Here is the skinny on last Friday’s GDP report:

• The GDP number came in at 1.6%, well below the consensus of  2.2% and almost a point below that of some forecasters like Moody’s.
• The big drag on the GDP was the housing sector which fell almost 20% at an annual rate.
• The consumer remains the stalwart, contributing 2.1 percent to the number.  Ordinarily, that should be enough as consumption is 2/3rds of the GDP.  BUT the housing sector shaved off 1.1 pts. 
• There was also some evidence that businesses are cutting production and inventory because that shaved off another one-tenth of a point.
• The big unheralded hit was net exports.  With a trade deficit hitting close to 70 billion a month, the U.S. trade deficit shaved off .6 of a point.  That’s HUGE!

Here’s the good news. 

The fourth quarter looks a bit better as consumption is rising on falling oil prices and the housing market freefall is slowing because of falling long end interest rates.  Of course, all of this means lower inflation and therefore an end to the Fed rate hike cycle – now on pause.  Now, the only discussion will be when the Fed will cut rates.  That will become clear in another quarter or so as new data arrives.

In the meantime, the bond market certainly got this number right with its inverted yield curve.  As to why the stock market remains so robust, part of it is the Oct-November annual mutual fund madness.  But part of it is the decoupling of U.S. financial markets from the domestic economy – a consistent theme in this column. However, let us duly note that the markets ended on a dour note after the report was issued.

This Week’s Market Movers
The first week of every month is always big on the market mover front.  On Monday, it’s personal income.  Wednesday features construction spending and the ISM index.  Thursday, its factory orders AND productivity..  And Friday, the Big Kahuna Jobs Report.  I’m betting that the three biggest market movers will be ISM and Jobs.  ISM has been holding up but if it shows an unexpected dip, look out below.  Productivity, which is the key to holding down inflation and increasing wage growth, is likely to show weakness – and therefore be bearish.  The job situation has been weak, but any negative surprise here would likewise be very bearish.

Navarro’s Portfolio Shorts and Longs 
I don’t see this next week as a good week for entry into stocks on the long side.  Let me simply note that there is an inordinate amount of oil and energy stocks that have firmed up technically in the last week or so.

Vaino’s Biotech Corner: A Break From Organic Chemistry!

Medicinal chemistry (on which the Biotech/Pharma industries are based) is just a subset of organic chemistry.  Organic chemicals are derived from living organisms. One of my pet peeves is the misuse of the term “organic food”.  ALL food, except for salt and water, is organic.

So, needing a break from marking dozens of sophomore organic chemistry midterms, I thought I would write about a company based on inorganic chemistry.  Ceradyne (CRDN) sells composite materials for an array of applications. 

Ceradyne’s best-known product is bulletproof armor made of boron carbides.  This material is the lightest, strongest material known, and, as CEO Joel Moskovitz is fond of saying: “it stops bullets too”.   Ceradyne also sell ceramics for industrial, dental, and automotive applications. Last year 66% of their revenue was from the sale of armor. 

But Ceradyne has another product I think will be even bigger.  One of the cool properties of boron is it stops neutrons too!  Nuclear waste is radioactive due to decomposition of uranium into other transuranic elements, a process which emits a neutron, or a beta particle.  In this country 20% of electricity is generated by nuclear power each year.  A total of 50,000 tons of nuclear waste are being stored in temporary facilities across the US in anticipation of the US Department of Energy opening a permanent facility at Yukka Mountain in Nevada in 2017. 

Ceradyne announced in June that they were collaborating with Alcan to build a facility to manufacture a boron carbide aluminum metal matrix composite for nuclear storage.  The plant will be located in Quebec to take advantage of cheap electricity.  Last month they announced they had received their first order for this, and expect to ship in Q2 of 2007.  My take is this will be even bigger that their body armor.

While simply storing nuclear waste isn’t an ideal solution, storing it in armor that also absorbs neutrons is pretty smart.  Ceradyne has already demonstrated an ability to obtain government contracts, so dealing with DOE shouldn’t present a problem.

Now, Ceradyne has had some “issues” with option backdating.  With this sort of accounting tomfoolery is not meritorious, it’s also, unfortunately, not uncommon.  Ceradyne announced on Oct 23rd they had completed their backdating investigation and, with the appropriate mea culpas, filed their Q2 10-Q to become compliant with NASDAQ regulations. 

I think is this is a good company whose stock has taken a hit, and is now set for growth.  Once the true potential for their nuclear fuels protection system is realized the stock will skyrocket.

Ceradyne’s quarter over quarter profit has been increasing for the past six quarters.  They will announce Q3 earnings on November 1. 

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.