Navarro's Big Economic Picture: Confusion

It’s easy to be confused right now by this market – and lose a lot of money. For example, the press reports that “the market” is at six year highs. But they certainly don’t mean the NASDAQ exchange which remains at around 2300 well off its 2000 peak of 5000. So if you are speculating on techs, you are certainly not doing as well as speculators focusing on S&P 500 and blue chip type plays.

The confusion is a reflection of mixed economic signals. On the one hand, the economy continues to grow robustly and reliable indices like the ECRI suggest that 2006 will see continued growth. On the other hand, the Fed inexorably continues its upward interest rate march threatening contraction, and the list of shocks to the markets just keep on coming, particularly in the energy markets. 

In fact, the oil supply chain has never looked to be in more peril than now – at least since the 1970s. Rebel activity in Nigeria is all too real as is labor strife in Norway. Civil war in Iraq is a real possibility. It’s only a matter of time before terrorists make a direct hit on Saudi production. Venezuela is a leftist tiger running propaganda circles around the Bush Administration. Meanwhile, the new Fed Chairman is making appropriate noises about the need to raise taxes or cut spending to rein in the budget deficit, but neither option seems political tenable and either would quickly lead to a slowdown.

This makes the current market one for short term traders only or an arena to play in with stocks that are largely outside the purview of the business cycle. These include story biotech stocks, “better mousetrap” disruptive technologies, and so on.

This Week's Market Movers

There will be a considerable slowdown in data reports moving the markets this week. The first biggie will be the PPI on Tuesday. The markets will be looking for a confirmation of the same kind of softness viewed last week with the CPI. An divergence on this point will pummel the bond market and roil the stock market.

The housing sector will be on the line once again with both new and existing home sales come in on Thursday and Friday respectively. The Davio column implies coming positive news for the week to trigger a sector rebound. We’ll see.

Of lesser and more long run interest will be the bankruptcy filings on Monday. They’ve been going up because of changes in the bankruptcy law. Let’s see if they stabilize – or whether credit card debt is catching up with more and more Americans.

Portfolio Shorts and Pans

My solar play ESLR picked off from Barron’s took a very heavy hit on Friday from some profit-taking. I dumped my shares as a “cut your losses” quickly risk management tool. I won’t look back, even if that puppy bounces.  I likewise dumped the rest of my HTI with a small gain. The stock is simply too illiquid to feel comfortable about.

I added to my ISIS position as it held $8 at the end of the week. I really like the management of this company, and that is always a good start. As I noted in my daily blog, I also added CCC, a water filtration play on good technicals (although it is not as liquid as I like – no pun intended). I reloaded on STEM as it has been basing and is flashing buy signals once again after a big drop some months ago.

I am sitting underwater on a small position in VRX. I will wait and see on this one as, based on a previous Vaino biotech column, there are sound fundamental reasons to like the stock. More broadly, this is a tough environment to make money in. Be cautious, trim your losses quickly, and don’t be afraid to sit on cash.

Davio's Hedging Your Bets:  Housing Bull

I wanted to take a look at an issue that everyone and their great aunt have been discussing for the past few years,   Housing Bubbles.  I am in the camp that all asset classes get over- and under-extended and in the long term, I believe that housing will revert to a mean.  There is clearly froth in many housing markets in the US. There are also markets that are undervalued and offer opportunities as an investor. As an arbitrager, my job is to decipher the static and make a dynamic placement whether long or short in markets.

All that being said, and “bearing” in mind my personal longer term bearish outlook on the housing sector, I actually see the housing stocks index (HGX) as a low risk bet on the long side over the next few months.  Let’s take a look at the chart and see why. 

The HGX chart shows me that a breakout in housing stocks took place on a strong close this past Thursday, and you’ll see that where the chart crossed through the thin red line. At the moment though, the index is now a little overbought, but I would buy any dips that put the index anywhere near $255-$265. I would continue to buy any weakness in housing stocks until the old low near $250 is taken out. This is what we call risk management. The shorter term favors the long traders here and although my bearish macro-outlook in housing still persists, this doesn’t mean we can’t break out the static from the dynamic and benefit as speculators in the interim.

Vaino's Biotech Corner: unDIVERSAfying!

“Ultra-Thin” enzyme is a novel, next-generation alpha amylase enzyme designed to offer ethanol producers superior liquefaction performance. It works in concert with other enzymes to efficiently convert the starch present in corn into sugars that can then be processed into ethanol or other value-added products such as high fructose corn sweetener. Ethanol producers have traditionally used other alpha amylase enzymes that operate at a sub-optimal pH, requiring costly process changes to adjust the pH of the production process. Because “Ultra-Thin” enzyme is capable of operating robustly at pH 4.5 – the same pH of the production process – it can help producers to lower their operating costs significantly. This enzyme has received FDA approval for use in ethanol and sweetener production as well as additional applications.

                                                                 Diversa Corporation

I really like enzymes. They are Nature’s catalysts; and in my work, I spend most of my days thinking of ways to make enzymes better. So do the folks at Diversa (DVSA).

DVSA started out in 1992 with a clever idea, to seek out enzymes that function under extreme conditions, for example hot springs in Yellowstone, and see if they could be applied to industrial processes (enzymes can be finicky and often won’t work in a non-aqueous environment or outside of a narrow temperature or pH range). 

DVSA had timing on its side; they went public in February 2000 and raised $200M. The stock did pretty well, closing at nearly $150 two weeks after its IPO. Unfortunately, with all the hubris associated with the biotech industry at the turn of the century, a lot of newly public companies started believing their own press and got greedy – and DVSA was no different. 

In this instance, DVSA decided that it wasn’t just good at engineering enzymes. It was also good at drug discovery. So DVSA set up a drug discovery effort and even licensed-in an anti-fungal lead compound from GSK. The Market punishes such arrogance, and DVSA went on a severe, multi-year  downward slide. Indeed, just six months ago DVSA was trading for a measly five bucks, 97% lower than its exuberant peak. 

Now, the stock has bounced back to the $8 range these last few weeks, and I think with good reason. DVSA’s CEO resigned late last year under pressure, and the company is finally restructuring, getting out of businesses it never should have gotten into in the first place. DVSA also recently announced FDA approval of their “Ultra-Thin” enzyme. As the introductory excerpt from the corporation, this is an amylase or digestive enzyme that will make creating ethanol a lot easier and cheaper.

Diversa should, then, be able to leverage the current oil situation and the President’s calling for greater use of ethanol as fuel to its advantage. GM’s “Live Green-Go Yellow” ad campaign to sell its flex-fuel vehicles that can run on either gasoline or ethanol can’t hurt either.

NYBOT recently introduced futures and options trading for sugar-derived ethanol and CBOT will follow with futures contracts for corn-based ethanol later this year. From a practical point of view, ethanol won’t even make a dent in our oil consumption: but that doesn’t matter. The politics of ethanol will give members of Congress from Iowa and Nebraska the ability to get huge ethanol producing plants built in their states. New ethanol plants will want to use the best catalysts possible, and, right now, I think DVSA’s Ultra-Thin is it.

A big note of caution: DVSA isn’t going to be an overnight success. I listened in on their earnings call three weeks ago, and they are anticipating revenue of ~$20M for their Ultra-Thin enzyme for 2006.  DVSA predicted it will be profitable in 2007, and there is a chance they’re correct. I think DVSA is a good long term (2 yrs) buy.  However, I am concerned that DVSA has underestimated their restructuring costs and the stock is going to get hit the day after the next few earnings reports and recover in the following weeks. That’s a buying opportunity.

CONTACT INFORMATION
Peter Navarro
Irvine, California USA
Email  |  Website

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.