Yesterday’s market action was really something. You won’t hear me complain about all the major U.S. markets closing up for the day or for a 200-point gain on the Dow. However, it will take some follow-through to convince me the downside is over. In addition to the “Bernanke Box” problem that I have talked about before and will discuss in the Market Outlook, geopolitical events are driving the market lower, in part directly and in part by inflating the price of oil. So, it is predictable that when those pressures subside the market will truly bounce. I am still expecting to see 1185 on the S&P 500 before that bounce happens, and then we should get a 100- to 150-point relief rally in the index. But the day after Labor Day often marks a market reversal, and by then the emphasis should be on slowing U.S. growth, estimate reductions and fear of third-quarter earnings reports. The deteriorating results at Apple, Wal-Mart, 3M, Disney and many other companies in almost every sector of the economy tell me that a widespread problem is about to raise its ugly head. That should be enough to take the S&P back down to set the year’s low around 1040, just about the time I hope to see you at the San Francisco Money Show, October 16 to18.
That’s the bad news.
The good news is that coming out of that low, we are likely to see a very strong market through 2007 and continued good news in 2008. The second half of a Presidential term usually is pretty good, with the third year (2007) often posting about a 50% move from the prior year’s October low to the closing high at the end of the year.
The even better news is that those who have been carefully tracking lagging indicators, like business capital spending and commodity prices, in the mistaken belief that lagging indicators have anything at all to do with a leading indicator like the stock market, will be dumping stocks in October due to the slowing economy. We’ll be able to buy stocks cheaply then, and the economy will slow rather sharply in the December 2006 and March 2007 quarters.
A recent CIO magazine survey showed that the folks who write the checks for new Information Technology equipment and software have already pared down their growth forecasts for the next 12 months from +8.6% to +6.9%, and they are usually almost the last group to get the word to cut back. But the stock market will head up in 2007, doing its usual forward-looking discounting of the improvements to come, and I’m predicting the Fed will finally be cutting interest rates, too late to avoid the weakness (also as usual).
But the best news of all is that the leaders of the next upturn are not likely to be the leaders of the last one. The commodity stocks are likely to take a breather until all the speculative holders are wrung out. Technology and healthcare have been underperforming for more than two years, and it is their turn to be in the limelight. A big upswing into and through 2007 will almost certainly be led by the NASDAQ, especially the semiconductor and biotech stocks. We will be there. I think our energy technology stocks will move with the tech sector, not the energy sector, because reducing or eliminating our dependence on the Middle East is now a strategic imperative.
So, with all this good news on the horizon, what should we do now? Well, our next course of action will be to use the relief rally over the next few weeks to trim any stocks that are not performing well, especially those related to capital spending. The last leg down in most bear markets is the worst, and a drop from the 1295 to 1325 range on the S&P in August to 1040 in October is going to feel pretty bad.
And, we are about to plunge into earnings reporting season, which means the next three Radar Reports will focus a lot on company detail and less big picture stuff. But that’s OK, because this is a crucial time to make sure our companies are on track — regardless of the market’s opinion, as expressed in the current stock prices — and to be sure we are focused on the very best ideas for the blast-off into 2007.
Avian Flu MegaShift
If you regularly eat goose intestines, you should abstain for a bit. Here’s why: On June 27, one of the Michigan raids on an Oriental food warehouse, which I talked about in the last issue, found five boxes (150 to 200 pounds) of goose intestines illegally imported from China. They were tagged for destruction. But when the USDA and Michigan health officials returned on July 5 — a mere eight days later — someone had replaced the goose intestines with chicken parts. The goose intestines are still missing, and are either in the refrigerator of someone who really likes this delicacy or were sold to Chinese restaurants somewhere in America.
The National Governors Association also recently released this advice to U.S. governors: Stockpile food in schools and prisons, and prepare facilities to quarantine people. The Department of Health and Human Services now says that in a pandemic 90 million Americans will get sick and 1.9 million will die.
My advice: Stockpiling food is OK, as long as it isn’t goose intestines. And for public relations reasons, please don’t refer to the quarantine facilities as “the camps.”
Just in case the H5N1 virus does get loose, Roche said that they now have 15 production partners in 10 countries to make more Tamiflu. They now have the capacity to produce 400 million doses in a year, which is double the 200 million doses governments have ordered, and would be enough to treat 6% of the people in the world. What the other 94% are supposed to do in the event of a pandemic, Roche didn’t say. But this was good news for Gilead (GILD) because it means more royalties sooner. The January 2008 $50 call LEAP (YGDAJ) went over my $16 buy limit, and because of that it is no longer a Top Buy, but you should continue to hold it for my $30 target. The January 2007 $60 LEAP (GDQAL) is still trading under my $9 buy limit and is a higher risk/higher reward position for a $20 target.
Crucell (CRXL) got some good news as Novartis said that they will build a $600 million flu vaccine plant in North Carolina that will grow the vaccines in cell cultures, not eggs. They are using $220 million of taxpayers’ money and expect to be able to produce 50 million seasonal flu shots and 150 million pandemic flu shots a year by 2011. By using Crucell’s cell culture technology, Novartis can make a new vaccine to cope with a mutating virus many weeks faster than an egg-based product. This is good news considering that if the bird flu rips through the U.S. chicken flock, there may not be very many eggs around. Novartis also submitted the first cell-based flu vaccine to the European Union for approval. CRXL remains a good buy under $28 for my $50 target.
Biotech MegaShift
Geron (GERN) is holding an analyst day today, so there should be lots of commentary tomorrow and next week. They announced that their stem cell product for spinal nerve regeneration passed preclinical safety tests, which was no surprise. Continue to buy GERN under $9for my $18target when positive clinical news or major media stories come out.
Reporting Season is in Full SwingAvian Flu MegaShift: Biotech MegaShift: China MegaShift: Content on Demand MegaShift: New Energy Technology: New World Economy MegaShift: Security MegaShift: Nanotechnology & Materials MegaShift: Video iPod MegaShift: WiMAX MegaShift: |
QLT (QLTI) said that partner Novartis announced sales of Visudyne, their macular degeneraton treatment, were $95.3 million in the June quarter. That was not a good number — it is down 10.7% from the first quarter, and down 26.1% from the second quarter of 2005. The company is losing market share because doctors are experimenting with other, newer drugs. Longer term, QLT needs to get doctors to try combination therapies including Visudyne, and also see the clinical trials finished for combinations with Lucentis and Macugen. I expect this to be the major focus of the earnings conference call next week, and I will update you then on their plans. Assuming that QLT is aggressive about these issues, I may put the stock on the Top Buys list after the call. However, until we hear what they plan to do, I want to move it to a Hold.
Content on Demand MegaShift
Telkonet (TKO) put out a statement yesterday in response to the falling stock price:
"We recognize that the company’s stock price in recent weeks has been under a lot of selling pressure. The company is not aware of any adverse business events that should affect the stock price. The company continues to aggressively pursue both contract and channel partner relationships. Our suite of FIPS-140-2 products has been approved for government use and we are finalizing installation procedures with a major Tier-1 systems integrator, which will permit the integrator to use the products on an existing contract. We continue to aggressively pursue additional government subcontracting opportunities. We are in various stages of commercial trials with companies using our commercial products. I have returned from my medical leave, have been and will continue to be engaged in the day-to-day operations of the company."
The hang-up with announcing the EDS deal (the “major Tier-1 systems integrator”) continues to be getting the formal award letter from the government, and Telkonet continues to think that is imminent.
One thing the company did not comment on, and I have urged them to do so, is the level of naked short-selling in the stock. Naked short-sellers go short a stock without borrowing it, as the law requires. They then “fail” to deliver the stock, and after a few days the broker will buy back their position. Then they promptly short and “fail” again.
The American Stock Exchange keeps a “Threshold List” of stocks where fails to deliver exceed 10,000 shares for more than five days in a row and the total fails exceed 0.5% of the outstanding stock. TKO has been on that list for 43 days, which is outrageous. Some hedge fund is shorting the stock, planning to cover when the company announces the strategic investor, in hopes there will be extra stock around. It is despicable behavior, in addition to being illegal, and I have urged the company to get to the bottom of it.
Also, I know there has been some confusion with a Canadian stock that has the symbol TKO — Taseko Mines — that put out some negative news on Monday when a joint venture fell apart. Fortunately, I think Telkonet with have a couple of good announcements by the end of the month. Squeezing the naked shorts should come next. TKO is a Top Buy all the way up to $5, and I see no reason to change my $15 target.
New Energy Technology MegaShift
Gasco Energy (GSX) has been held back by the current, relatively low price of natural gas, right around $6. There is a very temporary surplus of gas that both I and the futures market think is certain to disappear over the next few months. We bought GSX as an important supplier to the utilities in the Green River oil shale basin, because those utilities will be supplying huge amounts of power to Royal Dutch and others who need to heat the shale in order to extract the oil.
Gasco is a very successful exploration company, bringing in new gas wells about 20% faster than they deplete the old ones. With their reserves constantly growing thanks to a drilling success rate above 80%, their cash flow growth is accelerating towards 20% per year. They are strongly cash flow positive even at current gas prices. Just based on their current leases, they will be able to keep growing their drilling program for more than a decade.
At this point, they have about 77 billion cubic feet of proven reserves, with only a bit over 25% of that already developed. A whopping 97% of their reserves are natural gas, not oil, which is where we want to be for the oil shale MegaShift, and also makes them an attractive acquisition target. I’m adding GSX to the Top Buy list this week, so continue to buy GSX under $4.50 for my $9 target.
Infinity Energy (IFNY) hit a 52-week closing low today, just after they announced that they hired an investment banker specializing in energy deals to explore alternatives for developing their 1.4 million acres of oil concessions off the coast of Nicaragua. This is going to be a big deal that will put this company on the map, and it really is a freebie for us, because we are invested for their oil shale holdings. I’m also adding INFY to the Top Buys. It remains a buy up to $6.50, and my $9 target is just the first stop on what I think will be a huge winner over time.
Plug Power (PLUG) won a contract with Telefonica Moviles, the second-largest cell phone company in Venezuela, for an initial deployment of nine GenCore backup power systems in the Caracas area. This followed an eight-month test of a system that worked through several power outages, including one that lasted 12 hours.
Telefonica Moviles has 700 cell towers in Venezuela and 10,000 sites across Central and South America. Many of those sites can’t use generators or battery backup, some for noise reasons and some due to bad weather. This is a big win for Plug Power and means competing cell systems will have to do something to improve their availability during power outages. It is another showcase installation in a completely different industry. PLUG is a Top Buy up to $7.50 for my $15 target.
Rentech (RTK) partnered with Peabody Coal to build two coal-to-liquids plants — one in Montana and one somewhere in the Midwest, right at one of Peabody’s major coal mines. Each plant will produce 10,000 to 30,000 barrels a day of transportation fuel. Reading between the lines, it looks like Peabody is paying most of the costs, with third party contractors to be shared, and Rentech will own half the project. This was a big, big win for Rentech, because Peabody is looked to as a leader in the coal industry. Not a single coal company missed this announcement.
RTK jumped 21% on the news, but drifted back under $5 today. I am making RTK a Top Buy on this news, while keeping the buy limit at $5 and the target at $11.
Security MegaShift
Check Point Software (CHKP) reported an in-line June quarter. Revenues hit $138.9 million, just under the $140.l2 million consensus, and pro forma earnings were right on the button at 32 cents a share. They guided the September quarter down a bit, but left annual guidance approximately unchanged. That means that they are planning to have a very good December quarter, showing about 20% sequential growth. While December is usually a good quarter, the growth tends to be around 11% to 12%. The company believes their new products, outside their traditional firewall area, will take off. It is a gamble.
For the September quarter, they guided to $135 million to $144 million in sales, compared to the consensus for $143.4 million. They also guided for 31 cents to 34 cents a share, and the consensus was at 34 cents. But for the year, they guided for $570 million to $600 million, and the consensus was at $580.9 million. The company expects earnings of $1.33 to $1.40, and the Street was expecting $1.36.
While I think capital spending on security will hold up during the second half of the year, it is likely to be hit next year in a softer economy. Therefore, I am moving CHKP to a Hold and suspending the target price. We will use this rally to sell the stock if we can get out gracefully before the next leg down into October.
Symantec (SYMC) was the subject of a negative story in today’s Wall Street Journal, but there really was nothing new mentioned. The Journal talked about how hard it was to merge two big software companies and referenced increasing competition from Microsoft. Management will respond to the merger consolidation issues on the conference call next week.
Veritas Software, which Symantec acquired, is subject to the same pressures as Check Point, and for the same reasons I am moving SYMC to a Hold and suspending the target price. These are both very cheap stocks, but they may be dead money in 2007, and our best chance to get out could come in the next few weeks, if the current rally continues.
Video iPod MegaShift
PortalPlayer (PLAY) should have OK earnings. Apple announced that they shipped 8.11 million iPods in the June quarter, down from 8.53 million in the March period. That was better than analysts were expecting, yet the fact that it was down really puts the pressure on Apple to settle the Burst.com lawsuit and get the new video iPods introduced. As I’ve said, if PortalPlayer is not the integrated chip in a new high-end iPod, then all of Apple’s competitors (including the new Microsoft MP-3 player) will consider using the PLAY chipset. Buy PLAY under $11 for my $20 target.
WiMAX MegaShift
MobilePro (MOBL) said that they are getting double-digit monthly revenue growth in their WazTempe Wi-Fi network. They have installed over 800 access points, and for now it is the biggest municipal Wi-Fi mesh network in the country. The usage growth is coming from both fixed customers and mobile, with the latter split into subscribers and temporary users that pay a daily rate. Although the stock has been battered by the market’s fear of anything small and the potentially toxic convertible financing, MOBL remains a leader in municipal Wi-Fi systems. Continue to hold.
Market Outlook
Poor Ben. The stock market peaked in early May, and usually leads the economy by about six months. So, the Fed should be looking for a softening economy starting in November. The tools they have to shore up the economy work with a six- to 18-month lag, so they should have started cutting interest rates in May.
But Gentle Ben has committed to an explicit inflation target, and because inflation is a lagging indicator, it will be in his face for a few more months. The producer price index, reported Tuesday, was above expectations, but the components showing the inflation in the pipeline were downright scary. The trends in year-over-year changes of core prices, excluding food and energy, were:
| March | April | May | June | |
| Consumer (headline) | 1.90% | 1.60% | 1.60% | 1.90% |
| Finished goods | 1.70% | 1.50% | 1.50% | 1.90% |
| Intermediate goods | 4.40% | 4.90% | 6.30% | 7.30% |
| Crude materials | 13.30% | 16.10% | 26.70% | 33.20% |
| Intermediate inc. energy | 19.00% | 18.50% | 20.90% | 19.10% |
| Crude inc. energy | 12.50% | 7.10% | 14.90% | 7.70% |
The headline number for wholesale prices of consumer goods, +1.9% in June, is right at the top of the Fed’s 1% to 2% comfort level. Wholesale prices of finished goods are similar. But look at what is in the pipeline for intermediate goods — stuff that is being manufactured. The +7.3% number for June has to be worrying the Fed, because unless companies eat the cost increases and squeeze their profit margins, that +7.3% will show up in finished goods in future months. Then look at crude materials — and that doesn’t even include energy! Companies just can’t absorb a 33.2% year-over-year increase — they have to raise prices. Sheet steel prices rose 5.2% in June — not year-over-year, but in one month — to a 15-month high. The prices of goods imported into the U.S. rose 0.7% in the month, after rising the same amount in May — the biggest back-to-back gain since the government began keeping records in 2001. It looks like the one-time savings from outsourcing manufacturing to China may be over.
Just for comparison, I’ve listed the price increases including energy for intermediate goods and crude goods. Remember, this was before the latest battle started in the Middle East, sending oil prices to record highs. Today, the consumer price index came in above expectations at +0.35 for the month. That’s the fourth straight month at +0.3%, the longest such run in 11 years. The year-over-year June increase was +2.6%, the largest since 2002.
How can Bernanke’s Fed even pause with these numbers? They can’t. It was obvious from Bernanke’s Congressional testimony yesterday and today that he would like to pause, and he is even tossing out the idea that because Fed policy works with a lag, he should be able to pause even with inflation this high. But the bond market would tank as their suspicion that Helicopter Ben is soft on inflation got some hard evidence. He’ll be raising rates at the August 8 and September 20 meetings. He should have room to pause by the October 24 meeting, and at the December 12 meeting I think he will revert to the tradition of not raising rates during the holiday season.
Intel will report third-quarter results after the close on October 17. That is highly likely to mark the bottom for the market, as analysts give up on 2006 and start looking forward to 2007. A bit of a rally and then a retest a week later on October 24 would be the perfect scenario for the Fed to announce a pause and set off a 50% rally to 1560 or so on the S&P 500 by the end of 2007. Market events rarely unfurl exactly as expected, but this is the most likely scenario given the data we have today.
Top Buys
Additions: Infinity Energy (IFNY): I’m adding INFY to the Top Buys because they are about to monetize their Nicaraguan offshore oil concessions.
Gasco Energy (GSX): I’m adding GSX because the price of natural gas should be about to start a steep climb from $6 to $12 an mcf over the next six months..
Rentech (RTK): I’m adding RTK because their showcase deal with Peabody Coal will accelerate their technology licensing activity.
Deletions: Gilead January 2008 $50 LEAP (YGDAJ): I’m deleting YGDAJ from the Top Buys because it crossed over my buy limit this week.
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