Weekly wrap-up 7-28-06

My sincerest apologies for the tardiness of this missive. Last week saw surprising life in equity markets, and a renewed spark in commodity buying. The Nasdaq and stocks in general closed the week strongly (with 2%+ gains on Friday), laughing in the face of our anticipation of a precipitous decline in the near future. We would like to note the seasonal strength at the turn of the month, to which July proved to be no exception. It may be wise to hedge/cover shorts as the end of the month approaches in the future – we were not aware of this historically persistent phenomenon previously. A valuable lesson learned! We are not concerned that our prediction of the bear market commencing is false. Leadership in July’s rally was concentrated in defensive sectors – healthcare, pharma, oil, etc. These sectors do not lead broad sustainable rallies, they signal a transition to a bear environment.


Moving on to every commentator’s favorite catalyst of the oh-so-hoped-for equity romp: the Fed rate hike pause (and subsequent rate cuts, we presume). How short our fellow market participants’ memories prove to be! A look back to only five years ago shows that the last time the Fed paused after an extended period of rate hikes basically marked the top for the soaring Nasdaq 100 index. The Fed pause, whenever it comes, will probably be the “sell the news” event of the year.


As to whether the Fed pauses or hikes on the 8th, we do not have a strong view. We know that we do not envy Bernanke & Co., who must realize that the US economy is rapidly rolling off a cliff, with housing in the driver’s seat. The sell-off in the dollar will be vicious when it is ultimately sacrificed in an attempt to resuscitate the limp, cold, stick-a-fork-in-it-cuz-it’s-dead US economy. We will carefully observe the various markets’ reactions to gauge prevailing sentiment, which we expect to be quite sour, regardless of the Fed’s actual move.

We took profit on our long in an energy stock index, and have resisted the temptation to pile back in as the leader of the pack, Exxon Mobil, soars to new highs. We don’t trust this rally, especially given the weakness in volume. Nor do we view this as an attractive low-risk entry point, as we note the overbought levels. We are actually tentatively bearish on energy, medium-term. We expect slowing demand from the ailing US consumer to alleviate pressure on supply as spare capacity rebuilds. We note that in the first quarter of 2006 world oil demand shrunk while supply rose relative to the fourth quarter of 2005. This sector is not to be shorted, however, in light of the non-negligible probability of a totally unpredictable geopolitical/supply shock, which would send oil prices rocketing upwards.