MA around 480. Don't get us wrong, the market has not completely broken down technically as of yet, but the Bulls will be pushing on a string if any further upside is to be made.

Anecdotally, Mark Faber alias “Dr. Doom” just turned Bullish on the Market's near and intermediate term prospects. The conversion of this Perma-Bear is not what the Bulls should want to see at this juncture. Quite often market quips about the capitulation of the "last Bear standing" often produce at least some downside action. We will see if today's ugly action has any follow through next week from the Bears or will the anxious dip buyers continue to do their “thang”.

If You Held a Taser to Our Head:
Next week brings a host of economic reports and the potential for more preannouncements. We believe that the dip buyers will have their opportunity to jump on lower prices which has been the object of their hearts desire recently. Funny thing about dip buyers…when they actually see a decent dip they're often too afraid to commit. That is how simple profit taking can morph into a serious down trend when the fundamental and technical condition of the market is not favorable.

We continue to maintain a defensive posture using any rallies to lay out shorts and using dips to partially cover. This market has significant risk for both Bulls and Bears alike, however we prefer to hang with the Bears for now.

Enjoy the Holidays. See you next week.

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