Navarro’s Big Economic Picture

Here’s a quick snapshot from Market Edge that is consistent with my current short term bullish posture:

“After a sluggish start early in the week, stocks turned up on Thursday as both the DJIA and S&P 500 posted new highs for the year. The DJIA continued on its march to 12000 as it recorded record highs on Tuesday, Thursday and again on Friday (DJIA – 11960.51). The rally was fueled by a sharp decline in oil prices and some decent earnings reports. Friday's retail sales report coupled with a reversal in crude prices failed to slow the rally as most of the major averages managed to post gains for the period. For the week, the DJIA gained 110 points (+0.93%) and ended the period at 11960.

The NASDAQ continued on a roll as it is now up over 16% from it's 07/21/06 low, 2020.39. … Year-to-date, the Dow is up 11.6% while the NASDAQ has gained 6.9%. Trading the DJIA (DIA) using a buy/hold strategy has produced a gain of 1243 points (+11.6%) while utilizing the Market Edge long/short approach would have generated a loss of 600 points (-5.6%). “

I offer this quote because it reiterates a point I made earlier that the technicians are getting slaughtered this year – as evidenced by the failure of Market Edge to even match the performance of the indices.  One of the problems here is that everyone is watching the same technical indicators now and acting on them, which creates a crowd-like psychology that it has become profitable to fade.

As for the coming week, we are now in the classic Oct-Nov. silly bullish season where a lot of money managers bet the farm in an attempt to have a good year.  With some much money on the long side, the rally is likely to continue.

This Week’s Market Movers
There’s not a lot of economic reports of import this week but the two that have clear market moving potential are the producer and consumer price indices, flying on Tuesday and Wednesday, respectively.  I don’t really expect any inflationary jolts here to wake of the bears, but my short run trader audience needs to pay these reports appropriate heed.

Navarro’s Portfolio Shorts and Longs 
I continue to keep my eye on one of Andrew Vaino’s original picks, Diversa, the biofuels play.  DVSA has made a strong comeback from the sixes and is approaching $10.   My sense is that this could be a stock that once it breaks the $10 barrier might have a pretty good run.  The big caution would be a collapse in oil prices.  Otherwise Bon chance!

Vaino’s Biotech Corner: It’s All About the Pipeline

Look at the performance of the biotech exchange traded fund BBH – its underperforming the S&P by about 10% in the past year – and you might wonder if investing in biotech is even worth it.  Fortunately, the past few weeks have demonstrated why investing in biotech can be exciting.  On September 25th Acorda Therapeutics (ACOR) announced positive results of a Phase 3 study, one of two studies the company is completing in advance of filing a new drug application on an multiple sclerosis drug called Fampridine-SR.  The stock closed at $2.22 on September 22nd, and was trading as high as $17.50 on October 13th.  Not bad.

In a similar vein, New River Pharmaceuticals (NRPH) closed at $26.21 on October 6 and closed just under $46 on October 13th, also an OK return.  In this case the jump was on the announcement that the FDA had granted conditional approval for a drug to treat ADHD. 

Now, to be fair, there have been some pretty good free falls the other way in the past few months:  Neurocrine (NBIX) went from a high of $63 in mid-April to as low as $9 and  Anadys (ANDS) dropped from over $16 in April to the $3 mark.  Of course, these would have been good short plays.

The trick to biotech investing is finding companies with good pipelines. There, that should clear things up! 

More broadly, there will always be a substantial element of risk in biotech investing.  Clinical trials can be difficult to predict, making stock prices volatile.  I usually prefer investing in companies with the bulk of their pipeline in Phase 3, but sometimes there are companies with good pipelines that are mostly Phase 2 candidates.  I think Exelixis (EXEL) is one of those companies.

Exelixis is a San Francisco-based biotech that has amassed a pretty good pipeline.  The stock took a, predictable, beating over the summer as they announced a follow-on offering of stock.  While they have a Phase 3 clinical trial underway, on a drug to treat bile duct tumors, I think their most exciting product is XL999. XL999 works by inhibiting kinase enzymes:  it’s mode of action is similar to Novartis’ successful Gleevec.  The past few years inhibiting kinases has been all the rage, similar to the situation a decade ago when everyone was inhibiting proteases.

Results of a Phase 1 study, presented at a November 2005 conference of the American Association for Cancer Research were very encouraging.  Currently XL999 is being evaluated in six different Phase 2 studies to treat colon, ovarian, non-small cell lung cancers, renal cell carcinoma, AML, and multiple myeloma.  In addition to the clinical studies for XL999, Exelixis also has Phase 2 clinical trials underway with other, similar, molecules to treat diabetic kidney disease and papillary renal cell carcinoma.  They also have three Phase 1 studies underway. 

Exelixis is technically strong, though the stock is stochasitically (and by MFI) overbought.  Positive results on just one of the Phase 2 studies will give the stock a nice boost.

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.