Market Edge Market Summary
A mixed bag of economic reports coupled with a jump in oil prices saw stocks trade in a volatile, see-saw pattern last week with most of the major averages ending the period in the loss column. An example of the conflicting reports occurred on Friday when a strong durable goods number for December was off set by the decline in new home sales for 2006, which was down over 17% from 2005. This was the largest, year over year decline since 1990. But the real drag on stocks was the continued rise in interest rates and the realization that a hope for a rate cut anytime soon has all but vanished.

The DJIA was all over the board as it lost 88 points on Monday (DJIA – 12477.16) and then posted it's 26th record high on Wednesday with a 87 point (1.3%) gain closing at 12621.77. The move was trumped on Thursday as the blue chips dropped 119 points (-0.9%), it's largest point decline since 11/27/06 and finished at 12502.56. Friday's action saw further declines as the DJIA ended the session at 12487, a loss of 78 points for the week.

Navarro’s Big Economic Picture
I’m not buying that a stronger than expected economy is putting a damper on the stock market. The logic is that a strong economy raises the prospect that the Fed won’t cut rates and might raise them. Who cares if the economy is robust, which would mean good news for earnings.

Nope. The big thing driving up the long end of the yield curve and roiling the stock market is a change in Chinese strategy which involves buying fewer U.S. bonds. That’s the real problem: the prospect of higher interest rates and mortgage rates due to changing bond market fundamentals.

This Week’s Big Market Movers
The Fed meets on Wednesday and that’s likely to be the fulcrum for the market’s week. I don’t expect much change in policy – certainly not a rate cut or hike. The only thing in play is the Fed’s language re: bias.

Vaino’s Biotech Corner: Will Hollis-Eden Ever Find Paradise?
The upcoming week will be a big one for Hollis Eden Pharmaceuticals (HEPH), a company I’ve written about previously. The company was founded in 1992 and they’ve not advanced a single drug to a Phase 3 clinical trial.

Their lead compound, called Neumune, prevents loss of white blood cells (neutropenia), loss of platelets (thrombocytopenia), and loss of red blood cells (anemia). This drug has been demonstrated safe in several Phase 1 clinical trials. The biggest indication for Neumune is protection against acute radiation syndrome (ARS).

Project Bioshield, a response to potential terrorist attacks, was signed into law in July 2004. One of the purviews of Project Bioshield is to develop and stockpile drugs to protect Americans from biological, chemical, and nuclear attacks. The anthrax scares in Washington DC are a chilling reminder of why this may be important: I’ll leave comments about feasibility aside.

Sensing opportunity, Hollis Eden has been seeking to provide the Government (specifically the Department of Health and Human Services, HHS) with Neumune to protect against a radiation attack. At first glance, this was a smart strategy. Implementation, however, has not been so easy.

HEPH has been trading wildly (according to Yahoo Finance beta = 5.42) over the past few years, due in large part to their attempts to secure a contract for Project Bioshield. In my opinion Hollis Eden has an extremely weak pipeline, and this procurement is their last hope. Trouble is, much like Lucy pulling the football away before Charlie Brown can ever kick it, HHS keeps moving the deadline back. Initially a target date of September 30th 2006 was set, which was pushed back to November 30th, which was pushed back to January 31st—next Wednesday.

So, while I would never recommend HEPH as an investment, I think it will be a fun stock next week for day traders (take a look at Friday afternoon’s minute-by-minute chart) and those looking to speculate next week. If HHS awards a contract to Hollis Eden the stock will take a nice spike. If they don’t deliver on a contract, or delay it a third time, I think the stock will take a substantial dive.

There are a couple of ways to play this. A good volatility play is a straddle with March $5 options: open interest on February options is very low, and March options, while still illiquid have a higher open interest.

Now, Project Bioshield has hit some hiccups. A debacle in which a $1B contract was cancelled sent Vaxgen’s stock (VXGN.PK) to the Pink Sheets. There have also been calls, by Senators Collins and Lieberman, for a congressional investigation into Project Bioshield.

But here’s another twist. A week after announcing the November delay in the HHS procurement, Hollis Eden announced it was selling $26M worth of shares at $6.50, a substantial discount then. The company had $48M in cash at the end of Q3, and were burning on average $6M per quarter: there certainly was danger of running out before the January 31st tentative date set by HHS. Waiting until after a contract award would have meant a higher share price, and a bigger infusion of cash.

One can speculate endlessly about what the secondary offering of stock means about management’s confidence in obtaining the contract. To be clear, according to a November press release, Hollis Eden is “not aware of any other company that remains in the competitive range for this contract award”.

Whether or not HEPH gets a contract next week is pure speculation. The stock is trading near $6, so shorting it can be risky—shorts I recommended on AVNR and ENCY were both in this range, and both paid off very well! This is a situation where I like to buy puts, and I have purchased some. To be clear, this is highly speculative, but I like the odds of betting on government inaction. Should be a fun week!

The International Scene – Technical Take
Germany, Japan, Brazil and Mexico all showed modest technical improvement as did gold.



Peter Navarro is a business professor at the University of California-Irvine, and can be contacted at pn@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.