I left for China on July 11 for an extended trip to tie up some loose research ends on my forthcoming book The Coming China Wars.  Before I left, I threw on a QQQQ short just as a hedge on my long positions.  Today, almost a month later, that QQQQ short is within pennies of the price I put it on – market gyrations aside.  And that’s precisely why before I left, dear reader, I urged you all to go flat and go to the beach as this summer the market is sorting out a number of conflicting forces.

Today, however, the picture is becoming much clearer.  The ECRI Weekly Leading Index now projects an economy that is close to the flat line – an anemic 0.1% annualized U.S. growth rate.  That’s a recession in anybody’s playbook – through technically not such – and it certainly justifies the flat and inverted yield curves that have been yo-yoing us for months.

The Fed’s current conundrum, of course, has to do with why inflationary pressures continue to build.  Wage pressures are rising because most American corporate executives are too stupid to see the slowing economy ahead and they keep hiring at premium wages – and see my book The Well-Timed Strategy for lots of evidence of this stupidity.

As for commodity prices – oil, steel, cement, etc. – that gets us back to the China beast.  While Europe and the U.S. economies are flat-lining, China is growing 11% a year and it’s been maintaining this double digit pace for over a decade.  Besides all of the obvious manufacturing activity been moved to the PRC, Beijing is building for the 2008 Olympics and Shanghai is readying for the 2010 World’s Fair.  Not surprisingly, the PRC booming.  And while I won’t bore you with the details of a trip that went from Hong Kong and Guangzhou in the South to Beijing, Tianjin, Dalian, and Shanghai in the Northern area, I will say that the scariest site I saw was the mouth of the Yangtze River in Shanghai stuffed with more cargo ships than even the most fertile imagination could envision.  This is a country that is kicking the world’s butt and, as I document in my new book, China is doing so by bending or breaking many of the rules of the free and fair trade road.

This Week’s Market Movers – Ironies Abound
On Tuesday, the Fed will meet to parse this conundrum.  The bond market crowd – led by Pimco’s Bill Gross – is trying to get out in front of the Fed and bend it to its “halt the rate hikes” will.   Given that chorus and the obvious signs of economic stagnation building, I’m not interested in taking the opposite side of the bet.  On the other hand, it’s pretty damn clear there is plenty of inflation left in the economy.  That’s why it would be really ironic if on Tuesday the Fed declares a halt and the Q2 productivity numbers come out with productivity way down and labor costs way up signaling lots of inflation. 

As for the other potential market movers, the trade report always has the potential of roiling the dollar, then bonds, and by extension the stock market.  There’s little evidence of course that that report will do anything other than document another whopping deficit – dollar down, gold up, no?

Portfolio Shorts and Longs
As this remains a difficult market to make money in, I don’t have a lot of inspiration for you.  That said, I really like my long position in the Vaino biotech pick EPIX – but I cut my holdings in another bio penny VITA after some bad news pushing its technicals into Bearland.

Last week, I also opened two new positions.  I’m long EWZ, which is the Brazilian ETF.  Brazil is benefiting greatly from its China trade and is a nice international hedge. 

I also dipped my toe in the water on ABAX.  Here’s what Yahoo Finance says about it: Abaxis, Inc. engages in the development, manufacture, and marketing of portable blood analysis systems for use in veterinary or human patient-care setting to provide clinicians with blood constituent measurements. Its primary product is blood analysis system, consisting of a 6.9 kilogram analyzer and a series of single-use plastic discs, called reagent discs that contain chemicals required to perform a panel of up to 13 tests on veterinary patients and 14 tests on human patients.

It’s earnings are up, the stock is on fire, and I had a really hard time trying to find an entry point as there hasn’t been any dips lately.  Maybe I being sucked into a momentum play that is going to collapse, but its sales are robust and the company seems to have a bright future.  Plus, it’s a non-cyclical play in a world where cyclicals will soon be taking a beating.  Stay tuned.

Vaino’s Biotech Corner: Hewers of wood, haulers of water, and makers of drugs?

Canadian biotech stocks don’t get the attention of their American counterparts:  there simply isn’t a critical mass north of the border.  So, while escaping the heat on the shores of the picturesque Bay of Fundy in Digby, Nova Scotia, (home of the world’s largest scallop fishing fleet), I went looking for underappreciated Canadian biotechs.

Axcan Pharma (NASDAQ: AXCA) is a Montreal-based company that’s been around since 1982.  Their business model, acquiring and developing drugs to treat gastro-intestinal ailments is sound, and they’re profitable.  AXCA took a dive in February when a Phase 3 clinical trial of ITAX, a drug to treat functional dyspepsia, failed to meet its endpoint.  Functional dyspepsia is a poorly understood disease that accounts for up to 5% of all visits to primary care physicians in North America.

ITAX is a dopamine agonist that is currently in use in Japan.   Results of a clinical study, published in May in The New England Journal of Medicine, showed the drug to be effective at reducing gastric pain in patients.  Gastric pain isn’t as dire as many other diseases, but, if you suffer from it you want to get rid of it.

AXCA’s financials are strong and they are profitable, though not spectacularly so.  Despite the failure to meet its clinical endpoint, ITAX is a useful treatment.  I expect Axcan will submit a New drug Application in the near future to permit it to sell this drug in North America.  If they are successful it will be the only drug on the market to treat functional dyspepsia.  There’s nothing like being the only product on the market to sooth an upset investor. 

Aside from ITAX, Axcan has three other drugs in late stage clinical trials.  Their clinical trial on Viokase, a pancrease enzyme replacement therapy, is on a drug currently being sold by Axcan:  the clinical trial is the result of an FDA rule that all pancreas enzyme replacement drugs (they help to breakdown lipids) must have passed clinical trials by 2008 to remain on the market. 

Axcan is safe financially and, if an NDA for ITAX is filed, the stock will jump.  AXCA is stochastically overbought right now.  My play will be to wait for a pullback and scale in over the next few weeks.

Matt Davio's Hedging Your Bets: Matt is On Vacation

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.