Navarro's Big Economic Picture
Snake Oil and Truth Serum

I happened to hear two interviews last week that offered polar views of the market.  The “snake oil” view was offered on Larry Kudlow’s show by Art Laffer, the economist who invented the so-called Laffer Curve which purports to show that lowering taxes can raise government revenues. This, of course, was the linchpin idea of the Reagan revolution – and helped lead, one might add, to historically high budget deficits in the late 1980s.  According to Laffer, he’d never see a better time to invest in U.S. stocks.

Contrast this with the “truth serum” advice offered up by George Soros in an interview with CNBC’s Maria Bartiromo. Soros' advice: “Stay in cash – but not dollars.”  To support this view, Soros then offered a litany faithful readers of this column will recognize – chronic budget and trade deficits, oil price shocks, a collapse of liquidity and the housing market, an expensive war, and, well, you know the drill.

So if you’ve got your life savings in a pension account, are you going to go long the U.S. market a la Laffer, and possibly see your portfolio shrink from a declining market AND a weakening dollar. OR are you going to get sophisticated and try to figure out how to implement the Soros’ defensive play?

My own bet is on George Soros -- although Art Laffer has been wrong so much that at least one time he might get it right, if purely by chance.

Last take: If you are wondering why the yield curve remains stubbornly inverted, with the long end soft as a brown banana, look no further than one of my favorite indicators, the ECRI Weekly Leading Index. It has been falling steadily and now projects an annualized GDP growth rate of 1.5%. 

This Week's Market Movers - Slim Pickings

Nothing in the government reports to get too excited about this week. New home construction on Tuesday will likely show a continued downshift in the sector and is the most likely market mover, but only marginally so.

That’s why the bigger source of market movement is likely to be the start once again of earnings season.  Everyone expects earnings to be downshifting. The big questions are by how much and whether there will be a lot of downward revisions by companies for the future. My guess is that earnings will be a net-negative for the market – more fuel for the bearish fire.

Portfolio Shorts and Pans - Epix and Vita

With the market bouncing up and down, I’ve curbed my enthusiasm for shorting the Nasdaq.  ’m content to continue to build a position in Epix Pharmaceuticals, which was featured in last week’s newsletter and which had a very nice week last week. With all of its news out now, the risk to the downside seems a lot less than the upside reward.

I will also try to scale into to Orthovita, which Andrew Vaino highlights in the tech corner  I brought this stock to Andrew’s attention earlier last week on signs of technical strength and wish I had opened a position then. But this stock looks solid.

Davio's Hedging Your Bets
Take Our Medicine

Last week’s “Quad witching” started Monday’s markets with a whimper. Equities paradoxically had a nice bang on Wednesday and Thursday in the face of a higher than expected CPI number. The markets then finished with a waning effort on Friday. Let’s read the tea leaves.

Volatility exploded Monday through Wednesday and then reverted back to the mean through Thursday’s close, which is when the big boys square most positions. Friday continued the new trend of higher volatility. I firmly believe the technical downside damage done to the equity markets will be most difficult to overcome in the near term future. Momentum seems to have left the market and the major indices’ 10-day, 20-day, and 50-day moving averages have all been broken. Support becomes resistance. Party on!

As we leg into the slow summer months, what this new environment does offer is renewed volatility. Earnings are upon us once the 2^nd quarter closes and more rate hikes should also follow. The momentum specialists like IBD and Cramer are having a hard time getting the ball rolling again as the liquidity that was created the past 3.5 years is now being taken away by the esteemed Fed. If the FOMC would have raised rates more aggressively in the past two years, I firmly believe we wouldn’t be in the “conundrum” phase we are clearly stuck in. 

To me the end result of said conundrum is “damned if you raise ‘em now and damned if you don’t”. That’s what happens when the Fed chooses not to allow the markets to run their course and squeeze out the weak hands. If you try and satisfy all players you are likely to end up like Japan. Why the FOMC doesn’t believe in deep, cleansing recessions -- as we haven’t had one since late 80’s -- I have no idea. Capitalism allows the strong to survive and the weak to find new niches of success

Vaino's Biotech Corner
Livin' La VITA provechosa

Orthovita (VITA) is a rapidly growing biomaterials company.  The stock has been showing strong technical signs, and is backed up by good science.  Biomedical devices and biomaterials are the hottest ticket in the healthcare sector right now.  Think back to the 25 billion dollar deal for Guidant a few months ago.

Orthovita has two products, Vitoss and Cortoss.  Vitoss is basically a malleable form of calcium phosphate.  It looks like a sponge and is surgically molded into bone defects.  The material is slowly eaten away by the body, but the calcium has been demonstrated to help in bone regeneration.

Orthovita also makes Cortoss: a mix of polymers that can be used in place of bone grafts.    Most current synthetic bone grafts are simple poly methylmethacrylate (PMMA).  VITA’s stuff is a bit more flexible.  They added glycol spacers to the polymer.  It crosslinks easily, meaning that basically it reacts with itself to form a denser network.  The mode of application is simpler for physicians, i.e. there is no premixing  required.  In fact, it’s actually mixed together as you apply it, sort of like an epoxy gun from Home Depot – what engineers refer to these as static mixing chambers.

Cortoss is sold in Europe and Australia.  VITA has an ongoing clinical trial in the U.S. for Cortoss that, if successful, will permit them to sell it here.  If they hit here,  it will be big.  The FDA recently permitted them to reduce the number of patients in their final clinical study.  I think this is a very good sign.

In addition, there is a third product Vitagel, which is used for controlling bleeding during surgeries.  Vitagel is a combination of bovine collagen, a biopolymer composed of amino acids that forms connective tissue in mammals, and bovine thrombin, a protein that enables blood clotting.  It’s basically a super-effective “liquid bandage” that surgeons can use for procedures where substantial bleeding is common.  On Friday, the FDA gave it approval.  Orthovita has already prepared batches of Vitagel, and will begin selling it immediately.  The stock jumped to 56 cents to a 52-week high.

VITA has a decent size sales force (50 direct reps and 40 independent).  Year over year sales have been increasing by at least 50% since 2001.  It should be noted that operating expenses have been increasing at the same rate and they are not yet profitable.  This is understandable in a fast growing company.    I think there are some parallels here with Integra Lifesciences (IART), a biomedical device company that was trading at $3 in 1999 and is now flirting with $40.

I think the science is good.  The stock has been moving sideways over the past two years and now looks like it is breaking out.

“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.