This market has been showing remarkable resiliency during what is typically a seasonally weak period. The last half of September and the first half of October are normally especially bad. But maybe this year everyone knows it and has discounted it for the time being. I find that hard to believe, though, because the Fear & Greed Index — the VIX — is still bumping along at multiyear lows. This shows that investors are complacent and not worried about volatility.
What has investors in such a contented state? It could be the drop in oil prices, the benign hurricane season, less saber-rattling around Iran, reduced inflation numbers or the prospect of a split, and therefore, less disruptive Congress that are providing the fuel for this feel-good atmosphere. The lack of negative earnings preannouncements isn’t hurting matters either. Although, there never was much question that companies that gave cautious guidance in July would make their numbers in September. But the real question on my mind is what will guidance look like for the December quarter, especially in the context of a rapidly cooling economy.
In the meantime, the low VIX is at a level that assumes there will be no more hurricanes, a diplomatic solution to the Iran situation, a mild winter in spite of the developing El Niño, a soft landing for housing and good guidance in the October conference calls. Pretty much all of those have to happen to keep the market at current levels. Most of them don’t look likely to me.
Plus, the current state of the market is reminding me more and more of the market we had in May. The steady upturn over the last two months is similar to the steady upturn from early March to early May with this week marking a double top with the early May top. If the market continues along the same path as the May markets, the next five weeks will see a sharp plunge mirroring the May-to-mid-June drop. I believe that’s a higher-probability scenario than what Wall Street is expecting, and it is the risk I want to keep you away from.
Today’s decline triggered an hourly sell signal that bounced weakly up to the prior breakout levels. By closing at 1318, it also triggered a more serious daily sell signal. It would have to close below 1300 tomorrow to trigger a weekly sell signal, and if that happens, I think the complacency will be routed pretty quickly. My idea had been that we’d see the lows during the San Francisco Money Show as October earnings reports got rolling, but I now think a major decline would last into November. We should know soon.
So, with the market currently mirroring the May scenario and a decline on the horizon, I’m not comfortable making any new recommendations at this time. I have several new ideas on my plate right now, but I don’t think it’s wise to even nibble at them just yet. We will have plenty of time to buy new, great stocks at attractive prices once we are through the down period that I’m expecting over the next couple months. And don’t forget, just as life insurance is not a bad idea even if you don’t die, holding cash during a potentially risky period is prudent, even if the market doesn’t go down.
The Canary in the Coalmine
The action in Google (GOOG) is especially interesting to me right now. Google led the market up at the end of last year and earlier this year, and it has been the canary in the coalmine for many of the downturns and upturns since. On Tuesday, Yahoo’s CFO was presenting at the Goldman Sachs Communications Conference and said that advertising demand is slowing “a little” from automakers and financial companies. “A little” turned out to be enough to put Yahoo’s results for the September quarter at the low end of their guidance range. Both Yahoo and Google were hit hard — Yahoo dropped about $4, and Google lost $17, slipping below $400 on Wednesday’s close. Of course, this is the thesis behind my short sale recommendation –advertising is very cyclical, and incremental revenues have nearly 100% profit margins. Cheerleaders like Jim Cramer haven’t seen that yet — on yesterday’s Mad Money, Cramer said that Google “is a repository of all things great” and that the stock may exceed $500 a share because so many children use it and the company generates a lot of cash. I’m sure advertisers will be thrilled to learn that the clicks they are paying for are coming from children.
The big drops in Yahoo and Google on Tuesday and Wednesday are just the sort of initial moves that start a serious decline. At this point, Google bottomed at $395 and bounced to $408 today. I think that it could bounce as high as its Monday high at $418 and still be in the decline scenario. So, I am looking for a break under $395 to short the stock again, and a failure to get back above $410 over the next few days will make me especially interested in getting bearish on Google again. But if GOOG can break through $418, I’ll go back into my cave and wait for another day. I will send you a Flash Alert when the time comes to re-short GOOG.
Meanwhile, we are in the quiet period before the end of the quarter, without a lot of news from the companies. But we have had some interesting developments in a number of our holdings that I want to tell you about today.
Avian Flu MegaShift
Indonesia confirmed another case of human-to-human transmission of bird flu, when a man who cared for his sister in a hospital for six days caught the disease from her. This raises the possibility that the strain of the flu circulating in Indonesia, which has killed 49 of the 65 people infected so far, has begun to make the mutation jump that everyone fears. It is still labeled an avian strain, but one more mutation would probably be classified as an infectious human strain, capable of spreading by coughing or sneezing. I still expect this to happen eventually.
BioCryst (BCRX) said that their cofounder and current CEO will retire in 2007, and began a CEO search. They have plenty of time to pick someone terrific to run the company, and there will be no shortage of applicants now that they’ve made the press release. This does not affect my recommendation to buy BCRX up to $19 for my $30 target, which I expect after the fall migration season brings infected wild birds into the U.S.
Biotech MegaShift
Dendreon (DNDN) will present at the UBS Global Life Sciences Conference on September 27, with a live webcast on their site. I expect them to say that they are on track to complete their BLA filing for Provenge with the FDA by the end of the year, and they may even accelerate the time frame a bit. DNDN remains a buy up to $7 for a $14 target after Provenge is approved.
eResearch (ERES) will also present at the UBS Conference, on Monday. They may update their order forecast for the September quarter, which would help the stock if business is as strong as I think. ERES is a Top Buy all the way up to $16 for my $30 target.
Millennium Pharmaceuticals (MLNM) will present at the UBS Conference, also on Monday. I expect them to focus on their pipeline of new drug candidates, which is getting stronger. Buy MLNM while it is under $11 for my $23 target.
ViroPharma (VPHM) will present at the Conference on Wednesday, and may have an update on the timeline for the FDA review of their challenge to the change in regulations for making generic Vancocin. Buy VPHM while it is under $13 for my $28 target.
China MegaShift
UTStarcom (UTSI) will show a seasonal sequential decline in new PAS phone sales in China, but I still expect their cost-cutting efforts to pay off on the bottom line. The consensus is looking for a 30-cent loss, and I calculate that it will be between 15 cents and 20 cents. Wall Street likes cost cutting, so if the company has good news in its newer product areas, like broadband access, Internet Protocol TV and cellular handsets, the stock could keep rallying. There’s a large short position to be squeezed, as 23% of the shares are sold short. Buy UTSI under $9 — it’s trading back and forth around $9 now — for my $15 target.
Content on Demand MegaShift
Comcast (CMCSA) is benefiting from couch potato syndrome. In spite of the Internet, iPods and new video games, television viewing in the U.S. rose 1% last year to a record eight hours and 14 minutes per household. Teenagers increased their viewing by 3% to an average of three hours and 24 minutes a day, even as they spent more time on the Internet or with music players and video games. Teenage girls’ viewing increased by 6%. In addition, cable continues to gain shares from broadcast and video-on-demand, while the tiny video-to-mobile-device market is the fastest growing of all. This is probably not good news for international competitiveness, the number of homegrown scientists and engineers, SAT scores and the obesity problem, but it’s great news for Comcast.
Comcast is also clobbering Verizon in the Northeast with a $99 a month VVD (voice, video and data “triple play”) offering, and Comcast has signed up over one million phone customers in two years. They also have more than 10 million broadband Internet customers.
Comcast thinks the new video build out by the phone companies will have a minor negative impact. They expect to lose 100,000 video-only customers to the phone companies in 2007, but pick up three million phone customers — and so far, 75% of the recent converts have taken the VVD package.
In addition, the latest auction for wireless spectrum ended Monday, and one of the big winners was SpectrumCo, a joint venture of Comcast, Sprint and TimeWarner Cable. They won enough wireless spectrum to cover 267 million people, or 89% of the U.S. population. This will let Comcast offer wireless phone service using VoIP, as well as audio and video services over the wireless spectrum to mobile devices like phones. Kids will watch MTV on their phone and then buy and download the music video or song they just heard. People will also watch football game highlights on their phones. The OnStar-type service will merge with in-car navigation systems to connect to Comcast so passengers can watch live or on-demand TV, or play multiplayer video games with people in other cars. Comcast is a solid hold for my $62 target.
Silicon Image (SIMG) has a subsidiary, Simplay Labs, which focuses on HDMI design standards, interoperability and testing to be sure different manufacturers’ high-definition consumer products will plug in and play together. It’s the next best thing to an independent industry certification lab, and they announced that 13 more big manufacturers have joined, including Bose, Grundig, Hewlett-Packard, JVC, Microsoft, Panasonic, Thomson and Yamaha.
The stock had a good run recently, and I don’t want you to chase it during this risky period for the market. If necessary, I’ll raise the buy limit later, but for now buy SIMG only under $10 for my $18 target.
Telkonet (TKO) received a patent for an integrated safety disconnect circuit breaker that goes into the Telkonet Coupler to attach power lines to the company’s Broadband-Over-Powerline customer premises box. This is a necessary technology to convince a utility to let TKO take control of the power line before it gets to the building circuit breakers. TKO remains a Top Buy up to $5 for my $15 target.
New Energy Technology MegaShift
Connacher Oil & Gas (T.CLL) received an excellent updated reserve report from their independent consultants. Estimated reserves in their oil sands properties increased a whopping 59%, and recoverable reserves increased 48%. Connacher is going to drill 60 more test holes on its main lease block during the March quarter, and I expect that to lead to another big increase in estimated reserves next year. This is terrific news for us, as it means there is even more oil behind every share than we originally thought. The stock moved up on the news for a few days, but gave the whole move back on weaker oil prices. That is short-term thinking at its worst, and you should keep buying T.CLL up to $4.50 for my $7 target.
Gasco Energy (GSX) is buying their working interest partner, London-based Brek Energy (BREK), for 11 million shares worth about $30 million. The deal is accretive to book value and won’t require any additional capital spending, but will slightly reduce earnings per share next year. Brek held a 14% interest in Gasco’s leases in the Uinta Basin in Utah and the Green River Basin in Wyoming. This is one of a series of small acquisitions of working partners, all meant to increase Gasco’s acreage position in its core exploration areas.
Although natural gas is selling near a five-year low today at $4.73, the January futures are well over $8. The El Niño that is developing will bring the usual very cold weather to the Northeast, where natural gas is used for heating. This is a great time and a great entry point to buy GSX cheaply, well under my $4.50 buy limit, with a $9 target that is still realistic when cold weather hits.
Royal Dutch Shell (RDS.A) had to shut down part of their upgrading (refinery) oil-sands plant when they discovered a leak. The plant turns heavy oil from the sands into synthetic crude, and it is producing 155,000 barrels a day, down about 14% from the pre-leak levels of 180,000 to 190,000 barrels a day. They should have it fixed by this weekend.
The news that Russia is going to cancel Shell’s permits to build the huge Sakhalin-2 project hurt the stock. The project won’t be cancelled, and Shell will be reauthorized, but there will probably be a six- to twelve-month delay in the $20 billion project, and the government may try to increase their royalty percentage. The news knocked the stock back under my buy limit, so if you want to own the technology that will unlock the oil trapped in shale in the Colorado Rockies, buy RDS.A under $66 for my $75 target and collect a 3.9% yield while you wait.
Rentech (RTK) commented on the first Air Force test flight of a B-52 at Edwards Air Force Base using Fischer-Tropsch coal-to-liquids fuel. Rentech received a request for information from the Department of Defense (DoD), which has said that it wants to use coal-to-liquids fuel for energy security reasons. The DoD has a 10-year plan to replace the 50% of current fuel consumption provided by foreign sources. The Air Force spokesman said: “This is an extremely important moment. Our goal is by 2025 to have 70% of our aviation fuel coming from coal-based sources.”
Although the stock didn’t budge on this news, it is obvious that this is the sort of concept that can catch investors’ imaginations at any time, skyrocketing the shares. RTK has a total market capitalization of less than $700 million, and is an obvious acquisition candidate for any of the major energy companies. Buy RTK under $5 — it is a Top Buy for my $11 one-year target, and I expect us to hold it for a few years for much higher prices.
Security MegaShift
CheckPoint Systems (CHKP) has been strong on a rumor that Hewlett-Packard is about to make a bid for the company. It’s a great idea and a nearly ideal fit, which means many investment bankers must have been pitching it to new CEO Mark Hurd for quite some time. H-P could use a diversion from their boardroom scandal, so maybe something will happen between them and CHKP. The rumor also puts the stock “in play” for anyone else who wants to buy a #1 technology position for less than 15X this year’s earnings. I don’t see much risk in this stock, and CHKP should be held for higher prices or a potential bid, where we will exit.
Symantec (SYMC) benefited today when CIBC raised their target price for the stock to $24. CIBC expects the company to beat the September earnings consensus for the third quarter in a row, and pointed out that the on-time release of Norton 2007 at higher renewal pricing will provide a revenue boost. After that, Norton 360 and Norton Confidential will be released, and the company has announced partnerships with Juniper and Dell, with the latter to get control of email archiving. Like Check Point, there isn’t much risk in this stock, and SYMC should be held for higher prices.
WiMAX MegaShift
Airspan Networks (AIRN) settled their differences with Yozan, their major customer in Japan. The way I read it, they will be able to book some of the delayed revenue in the September quarter and most of the rest by the end of the year. Apparently, Yozan insisted on a network optimization program and test. Airspan did that in July and August, and it was totally successful. They showed 99.9% service uptime over the combined WiMAX and Wi-Fi network.
AIRN agreed this morning with Yozan to reduce the contract from $42.9 million to about $28 million for now, and Yozan agreed to take delivery by the end of the year. Yozan will also add on monies for additional network planning, installation and testing, as well as maintenance. Although the stock only rose five cents today on the news, I think people are just not paying attention. This removes a major psychological overhang, plus the uncertainty of when, and even if, Yozan would pay. AIRN can be bought all the way up to $6 for my $10 target as the WiMAX rollout accelerates.
Alvarion (ALVR) has you covered on your next trip to Tonga. The Tonga Communications Corp. is going to use Alvarion’s BreezeMAX 3500 to cover the whole archipelago with high-speed broadband wireless access. The 100,000 inhabitants live on 42 of the 170 islands that comprise Tonga, which are spread over 270,000 square miles. Some of the islands are mountainous and all have tropical rains. Alvarion was the only supplier that could meet their requirements. ALVR is a Top Buy up to $9 for my $18 target.
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