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August 09, 2006

Post Pause Prospects
by Deric O. Cadora

The wait for a pause in Fed hikes is over, and so is, most likely, the equity rally associated with it. Psychology has set up for an ideal sell-the-news slump, and a mountain of technical evidence backs up this read. The S&P 500 has failed for five consecutive days to hold above 1280, volume has been declining throughout the recent rally, and a huge reversal was put in last Friday... the day the unemployment report all but locked in the pause. In addition, once the pause was confirmed, bulls failed to muster the troops, and the index drooped a half percent, sending it out near the day's low.

Perusing the charts of various large banks, we see that most of them are looking rather toppy. Since banking and finance shares comprise about 30% of the S&P 500, their weakness will certainly weigh on the index. A few examples:

Phase II of the housing meltdown will put pressure on spending power in coming months, meaning consumer stocks like Best Buy, Circuit City, Wal-Mart, and others will continue to be punished.

Higher up the food chain, a lot of pain has already been felt. Component suppliers such as Intel, SanDisk, Lam Research, Broadcom, and Applied Materials have already been clobbered and give no indication of being anywhere close to bottoms. We find no argument from the Nasdaq 100, which appears to be breaking down from a bear flag.

While precious metals will likely slump along with stocks in sell-the-news fashion, their 3-year positive correlation with equities should be broken in coming weeks. As the problems in our economy become more ubiquitously recognized, and the Fed moves toward softer policy, stocks will continue to suffer while metals... and commodities in general... soar.

Therefore, the current macro and psychological situations would suggest a strategy of selectively shorting U.S. equities with the intention of shifting capital toward commodities in coming weeks, hopefully with both at lower prices.

Deric O. Cadora
www.theDOCument.com

Deric O. Cadora is the editor of The DOCument, a daily newsletter offering stock market commentary, macro economic discussion, and technical trade signals. Deric is a professional investor and the proprietor of Atavia, Inc., a thriving web applications and web hosting company. His investment experience spans two decades, during which time he served as principal of a broker-dealer and developed proprietary statistical trading models.