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Wishful Thinking


Keep a tight leash on that energy trade.

"The greatest trick the devil ever pulled was convincing the world he didn't exist."
--Usual Suspects

Desperate times call for desperate measures. Investors are currently measuring where to place the blame for our crude realities.

Politicians are pointing at speculators, the US media is fingering foreigners and Wall Street is assigning surging demand and supply constraints as reactive rationalization for the incessant price appreciation.

From the papers to the pump, the people have spoken. They want answers and in the absence of clarity, they want someone-or something-to vilify.

As is often the case in the markets, there are no easy answers. The price action in energy-or any other financial instrument, for that matter-is the residual grist of a multitude of fluid and ever-changing factors. That, in a nutshell, is why trading is more of an art than an exact science.

Two weeks ago, I wrote a column that chewed through the bear case for crude. While catching cusps is a dangerous game, I shared the other side of the upside ride with hopes of providing some necessary perspective.

Just as the reaction to news is often more telling than the news itself, the reaction to that column may offer similar, albeit completely anecdotal, insight.

Last summer, when we offered a cautious take on banks while they traded at all-time highs following the Blackstone (BX) IPO, the pushback was palpable. Ditto March 17th, when we assumed a constructive trading stance into the Bear Stearns (BSC) abyss.

While past prickliness is no guarantor of future results, it's worth noting that our credibility card was again called into question on the heels of the energy muse.

The jury remains out on that particular bet but, as this is a pure trade rather than an attempt to anticipate the crossroads of inflation and deflation, I've been trading around that thesis and unwound some energy exposure as a function of the recent pullback.

The purpose of this column isn't to talk about what we've seen or who is right. Instead, the message is simple: Be careful for what you wish.

Convention wisdom and mainstream media has concluded with seeming certainty that the rising cost of energy is directly responsible for the supply side in equities. That, in my view, is the single greatest misconception in today's marketplace.

While inflation in things we need is clearly a drag on a consumer already burdened with housing deflation, our fear is that the eventual price break in crude will prove to be one of the more vicious head-fakes in recent memory.

Quite simply, the rampant rise in crude didn't "matter" for stocks as it ran from $30 to $50 to $70 to $90 to $120 and beyond. Commodities-and stocks-have traded on a simple seesaw since the beginning of 2002 with asset class deflation on one side and dollar devaluation on the other.

While on my West Coast business trip last week, I had dinner with Professor Bill Fleckenstein in Seattle. I shared my view that three ingredients could conceivably combine to create a significant market melt.

The first is a sustained rally in the dollar, the second is a meaningful decline in crude and the third is the break of BKX 75, which would be fresh lows for the financials.

He agreed with my view with one notable-and potentially very important-distinction. The Pavlovian response to lower oil might create a knee-jerk upside reaction before market forces prevail and reality sets in.

Be that as it may, this is your friendly Minyanville reminder to be an independent thinker and choose your own path. At the end of the day, you're the one who will reap the rewards-and bear the burden-of your financial choices.

Some Symmetry to Chew On

Unrelated to the above theme, I wanted to share some interesting data points that we recently fished out in Minyanville.

On October 23th 2007, three stocks-Apple (AAPL), Google (GOOG) and Research in Motion (RIMM)-were responsible for nearly 50% of the entire year's NASDAQ gains of 400 points. From that day forward, the NASDAQ lost 25% of its value until it bottomed on March 17th.

From the March 17th low through May 20th, the NASDAQ rallied 311 points with almost half of its gains generated by-yup, you guessed it-Apple, Google and Research in Motion.

But wait, there's more…

In 2001, the S&P rallied from the third week in March to May 18th (the week before Memorial Day) and touched the 200-day exponential moving average. It subsequently declined 26% into September.

This year, the S&P rallied the third week of March and touched its 200-day moving average on May 19th (the week before Labor Day). If a similar decline unfolds, the S&P will settle near 1080.

As Mark Twain once said, history doesn't always repeat but it often rhymes.

If the tape follows suit, we could be in for a bumpy ride in the months ahead.
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