As I expected, the economy is much weaker than the consensus predicted. Real GDP growth slowed to 1.6% in the September quarter, the slowest since the March 2003 quarter. It is going to slow further, as housing is coming apart at the seams. Investments in housing fell 17.4% in the quarter, the largest decline since the first quarter of 1991. Housing subtracted 1.1 percentage points from third-quarter GDP growth, squashing the impact of solid spending by consumers and businesses.
But there’s the rub. Consumers have not adapted their spending behavior to what is happening to their real estate wealth. An August Wells Fargo survey found that only 6% of homeowners thought their home’s value would decline in the next 12 months. Yet, it is more probable that 100% of their homes will drop in value. Consumers are always late to the train on these issues. For example, even after the Fed started raising interest rates, consumers kept opening new equity lines of credit for six months, and then suddenly the situation hit them and they stopped.
With the housing crunch continuing for another six to twelve months, consumer spending will soften. Business inventories are already too high, especially in the cell phone and personal computer area, and business capital spending budgets are just starting to come under pressure. When consumers slow their spending, imports fall to prevent excess retail inventory, businesses stop investing, exports fall as worldwide economies soften, and then, guess what we get — a recession.
While it is popular today to say that the Fed is engineering a soft landing and will start cutting rates in March, I think it is far more likely that we will get the usual hard landing — two consecutive quarters of negative GDP growth. Single family home rental expenses, which are a large fraction of the Consumer Price Index (CPI), rose slowly over the past five years because they were subsidized by increasing prices, which made landlords feel better. Now rental expense is going up as house prices fall, so the CPI is going to stay well above the Fed’s “comfort range.” Will they cut rates anyway, making a mockery of Chairman Bernanke’s 1% to 2% stated inflation goal range? Probably. But it will be a struggle, and unlikely to happen as early as March.
The stock market has been a big believer in the soft landing, and through Tuesday we had 78 straight days of the S&P 500 not dropping more than 1% in a single day. That was a very strong rally, with the last comparable run in 1995.
But yesterday’s break under 1377 probably marked a change in character for this market, and set the stage for a decline that will tell us a lot about what is coming next. That was the first break of a support level since the rally began, and it would be normal for the market to rally back to that level from below. If it can break through, the levels I mentioned in last week’s Radar Report — 1405, 1440 and maybe even 1553 — are likely, with record highs to be seen in 2007.
However, the most likely scenario is that the S&P 500 can’t break through 1377, and “kisses it goodbye” to go down and test support at 1325, 1295 or even 1220. I was surprised that the market couldn’t even muster a feint back to 1377 today. Yet, I would consider a clean, quick test back down to be very bullish, as that would reload the troops for the next big move up in the bull cycle that I think is unfolding for 2007 and 2008.
A more complicated up-and-down double or triple top before the decline gets underway would be much more serious, and suggest we are in for several months of poor returns. At this point, I don’t think that’s the likely path, but I am closely watching how things develop from here.
I still think you are safe in putting some money to work in the stocks that I named in the last issue, as they have very little downside risk even if a market correction has begun. Just to remind you, those stocks would be BioCryst (BCRX), Dendreon (DNDN), eResearch (ERES), Harmonic (HLIT), Zhone (ZHNE), Omniture (OMTR), Connacher Oil & Gas (T.CLL), Gasco Energy (GSX), Infinity Resources (IFNY), Rentech (RTK) and Alvarion (ALVR). I would also add last issue’s new recommendation, Affymetrix (AFFX), to the list when it dips further and goes under my $24 buy limit.
If you haven’t put any new money to work and are comfortable with your cash position, wait to see how a market decline plays out. But be ready to put some money back to work if you see the S&P 500 post a strong close back over 1377, as that will signal this little downturn was a bear trap, and the market is headed substantially higher in a hurry.
Avian Flu MegaShift
According to researchers, bird flu killed a dog in Thailand a couple of years ago, which reminded everyone that cats and dogs can get the H5N1 virus and then infect their human owners. In China, scientists identified a strain of bird flu that eluded avian vaccines and is primarily responsible for the third wave of animal infections in China and other Asian countries during the last year. This strain, called “Fujian-like” virus, replaced the other H5N1 flu strains that were circulating in Chinese poultry.
I am not surprised. China very actively vaccinates poultry, including using illegal vaccines, and the only long-term effect is to cause the virus to mutate to a more deadly form that is immune to the vaccines. Researchers have their blinders on, and say things like: “It’s the same vaccine, and it’s made in China, so we need to find out if the vaccination policy is not being followed or some vaccine is not up to snuff. If the vaccines are not protecting against new strains of the virus, then those strains have to be included.”
BZZZZT! WRONG! That is a recipe for breeding a super strain of H5N1 that will be resistant to all vaccines. But they aren’t going to stop any time soon, so this crisis is simply going to get worse. Buy BioCryst (BCRX) under $19 for my $30 target,
Crucell (CRXL) up to $28 for a $50 target, and hold both the Gilead January 2007 $60 LEAPs (GDQAL) for my $20 target, and the 2008 $50 LEAPs (YGDAJ) for my $30 target.
Biotech MegaShift
Biogen Idec (BIIB) jumped $3.69 on Tuesday after they reported a great quarter and, just as I’ve been expecting, good Tysabri sales of $8 million (split $5 million for BIIB and $3 million for their partner, Elan). Avonex, Biogen’s current leading multiple sclerosis drug, had very strong sales of $445 million, at the high end of the $410 million to $450 million that analysts expected — yet, Tysabri will eventually pass it. Tysabri will be a $1 billion drug by 2010, or earlier.
The company reported $703.5 million in sales, up 18% from last year, and 57 cents a share proforma, compared to the consensus estimates for $681.3 million and 49 cents. They raised their guidance for 2006 to something over $2.20 a share, compared to their prior guidance for $1.95 to $2.10 per share.
Our LEAP options took a big jump with the stock, and I think this is just the beginning. BIIB is becoming a must-own biotech, like Genentech, and the biotech group looks like it will lead the market higher when the next up leg begins. The January 2007 $45 LEAP call (IDKAI) is becoming more of a gamble due to the limited time left for it to work out, although I still think it will. But, for safety’s sake, sell IDK AI and roll the money into the January 2008 $45 contract (YZUAI) under $12 for my $23 target, or higher. I am only recommending this because a broad market decline at this point could delay BIIB’s ascent to $66 past January, and I want you to be able to relax and give Wall Street plenty of time to run this stock to the level it deserves.
Dendreon (DNDN) has been flirting with $5 a share for a couple of weeks now, following their presentation at the Prostate Cancer Foundation’s Thirteenth Annual Scientific Retreat. They presented some positive additional data on the current Phase III clinical trial for Provenge, which will not be part of their filing for approval. That filing will be completed by the end of the year, with Fast Track review in the first half of 2007. I still think they will get approval because they extended survival in advanced prostate cancer cases by 11 months. Genentech’s Avastin extended survival by five and a half months, and it is a blockbuster cancer drug.
When approval comes, DNDN will spike to my $14 target, and we may hold it for higher levels, which I expect to come later. Provenge will be adopted very rapidly, as there is no other treatment available, yet Wall Street continues to act as if personalized cancer vaccines are unlikely to be approved, and if approved, unlikely to be used by doctors. Wrong and wrong. DNDN remains on the Top Buy list up to $7 and is a steal at current prices for my $14 target.
ViroPharma (VPHM) reported a great quarter this morning. The numbers were super: Record Vancocin sales of $55.1 million and 33 cents a share versus the Street consensus of 26 cents. There was about $8 million in wholesaler buying ahead of a price increase, which will make for a tougher comparison next quarter. But Vancocin prescriptions grew 19.5% from last year’s third quarter, and remain strong.
Their clinical pipeline news also was strong. VPHM started their Phase III trial of maribavir to prevent cytomegalovirus disease in stem cell transplant patients, and will present Phase II results at the upcoming American Society of Hematology (ASH) meeting. They also are about to start a Phase III study in solid organ transplants.
VPHM announced positive Phase 1b results for HCV-796 in combination with pegylated interferon as a treatment for hepatitis C, and will start a Phase II trial shortly. Hepatitis C is a rapidly growing problem, and the virus mutates quickly. It looks like HCV-796 targets a portion of the virus’ protein coat that does not change, so it may be a very effective drug for this troublesome disease.
They still hope to close a major acquisition this year, which would give them a drug to pick up the slack when Vancocin eventually does get generic competition. Perhaps the best news of all, which I found out separately from the conference call, is that their efforts to stop early approval of generic Vancocin may have already paid off. There are new rules from the Office of Generic Drugs that say the critical path for faster generic approval no longer includes generic Vancocin. That should put off competition to late 2008 or 2009. This news has not been reflected in the stock price yet, and I think VPHM is one of the cheapest stocks in the whole healthcare area at 15X earnings for 22% growth. Buy under $13, where it was yesterday, for my $28 target.
China MegaShift
UTStarcom (UTSI) dropped $1.12 today after a Hong Kong–based Merrill Lynch analyst cut the stock from neutral to sell because it has doubled from its June low. He didn’t mention that it is still 50% below its 2005 high. Sheesh. Ignore him, and buy UTSI if it gets hit under $9 for my $15 target.
Content on Demand MegaShift
Silicon Image (SIMG) reported just after the close last Thursday, and I commented briefly on the numbers in last week’s Radar Report. They did 24cents a share on $78.3 million in sales, beating the consensus, but guided for a decline of 3% to 5% due to normal seasonality, or $74.4 million to $76 million in the December quarter. Wall Street was looking for $79 million in the fourth quarter, so the stock was hit for $2.42 on Friday. Then on Tuesday, SIMG revealed an informal investigation into their option granting practices due to an SEC inquiry, so they are caught in that malaise as well.
As I said last week, I am not worried about the December quarter, and I continue to think that they will show strong revenue growth in 2007 as many new HDMI-connected products, where SIMG has the design win, get to market. But I am worried that a consumer slowdown scares Wall Street, and keeps the stock cheap. So, I moved SIMG from a buy under $10 to a hold last week, and the lowest it has gotten so far was $10.88 yesterday.
If we get a chance to pick it up in the next few weeks between $9 and $10 due to broad market weakness, I will move it back to a buy. But given the options investigation and two weak quarters (March being seasonally weak), there’s no reason to rush to buy it today. Just to be clear, I would not sell the stock, either. SIMG is a strong hold, based on the fundamentals of its business, for my $18 target in 2007.
Telkonet (TKO) has a subsidiary, MST/NuVisions, that has quietly become the largest Wi-Fi supplier in Manhattan. For the New York City Marathon, the largest such race in the world that will be run this Saturday, they are providing a dedicated Wi-Fi network to link spectators, staff, organizers, security, press and medical personnel. It should give them a bit of exposure, while demonstrating how well their wireless high-speed backbone copes with surges of traffic. This is a part of TKO that I don’t talk about much, but they are expanding the number of Wi-Fi hotspots monthly, and the day may come when the city government realizes how much money they could save by using the MST/NuVisions system. The trade, of course, is free access for the city and for special events like the marathon, in return for a franchise for all of Manhattan. TKO is a Top Buy up to $5 for my $15 target.
New World Economy MegaShift
Omniture (OMTR) will make a major product announcement on December 11 in San Francisco. The product is “plug and play” technology used to integrate online marketing analysis into a company’s existing systems. This is going to be HUGE — some call it Marketing 2.0, piggybacking on the Web 2.0 terminology.
We all had plenty of opportunities to buy this stock under $8, and it has moved up nicely this week. I am raising the buy limit on OMTR to $10 in case you missed it, while keeping my target at $20. If you are hesitant to buy in the face of a potential sharp market decline, get half a position here and try to fill out the rest closer to my original $8 limit.
New Energy Technology MegaShift
Oil prices seem locked in a $58 to $59 range for now, with the drop to $57.05 on Tuesday quickly rejected by traders. Slightly warmer than usual weather in the U.S. and high inventories are being offset by concerns over OPEC production cuts. Wall Street is very skeptical about the stated 1.2 million barrels a day target for the cuts, and is betting reality will be closer to 200,000 or 300,000 barrels a day. But Oil Movements, an industry consultant that actually measures shipments, says that there will be a 2% decline through November 18, or 400,000 barrels a day. So, the cuts are starting to bite, and I think we are one cold snap away from using up a significant amount of inventory. With all the energy sector stocks depressed, now is the time to step up to the plate.
Holly Corp. (HOC) reported yesterday morning, easily beating the consensus. They did $1.17 billion in sales and $1.37 a share, excluding nonrecurring items. On the same basis, the Street was looking for $0.99 billion and $1.28. The stock bounced up $1.58 yesterday and another 15 cents today.
On the conference call, management said that their Navajo refinery expansion is now producing at full volume, and they will have a record year in 2006. They had $79 million remaining on the $200 million share buyback program that they announced last December, and the Board just added another $100 million to that. So far, they’ve bought back 1.3 million shares at an average cost of $45.64. It looks like they will do over $4 a share this year, so at 12X earnings, why shouldn’t they buy back their stock? HOC is a buy on any dips under $46 for my $60 target.
Plug Power (PLUG) received $8.6 million in three awards for hydrogen fuel cell research, development and demonstration projects from the Department of Energy. The first award is for an ethanol-based fuel cell system connected to the utility grid. The second is to develop a high temperature combined heat and power fuel cell system for apartments. The third is a new design for a one kilowatt proteon exchange membrane fuel cell stack. The stock went down 10 cents on the news — hello? Is anyone listening? All of these programs are expansions into markets adjacent to PLUG’s backup systems business. This was good news, and PLUG remains a buy up to $5 for my $10 target.
Security MegaShift
@Road (ARDI) held their conference call after the close last Thursday. As I covered in last week’s Radar Report, they came in with $25.2 million in sales and a profit of three cents a share, beating expectations. On the conference call, management said that they got almost 17,000 more subscribers in the quarter, well above expectations, and are on track for their 181,000 subscriber goal by the end of the year. They guided for $26 million to $27 million revenues in the December quarter, and three to five cents a share, at or slightly above consensus. Then they surprised me by giving 2007 guidance for 20% to 25% growth, which they added (a) could be low and (b) they already have 85% of that committed. The number of subscribers will grow 30% to 40%, and profit margins will improve. They are going to add some indirect sales channels in 2007, and any business from that direction will be additive to the current guidance.
One of the venture capitalists filed to sell one million shares, and I think those cleared last Friday and Monday, even as the stock was rising. It closed today one cent below its 52-week high. ARDI is well above my buy limit, so I am moving it to a Hold for my $8 target this year and $10 to $12 in 2007.
Video iPod MegaShift
Portal Player (PLAY) reported as last week’s issue was about to be posted on the web. The September numbers were OK, as I reported last week, but their December-quarter guidance for $31 million to $38 million and five cents to 14 cents was weak compared to the consensus expectations for $38.9 million in revenues and 12 cents a share. After an initial 40 cents a share hit last Friday, due in part to a downgrade from one Wall Street firm, the stock has been quite strong this week. I think one reason for the strength is the increasing buzz over a coming Apple iPhone — a cell phone and music player. PLAY has a chip for that combination to sell to Apple or any of their competitors.
On the conference call held later last Thursday, PLAY said that they have their new generation of chips ready to show at the Consumer Electronics Show in January. They added that they continue to ship products to Apple for the video iPod — that was interesting — and won a SanDisk contract for that company’s c200 MP-3 player. In 2007, the company is looking for a very innovative year for the personal media player market. They expect to see new media players with a variety of capabilities, enhanced video (including high definition) and other new features.
PLAY is also looking forward to the Windows Vista introduction, which will bring the little Preface screen on the outside of a laptop to let users access things like calendars without starting the computer. PLAY and Microsoft had been thinking of this as a simple in-lid display, but as they’ve worked through the design opportunities with customers, they’ve realized that the potential applications are much broader than that. PC manufacturers want to use the technology to differentiate their products, so they are designing new ways to implement Preface. For example, the secondary display can function as a media remote control, or a personal media player, or a Bluetooth-enabled voice handset, or a combination of these.
These new products will have a lower profit margin at first, which is the main reason the December quarter will be soft. But they expect margins to recover quickly in 2007, so I am comfortable keeping PLAY as a buy under $12 for my $20 target.
WiMAX MegaShift
Alvarion (ALVR) reported this morning, booking a proforma profit of two cents a share on $54.0 million in sales, up 7% from the June quarter. The consensus was looking for breakeven on $52 million in sales, and the stock barely budged today on 1.5 million shares, more than double the normal volume. They guided in-line for $52 million to $56 million in sales and one to four cents a share proforma profit for the December quarter.
WiMAX accounted for a third of their sales in the September period, and represented initial orders from many customers rather than a few big rollouts. The big rollouts are coming in 2007. Alvarion has 100 WiMAX deployments and 120 trials underway, and said bookings were “very strong” in the quarter. They will see good sequential growth in the current quarter. ALVR remains a Top Buy up to $9 for my $18 target.
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