Navarro's Big Economic Picture
Short Squeeze

Well, last week was a refreshing change from the usual market grind. The broad market lifted all five of the stocks in my portfolio – and damn near everything else.

The trigger for this rally was what was generally billed as some benign news on inflation. In particular, on Tuesday, the producer price index for finished goods fell for the first time since October of last year. Falling prices for autos, light trucks, aircraft and mobile homes contributed to the monthly decline. This news sent the markets off on a tear that, in turn, was suddenly fueled by a short squeeze – with a large battalion of bears apparently caught off guard by the PPI. Up, up, up the markets went.

In celebration, Investor’s Business Daily reversed its market position from “market in downward trend” to “market in a confirmed rally.” This news was consistent with something I had been observing and mentioned in a previous column, namely, there has been a general improvement in technical conditions for a wide range of stocks in a wide range of sectors.

The question, of course, posed by this new rally is: How long? One answer might be found in the same PPI report that fueled the rally. While inflation for finished goods fell, PPI inflation at both the crude and intermediate levels remains robust. As noted in dismalscience.com:

• Price appreciation in July was broad-based across intermediate producer goods. Prices for materials used by both durable (2.3%) and nondurable (0.2%) manufacturing operations continued to rise, as did prices for inputs used by the construction industry (0.7%).

• Prices for crude producer goods rose sharply in July (3.1%), due in part to rapid increases in prices for energy (4.8%) and food (1.8%) products. Core prices for crude goods rose as well, despite the fact that inflated scrap metal prices turned down somewhat.

This data suggests that the bullish celebration may be a bit premature – and that the recent action was indeed fueled more by a short squeeze than an improved longer term economic prognosis. Naturally, we’ll keep our eyes on this situation, mindful that the economy continues to slow.

On this subject of a slowing economy, and again as noted in www.dismalscience.com’s analysis of the ECRI Weekly Leading Index: “The growth rate has now been negative for two consecutive weeks, which last happened in early June 2005. We will now have to be on the lookout to see if this trend persists. The growth rate was consistently negative for nearly a year prior to the beginning of the 2001 recession, but has also been known to send false signals such as the 16-week period from late July to mid-November in 2004.”

This Week's Market Movers: Gimme Shelter

This will be a quiet week for economic reports, with only the housing sector in line for a major whipping.  Existing home sales are reported on Wednesday and new home sales on Thursday. With the home builders lowering guidance, the likelihood is that the news will not be good. If the sector shows another decline, it will be the fourth in four months. The big question here remains: Will the housing sector have a soft landing or will its bubble burst? It’s too soon to tell, but we’ll get another dot to connect this coming week.

Portfolio Shorts and Longs

As I noted earlier, all of my stocks made good money last week; and I scaled further into ABAX, AXCA, and EWZ.  Meanwhile, I took a small profit on ANST.  I just wasn’t comfortable with a stock tied that close to the business cycle, my last week’s ruminations notwithstanding.  That’s why I like the biotechs these days – they rise and fall on clinical data, not the economy.   To that end, I added a small position in Andrew Vaino’s featured stock in the biotech corner, Halogen Therapeutics (HTI).

Vaino's Biotech Corner
Fishing In Less Crowded Water

Halozyme Therapeutics (HTI) is a tiny San Diego biotech —call it a nanocap— that, I think, has a lot of promise. This is a stock that is not on anybody’s radar screen. As best I could find, only four analysts even cover the stock. And it is a tiny stock. Halozyme’s market cap is less than $150M, and the stock is highly illiquid, with an average three month daily volume of less than 70,000.

In fact, if you type ‘HTI’ into sites like Marketedge.com or Tradingmarkets.com you’ll see that the stock isn’t even covered. As many of you will recall from classes in Statistical Mechanics, small populations of data can behave idiosyncratically, foiling technical traders. Heck, they’re so small they don’t even file 10-Ks.  Instead, they file 10-KSBs.

Small illiquid stocks are definitely risky. HTI’s chart shows a decided spike last March followed by the air slowly being let out of the stock. Looking at the company’s press releases, the best reason I can find for this spike was initiation of a clinical trial for bladder cancer. Why the stock has been on a slide is unclear to me. That’s one of the problems with thinly traded stocks.

But here’s why I like Halozyme anyway. Their technology revolves around using enzymes (humanized hyaluronidases) to break down hyaluronic acid, a carbohydrate-based polymer that acts as an intracellular space filler. Breaking down this tissue makes it easier to get a drug to its site of action, which may then improve the efficacy of the drug. Chemophase is currently being examined as a treatment for bladder cancer in conjunction with mitomycin, a common chemotherapeutic. They also have a clinical trial underway to use the same technology to enhance the efficacy of protein therapeutics. Positive results from these clinical trials will be big news. That is, if they prove efficacy in these clinical trials it is highly likely this approach will be successful in a range of diseases.

But there’s more to this story. Halozyme has an approved product, Cumulase, which is a form of hyaluronidase used in in-vitro fertilization (IVF). In a study published last May in the Journal Fertility and Sterility, Cumulase was found to be up to 20% more effective in IVF than the currently used bovine enzyme. Now, 20% in itself is substantial but, for an issue as emotional as pregnancy there is no doubt in my mind couples will pay a premium to get that 20% edge.

But it gets better. According to the US Center for Disease Control (National Vital Statistics Reports, Dec. 2002), the median age at which women gave birth in 1970 was 25.4. This had increased to 27.1 in 2000. Biologically, it’s more difficult for women over 35 to get pregnant. Women over age 35 are the fastest growing group of women giving birth. It’s not entirely clear to me why the CDC keeps statistics on pregnancy. But with more women waiting longer to have kids, the market for services like IVF is only going to get bigger. From a demographic point of view, the states having the highest increase in median age of pregnancy were also the most affluent (coastal states and Illinois). To my mind this is a great macrowave play, a growing, affluent, market seeking an edge at one of (if not the) most important events in life.

Currently, Halozyme is trading at about $2.50. It’s illiquid, and its balance sheet would probably fall over in a bad storm (fortunately they’re in San Diego). Stochastically the stock is overbought, but the MACD looks promising.  For me, this stock doesn’t trade enough to have any confidence in the technicals. My take is Halozyme has a great product waiting to be discovered, and a pipeline with lots of potential to boot. But just remember, the pioneers are often the ones with the arrows in their backs.

Davio's Hedging Your Bets
Commodities Deflating

Big week for the bulls on August expiration. We had the Monday rally followed by a mean reversal that was then followed by three straight gap up days and strong bullish closes. The bull is back in town or is she?

This week, I want to continue on the theme I touched on last week in oil and broaden our view of the commodities.  Interesting times with the Fed pausing, the BLS numbers showing benign PPI and CPI after they take out everything that is rising. I don’t know what to make of it all as we continue to be in very odd market times. The Bond market is selling off and indicating lower interest rates and we all know that stock markets love lower interest rates. But let’s look at the hot commodities markets. What is going on there?

The commodities as we know have been on a tear for over 3.5 years. Flat out ripping, gold, oil, copper, natural gas, wheat, ethanol etc., etc. Costs have been rising, throw in the cost of transportation and I don’t know how the Fed calculates a lack of inflation. But this week, we have a very new development. Could it be along with oil weakening and appearing to test $60 a barrel by the end of the year as we discussed here last week that commodities in general are beginning to end their long run? Or at least a pause? I have suggested that the bull market in equities has been lead fair and square by the commodity complex. Without the oil and commodity stocks, equity indices would be much lower. Let’s review the technicals:

For the commodities index, it broke through the 50 dma recently; and this week, solidly smashed thru the 200 dma. This is not the first time in the past year, but this time the action above appears more toppy than ever before. There is a left shoulder from early 06 @ 351 and the head from mid may @ 366 followed by a recent right shoulder near 358 in July-August time frame. This is clearly being led by the oil complex.  Now, what about copper?

Copper is showing 3 successive lower lows. As the saying goes, no bull market in equities can continue without copper leading the way as it shows strength in major industry with its leading higher prices due to expansion of demand. Is copper suggesting a slowdown or deflation? If 291 is broken there could be a quite a leg down for copper with the top it may be putting in. A major deflationary adjustment.

The dollar likewise is technically falling into Bearland. With interest rates falling again, we are put into a precarious position as it relates to the US Dollar. The fiat currency has been breaking down for some time as it crossed the 200 dma back in April for good and has been languishing even below the 20 and 50dma’s and putting in what appears to be a minor top before it breaks thru to new lows and approaches most recent lows seen back in January of 05 in the 80 range. This likewise portends weakness for equity markets.

Finally, let’s look at the transportation index. The delivery of products and services has also been on a huge tear the past 3.5 years as the economy has ripped and the American consumer has done their job in excess consumption per usual. Are the Trannies showing us there is a inevitable slowdown of consumption with its recent breakdown of the 200dma? As a matter of fact the Trannies are testing the 200dma on this weeks bounce with the other indices? Will it bust back thru and continue back up over its highs to confirm bull market territory with a new high in the Dow Industrials? Until that happens, I respect Dow Theory and don’t see a bull market.

Is it possible that deflation could be led in the equity markets by the commodities bearish turn? I have to think this is a real possibility as we proceed into the Fall markets. Something to consider with the consumer tapped out by falling housing and weak savings rates and a Fed in a true conundrum in that if they lower rates the consumer may not want to borrow any more money.

“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.