p>Eight years ago, on August 28, 2000, I made a fateful and wrong decision. The dotcom stock market bubble had scared me earlier in the year, and in February I had the model portfolio in my California Technology Stock Letter up to 85% in cash. After the big market break in April and May, I recommended putting some money to work. But in early July I realized Microsoft was going to miss the published estimates, so I wrote that in the newsletter and recommended raising more cash. The Wall Street Journal picked up my prediction, which caused a drop in Microsoft’s stock and resulted in an angry call from Microsoft Investor Relations saying that while my estimate was OK, the consensus range I had given the Journal was not accurate. I pointed out to them that was the consensus on Bloomberg at that very minute. A few hours later, the highest estimates on Bloomberg were suddenly revised lower–a very impressive display of power by the Microsoft IR folks.
When Microsoft reported, they hit the revised range, but then gave soft guidance for the September quarter, so the stock was clobbered anyway. It dragged the tech sector and the whole market back down for a couple of weeks, but then the market posted four straight weekly advances. Most of them were small, but by the end of the run the S&P was back over 1500 and nearly up to the all-time high.
As I sat down to write the last issue in August, to be published August 25, 2000, I added up the pluses and minuses. Tech stocks were not cheap, but business was booming. The fourth quarter is the best of the year for the broad market and for technology. It looked like a great holiday season for consumer technology products. The stocks had absorbed a big hit in April-May, and found strong support and fresh buyers to rally them back to the breakdown point. It was a Presidential election year, which usually meant the market would hold up well through the election into the New Year. I decided I had been too cautious in February, and recommended going fully invested by Labor Day to catch the next leg up.
Wrong.
The next week was up. But the week after Labor Day was down–and so were the five weeks following that. The market stabilized for a few weeks after that, until the election, and then tanked while the world focused on hanging chads and the Supreme Court picking a President. And after that, things really fell apart.
That’s when I started researching a better way to approach the broad market, one based on real statistics, with the goal of understanding the risk and reward at any point in time, rather than trying to predict the outcome. The old shibboleths work about half the time, and this year the “sell in May and go away” crowd may have something to crow about, as the first five weeks after the end of May were all downers. I say “may have” because they also tell you to buy back in during the usual October slaughter, so a big rally from here could take away everything they can claim to date.
So what are the risks and rewards right now, on the edge of another Presidential election cycle, after a sharp drop in the market? The 1265-1275 level on the S&P 500 has been a very powerful attractor/repeller level since the July 15 market turn from 1200. All three bear raids to drive stocks lower than 1265 have failed. Every bull run to break away has failed, most recently at 1302 on August 15. Today’s run puts us back in striking distance of a breakout over 1302, but we’ve been here before and failed.
So the risk is that the 1265-1275 level doesn’t hold up under a fourth bearish assault, and we head back down to 1200–a 7.5% drop. Of course, after a consolidation around 1200 there could be another drop to the next support level at 1100, set in August 2004, but that is an issue to deal with at the time.
The reward is to about 1380 right now. There is an important barrier at 1326 that would take a few days to get through, but 1380 is the reward equivalent of the drop to 1200. That is a 6.4% reward. From there, the attractor/repeller levels are at 1440 and 1555, the all-time high. But, again, that is an issue to be dealt with at the time.
While I still think the market will resolve this long period of consolidation to the upside, what I know is that between 1265 and 1302, the market is not telling us anything useful. It is just consolidating. So no one can tell you which direction the market is going to go next until the market itself tells us by either decisively breaking 1265 to the downside or 1302 to the upside.
That could happen next week, as the portfolio managers come back from the beach. The first few days after Labor Day will show their initial bias, bullish or bearish, and then if the other side cannot turn that tide, we’ll know what the major trend is.
If that trend turns out to be down, I expect the weakness to come from and be focused in the homebuilders, related retailers, the financials and possibly energy. The home mortgage resets will be about five times as bad in 2009 as they are in 2008, so there is good reason to anticipate weakness in these areas. On the other side, we should see strength in technology, exporters, materials, commodities and the like.
If the trend turns out to be up, it almost certainly will be led by technology and exporters, as the financials have a long way to go before they’re back on solid ground. So I think we are in the right sector, whether the next move is up or down, and we should know shortly which direction we’ll be dealing with.
Biotech MegaShift
Amgen (AMGN) finally got FDA approval for Nplate, their blood platelet booster for chronic immune thrombocytopenic purpura (ITP). ITP is an autoimmune disorder that results in low platelet counts, which can lead to serious bleeding events. There are 140,000 treated chronic ITP patients in the U.S. and Europe, and Nplate looks like another blockbuster billion-dollar drug. Nplate is the first drug that directly encourages platelet production by stimulating the patient’s bone marrow. Approval was delayed twice by the FDA, first in April and a second time in July.
In a strange bit of news yesterday, Amgen said they will no longer offer rebates to oncologists for their use of Aranesp. Critics said the rebates were causing overuse of the drug, so Amgen will instead offer up-front discounts to heavy users. But, guess what? The company undoubtedly will price things so their net revenue from Aranesp goes up. Thank you, critics!
And if you think Aranesp is “overused.” now, wait until you see what happens when the stupid new Medicare reimbursement rules run the blood supply down to zero. Doctors have been giving blood transfusions instead of using Aranesp, per Medicare’s instructions, and the blood situation is critical all over the country. In my backyard, the Red Cross Northern California Blood Services Region said just this Monday that several blood types, especially type O, are at extremely low levels. Red Cross currently has less than a one day supply of both O-negative and O-positive blood, and less than a two-day supply of all other types. Donations tend to slow in the summer, and people don’t donate right before a three-day weekend. Nearly half of the population has type O blood, and O negative blood is also the “universal donor” blood often used for emergencies.
Amgen already sells four of the top 10 best-selling biologics in the world, and their osteoporosis drug will make that five out of 10 after it is approved. The stock has been hitting new 52-week highs, but the short sellers are digging in their heels. I think they are about to be run over. The Amgen January 2010 $40 LEAP call (WAM AH) has run up sharply and I am moving it to a hold for my $35 target. The January 2009 $70 LEAP call (YAA AN) that we bought originally has come back to life, but I am also moving it to a hold until expiration. There probably is not enough time to get AMGN up to my original $90 target by mid-January, but it can get substantially higher from here and give us a better exit price for the 2009 LEAP.
Isolagen (ILE) announced another win for the Isolagen Process. This was a 40 person Phase II, open label (no placebo) trial to treat facial wrinkles and creases all over the face. Patients received two treatments approximately five weeks apart. About 83% of the patients and 75% of the independent dermatologists evaluating the results (they did not perform the treatments) found improvement in the appearance of wrinkles. But what was really interesting was that more that more than 90% of both patients and dermatologists saw a six-month improvement in skin quality: softness, suppleness, smoothness, firmness, thickness, moistness, evenness in appearance and refreshed appearance. I think the aging baby boomers will jump on this treatment as soon as it is approved for anything, and dermatologists will use it off-label. In my experience, dermatologists are like surgeons and they do pretty much whatever they want to. ILE remains a Top Buy up to $2 for my $9 target.
QLT (QLTI) continued their promised divestment and downsizing program, as this week they licensed their Atrigel sustained-release drug delivery technology to Reckitt Benckiser Pharmaceuticals for $25 million, plus up to $5 million in milestone payments. Reckitt also took on a facility in Fort Colllins, Colorado, and 18 employees. QLT has sold off $240 million in assets so far, including their acne gel Aczone to Allergan for $150 million. Still to go: QLT USA, and Eligard. That will let them focus on Visudyne.
What, Visudyne? The dead, old-news macular degeneration treatment? Yes, indeedy. In the June quarter, they saw the first significant sequential growth in Visudyne sales in three years, up 12%. Even better, a number of the combination clinical trials are coming to a conclusion, and I think they all will show that the proper way to treat macular degeneration is to use a course of Visudyne first, and then follow up with a round of the anti-VEGF drug of choice. Instead of “losing” to Lucentis, Visudyne+Lucentis is going to be the standard of care.
Obviously, Wall Street does not believe me. But the RADICAL combination Phase II trial of Visudyne followed by an anti-VEGF is on track to release six-month data results in the fourth quarter. Novartis has two ongoing combination studies with data coming in 2009. The MONTBLANC study is fully enrolled and 12-month data is expected in the first half of 2009. The DENALI study is almost fully enrolled, with results expected in the second half of 2009. QLTI can be bought all the way up to $6 for my $12 target.
China MegaShift
UTStarcom (UTSI) was named the #1 broadband infrastructure company in India by Voice & Data for the second year in a row. Voice & Data is the leading telecom publication in India, and they specifically commended UTSI for its direct impact on India’s telecom market growth. Not too shabby. UTSI remains a hold for my $10 target.
Content on Demand MegaShift
Motorola (MOT) is holding its third-place market share in the latest Gartner Group report on worldwide cell phone sales. Motorola had 10% of the market compared to 10.2% last year. Nokia still leads with 39.5% and Samsung kept second place with 15.2%. LG has 8.8%, up from 6.8% last year, and could pass MOT if we don’t see the iPhone competitor soon. Gartner reduced their growth rate forecast for industry sales this year by a couple of percent, but it’s up to MOT and new co-CEO Sanjay Jha to execute well and start growing its share again. Buy the Motorola January 2010 $10 LEAP call (WMA AB) up to $2 for my $7.50 target price, based on MOT stock getting to $17.50. I think we’ll see that price long before expiration.
Zhone Technologies (ZHNE) said the Board of Directors has approved a reverse stock split to keep their shares trading on the NASDAQ. They are recommending something between a 1-for-5 and a 1-for-10 split, and there will be a shareholder vote. I recommend voting no. I’m sure there is a reverse split somewhere that actually increased shareholder value, but I haven’t seen it yet. What usually happens is this: Zhone reverse splits 1-for-10, the stock goes from 35 cents to $3.50, it maybe gets up to $4, then they announce a poor quarter and it goes to $2.50. Happens almost every time.
They also made a confusing statement about repricing options to “the last reported sale price of the stock on the grant date.” Seems to me that’s where they are already, so I’ll wait for the proxy materials to see what they mean. For now, hold ZHNE for my $1 target, most likely in an acquisition.
New Energy Technology MegaShift
Canadian Solar (CSIQ), like all solar stocks, will continue to be volatile until the reimbursement rules are set in Germany and Spain, and it becomes clearer when the polysilicon shortage will end. LDK Solar said they were able to expand their wafer production ahead of schedule, and raised their 2009 revenue guidance to $2.8 billion to $3.0 billion. Analysts were expecting $2.43 billion. LDK also said they will increase capacity from 1.2 gigawatts at the end of 2008 to 2.2 gigawatts by the end of 2009 and 3.2 gigawatts by the end of 2010. There seem to be no issues about demand; it is all about supply of polysilicon and realized prices. Because Canadian Solar recycles their own polysilicon, they are less affected by wafer shortages and profit pressures.
Solarfun, another public Chinese solar stock, said they expect average selling prices to fall 5% to 10% in 2009. That knocked Solarfun’s stock down 8%, which is silly: A 5% to 10% drop would be the lowest annual drop in several years. The company also raised its 2008 revenue guidance and said they expect 50% growth in 2009, even including the price drops. It is vital that prices fall every year, because the industry needs to get from today’s $4 per watt down to around $2.50 or $2.00 per watt in order to drive a wholesale conversion to solar. It’s the old semiconductor story, where in the 1980s Wall Street would knock Intel down every time they cut microprocessor prices, simply because the Street did not understand a business model based on Moore’s Law.
I expect Canadian Solar to grow revenues this year by 220% to $965 million, and then double that in 2009. The stock would be cheap at 24.2X, and it is selling for that multiple on trailing 12 month earnings of $1.28. But they will report $2.70 this year, so it is selling for only 11.5X this year’s earnings. When you can buy such rapid revenue growth at such a low multiple, do it! CISQ remains a buy while it is under $31 for my $65 target next April, or possibly as early as the end of this year.
FuelCell Energy (FCEL) reported results last night and held their conference call this morning. It was a great quarter on the top line: Revenues increased 106% to $27.9 million, driven by a triple in product sales to $23.2 million. The company increased its manufacturing run rate to 30 megawatts a year in order to fulfill the backlog. Although the product cost-to-revenue ratio improved from last year to 1.68, that was worse than the March quarter due to a $2 million charge for a manufacturing defect in fuel cell stacks. However, management said they are on track to hit their 20% cost reduction target this year.
The company lost 39 cents a share, worse than last year’s 24 cents, in part because they are shipping more and still lose money on every box out the door. They burned $17.4 million in cash and have $104.4 million left on the balance sheet.
On August 15th, South Korea announced a plan to increase the country’s energy self-sufficiency to 50% from 5% by focusing on low-carbon green energy technologies like as fuel cells. Posco Power, FCEL’s South Korean partner, has ordered over 38 megawatts since the partnership began in 2007, and will have their 50 megawatt plant open in September. They plan to increase it to 100 megawatts by 2010. FCEL will deliver fuel cell modules to be incorporated into systems by Posco.
Next year should bring the company close to a positive gross margin, which will reduce the quarterly cash drain. FCEL remains a Top Buy up to $12 for my $22 target.
Gasco Energy (GSX) filed for a $250 million shelf offering that could be debt securities, preferred or common stock, or other securities. This does not mean they are going to sell stock now or at these low prices. It is just smart to get through the registration process and have it sitting on the shelf, ready to go if an opportunity or financing window comes along. GSX remains a buy up to $4.50 for my $9 target, probably as natural gas prices soar this winter.
USGeothermal (HTM) held their annual meeting and said the water-cooled Unit I power plant at Raft River is performing well during the hot summer conditions, generating between 9.5 megawatts and 10.5 megawatts with 99.9% operating availability for the past three months. The company has a new reservoir model and will drill in spring 2009 to increase fluid rates and bring the plant up to its 13 megawatt rated capacity.
vIn Nevada, the existing water-cooled San Emidio power plant is generating between 2.5 megawatts and 2.7 megawatts during the summer heat. They’ve started drilling on a well projected to go to 1,800 feet and support a new power plant planned to increase power production by an order of magnitude to 27 megawatts.
In Oregon, they are waiting for permits to drill three more wells at Neal Hot Springs to scope the potential size and production capability of the reservoir. I am pleased to see them making the transition to an operating company, solving the real-world problems that the wannabes don’t even know exist, and growing the company to multiple geothermal fields and power plants. Geothermal made sense at $40 oil; it coins money at $80 oil. HTM is a Top Buy up to $4 for my $6 target, which is nearly a triple from current levels.
Security MegaShift
American Science and Engineering (ASEI) booked the $22.2 million order I told you to expect for 22 Z Backscatter Vans, including operator training, spare parts, service and warranty. This adds to their whopping backlog, and the stock soared over my buy limit. For that reason only, I am taking it off the Top Buy list, but if a sudden market drop knocks it back, don’t hesitate to buy ASEI under $59 for my $93 target.
SiRF Technology (SIRF) dropped sharply Tuesday after a judge at the U.S. International Trade Commission (ITC) recommended that imports of some of SiRF’s GPS chips be banned. The ban would affect both the chips for personal navigation devices and cell phones, and the devices themselves, if they already include SiRF’s chips. All this is because Broadcom won an initial ruling from the ITC that SiRF violated six patents on global positioning systems.
The company immediately filed an appeal and, in a really interesting development, <>the ITC staff also filed a separate appeal. I haven’t seen that happen before. SiRF said they have “multiple ways” of dealing with a ban, even if one is imposed–which seems unlikely. The appeals will be heard in December, and then the final ITC ruling is subject to a sixty-day Presidential review period. After that, it can be appealed to the Federal Circuit Court of Appeals.
SiRF has more than 250 worldwide patents and more than 370 applications pending. The issued 250 patents include some of the early GPS patents that SiRF acquired when it bought Conexant’s GPS business in 2003 and Motorola’s GPS assets in 2005. I think Broadcom wants access to some of these patents and eventually there will be a cross-licensing agreement to settle the matter.
It is far more important for SiRF’s recovery that they introduce a combined processor/GPS chip at a price point that gives them high-volume design wins in the next round of consumer devices. I believe they have the technology to do that, and the acting CEO certainly knows how to manage engineers. But they still need the right permanent CEO and a successful processor/GPS chip to really get back on track. From these levels, there is little risk in giving them some time to execute their plan. I am lowering the buy limit on SIRF to $5 and the first recovery target to $12, which still makes it a very attractive speculation on a successful processor/GPS program.
WiMAX MegaShift
Airspan Networks (AIRN) supplied the equipment to Nth Air, which launched a WiMAX network in Denver in time for 5,000 delegates and 15,000 media people at the Democratic National Convention. The wireless broadband network was sold to Nth Air by an Airspan partner, Fujitsu Network Communications, and eliminated worries about potential bandwidth bottlenecks in existing wireless networks due to the influx of people. AIRN remains a hold for my $5 target.
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