Navarro’s Big Economic Picture:  A Goldilocks “Not Too Hot” GDP Number

Last week, my top pick for “market mover” was the GDP revision for Q1 of this year.  When the actual number came in well shy of the estimated 5.8% on Thursday, the market took off and finished the week strong.  

Hey, this macro analysis really does work pretty well.  The market’s reaction was quite logical and based on the idea that maybe there isn’t as much inflationary pressure in the economy as the bears fear.  If that’s true, then maybe, just maybe, the Fed will pause in the rate hike cycle in June – and maybe even call it quits for a while.  In this scenario, the bulls once again take the upper hand – or so the thinking goes.

But here’s the obvious next question: Suppose the Fed does announce a pause at the June 29/30 FOMC meeting and the market makes an upward move on that.  After that move, what fuel is likely to feed its bullish fire? 

On my  list would be a moderation of the ongoing energy price shocks, a moderation of inflationary pressures, strong productivity, a modicum of peace in Iraq, or some signs that the housing sector is stabilizing.  At this point, I wouldn’t bet the farm on any or all of these factors coming to fruition. 

So the bottom line is this: Short sellers beware the heavy risk of a Fed-pause inspired bullish boomlet.  Long sellers face the question of what can possibly keep the party going after the Fed does its pause thing.

This Week’s Market Movers – Waiting For June

The week’s major reports don’t hit until June kicks in on Thursday.  Before that, only consumer confidence is likely to be of interest on Tuesday, with the expectation of bad news already built into the market.

On Thursday, however, we get productivity, the ISM index, and auto sales – quite a trifecta.   Lower productivity and/or a higher ISM will spark inflationary fears, and vice versa.  Auto sales will gauge the consumers’ interest rate sensitivity once again and also signal something about the housing sector.

Then, on Friday, the Big Kahuna Jobs Report flies along with factory orders.  Again, an “under” number on jobs and/or factory orders will give succor to the inflation doves and vice versa.

So expect an easygoing week until the reports hit the fan on Thursday.

Portfolio Picks and Pans: Two Thumbs Down on Business 2.0’s List

I’ve started to very cautiously scale back into my QQQQ short but fear the ongoing bounce here.  Mostly I’m in cash.

This doesn’t mean I’m not looking to buy.  That’s why I was intrigued by this month’s Business 2.0 feature on the “100 fastest growing tech companies.”  I will be looking in more depth at some of the companies on this list in future editions of this newsletter, but the big picture for now is this: If you are a naïve and/or compulsive fundamental investor who, after reading a story like that, is likely to run out and buy a bunch of companies off such a list, hold your damn horses.

Only 11 of the 100 stocks on the list exhibit strong technical characteristics and are worth going long on right now.  More than half of the stocks on the list can be characterized as “avoid” or “short sell”.  This means that if you could buy an index of these “great” stocks, you would likely wind up in the red and have to wait some goodly while before the “fundamentals” got you back into the green – if ever.  This might be an acceptable strategy for long term buy and holders, but even long term buy and holders need to consider the appropriate time to enter a stock.             

Matt Davio’s Hedging Your Bets: Any More Dips in the Chips?

Market bulls chose the timely pre-holiday week as the time to rally off the recent two week sell off.  The week before Memorial Day is seasonally strong – the market rallies about 80% of the time.  Add to this the oversold nature of the market off the highs and I think this bounce was somewhat expected – and then fed on itself technically. 

The SPX is up towards 1275 and looking like it’s on its way to resistance @ 1285, with 1300 looking possible. I expect the rally conditions to continue thru at least through the end of next week and possibly to the 2nd week of June. We are in an economic, Fed, and company-specific news vacuum the next few weeks, which should help the bulls wave their horns.

Now here is something to consider: The semiconductors have yet to rally with the broader stock market and I ask, “What rally exists without the semi’s rallying?”.  It is my experience that the semiconductor’s exchange traded fund – SMH --  usually leads the market up and down, and no rally can occur without this major sector joining in. The Semi’s really got hit during this sell-off, tumbling over 10% from the low $38’s to the high $33’s.   As a leading indicator, what do you think this portends for the general market?

The weak performance of the semi’s is why I think that the market has ultimately more correction work to the downside.  More broadly, both the Semi’s and Biotechs generally lead the markets and both have been very weak the past few months.   The BBH sector peaked in November of 2005 and since then the sector has fallen to this week’s lows of $167, a 20% downward move, which is typical behavior of a bear market.  The Semi’s (SMH) did had similar action - peaking in Dec of 2005 and hitting a recent low, 25% off the peak.

These were key divergences for me during this year’s rally, when the market leadership was waning and concentrated in a few non-traditional sectors like the commodity companies.  This is not typical bull market behavior and why I still think the markets have some downside catch up work.  And since I have found this correlation with the BBH and SMH as leading indicators for the overall markets, I believe that  the recent past behavior of these sectors shows that there is more downside to come. The 5% corrections we just saw in the SPX should lead to further declines sometime in the next year.  The market mode has changed and unless the recent May highs can be overtaken, I believe that selling rallies is the right side of the equation versus buying the dips. 

Vaino’s Biotech Corner: Leaping Lizards! (AMLN)

Amylin pharmaceuticals (AMLN) has been around since 1987.  I like Amylin because its best drug was discovered the old-fashioned way, by intuition; and Amylin’s success is one of the reasons I like medicinal chemistry. 

Consider, on the other hand, what many other biotech companies do.  They engage in practices known as “rational drug design” or “combinatorial chemistry”.  These practices were developed on the premise that using computers and robots to create more novel compounds would create better novel compounds. 

In the biotech boom of the late 90s, many biotech companies were able to raise millions of dollars by touting these newest ways to discover drugs.  The technology sounded great and no one really stopped to think about it for too long.  Turns out, not too many drugs have been discovered this way.  The Economist printed a scathing article in March 2004 showing that despite a doubling in global pharmaceutical R&D spending in the 1990s, the rate of new drugs discovery was cut in half. 

Enter stage right, Amylin.  Its best drug is based on an idea from John Eng, a researcher at the Bronx Veterans Affairs Medical Center.  Dr. Eng bet that the poisonous saliva of the gila monster might have useful endocrinologic activity.  A synthetic peptide composed of 39 amino acids mimicking this saliva is now sold as Exetenatide; it’s very effective at regulating blood glucose levels.  The drug was approved as a diabetes treatment by the FDA in April 2005.  A second drug, Symlin, was approved a month earlier.

Other examples of intuition-based drug discovery include the cholesterol lowering statins, likely the best selling prescription drugs of all time – think Lipitor, Zocor, Prevachol, and Crestor.  Japanese scientist Akira Endo’s intuition told him fungi found in mushrooms should help to break down cholesterol in the body.  Turns out he was right.  After testing thousands of mushrooms and other molds he proved his hunch, and millions of people are healthier as a result.

In addition to lizard saliva, AMLN has a phase 2 clinical study underway to evaluate the use of pramlintide  as a treatment for obesity; this is the active peptide in Symlin.  Americans are eating more and getting less exercise.  A drug to treat obesity will sell like hotcakes, as in hotcakes with a double serving of syrup and extra butter.

Other companies are looking into obesity drugs.  For example, Arena pharmaceuticals (ARNA) has a phase 2 study underway for an obesity treatment.  Phase 2 is a long way from approval, but Symlin and Exenatide give Amylin a very healthy revenue stream that is only going to grow as the incidence of diabetes increases.  Being able to treat obesity will be icing on the cake.

AMLN has been oscillating between the high 30s and mid 40s for the past few months: not bad for a stock nearly delisted from the NASDAQ a few years ago.  I think the stock will continue to trend upward as sales of Symlin and Exenatide are reported.  The stock’s volatility makes it appealing to technical traders.  The company’s fundamental value, well, that’s just gravy.

Now, A Portfolio Update

With the decline in the Market over the past two weeks I jettisoned pretty much all my biotech stocks except CELG, DVSA, ELN, HTI, and INSM. I wish I had followed Peter’s advice and sold off sooner, but my hair will grow back. I saved these stocks as they all have products and either generate revenue or will soon generate revenue.  I used the overall Market sell-off to pick up some CELG and AMLN calls, and by the end of the week I was glad I did.

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.