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Monday, September 18, 2006

Where Do We Go From Here?

By Yaser Anwar, CSC of Equity Investment Ideads

We have been witnessing a stellar rally of late in the markets. Investors should note that at the moment short interest is at 5 year highs. August saw a major rally as short interest had risen over 3.5 MoM & today we stand at short interest levels not seen for a long time, 5 year highs to be exact.
The market has been rallying due to; Ben Bernanke's not so vigilant efforts to fend of inflation, market had been buoyed by some great earnings, especially from brokers such as GS, LEH & retail sector, BBY (analyzed here) & the negative pessimism investors have coming into September & October.

CPI is almost at 10 year highs if we round the core CPI, currently 2.9%, to 3. The CPI data exhibits inflation is building up & that it's above the Fed's comfort levels. One could have argued that the GDP at 2.5 the economy had slowed down materially but at the revised figure of 3.0, the economy is doing much better & can take another rate hike.

The Fed has been pumping money through REPO activities. Why? Well don't we have the midterm elections just a month or so away? As you can see in the image below, there has been quite a lot of REPO activity of late. A possible reason could be to spur the market so the economy looks strong for republicans going into the elections. Whether this is true or not I'm not sure but the Fed has been pumping liquidity in the markets.

The NYSE composite, a fairly good indicator of general market strength, recently is at overbought levels & the NYSE ADX index is at levels it was last September, which rallied in 2005, only to correct itself in October. Put/Call ratio has remained at high levels even with the rally we are witnessing, hence investors are still skeptical about the recent run up & DeMark signals are suggesting selling. However, of late choppiness is in decline, which is another way of saying a trend is underway.
Last August when we saw record high short interest levels in the S&P 500 & NYSE, the market went corrected itself in October, from then on it did extremely well to end the year & start 06. We've had our 10% correction through May this year. Last year we saw a rally in September but a break down during October. Does this mean we will see another sizeable correction in October, which could be a great buying point? It remains to be seen.

Whether you're a bull or bear: I believe it would be prudent to
1) Write covered calls or
2) Utilize Equity Collars or
3) Simply short the stock, to hedge yourself.

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