Navarro's Big Economic Picture
Hu Was That Guy?

I’m still trying to figure out the point of the Bush Administration hosting the state visit of Chinese President Hu Jintao -- at least from any American perspective. We got zero-zip-nada on pressing trade issues other than a few promises to buy a few billion bucks worth of planes and other goodies – but nothing on a scale that will diminish our growing trade deficit with China. On two of the big issues – piracy and currency revaluation – the U.S. got absolutely nothing of substance.

Of course, from the Chinese perspective, this was all very prestige-enhancing. The President of Buccaneer Nation firmly held his ground against the American hegemon. The result was a political zero sum game in which President Hu’s stature in China was raised by about the same amount Mr. Bush’s stature in China was lowered.

The interesting thing here is that if China does not revalue soon, it is going to wind up with a bubble economy as foreign direct investment will continue to flood into China seeking cheap, yuan-denominated assets. At present, to accommodate this investment, China sucks in the yen and euros and dollars into its reserves and then prints a bunch more yuan to cover the tab. No more effective inflationary printing press has yet been invented.

This Week's Market Movers

It’s likely to be a kind of wait and see week until the first quarter GDP numbers hit the wire on Friday. The big question is how close to the consensus of 5% real growth the actual numbers will be. There’s a lot of ways this could go, which means there’s a lot of chances to make a few bucks.

Let’s say that the number comes in at 5.5% or even 6%. This would buckle the knees of the stock market, as it would dramatically increase the probability of at least two more Fed rate hikes and possibly more. Meanwhile, the bond market would tank as yields on the long end rise. So the “over number” is clearly a bearish scenario.

That doesn’t necessarily mean the “under number” – say 4% to 4.5% -- is necessarily bullish. Sure, it would subtract fuel from the Fed’s fire and greatly enhance the “one and done” possibility of a May close for the current interest rate hike cycle. However, it would also signal softer growth than expected, validate the flat yield curve as a recessionary signal, and raise concerns about a softening economy and lower corporate earnings.

So gentlemen – and ladies – place your bets on the GDP!

Now before moving on to Matt Davio and Andrew Vaino, let’s finish the economic calendar for the week. On Tuesday and Friday, we get consumer confidence and consumer sentiment respectively. No big surprises likely there. New and existing home sales on Tuesday and Wednesday, respectively, are likely to be a bit more interesting. However, with mortgage rates now hitting 6.50%, no amount of healthy housing numbers are going to change bearish concerns about the future.

Finally, Fed Chairman Ben Bernanke will wax eloquent before Congress on Thursday so that definitely has market moving capabilities, particularly if he directly says “yes” or “no” to the question of whether the Fed will stop raising rates soon.

Last take: Earnings continue to roll in and rising oil prices continue to roil the markets. Put your seat belt on.

Portfolio Shorts and Pans - Barron Von Medarex

I took my profits on XING, the China mobile telephone play. I still like this stock and may reload, but my market posture overall is bearish and just didn’t want the exposure.

I did start to build a small position in Medarex (MEDX), a biotech play touted in Barron’s last week. What’s interesting about that tout is that the company got absolutely no “Barron’s bounce” and it’s technicals are signaling a short sale. However, I checked with our in-resident expert Andrew Vaino, and he sees a “phenomenal pipeline” and good long term prospects (see his column below). So I rolled the dice with a small position to possibly scale into a larger one. Bon chance!

I’m holding AKSY, a hemodialysis play; Acacia Research (CBMX), a genetics play; Diversa (DVSA), an ethanol play showing signs now of some technical weakness; Spherix (SPEX), a biotechy sweetener play, Synergetics (SURG), a glaucoma microsurgery play; SVA, the bird flu play; and Xoma (XOMA), which manufactures antibodies and other genetically-engineered protein products to treat immunological and inflammatory disorders, cancer, and infectious diseases.

I’m remain short QQQQ, although its safe to say my conviction was sorely tested last Tuesday when the market had its biggest one day gain in a year. By Friday, however, most of that had evaporated, which is precisely the kind of pattern you want to see if you think a stock is topping.

Davio's Hedging Your Bets
Strange Brew

The spin, THE SPIN!!! The Fed’s double talk has become triple talk. Fed governors are everywhere, blowing their horns of prosperity on CNBC and regularly in press releases.

Here’s the pattern emerging over the last half dozen Fed rate hikes. The subsequent “Fed-speak” in the wake of the rate hike sparks a rally taking out the old high. This proves to be an interim high until the next Fed announcement. Is this the game we must play now – a one-dimensional market pinning its whole hopes on what the Fed does? And never mind what energy prices, budget deficits, and trade deficits are doing. Indeed, as an active market participant, the technical divergences continue to blow my mind.

That’s my big picture. Now here’s a little picture look at last week’s action, such as it was. After the big rally on Tuesday, we flat-lined the rest of the week. Options expiration probably assisted in pinning the market to its Tuesday’s gains. It will be interesting to see how the last week of April gets marked. I would think the markups would continue to the upside, although our indicators don’t anticipate much up or down for next week.

And note this: Last week’s “strange day” was not the monster rally on Tuesday, although that did have a very automated feel. The strange day was Thursday morning…when you have a minute, do go back and look at the charts. While the Dow was up big in early-morning trading and gains were concentrated in 5-7 Dow names, the Nasdaq and small cap stocks didn’t participate and ended the day in the red. Gold and silver also got hit hard, with silver down 14% by mid-day and gold down from pre-market highs of $649 to $610 by mid-morning. What gives?

On the subject of gold and inflation, the M3 measurement of money is now gone, so we don’t have much of a way to see how the reflation game is going to continue. However, my gut tells me that there truly is a “man behind the curtain” right now. There are too many cross currents and divergences in these markets to feel comfortable for my risk parameters. Risk is heavy and must be managed. Tops are processes, not moments, and I believe we are in the process of topping in markets by the 2^nd quarter of 2006.

Vaino's Biotech Corner
Putting on the Puts

I’m hard pressed to find any biotech stocks I’m excited about right now. Barron’s had an article last week touting a couple of stocks, namely, CV Therapeutics (CVTX), Celgene (CELG), Genentech (DNA) and Medarex (MEDX). I wrote about CELG last week, and even though it’s down a smidge since Monday I still really like it and increased my long position as it dipped below $37.

 I bought some MEDX for my portfolio. Not having anything on the market, it’s a bit on the risky side. However, their pipeline is phenomenal. I also think the other Barron’s touts -- CVTX and DNA -- are good companies, but I’m ambivalent about their stock.

I like to keep a positive spin on things. But, if you can’t make money running with the bulls, maybe it’s time to hang out with the bears for a while. So, with the UMaine Black Bears recent loss to Wisconsin in the NCAA Div 1 hockey semi final still fresh in my mind, I think there are definitely some biotech stocks out there that are trading way too high.

Exhibit A: Neurocrine Biosciences (NBIX). This is a really good company. They have a decent pipeline. They are on track to launch (with Pfizer) a pretty impressive sleeping pill later this year, and they have four ongoing phase 2 clinical trials and two phase 1 clinical trials. Right now, most of the value of this stock, which is trading in the low $60s, is derived from their insomnia treatment Indiplon, a drug they licensed from Dover Pharmaceuticals (DOV) in 1998. (DOV had licensed the drug from Wyeth.)

Insomnia is a good market, about $2.5 billion a year. Trouble is, there are lots of sleeping pills out there. Indiplon will be a good drug, but not that good. A recent Barron’s article suggested that Sepracor’s sleep aid Lunesta could well wrap up half the market. Also, popular sleeping pill Ambien will go generic next year. With the current state of pricing pressure in the drug industry, generic Ambien will be viewed very favorably by insurers footing the bill.

My bottom line: Insomnia treatment is a good, but crowded, market. To justify it’s $60 stock price, NBIX is going to have to capture a big chunk of the market and not have any more run-ins with the FDA (there have been some issues in the past). Also, bear in mind that revenue from Indiplon is being split with Pfizer and DOV. I think with a flat to bearish Market outlook on the whole, this stock is going to come down some, and there’s some money to be made when it does.

NBIX will announce Q1 results after the Market closes on Monday the 24^th. The FDA has committed to rendering its approval or disapproval of Indiplon by May 15^th. I don’t know what they will report on Monday, but I do know they have already amortized almost all the upfront money they got from Pfizer. I think the drug will be approved, but that the Market will realize it won’t generate the earnings needed. I’m going short on NBIX. I prefer using derivatives to outright shorting, and am looking at November 55 puts.

“Any trader or investor who ignores the power of macroeconomics over the world’s
financial markets will, sooner or later, lose more than they should—and if they are
trading on margin, perhaps more than they have.”
 -- If It's Raining in Brazil, Buy Starbucks

CONTACT INFORMATION
Peter Navarro
Irvine, California USA
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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.