Navarroâ,"s Big Economic Picture
The range of news stories splashing across the front page of Investors Business Daily last week pretty much summed up the short term bullish drivers. Retail sales were reported to be strong, as consumers continue to shrug off the effects of higher gas prices. Crude dipped below $70 as inventories were higher than expected. And, most importantly for inflation watchers, productivity bounced strongly back in the first quarter of 2006 to 3.2% after a disturbing dip in Q4 of last year.
I certainly donâ,"t want to get in the way of such bullish news by staying on the short side so I will bide my time here. My theory is that a lot of consumers are staying afloat by juggling their debt across credit cards that promise zero interest rates for balance transfers â,“ and they are numb to their increasingly precarious situation. How else are they absorbing such gasoline price shocks while spending so freely? At some point, the time will be up for that kind of credit card maneuvering, and it may be the same time that adjustable rate mortgages start to move steeply up.
Weâ,"ll see. In the meantime, itâ,"s best to remain data driven and see what the economic reports are giving us and how the stock and bond markets are interpreting the data.
This Weekâ,"s Market Movers -- Fed Week
As for the coming weekâ,"s data, the biggest market mover will almost certainly be the Fedâ,"s interest rate decision on Wednesday, May 10th. The question is not whether the Fed will hike rates another 25 bips, Thatâ,"s a given. Rather, it is whether the Fed will announce or signal a pause, which Chairman Ben Bernanke implied in recent Congressional testimony. If the Fed does signal pause, be damn sure you are on the long side by Wednesday.
That said, last weekâ,"s jobs report will surely give the Fed pause about any pause. Sure, the number of jobs created was well below expectations â,“ and the markets rallied on that dovish inflationary news. But lost in translation was the fact that wages popped up sharply. At any rate, we will soon see â,“ quite literally.
And by the way, the rest of the economic news is likely to be rather pedestrian. Key reports include business inventories and retail sales on Thursday and the trade report and consumer sentiment on Friday. Ordinarily, these have market moving potential but I just donâ,"t see any surprises here.
Portfolio Shorts and Longs â,“ Cleaning House & Sweeps Play
ABC Scares Up Bird Flu Movie
â,"May sweeps will soon be upon us, and this year ABC will feature one of the ratings-grabbing month's most time-honored traditions: a ripped-from-the-headlines disaster thriller.
The network has scheduled a movie called "Fatal Contact: Bird Flu in America" for Tuesday, May 9. The "meticulously researched" two-hour film will tell the story of an avian flu outbreak in the United States, the people affected by it and those trying to stop it.â, -- Zap2It
On the basis of this news, I doubled my holdings of Sinovac (SVA) on what might prove to be either a dumb idea or brilliant. The macroplay here is that I expect bird flu stocks to get some play from the airing of the prime time movie. But the movie does go head to head with American Idol and the Unit and ABC has done little to promote the movie. Weâ,"ll see.
As for two other stocks of note, I scaled into Discovery Labs based on the Vaino column as it dipped last week. I did think about bailing on the legal issues, but decided to give it another week. Glad I did, as the stock finished strong.
I also opened a position in ONYX Software, which I have recommended before. Itâ,"s sitting around $4.50 but it has some acquisition interest and could sell as high as $5.50 to $7.00. Itâ,"s technicals are improving. I donâ,"t see much downside here. However, the stock is very illiquid.
As for the rest of my holdings, they are gone. I closed my QQQQ short early last week and avoided another nick and cut of the bullish blade. I also jettisoned most of my penny stock brigade â,“ AKSY, SPEX, SURG, and XOMA â,“ on deteriorating technicals.
Davioâ,"s Hedging Your Bets: Main Street Versus Wall Street
The Jobs Report came in very weak for April; about 65k under the expected number. On top of that, the March report was revised down another 36,000.
Main Street may have been alarmed but Wall Street loved it. Why? Because people think that employment softness indicates that the FED will soon be done raising rates, which will somehow be a positive for the future of equity markets.
This is the same old story with the overall â,"Fed is doneâ, equity rally. Basically, I think that the market will translate any news as positive for the last push up to the top end of the SPX where our target has been set at 1340-1380. Yet to me, low job growth and inflation just donâ,"t mix in the long run. Since the first week of 2006, when the broader US indices had their exaggerated upside move, the â,"Big 3â, Indicesâ," (S&P, Dow, Nasdaq) gains have been rather muted when compared to Gold and Interest Rates, as I illustrate in the table below.
Even momentum names like Empire Resources and DXP Enterprises, which are on the IBD â,"Momentum Specialsâ, list, got crushed last week for no apparent reason.
When I see reversals like this in a midday with no catalyst. I know there is a change a brewing. Rememberâ,¦tops are Processes not Moments. There is a change in the feel to this rally. It feels heavy and tired to me.
I would love to see a final run up to 1340-1380 range. It would be a great spot to sell longs and begin setting up for a bearish summer/fall fling to new lows.
Earnings are over for the most part and there isnâ,"t a lot of catalytic information in the near future, outside of Fed meetings. Who is left to buy after all the good news is out?
Letâ,"s review.
1/8/06 Closing Prices 5/4/06 Closing prices %Change
GOLD 564/oz 682/oz 20.92%
10-year Interest 4.35% 5.15% 18.39%
SPX 1287.61 1312.25 1.91%
COMPX 2317.04 2323 .02%
INDU 10960 11452 4.49%
Vainoâ,"s Biotech Corner: DSCO Redux & Some Updates
Last week, a spate of shareholder lawsuits were announced against Discovery Labs (DSCO). This is a company I recommended last week prior to the lawsuit announcements. I made my recommendation based on DSCOâ,"s recent fall from grace, which I saw as an overreaction.
In particular, DSCO fell 50% after an announcement that batches of its product Surfaxin had failed to pass six month stability tests.
Now hereâ,"s what the law suits (seven at last count) allege:
â,"The Company admitted that although it had been testing the â,˜production validation batchesâ," periodically for stability, stability had never been achieved.â,
I am troubled by this. One of the very important criteria the FDA requires prior to beginning a clinical trial is proof that a compound is stable over a certain period of time. That is, the FDA wonâ,"t give a company permission to dose patients with a drug unless they can prove the drug going into the patient is the same one that was put in the bottle. In the case of a six month stability study, this means that only batches of the drug less than six months old could be used in any clinical trial. In cases where the clinical trial is meant to be short, it is possible for the company to provide correspondingly short stability data (21 CFR 312).
My advice was to buy this company â,"on the dip.â, I did not, however, anticipate that such a dip would come as the result of legal action. The above allegation is very serious, and I am eager to hear DSCOâ,"s response. My gut feeling is still to buy. However, in light of these lawsuits this pick has become much more of a speculation than I intended. As a final DSCO take, the stock started the week at about 3 bucks, fell to less than $2.50 after the lawsuit dip, but it did finish very strongly with a 12% gain on Friday on above average volume.
Diversa (DVSA) has been doing pretty well over the past two months. Since I recommended the stock on the weekend of March 18 it increased from $8.55 to as high as $11.80 on May 2. I did mention that I thought the stock was a long term (2 yrs) play, and that the price would take a hit for the next few earnings reports.
DVSA announced Q1 earnings on May 1, and the stock dropped to as low as $9.60 last Tuesday morning. By mid afternoon, however, the stock was trading back in the mid $11s. I think the same dip will happen when they announce Q2 earnings, and will time accordingly. I still have no rational explanation for this nice pop now. Some things Iâ,"m happy to take on faith.
I recommended Tercica (TRCA) almost two months ago. Since my recommendation the stock is down almost 25%. TRCA launched Increlex as a treatment of childhood endocrine deficiencies in January. They have an earnings conference call scheduled for May 9. The Market obviously thinks sales arenâ,"t going to be good. While I donâ,"t have any information on what TRCA will report on the 9th, based on their orphan drug status I think the news will be good, and the stock will go up. Be careful, however, as Market Edge has it as a short sale candidate. So just to be clear, TRCA is not a stock for the faint of heart. Iâ,"m scaling up my own holdings.
I suggested shorting Neurocrine Biosciences (NBIX) two weeks ago. The price has since dropped from $62.82 on April 24th to below $50 on May 3. As I mentioned, I do believe NBIX is a good company overall, it was just trading too high. The FDA has committed to ruling on Indiplon by May 15th. Consensus is the drug will be approved. Even while approval of Indiplon is already priced-in, the news will inevitably push the stock price up a bit. Perhaps overcautiously (Iâ,"ve been burned on shorts before), I sold my puts for a nice profit. I was feeling speculative and bought some May 55 calls, with the intent to sell on May 16.
Peter Navarro is a business professor at the University of California-Irvine, and can be contacted at pn@peternavarro.com. Matt Davio is a managing partner at the hedge fund, Red Rock Capital Fund, and be contacted for hedge fund services at redrock@peternavarro.com. Andrew Vaino is a Ph.D. chemist currently teaching at The University of Maine.
DISCLAIMER: This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling, or holding of any financial instrument whatsoever. Trading and investing involves high levels of risk. The authors express personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The authors may or may not have positions in the financial instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future performance.
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