“Slow learner.” That was the first thought that I had after seeing Tuesday’s newsflash that the Fed cut the Fed funds rate and the discount rate by only one-quarter point, instead of a half-point cut. Just like the action after the August 10 special meeting decision to leave the Fed funds rate unchanged, the markets immediately took the Fed to the woodshed. No surprises there.
When he was teaching, Bernanke always opposed gradualism and advocated early, decisive Fed action if there was a need to do something. Apparently, talk is cheap. The two-year Treasury note, which usually drives Fed policy, is around 3%, which means that the market is looking for meaningful economic weakness in 2008. That has become a reasonable worry, as the very sensitive Economic Cycle Research Institute Weekly Leading Economic Indicators took a recent downturn:
Chart courtesy of Economic Cycle Research Institute Weekly Leading Economic Indicators
In the past, when this index has dropped to a -5% growth rate and stayed there for a few weeks, a recession is likely immediately ahead. The growth rate just fell to –2.7%, and in the past when it got this low, it usually kept going down. But the stock market is an important part of the index, so if the Fed gets their act together or if we see a big rally for some other reason, the recession risk would go away.
So the Fed needs to get the funds rate down to 3% as quickly as possible in order to avoid a prolonged economic downturn. That means they needed to drop the Fed funds rate and the discount rate about 1.5 percentage points or 150 basis points ASAP.
They had a chance to surprise Wall Street a little bit with a 50-basis-point cut on Tuesday, and they blew it. If the Fed had actually done that, they could have done another 50-basis-point cut on January 30 and a final 50- or 25-basis-point cut at the March 18 meeting, if needed. Now they will either have to do an embarrassing between-meetings cut, which makes it obvious to even the uninformed that the market drives the Fed, not vice-versa, or they will have to accelerate to 50-basis-point cuts for the next three or four meetings. Or, of course, they can take a recession during a Presidential election year, and again watch a Clinton follow a Bush into office.
On top of all this, what really disconcerted me was yesterday’s announcement that the Fed is going to loan up to $24 billion to European banks to be sure that there is no shortage of Eurodollars, so the Fed can help those banks unlock their credit markets. Excuse me — a shortage of Eurodollars? The world is awash in U.S. dollars that it does not want, and the dollar has been plunging against the euro all year long. This is pure posturing, not sound monetary policy.
The accompanying announcement that the Fed will auction off $40 billion in credit this month makes a bit more sense. First, that is about 3% of the money supply, so it is a big injection of fresh money. Sure, the dollar will fall even further because of this, but at least the program is big enough to have an impact.
Second, there is a stigma attached to a bank that has to borrow at the discount window, even though we all know that many of them — from Citigroup to Washington Mutual — are in deep doo-doo. By calling this a “credit auction” instead of discount window borrowing, the Fed can give some of the weak sisters cover. The first $20 billion auction is next Monday, followed by another on December 20. There will be two more auctions in January.
But this is the wrong prescription, at the wrong time. The auctioned credit lines will go to the most desperate banks that need to raise capital to shore up their balance sheet against Structured Investment Vehicle (SIV) exposure. These “SIV-Positive” balance sheets will buy some time, but I doubt it will be enough to let them get the toxic assets off their balance sheets before they implode. Incidentally, “SIV” is not a takeoff on “HIV;” there really is a Simian Immunodeficiency Virus that affects monkeys and apes, and the label seems particularly appropriate to the current situation.
The Fed is trying to resolve the sub-prime crises by increasing the quantity of money, goosing the M3 money supply growth up to a ridiculous 18% rate even before this latest $40 billion injection. But that is only going to kill the dollar and, eventually, cause inflation. What they should do is what Alan Greenspan did: Drop the price of money to 1% so the banks can borrow at almost no cost and then buy Treasury bonds to re-liquefy their balance sheets.
Every year New York Magazine runs a contest for satiric titles for the World’s Shortest Book. My entry would be The Accurate Forecasts of Alan Greenspan, but in this case he was right. If you aren’t going to let the undeserving banks fail — and, remember, the Fed is not a government agency, it is owned by the banks — then the closest you can get to a free market solution is to let them borrow cheaply and figure out who gets the loans. But Bernanke wants to be his own man, and I still maintain that he will be forced to resign before his term as Fed Chairman is up.
The effect of all this on the stock market this week was unnecessary and nasty. Tuesday’s 350-point drop from the intraday high in the Dow Jones Industrial Average probably rang the bell for more downside action. The S&P 500 sliced right through the critical 1490 level and was unable to recapture that level yesterday or today, so I expect a test of 1440 is in the cards. If that does not hold, we’ll be looking at 1326 again for the bull market’s goal-line stand.
The structure of the market does not look like the big bull move is over, though, and I still expect to see a blow-off rally into late March or early April. But if things are going to change, now is when it will happen, as the daily and weekly charts are in neutral zones and could break either way. I am not recommending protective puts again because I do expect 1440 to hold, although that may happen after a scary spike down from that level to clean out some nervous bulls. But as I’ve been saying, the market doesn’t care what I expect, so I will send you a Flash Alert if I see something more ominous developing.
The Watch List
Despite the direction of the market over the next couple weeks and months, there are still going to be plenty of opportunities to make money. And I’ve been working on three new ideas that I wanted to give you a heads-up on today: Cree (CREE), Genomic Health (GHDX) and Nanosphere (NSPH). I’ve already explained in the December 6 Radar Report why we are not going to buy into Cree at this time or price, so today I want to put out my thoughts on Genomic Health and Nanosphere. Genomic Health and Nanosphere are both medical diagnostic companies, an area where billions of dollars will be spent as the baby boomers age, regardless of what happens to the economy.
Genomic Health is a Redwood City, California-based company focused on genomic-based clinical diagnostic tests for personalized cancer treatment. The Oncotype DX test predicts the likelihood of cancer recurrence, the likelihood of patient survival within 10 years of diagnosis, and (most important) the likelihood of chemotherapy benefit. This test is currently used for early stage breast cancer, where the chemotherapy regimen is long, arduous and destructive to the very immune system that must eventually clear a woman’s body of cancer cells. Genomic Health is in various stages of development for other cancers, including colon, prostate, kidney, non-small cell lung and melanoma. But the stock is selling near its 12-month high, with a $650 million market capitalization and the company is losing $34 million a year. I think it is too richly priced to move forward right now, but put it on your watch list for a potential buy down the road.
Nanosphere came public on November 1, and the stock pretty much immediately slipped below its $14 IPO price. They are just introducing the Verigene System, an FDA-approved molecular diagnostics platform that enables genomic and protein testing on a single platform. It uses nanoparticle technology to run multiple tests at the same time on the same sample, and the company can develop new test assays to run on the same platform. That makes the platform cost more palatable to their clinical lab and research customers. They are starting with a warfarin blood thinner metabolism test to find out if Coumadin will do a patient any good, and another test that is a hyper-blood coagulation panel.
The company is also developing diagnostic tests for a wide range of cancer, neurodegenerative (cystic fibrosis), cardiovascular and infectious diseases. They will also have pharmaco-genomic tests for personalized medicine. The ultra-sensitive protein detection nanotechnology provides earlier detection of various diseases, and it gives us a way to invest in both nanotech and medtech at the same time. Nanosphere reported September-quarter results this morning, and after listening to the conference call, I have some questions to resolve about their cash burn during this launch phase. The stock fell over 4% after the call. At a $250 million market capitalization, it is not cheap, but I suspect we will own it sooner or later because its cutting edge technology in the personalized medicine area fits perfectly into the Biotech MegaShift.
Again, I’ll send a Flash Alert when it’s time to pull the trigger on Cree, Genomic Health or Nanosphere. For now, though, here are the latest updates on some of our MegaShift holdings and a few answers to your questions during this traditionally slow-news period.
Biotech MegaShift
Dendreon (DNDN) jumped today after CNBC said that three members of Congress asked for an investigation of a Food and Drug Administration panel’s vote against Provenge. Reportedly, the bipartisan trio — Reps. Mike Michaud (D-Maine), Dan Burton (R-Indiana.) and Tim Ryan (D-Ohio) — asked Rep. John Dingell, chairman of the House Energy and Commerce Committee, to probe allegations of conflicts of interest and ethical violations of at least two FDA advisory committee members that opposed approval of Provenge.
What’s wrong with this story? First, the panel didn’t vote against Provenge, they voted in favor of it. So what they really must be asking for is an ethics probe into the Food and Drug Administration’s handling of Provenge after the positive panel vote.
Second, Dingell may not schedule an investigation now or ever. He may want to wait until after the Provenge interim results come out before scheduling it. Even if there is an investigation, it won’t make any difference to Dendreon, because Provenge is either going to hit its numbers at the interim peek in mid-2008 and get approved, or it isn’t going to show efficacy that early, and the whole Phase III process will have to play out through 2009. Either way, we’re in this for the long haul.
More than 21.5 million shares traded today, about nine times normal volume. That’s probably because 29.62 million shares were sold short, out of 84.53 outstanding shares. When 35% of a stock’s float is sold short, it doesn’t take much of a spark to light a fire. Interestingly, option buyers were bullish before the news came out, with call option volume of 52,227 contracts easily exceeding put volume of 21,665 contracts. Of course, some of those short sellers may have been long calls as insurance. Setting all this noise aside, DNDN remains a buy up to $8 for a $40 target after Provenge is approved.
Millennium Pharmaceuticals (MLNM) announced good multiple myeloma data for Velcade at this week’s big American Society of Hematology conference, and the stock moved up. The data will be used to support Millennium’s application to use Velcade in combination with other drugs as a first-line treatment.
At the same time, competitor Celgene announced mediocre results for Revlimid for multiple myeloma, clipping their stock 15%. Their data doesn’t look strong enough to persuade the FDA to approve Revlimid for first-line use, and more data won’t be available until 2009. So Millennium should get a nice head start in a market that will probably move towards a cocktail of Velcade and Revlimid. MLNM is above my $12 buy limit and headed for my $23 target.
Rochester Medical (ROCM) drew a short-selling question from Dave: “It appears that a short sale program has been in play for ROCM for some time. Should we back up the truck or wait some more until it is over?”
First, the numbers: ROCM shares sold short increased from 819,920 in October to 876,750 in November. That equals 6.1 days of average trading volume, which is a typical level these days. So, I don’t think that ROCM is being targeted especially; it is just caught up in the hedging and program trading that dominates day-to-day market moves these days. Short interest equals about 10.1% of the float, and that is a little high. But remember that big upswings usually start when something caused the shorts to rush to cover, and if you aren’t in before that move, you will miss the lift-off. See Dendreon, above.
I would buy every stock in the portfolio trading under its buy limit today, and I’d hold the rest. But I had a great question at the San Francisco Money Show, which was a variation on the “which one stock would you buy if you had to go to a desert island for five years” question. I was asked which 10 or 12 stocks would I buy if I had to follow Warren Buffet’s advice to buy as few stocks as possible in your life and hold them as long as possible, preferably forever. (If you recall, we discussed this previously in the October 4 Radar Report.) That’s very hard to do in technology, which I think is the main reason that he doesn’t buy tech stocks. But if I had to name names, I would pick Affymetrix (AFFX), eResearch (ERES), Geron (GERN), Rochester Medical (ROCM), Akamai (AKAM), Harmonic (HLIT), Energy Conversion Devices (ENER), FuelCell Energy (FCEL), US Geothermal (UGTH), SiRF Technology (SIRF), Alvarion (ALVR) and TowerStream (TWER). Some of these are Top Buys right now for shorter-term reasons, and others are not. Most are under their buy limits, but some are over. For a five-year holding period, I would put that portfolio up against any tech, growth or value portfolio out there today, including Berkshire Hathaway’s.
So, Dave, the direct answer to your question is back up the truck and buy a full position in ROCM today while it is so cheap that it could double to my $23 buy limit, on its way to my $40 target after the new Medicare rules on hospital infection reimbursement go live in October 2008.
China MegaShift
If the Fed can get themselves straightened out and the U.S. market rally resumes, I fully expect the China stocks to participate in the next upleg. But this really is a bubble, and a burst is likely to happen sooner, rather than later. Here’s an example: the second-biggest insurance company on a global basis is American International Group, but China’s Ping An Insurance is just about to pass them. AIG trades for 9.2X earnings and Ping An trades for 41X earnings. AIG’s monthly premium inflow just about equals Ping An’s yearly premium inflow.
Here’s another data point: Over half of the investment managers in Mainland China have less than two years’ experience, and a third have been running money for less than a year. That’s even worse than the situation in March 2000 at the top of the U.S. Internet bubble.
All this tells me that we need to continue to remain cautious about investments in China. We’ll continue to hold UTStarcom (UTSI) for their wireless phone services and Internet Protocol TV business, but other than that, we’ll continue to steer clear of the China bubble for now.
Content on Demand MegaShift
Motorola (MOT) might be broken up. At a Lehman Brothers conference in San Francisco last week, Chief Financial Officer Tom Meredith said: “I will just share with you that I believe that there is every opportunity for us to create significant economic value, therefore drive shareholder value higher, as a whole. Does that mean, however, that other options aren’t vital options? No, not all. And as I said, a change in circumstance sometimes requires a change in action. So I will leave it at that.”
Breaking up MOT would be a very big deal, and I don’t really think that’s the most likely way for us to cash in our LEAPs. But it is a possible route. The Mobile Devices division that makes cell phones accounted for 51% of sales in the September quarter, and Motorola’s last twelve-month sales hit $38.8 billion. So it could certainly be a stand-alone company.
The Home and Networks Mobility Division accounts for 27% of revenues, selling set-top boxes to cable companies (the old General Instrument business) and wireless equipment to telephone companies. It could be a stand-alone company, as well, but this is a hot area and more likely it would be sold to Alcatel or Siemens. I don’t think Cisco could get an acquisition of this division past the antitrust regulators.
The third division, Enterprise Mobility Solutions, sells communications equipment to corporations and governments. It accounted for 22% of September-quarter sales, and it is in a similar position as Home and Networks Mobility. It is big enough to stand alone, but more likely would get snapped up.
So there’s the plan: Sell Home and Networks, sell Enterprise Mobility, and keep Mobile Devices as the smaller, still-public MOT. The total value of all this would be well over my $28 target for the stock by January 2009, so continue to buy the Motorola January 2009 $17.50 LEAP calls (VMAAW) up to $4 for a $10.50 target ($28 minus $17.50) in January 2009.
Telkonet (TKO) did it! As of this morning, Ron Pickett, the drive-by CEO, becomes Vice-Chairman of the Board and, as I predicted, Jason Tienor has been named President and Chief Executive Officer. Tienor promptly named a new Chief Operating Officer, a new Chief Financial Officer (CFO), and a new Vice President of Global Sales. Sounds like a pretty clean sweep.
Tienor said that the company’s cost reduction program has projected savings of about $2.1 million a year. Telkonet’s energy management and hospitality businesses are scheduled to double, matched by continued growth within the government systems-related sectors. Gross profit margins will increase through 2008 in line with increasing revenues, and the company is still committed to cash flow breakeven in the near term and positive earnings per share for the full 2008 year.
The proxy is also out for the Board of Directors vote coming on December 21, and Ron asked: “What do you suggest when it comes time to vote?”
I suggest voting against Warren (Pete) Musser, the Chairman of the Board, and against Ron Pickett, the former President and CEO. Vote for the other directors. Truthfully, they all deserve a “no” vote for letting Pickett try to run the company by remote control for so long, but we will collectively have a bigger impact if Musser and Pickett get fewer votes than the others.
I like Pete Musser from his days at Safeguard, but I think he would be a bit shocked if he got a lot less votes than the other outside directors. He is 80 years old and probably doesn’t want any stains on his record at this point, so maybe shock would turn to action. Jason Tienor needs to be the management person on the Board, and Pickett needs to get out of the company.
Meanwhile, with the appointment of Tienor as CEO, I am making TKO a Top Buy again up to $5 for my $15 target.
New Energy Technology MegaShift
Goldman Sachs just raised its average 2008 forecast on oil to $95 from $85 per barrel. That means they expect oil to be over $95 for half the year, and probably over $100 for at least 90 days. While that’s bad news for consumers at the pump, it’s good news for New Energy Technology stocks.
Energy Conversion Devices (ENER) moved up over my buy limit after their UniSolar subsidiary announced an order from Sun Edison for up to 17 megawatts of solar cell laminates for large rooftop installations on industrial and commercial buildings in the U.S. Sun Edison is America’s largest solar energy service provider, so this was a big win for the company. Continue to buy ENER on any dip under $30 for my $55 target. I am taking the stock off the Top Buy list, because it is currently trading over my buy limit.
FuelCell Energy (FCEL) reported that sales were up 81% to $16.5 million in the October fourth quarter, while they reduced their loss per share from 47 cents in the October 2006 period to 25 cents per share this year. The backlog rose 107% to $57.8 million, and, in addition, in November and December, they received $35 million in orders from The Linde Group, the world’s largest industrial gases company, and the Eastern Municipal Water District in California. Wastewater treatment facilities now represent 33% of the company’s total business. The fuel cell uses the methane that these facilities generate to produce electricity, and the heat byproduct generated by the fuel cell can be used in the wastewater treatment process.
The conference call was very positive. The company announced the sale of two of the big 2.4-megawatt DFC3000 fuel cell power plants to POSCO, their Korean distributor. They are scheduled for installation in 2009, but if FCEL can increase their production capacity fast enough, POSCO wants them earlier. FuelCell is increasing annual capacity from 11 megawatts to 25 megawatts right now, and then will expand to 60 megawatts during 2008. They also intend to take another 20% out of their cost of goods.
The Connecticut Clean Energy Fund selected six FuelCell Energy projects totaling 68 megawatts earlier this year. The utility review and public hearing process are now complete, and the Department of Public Utility Controls will deliver its draft decision on December 21, with the final decision due on January 9.
Plus, the 2007 Clean Energy Bill now in a conference committee includes favorable provisions for fuel cells, with an eight-year extension of the investment tax credit and an increase in the available tax credit to 30% of the project capital cost or $3,000 per kilowatt.
One striking statistic: On the conference call, management pointed out that the Energy Information Administration says that global demand for electricity is expected to almost double from 14.8 trillion kilowatt-hours in 2003 to 27.1 trillion kilowatt-hours by 2025. Throughout the world, governments, businesses and voters are looking for ways to generate this electricity 24/7 by using renewable, ultra-clean technologies.
The stock jumped 16% on Tuesday, and we’ve all had plenty of time to buy it under $11. Just in case you didn’t buy it yet, I am temporarily raising the buy limit to $12 and making the stock a Top Buy for the December 21 announcement and the impending passage of the 2007 Clean Energy Act. The target price remains $22.
Dollar Death Watch
With everyone so negative on the dollar, it is hard for a natural contrarian like me to stay bearish. But then I get up in the morning, see what Bernanke has done today, and it’s a lot easier to be negative. The $40 billion of cheap money that he will pump in via the two December auctions — probably to be followed by another $40 billion at the two January auctions — should push M3 money growth way over 20%. That’s like hitting the dollar with a semi. If the Fed actually provides another $24 billion to European central banks, that’s like backing the semi up to run over the dollar again. I think he must know by now that he is in great danger of being remembered as the Fed Chairman that killed the dollar. Maybe he doesn’t care or, more likely, maybe that is the plan. Whatever the truth is, I can’t turn bullish on the dollar in spite of the fact that I now have too much company on the negative side. Continue to protect yourself.
Short Selling
In addition to Dave’s question on timing an entry into Rochester Medical, Norm wrote: “On Nov. 20, you wrote, ‘…a new SEC regulation on short sellers, requiring that all Failures to Deliver (illegal naked short selling) be located and closed out by December 4.’ You declared that Dendreon and Telkonet had heavy naked short interest. What exactly did this SEC regulation mean and why have both these stocks gone only down, down, and down. My calendar says it is December 4. Is it wrong?”
Unless it’s a digital calendar and the battery went dead, probably not. The S&P 500 is about flat since December 4. Dendreon traded double its normal volume on December 4, and it was up from $4.61 to $5.64 at yesterday’s close, before today’s jump. Telkonet was also pretty flat over the same time period.
Short sale data is collected in the middle of the month, and the listed data is made public around the 22nd of the month, followed by the NASDAQ data on the 26th. We’ll know then what has happened in terms of covering shorts. If I don’t see a big decline in the short interest, I will file a complaint with the SEC regarding each company. The TKO management news today should scare the shorts, though, and the Dendreon news caused obvious covering, although the shorts may come back quickly, so it won’t be clear what really impacted the data.
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