Navarro’s Big Economic Picture:  More Mixed Messages

Strip away all the punditry, and it was a typical summer week on the stock market.  A little up and a little down and a semi-flat ending.  Roiling underneath the surface, however, is a debate that continues to rage: Is the economy overheated and inflationary or about to fall off a consumer-led recessionary (or slower growth) cliff.

The data certainly didn’t help.  The payroll survey last Friday had jobs way down and deflationary but the household data had the unemployment at a dangerously inflationary 4.6% razor’s edge.  Meanwhile, consumer confidence took a dive – although it beats me why anyone was surprised because the previous week’s fresher consumer sentiment numbers showed the same damn thing.

The Fed wonks didn’t help either.  Federal Reserve inflation hawk Mike Moskow was at the top of his sky is falling game but there was no one in the Fed chorus to back him up.

Portfolio Picks and Pans: Quick Hits

Faced with this ambiguity, I did what a lot of hedge funds did – I played Trader Joe.  I bailed out – and then back in -- to the market.  Specifically, I closed my QQQQ short on the dip last Tuesday and then reloaded the short on Friday after the green futures fell into red territory after the market opened.  This is strictly small change stuff but it forces me to maintain the discipline of carefully handicapping the market.

This Week’s Market Movers – Weak Data Week

Given the dearth of economic reports this coming week, I expect a continuation of Trader Joe’s market. 

Ain’t nothing happening until Wednesday when consumer credit flies.  Ain’t nothing likely to move the market in the data at least until the trade report hits on Friday.  Wouldn’t it be refreshing if the trade deficit dipped by $5 billion or so on the weakening dollar and rising exports?  But that’s not something I’d bet a lot of money.   So the bottom line here is this is not a bad time to move into some more cash, use your portfolio time for some more basic research, and enjoy more of the summer.

Vaino’s Biotech Corner: Sanga Who?

Earlier this week Sangamo Bioscience (SGMO) was showing strong technical signs.  The stock closed at $4.59 on May 19th and was up to $7.60 on May 31st.  This caught my interest.

Sangamo’s technology is based on designing proteins that bind to zinc-finger DNA binding domains.  Similar to the anti-sense technology of Isis Pharmaceuticals, this type of treatment is aimed at disrupting the protein synthesis of diseases.  This approach can, in theory, be applied to any disease for which a gene has been identified. 

SGMO has been around since 1995.  Their development pipeline is not overwhelming.  According to SGMO’s 2005 10K, Edwards Lifesciences (EW) has two ongoing phase 1 clinical trials of drugs based on their technology.  I found two press releases from Edwards Lifesciences, from August 30th, 2004 and from June 23rd, 2005, corresponding to these.  I wasn’t able to find any press releases issued regarding even interim results of these clinical trials.  This makes me suspicious.  SGMO also has a phase 1 clinical trial of their own for a potential treatment of nerve damage associated with diabetes.

So why did the stock jump 65% in the past two weeks, on good volume I might add?  I haven’t a clue.  They had a press release on May 2nd of positive results in a preclinical study.  A positive result in a preclinical study is sort of like hearing the pilot on your flight welcoming you to Cleveland:  you’re happy the flight was uneventful, but you’re still in Cleveland.  It’s just not that exceptional.

SGMO’s financials are strong enough to get them through the next couple of years.  With nothing even in phase 2 it’s going to be at least four or five years before they have anything on the market, and there’s a lot that can go wrong in the meantime.

Coincidentally, on May 26th they filed with the SEC to sell up $50M in stock.  My take, after an irrational jump this stock is bound to dive.  Its float is small (24 million) and its 3-month average daily volume is almost 170,000.  Options aren’t traded on this stock, and my worst loss ever in the Market was shorting an illiquid biotech, but I really want to short this bad boy.

Matt Davio’s Hedging Your Bets: Liquidity Trap

I am struck by what I consider to be the start of a variation on the classic liquidity trap.  I am disappointed with the overall market performance but excited by the growth of opportunities that seem to be setting up due to excess liquidity.

Volatility has broken out on a longer term basis for the first time in what seems like 4 years. I am also encouraged by some of the downswings we have seen in emerging markets this May.  The BRIC complex, or the Brazil, Russian, India, and China emerging markets, have just been bludgeoned recently and this is, to me, the first sign of what I will call the liquidity crisis.  Easy fiscal and monetary policies must be unwound over time or inflation will be worse than Weimar, Germany, which is of course a possibility.  I digress.

Brazil is down 28.3% from its recent highs, Russia down 32.5%,  India down 31.1%, and China is down 15.5%.  Still, over this period the US S&P 500 is only down 3.1%.  Within the US Complex you have the Semiconductors down 18.4% and Biotechs down 19.9%.  Couple this with the US dollar down 9.3% and Gold up 50% and Oil over 53% in past year, I see nothing but inflation and higher costs to all businesses. Interest rates have broken out to the upside regardless of what the Fed says about controlled rates.  The Banking index remains up 18.5% for the past 12 months.  This all leaves me thinking a sea change is upon the US markets.  I respect that we may go higher before going lower as that is all part of the game, but ultimately the warning signs have been fired across the bow by both the emerging markets and traditionally leading sectors within the US such as the Semiconductors and Biotechs, which in turn points to a liquidity tightening.  You can already see this in the home building index, as the top was put in last July for the major US building stocks and since then they are off 23.2%.

What this means to me is that the future setups for the US markets will ultimately lead to a correction due to excessive liquidity.  Or we will live in a world that has inflation as its key component to higher prices in all assets. Either possibility is real, and the increased volatility will lead us to exciting times as we go into the future. As Doug Kass wrote earlier this week “Bubbles are almost always based on the same set of conditions:

1. Debt is plentiful.
2. Debt is cheap.
3. The egregious use of leverage becomes commonplace and accepted.
4. A new and growing asset class raises asset prices.

The above circumstances led to the Internet stock bubble in the late 1990s, to the bubble.

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.