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How to Navigate the Year-End Tape


For every risk, there is an offsetting reward.

"Bubbles, bubbles everywhere, and not a drop to drink... yet."
Willy Wonka

The chocolate factory is alive and well. Just don't tell the bears who are awaiting the sugar rush of supply.

Indeed, the market acts great and is exhibiting a tenor that would make Pavarotti blush. Macro concerns are being brushed off, geopolitical worries are a world away and fundamental data points are leading to sector rotation instead of a broader migration.

One of the first things I was taught on Wall Street is that the reaction to news is more important than the news itself. It's a fine line of interpretation, the disconnect between perception and reality. As traders, that is where the profit lies. That grist--the friction--is where money is made and views are validated.

I was recently asked if I thought we were living in a bubble. I reflected, before offering that we've been living in concentric bubbles for quite some time. The bust is old news, of course, but it's been replaced by other modern day balloons.

There's housing, with a conscious nod to the fact that homebuilders, as a proxy for real estate, are much different than real estate, which is a lagging indicator of disposable income and a negative real savings rate.

There's psychology, as evidenced by various sentiment surveys and compressed volatility. The chasm between the "all-time highs" (that we see on TV) and the wealth defect (fewer and fewer participants) has sowed seeds of societal acrimony.

And there's debt, with almost $4 owed for every dollar earned, a manifestation of our immediate gratification, consume now and pay later society.

That's the backdrop. It's the DNA of our financial fabric that is the proverbial wet paper towel in an ever-present stress test.

The elasticity of debt--and the ability to transfer risk--is sustaining this dynamic, as evidenced by Citadel and Ford Motor's ample debt offerings last week. Beg, borrow and spend. It is prevalent and accepted, but it is also cumulative and derisive.

I've learned, often the hard way, that big picture concerns tend to cloud short-term trading judgment. Conversely, while we must respect the price action, there is risk in deferring to the crowd mentality. As such, and as performance anxiety perks up by the bubble of funds tied to performance, these are some of the elements that will be on my radar as we ready for the home stretch of '06.


This complex holds the key to the broader tape. In addition to holding the highest weighting in the S&P, it encapsulates our finance based economy. With $370 trillion dollars of derivatives weaving these institutions together, JP Morgan is General Electric is Ford Motor is Fannie Mae.

Technically, the money centers are tickling all-time highs and if they breakout through BKX 115, that acne would indeed bode well for the broader tape. They carry the highest risk of any segment of the market, however, and how they act will speak volumes as we piece together the year-end puzzle.

The Homebuilders

Following an absolute drubbing from July of '05 through August of '06, this group was massively hated and heavily shorted. True to the path of maximum frustration, they've squeezed higher ever since. HGX 240, a level touched last week, was a 50% retrenchment of the entire down move. While I rarely touch this trading crack, I would not be at all surprised if that level caps 'em into Christmas.

The Transports

Those who subscribe to the Dow Theory are sitting up and taking notice of the action in the transports. They've formed a technical pattern called "head and shoulders" and are flaking a fair amount of dandruff. If these names are still a leading indicator of the overall economy, as many believe, it is offering cause for pause on the blind ambition tour.


December expiry arrives early this year--as in two days from now. Structurally, that is creating a synthetic magnet at both S&P 1400 and 1425 (as a function of the outstanding open option interest). Chances are that this bipolar disorder will contain the tape through Friday and then, just as the year-end hedges and protection expires, the tape will be free to trade. Be wary of an uptick in volatility once this milestone passes.

Emerging Markets

Last week, there was chatter that Ecuador was gonna default on their debt. I know, Ecuador doesn't matter, right? How could this small country matter to the mighty market machination?

I remember similarly smug looks when the Russian Ruble was deemed inconsequential. That, of course, was the catalyst for a financial contagion courtesy of John Meriwether and his Nobel nobles. Different times and better safeguards? Au contraire, Mon Frere--the correlation of financial assets has never been more acute.

In this regard, I've got one eye cast towards Brazil (still close to all-time highs), the Templeton Russia Fund (TRF), which was the red flag in May, and the Indian Sensex, which quietly shed six percent in two ugly sessions this week. This is my tri-fecta tell for the emerging markets and it warrants our attention.

The Dollar

The greenback is a mirror image reflection of the faucet of liquidity. I've long opined, thus far correctly, that we would experience asset class deflation or dollar devaluation since the back of the post-bubble reflation effort. Both could occur, I believe, but both cannot rally given the debt dependency, foreign holders of dollar denominated assets and embryonic secular trends of isolationism and nationalization.

This is a big picture dynamic and may not be 2006 business but it's important enough to include on our radar as we cast a collective eye towards the future.

For every risk, there is an offsetting reward. And those betting on a year-end ramp would be wise to remember that this is a two-way street. A "hands over eyes" assessment of the action bodes well for the bovine and, with year-end agendas rampant, it could continue. That's why I'm carefully watching the above-mentioned elements and will hear what the tape is telling me.

In the immortal words of Willy Wonka, "The suspense is terrible... I hope it lasts."

I would imagine that a whole lotta fund managers feel precisely the same way.

Good luck today.

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