Navarroâ�,��"�s Big Economic Picture:  More Fed Terror?

Twas a bit of a shock â�,�“ and more than a stretch â�,�“ to see Barronâ�,��"�s Michael Santoli recycling Wall Streetâ�,��"�s quip that it was Fed Chairman Ben Bernanke rather than Iraq terrorism mastermind Zarqawi that the U.S. should be gunning for.  My own take is that Bernanke has more in common with the hapless fall guy in the movie classic Body Heat.  That is, after five long years of fiscal and monetary irresponsibility and the emergence of a â�,��"permanent oil shock,â�,� Bernanke has put himself in an impossible position by virtue of his own lust â�,�“ in this case, for power, rather a sexy Kathleen Turner.

Be that as it may, what is most perplexing and annoying about Bernanke is his willingness to wear his ambiguities on his sleeve â�,�“ and too often his big mouth.  One day inflation is under control.  The next day it isnâ�,��"�t.  One day the Fed is one and done.  The next day we are looking at a possible 50-point rate hike.

Memo to Ben: You are correct, sir, that the Fedâ�,��"�s moves need to be data driven.  So,  Mr. Big Mouth, why not just let the data do the talking and the markets do the interpreting and take Fed policy like any good recovering alcoholic â�,�“ one FOMC meeting at a time.

This Weekâ�,��"�s Market Movers â�,�“ Inflation Nation

And speaking of being data driven, this is shaping up as one hell of a week for the markets.  On Tuesday, we get the Producer Price Index.  On Wednesday, itâ�,��"�s the Consumer Price Index.  Thatâ�,��"�s a possible Murdererâ�,��"�s Row if either, or both, exceed expectations.  On top of that, on Thursday, its capacity utilization and industrial production which, newbies note, are also helpful inflation indicators, particularly capacity utilization â�,�“ when it reaches a certain threshold, bottlenecks (and inflation) form.

Thatâ�,��"�s not the end of the story.  Look at retail sales on Tuesday and Fridayâ�,��"�s consumer sentiment to take the consumerâ�,��"�s temperature.     

So my market weather report is increased volatility with a chance of some heavier than normal summer activity â�,�“ bullish or bearish depending on the inflation picture.

Portfolio Picks and Pans: Penny Ante Stuff

As I noted in the Daily Blog, I closed by QQQQ short on Tuesday with a nice little gain.  And sure, I might have held until later in the week for a bit more, but letâ�,��"�s not get greedy, eh?

Meanwhile, trolling for penny stocks on the technical front, a couple of stocks came across my computer screen that I put positions on.  One is Epix Pharmaceuticals, which Andrew Vaino highlights this week in the biotech corner.  I added to it on Friday as it surged â�,�“ but am well aware I might get my head handed to me on a platter next Tuesday when an important FDA announcement is forthcoming.

The other was â�,�“ yes, was â�,�“ Bruker Biosciences (BRKR).  After taking a small position, the stock weakened and I excised it like a boil. 

So the bigger strategy for now is to find stocks that operate largely outside the business cycle and are more news driven like biotechs.  Once I get a little more data and clearer sense of whether a market bounce is coming, Iâ�,��"�ll go short or long as conditions dictate.

Vainoâ�,��"�s Biotech Corner: EPIX Dude!

Epix Pharmaceuticals (EPIX) published a study in the June 1st edition of The Journal of Medicinal Chemistry about the discovery and development of their lead compound PRX-00023.  The drug is an agonist of a receptor called 5-HT1A.  Currently, only one other such drug is available in the US: Buspar, sold by Bristol Myers Squibb (BMY).  EPIX was showing strong technical signs early this week.

A bit of background for you bio-geeks.  Serotonin is a neurotransmitter.  Neurotransmitters are how the brain sends messages to its various parts.  Serotonin is neurologically associated with feelings of well-being.  Most current anti-depressants, for example Prozac, work by blocking the removal of serotonin from the brain -- selective serotonin reuptake inhibitors, as my friends with wallet-sized Periodic Tables would say.  PRX-00023 is a bit different in that it causes the 5-HT1A receptor to release serotonin.

Serotonin is actually a common name for 5-hydroxy tryptamine (5-HT).  Our bodies make serotonin from the amino acid tryptophan.  If youâ�,��"�ve ever had a glass of warm milk to help you sleep at night you were just trying to get typtophan.  Milk has 14 milligrams of the tryptophan per ounce:  warming it doesnâ�,��"�t actually increase this, but itâ�,��"�s nice with cocoa and a splash of Kaluha.

PRX-00023 was actually discovered by another company, Predix Pharmaceuticals.  Epix had been trying to in-license a drug candidate since 2003. A few weeks ago Epix announced a merger with Predix.  In addition to the Phase 3 study, Predix also had two other clinical trials, for Alzheimers and pulmonary hypertension.  Iâ�,��"�ve written before that I think growing a biotech company by acquisition is the best way to go.

According to an industry survey from The Pharmaceutical Research and Manufacturers of America (PhRMA), on average it takes 10,000 compounds and six and a half years to get a drug to a Phase 1 clinical trial.  About ten percent of Phase 1 studies are successful.  Predix was able to start from scratch and get their drug to Phase 3 in less than two and a half years.  Based on experience, the â�,��"00023â�,� probably means itâ�,��"�s the twenty third compound they tested.  Thereâ�,��"�s always an element of luck to drug discovery, but Iâ�,��"�m still impressed.

But thereâ�,��"�s more to this Epix tale.  Epix also designs compounds for MRI visualization (called contrast agents).  Itâ�,��"�s a pretty cool idea.  Basically these are compounds that interact with a specific problem area, for example blood vessels.  Epixâ�,��"� lead MRI contrast agent, Vasovist, reversibly binds to the human blood protein albumin, allowing imaging of the blood vessels for about one hour after use. This can help physicians detect vascular disease. 

Vasovist has not been approved in the US.  Epix has received two approvable letters from the FDA for Vasovist.  The drug has been approved in Europe, and is on-target to be launched this year by Schering AG (no relationship to Schering-Plough [SGP]).  A caution here -- two of the key patents on this technology expire in 2006.

Epix is also developing another MRI contrast agent, this time to detect blood clots.  The cool thing here is that using an MRI machine, physicians will actually be able to watch the clots move in (almost) real time.  A phase 2 clinical study of this is underway.

EPIXâ�,��"�s market cap, with a drug in phase 3, an MRI contrast agent soon to be sold in Europe, and a total of 4 other clinical trials, is just under $84M.  The company I wrote about last week (SGMO), with a single drug about to enter a Phase 2 clinical trial, has a market cap of almost $240M.  This is clearly out of balance.  EPIX is a small stock, so it might take a while for the Market to notice, but it I think it will. 

This is a risky play in the short term.  EPIX will announce phase 2 results on PRX-00023 at a conference on June 13.  I have no clue if they will be good.  Patient enrollment for the Phase 3 study is already complete.  The FDA has to approve protocols for all clinical trials before they begin.  My bet is the FDA thought Phase 2 results were good enough to permit the Phase 3 trial.

Matt Davioâ�,��"�s Hedging Your Bets: Butterfly Market

The Perma bulls on Tout TV continue to spout the Pollyanna view that the economy is strong, that inflation is a lagging indicator, and markets will resume up to new highs. Anything is possible, but after nearly 4 years, the easy money days are over and costs are spiraling due to the rise in oil and commodities in general.  From where I sit, the cyclical bull has run its course and the longer term secular bear will get back to her business.

In this regard, the consumer is clearly tapped out.  Housing prices are stagnate if not falling as inventories pile up nationally, and the easy money finance days are over.  Banks are tightening lending requirements, and the pain will need to be taken by the consumer. And by the way, the housing bubble is potentially much more serious than the 2000 equity bubble due to the much greater illiquidity of the asset class.  This new, tight money trap has big bear teeth and was set by the FOMC policy.

As for the corporate sector, I think we have hit the highs in corporate earnings and the best days for companies have expired.  Volatility is back into the markets as the VIX broke out of its 4 year lows just 5 weeks ago.  Itâ�,��"�s held the breakout line and actually has continued to rise. In fact, the VIX spiked over 22.59 for the first time since early 2002.  The chart of the VIX very clearly shows a breakout and a great trading environment. 

Moving forward, we are somewhat overbought on volatility, which means the markets should revert somewhat and possible test the SPX 1300 levels. Anything beyond that would require some serious progress in world peace and some unforeseen bullish economic news to reverse the new trend.

Although volatility levels are high, the the SPX is essentially flat on the year, the Dow is slightly green, and the Russell 2000 remains on the green side. However, the tech heavy NASDAQ 100 is solidly red for the calendar year.  The NASDAQ chart is broken on down on all time frames while the weekly charts on the SPX and the DOW gave their first sell signals at last Fridayâ�,��"�s close since the current rally began in October of 2002.

To me this is a butterfly market.  That is, you can buy some options premiums out of the money on both the long and short side if you are willing to sit and wait for the next big move.  This might be one fairly cheap way to play the potential big moves coming in the markets.  Just be careful when flapping your wings.

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.