With the Dow Jones Industrial Average hitting record levels and the NASDAQ Composite at its best level in five years, October certainly hasn’t lived up to its trick-or-treat reputation for stocks so far. Normally, the first half of October brings some nasty tricks in the form of big down days before earnings are announced. The second half of the month brings treats in the form of big up days as analysts take the first three reported quarters for the year, add the companies’ guidance for the fourth quarter, declare the year over, and then look forward to how good things could be in the coming year and how much cheaper stocks are on forward-year earnings than they are on current-year earnings.
I have no problems with that process, having watched it for over 25 years. In fact, I can tell you the exact day that stocks bottom, on average: October 10. That was Tuesday, the very day the Dow hit a record high, which was surpassed again today. So, either we are dealing with something very different this year, or stock market investors are in for a rude awakening.
I remain open-minded on that subject, but still biased towards the “rude awakening” scenario. Because as long as the Fed says they are “data driven,” then the stock market will be data driven. And we will have to see what the real data says in order to determine the next market move.
So now, let’s take a look at some of the recent data out there that has me leaning towards the “rude awakening” scenario.
The bond market is in a free-fall, sending long-term interest rates back up. The good news from that is the inverted yield curve is less inverted, suggesting a recession will be brief, shallow, or maybe not even happen. The very large trade deficit with China that was announced this morning certainly points to a stronger consumer sector than I expected at this point in the cycle. The bad news is that rising long rates suggest rising inflation — a Fed no-no, as they reminded us this week — and also kick a major prop out from under the recent stock market rally.
If the bond vigilantes now agree with stock market investors that the economy is not going to weaken significantly, that may mean both bonds and stocks are in for a nasty tumble.
Also, the relative weakness in the Philadelphia Semiconductor Index (SOX) over the last four weeks — up only 0.7% while the S&P 500 rose 3.5% — makes me suspicious. The SOX should roughly double the S&P’s moves in either direction, yet it is still about 20% below its January high for this year. It’s hard to imagine a big new up-move getting underway without the semiconductor stocks.
And last week, regarding the price of oil I said: “It would be normal to see it retest that $57 to $58 range shortly, and then head up to probe the resistance at $68. The process of adding $10 a barrel to oil prices might prove pretty unnerving to the stock market.” Oil retested down to $57.24 intraday yesterday. We may be about to see rising oil prices take the market down.
Whatever the reason, my most likely scenario is the one I outlined last week: First, this quick move up to the January 2001 major monthly breakdown level of 1365 on the S&P 500, now just a couple of points away, and likely to be accompanied by 12,000 on the Dow, which will definitely give CNBC something to talk about. This move is almost certain to be followed by a decline back to the recent support level at 1327, and that’s where the next key move will begin. I think it will drop through support and then crack 1295 to head back to the 2006 lows around 1220, or even all the way down to 1140. It would happen much later in the year than I expected, but we would still use that downturn as a major buying opportunity for the next two years.
But if the S&P can bounce off 1327 and decisively break through the major resistance at 1365, then the August 2000 high of 1518, and maybe even the all-time high of 1553, become the next targets. In that case, as I said last week, I will raise some buy limits, bring you some new stock ideas and recommend going 100% invested.
Right now, earnings season is just barely getting underway, so there isn’t a lot of news from our companies. But I do have some thoughts on some of our MegaShifts, and there are a couple subscriber emails that I want to address today.
Biotech MegaShift
In addition to the SOX index, I often look at the AMEX Biotechnology Index (BTK) as a leading indicator for the whole market. Here, the picture is brighter. In the last four weeks, the BTK is up 7.8%, handily beating the broad market averages. The index slumped from last November through May and built a basing pattern through the end of September. It’s really come alive recently, as often happens in the fourth quarter. There are lots of scientific meetings coming up, and the FDA really does make an effort to approve some drugs before the end of the year to make their statistics look better.
If the market retrenches as I expect it will, and biotech can hold its own, this will signal that the biotech sector will be a market leader in the coming rebound. Institutions always look for non-cyclical investments when they smell an economic slowdown, and healthcare/biotech goes to the top of their shopping list.
QLT Inc. (QLTI) barely budged after Genentech announced strong results after the close on Tuesday. The results were driven in part by surprisingly strong sales of their new macular degeneration drug, Lucentis. Genentech also raised its guidance, based on a higher forecast for Lucentis. The drug was launched in the U.S. on June 30, and the company sold $153 million of it in its first quarter on the market. That’s better than even Avastin, their blockbuster cancer drug that brought in $133 million in its first quarter on the market.
Why is this good news for QLTI? Two reasons. First, the introductory splash around Lucentis will get more untreated patients into their doctors. Macular degeneration has one of the lowest treatment percentage rates of any disease, especially in its early stages. Second, when those patients get there, the doctor will explain that Lucentis has to be injected into the eyeball. And then they’ll give an alternative treatment option: QLTI’s Visudyne. Some doctors will urge patients to go on both drugs, as they have totally different mechanisms of action and anecdotal evidence from the combination trials underway suggests that a combination regimen is more effective than either drug alone.
When QLT announces results in a couple of weeks, we’ll find out for sure whether the Lucentis launch helped or hurt the quarter. The stock is trading within pennies on each side of my $8 buy limit, and QLTI can be bought now for my $20 target as Wall Street realizes Visudyne will be part of everyone’s combination therapy.
China MegaShift
Last week’s Radar Report triggered this email from Jake: “Are you then saying from your report today that you do not recommend we buy any stocks, including your Top Buys, until you advise us to? What about Ctrip.com (CTRP)? You had mentioned to me at D.C. Money Show in August to wait. Is now the time or not?”
First, what I have been saying is you should hold a large cash position right now, but not 100%. For the invested portion of your portfolio, you can buy any stocks under the buy limits. Focus on diversifying your portfolio, so you are not overcommitted to just one or two MegaShifts, and start with the Top Buys as my best ideas.
Regarding Ctrip.com: Not yet. The stock is down a couple of dollars since the D.C. Money Show, but if the U.S. market is hit on recession or interest rate fears, China will take a bigger hit. We saw this phenomenon play out in May, just after we sold CTRP. On the other hand, if the U.S. market takes off, it probably will pull some money out of the Chinese market for a little while, and give us a chance to get back in. I’ll be sure to let you know in a Radar Report or Flash Alert when the time is right to buy back into CTRP.
Content on Demand MegaShift
It’s all about video. That’s one of the big messages from the Google (GOOG) acquisition of YouTube for $1.65 billion in stock. It’s also the message from Microsoft’s announcement that their IPTV (Internet Protocol Television) software platform for set-top boxes will be supported in the next-generation, system-on-a-chip boxes coming from Cisco, Tatung and Philips. It’s also the message from Steve Jobs’ recent preannouncement of Apple’s iTV media center for your living room, coming in the spring. And, of course, these messages are all good news for our Content on Demand stocks.
Harmonic (HLIT) is not in the set-top box business, but anything that drives IPTV or more video over the Internet is good for HLIT. Harmonic sells the video infrastructure systems that go at the head end of the process, in TV studios and cable company distribution points. They also sell some of the video transmission network gear to get the signal out to neighborhoods and to the curb. I am raising the HLIT buy limit to $7 for an unchanged $12 target, as it seems unlikely to dip below $6 even in a significant market correction. HLIT remains a Top Buy.
Zhone (ZHNE) is another big beneficiary of video over the Internet, as they sell gear to both the telephone and cable companies to be used at the customers’ premises to make high-speed, broadband connections. After the negative preannouncement that I covered in the September 28 issue, the stock dipped below $1 a share intraday this week, although it hasn’t closed below that level.
But it has raised some concerns and a flurry of emails. The following three questions pretty much sum up the majority of the concerns I have received lately. From Carl: “You did not mention ZHNE in your last report. Is it still a great buy or is it going down the tubes?” Larry asked: “At what price are you worried the price will break down and we are ‘down and out’ with this stock?” And Jerry said: “When the price dropped, I loaded up. Now, you have quit talking about the stock. It has been one of your Top Buys for months. What now?”
Obviously, missing this quarter was not good for Zhone, as it adds to the uncertainty that has been depressing the stock’s price for two years. I think insiders decided not to let it close below $1.00 a share, as that is the level that brings about NASDAQ procedures that are better avoided. But we really won’t know more until Zhone reports after the close on October 19.
The company has cash, blue-ribbon venture capital support, a rapidly-growing market and industry-leading products. With a market capitalization just over $150 million, compared to over $1 billion in paid-in capital, I still think Zhone looks like a gift of major proportions.
As I said in the September 28 issue: “This should be as bad as it ever gets, as the September quarter is the hardest one to close international business. While the old products run down, their new DSL products are still growing rapidly. Management should guide very conservatively for the December quarter if they have any sense. I’m going to ZHNE as a buy based on price, not on timing, but reduce my buy limit to $2 to reflect this latest disappointment. I’ll cut the target price to $5 for next year, although there’s no reason they can’t hit the $7 figure if they execute better in a more favorable stock market environment.”
I think you could put in an order to buy ZHNE at $1.01, just above whoever is supporting the stock, and maybe get some more on a down market day. I’m putting Zhone back on the Top Buy list, as I said last week based on price, not timing.
New Energy Technology MegaShift
We never got the bad hurricane season the experts predicted — we never even really got one hurricane in the Gulf of Mexico. That, plus what passes for peace in Lebanon, plus the expiration of our firm deadline for Iran to do something (they didn’t), sent the price of oil falling to my lowest targets at $57 to $58. As I said above, oil looks like it just completed a retest of that range this morning, and I expect the next move to take oil up $10 a barrel or so to the $68 area.
That would mean the correction in energy stocks is about over. The Independent Petroleum Association of America held an investor conference this week, and few people attended. That’s another sign the sector is sold out. With the weather turning cooler, the benign “shoulder months” for energy demand (September and October) give way to worries about winter demand for energy. The National Oceanic Atmospheric Administration forecasts a 5.9% colder winter for the lower-48 states compared to last winter, which was fairly mild.
The Energy Department just said that fuel bills should average 12.5% less this winter due to lower prices, and they are classic trend-line thinkers who are very wrong at turning points. Natural gas heats 58% of U.S. homes, and the DOE used the recent abnormally low prices for gas to make their forecast. Also, you can look for a change in their forecast after the election is over.
All of my New Energy Technology recommendations are trading below their buy limits except Holly (HOC), which went back over the limit today. This is the time and these are the prices to put money into this area, as rising oil prices will push these stocks up even as they push the broad market down.
WiMAX MegaShift
Gary asked: “With the largest rollout of WiMAX being announced by spectrum-rich Sprint Nextel, and their teaming with Motorola, Intel, and Samsung just how is it that AIRN, ALVR, and/or TRBM are going to directly benefit from this mammoth deployment? I own INTC and am buying MOT in addition to your recommendations and agree that WiMAX will be big, but I want to be well covered for this powerful MegaShift.”
Gary, when the equipment orders come in, it is very possible that Airspan (AIRN), Alvarion (ALVR) and/or Terabeam (TRBM) will get a piece of the Sprint Nextel pie. More important, though, is the pressure the Sprint Nextel deployment of a fourth generation (4G) communications network puts on all their competitors. You have rightly perceived that this is a powerful MegaShift.
If Microsoft delays Windows Vista, you will be early on Intel. I find Motorola a difficult company to analyze these days, because most of their earnings come from high-fashion phones, where you are only as good as your last design. And while I like Samsung, I don’t think they will list their stock in the U.S. due to Sarbanes-Oxley, and it’s really hard to buy it otherwise.
So my answer is to own all three of AIRN, ALVR and TRBM now, and look to buy INTC after the Microsoft announcement, if it comes. Also, on a side note, Terabeam just won the WiMAX contract for Taichung, Taiwan, a citywide broadband project to be completed in two years.
MobilePro (MOBL), like Zhone, drew a couple of questions. Melbourne asked: “What are your feelings re: risk/reward/solvency?” And Carolyn asked: “Why are we still holding it? If not for your recommendation, I would have been done with this stock months ago.”
MOBL has enough assets to avoid insolvency, but the risk is on the structure of their liabilities and whether they can refinance or monetize the contracts they are going to announce with many, many municipalities that want to deploy Wi-Fi and WiMAX networks. You can tell by the stock price that this is a high-risk, very high-reward position. The company announced today that it obtained up to $3 million in lease financing for Wi-Fi deployments.
As for Carolyn’s question, we are holding it because tens of thousands of towns and cities plan to deploy Wi-Fi networks to cut their costs, revitalize their downtowns and stay competitive. MOBL is one of the top five companies in that business — arguably, one of the top three. They have “insurmountable opportunities” and we can make 10-to-1 or 20-to-1 on the stock. (The current market cap is only $71 million, so 10-to-1 or 20-to-1 is well within the reality envelope.)
Incidentally, you have probably heard about the 10b5-1 stock plans that top managements use to sell large portions of their holdings on a regular monthly basis over time, in an effort to avoid being accused of selling on insider information. The CEO of MOBL has a 10b5-1 plan, too, except his is to buy the stock. This week, he extended the plan through January 2007 and reported that he has acquired 422,000 shares of stock under the plan so far. Go thou and do likewise. MOBL would be a buy at twice the current price, as my buy limit is 25 cents for an initial target of 60 cents.
Google Short Sale
Google (GOOG) is up on the news that they are buying YouTube. We’ll let the stock tell us when to short it again — not yet, certainly — but I wanted to comment on the deal. First, they are paying stock, not cash for YouTube. If Google thinks that their stock is far overvalued (insiders have sold about $1.4 billion so far), then they really aren’t paying $1.65 billion. At my short sale target price of $200, they are really only paying about $800 million.
Still, I said “only” $800 million for a company with little revenues and huge losses. But look at the numbers. YouTube has about 75 million unique visitors each month, and the average user does 11 page views before they move on. Big websites think two to four page views is reasonable. So, if users only visit once a month, there are 750 million page views. But most people think the real number is about double that on the site, 1.5 billion page views, and an equal number posted to other sites and blogs, for a total of three billion page views.
Advertising rates run from around $10 per thousand page views on a general site like CNN to about $40 per thousand on a specialized site, like Edmunds.com. That’s one cent to four cents per page view, and Google is awfully good at matching ads to pages.
But assume they only get one cent a page view for the 1.5 billion pages per month on their site, and we ignore all the blog and other reuse pages. That is $15 million a month or $180 million a year in sales, currently growing at a 100% rate. So Google paid less than 10X this year’s potential revenues at the stated price, and less than 5X next year’s sales. At the “real” price implied by a $200 stock, they paid less than 2.5X next year’s sales.
The real issues here are how Google will handle copyright infringement, which is an epidemic on YouTube, how they will monetize the pages (Adsense and banners, most likely) and whether YouTube is a just a flash in the pan. Those are big issues, but they have little to do with my continuing interest in shorting Google. I am still looking for advertising prices to fall apart in an economic downturn, and I don’t think Wall Street has any concept of how hard that would hit Google’s bottom line.
The YouTube acquisition pushed GOOG up, making it an even juicer short when the time comes. I will send you a Flash Alert when that happens. It could be soon.
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