Over the past decade, Americans have had to endure a debilitating "triple-zero economy"—wage growth, jobs growth, and stock-market returns are all near zero. At least one zero is about to change for the very much better. We are on the verge of a new American bull market likely to rival that of the 1990s. Even better, this new bull market has next to nothing to do with politics, government, or last week's election.

I don't make this forecast lightly. For the past five years, I've been a permabear. I started with a call to cash in November 2007, just before the bottom fell out of global equities. After brief flings with a few bullish rallies, I once again issued a cash call in February 2011, and I have adhered to that strategy.

Today, however, I see America's next great bull market being driven by four powerful trends.

• First, the profits—and therefore the stock prices—of big U.S.-based multinational companies like Apple (ticker: AAPL), Boeing (BA), Caterpillar (CAT), Ford Motor (F), General Motors (GM), and General Electric (GE) are becoming decoupled from the U.S. economy. It's the inevitable result of an ever-increasing share of the profits of these largely flagless corporations being earned in production and sales offshore, as they open factories and gain market share in emerging Asian, African, and Latin American markets.

To put this most simply, the Dow Jones Industrial Average and Standard & Poor's 500 no longer measure U.S. stock markets; they just reflect markets physically located in the U.S. that will rise and fall, based more and more on events outside our borders.

• As a second macrotrend, coming after a difficult decade, the vast majority of globalized U.S. companies have adjusted to lower gross-domestic-product growth rates in the U.S. and Europe by "right-sizing" themselves. Add to this a sustained era of low wage growth in the U.S., cheap wages abroad, and little or no inflation, and you have a recipe for sustained corporate profit growth previously thought impossible. The big corporations will profit, even if the world's two biggest economic engines—the U.S. and Europe—remain stuck in low gear.

• The third macrotrend underpinning the next global bull market is the Federal Reserve's quantitative easing. It lowers long-term interest rates through massive Fed purchases of long-term government bonds. Because the Fed pays for these new bonds by simply printing money, the result is an ongoing flood of new currency onto world markets; this is positive for equities.

In addition, the U.S.'s quantitative easing also has sparked imitations from central banks around the world. This is because when the Fed cuts interest rates in the U.S., it lowers the value of the dollar and makes American exports more competitive. Other countries have responded with their own styles of printing money and devaluing their currencies, to avoid loss of competitiveness.

The only sensible thing for stock-market investors to do in this era of quantitative easing is to move out of bonds paying near-zero returns and into equities. Ironically, this extremely bullish macrotrend is likely to be around for years to come, because QE is likely to be a very ineffective policy tool.

• The fourth bullish macrotrend is the largely unforeseen energy revolution now underway. Just a few years ago, many analysts were glumly looking at a supposed peak in proven petroleum reserves, which was colliding with the undeniably rapid growth in energy demand from emerging countries like China and India. Bearish predictions of long gas lines and a rapid acceleration of energy prices that would cripple long-term global growth inevitably followed from this gloom-and-doom scenario.

Today, however, the technology-driven development of massive reserves of shale gas and oil sands holds the prospect of what once was unthinkable—North American energy independence. Even cost-effective development of arctic hydrocarbon reserves might become feasible. Simply put, we have the makings of another 30 to 50 years or more of cheap energy and attendant higher growth rates.

OF COURSE, ANY NUMBER of geopolitical flash points could smother this baby bull in its crib: a nuclear tango in Iran, a territorial clash between Japan and a rapidly militarizing China, and more rapid spread of Islamic terrorism, just to name a few.

I do not, however, fear that the global economy will soon be shoved off the U.S.'s fiscal cliff.

With this most bitter of election seasons over, a Republican-led House of Representatives and a Democratic-led Senate have far more room to move toward the middle of the playing field for a compromise that should put our fiscal house in better order.

As our politically divided nation heals, a new bull market should take root. As it does, the disgusted, disinterested, fearful, and cynical retail investors who have been on the sidelines for so long should come roaring back into the market, producing a bullish trend that should last for years. 

 

 

 

 

Since February, I have called the market trend as a sideways pattern.  This kind of trend dictates a move out of equities for the small active retail investors.  I reiterate that call now and see far more risk to the downside than reward to the upside.

I note that anyone moving to cash as of my February call would have given away no upside profits and would, at this point in time, have been protected from a more than 10% loss.

I also note that since February, Investor’s Business Daily has repeatedly missed the market trend, suckering participants into the market with announcements of “an upward market trend,” only to reverse itself in the face of obvious evidence to the contrary.

Finally, I note that the financial press has a strong aversion to cash calls and any urging to “stay out of the market.”  It’s all about the day to day action for the business journalists and pundits – but that won’t make you a dime unless you are a very active day or swing trader.

At a personal level, I continue to hold roughly 20% of my portfolio in non-cyclical small cap biotech while – and I don’t recommend this to others – I have been short the Chinese market using FXP.  For reasons I explain below, China’s equity market offers far more downside risk than upside at this point.

Finally, in what may be my version of Custer’s last stand, I am scaling into a short of the long bond by buying TBT below $20.  This is an ETF loyal readers will know that has taken its toll on my own portfolio over the last year because I failed to see the importance of periodic flights to dollar safety from Europe despite the weakening of the dollar.  But just as I kept nibbling at shorting the housing market pre-2008 and kept getting burned, I will continue to short the long bond as I see an eventual huge gain – just like the housing short.

Here’s an overview of the foundations of my cash call: The central problem facing global stock markets are major structural imbalances across regions that prohibit a robust economic expansion that all parties can benefit from.  In a nutshell, the U.S. and Europe still consumer too much and export too little while massive fiscal stimulus is now giving way to a rapid contraction in government spending.  China, for its part, remains far too export-dependent while Japan is simply over and only South Korea, Thailand, and the Philippines are likely to be resilient enough to prosper over the longer term.  And yes, Vietnam will be the next big growth story in Asia – after the current recession/depression runs its course.

Now a bit of a closer look:

The United States: America’s economy is looking increasingly like an economy only capable of generating meager GDP growth rates -- in the realm of 1% a year rather than the greater than 3% we need to get over 20 million Americans back to work. 

Consider that from 1947 to 2000, America’s GDP grew at a rate of 3.5% a year.  From 2001 to now, however, we are averaging less than half that!!!!!!!!  Yet most politicians and economists are in denial about this.  They think what is happening is a short run cyclical phenomenon and keeps recommending stimulus – government spending if you are a Dem and tax cuts if you are a Rep.  It’s all so much garbage.

In fact, America’s central problem is the offshoring of the U.S. manufacturing base which simultaneously depresses domestic investment and boosts the trade deficit.  These two drags on our GDP growth equation account for most of the slow growth we are experiencing. 

On the face of it, it is remarkable that our President and Congress and members of the financial press don’t want to acknowledge this drag.  However, the reality is that the big multinational corporations like Apple, GE, GM, Caterpillar, Intel, and so on that benefit the most from offshoring are the same corporations that finance our political elections.  These multinationals also either own our financial media or advertise heavily in the papers and on the networks.   So both the electronic and paper media are reluctant to bite the hands that feed them.

My view is that is borders on criminal for our politicians and pundits not to acknowledge the importance of trade reform in restoring American prosperity.  By that standard, most of Washington and much of the media should be locked up.

Europe: The euro is about to collapse amidst a sovereign debt crisis likely to lead to the same kind of meltdown the U.S. experiencing in 2008.  I’ve noted this problem for over a year now – just go back and read previous newsletters -- yet many in our mainstream media seemed surprised the very idea that the euro is bankrupt and Emperor Europe has not clothes.

Asia (AKA China): China is on the verge of a housing bubble collapse.  A combination of rapidly rising inflation due to an artificially under-valued yuan and too much government stimulus is about to collide with falling export demand from the U.S. and Europe as slow growth/recession woes take hold.  This is an economic house of cards with enough jokers in the deck to warrant a short.

To end, I will reprise the analysis I have been offering since February.  So read below and weep – and wonder why you haven’t been hearing this on TV or reading about it in the Wall Street Journal.  It’s so damn obvious it makes me sick.

 

1.     My overriding concern stated more than a year ago is that our investment-led recovery would not enjoy a follow through because of high unemployment, stagnant income, continued foreclosures, and high energy prices.  That concern has now heightened as I’ve watched the ISM manufacturing index – the best indicator of the investment led recovery – fall back into the recessionary range.  In addition, consumer confidence is in the toilet.  Ergo, this is a BEARISH signal.

2.     With the investment-led recovery faltering, we have no more ammunition from either a fiscal or monetary policy standpoint to re-stimulate the economy.  In fact, it’s just the opposite.  We are running high  budget deficits with little stimulative effect – this is largely the product of weak tax revenues due to slower than potential growth and excess government spending on our wars in Iraq and Afghanistan.  On the monetary policy front, Helicopter Bernanke has turned the king over on the chess board – and is left with only a swollen balance sheet and a weakened dollar.       Another BEARISH signal.

3.     Despite a weak dollar, we still run large trade deficits in oil and with China.  With China, the problem is the fixed peg of the yuan to the dollar.  As long as this peg endures, America will surrender almost a point of GDP growth annually to China at the costs of almost a million jobs we fail to create.   This is BEARISH, too; and if there is anything that truly ticks me off both about well-coifed airheads like those on the Sunday Meet the Press type shows as well as my doctrinaire colleagues in the financial press it is the stupid and stubborn unwillingness to realize just how destructive this peg is.  Earth to colleagues – you can’t have free trade in a fixed peg world.  It’s the mother of all oxymorons. 

4.     It is essential that we not forget the contractionary effects on the U.S. economy of the deepening state budget crises that have resulted in contractionary cutbacks in state spending.  Here in California, for example, revenues are falling far short of projections; and the state is likely to have to endure another round of what has already been very steep cuts.  From a macro perspective, that’s BEARISH.

5.     Europe’s sovereign debt crisis is deepening.  Italy and soon Spain will have joined Greece and Ireland as the weak sisters on the continent; and all the euros and Eurobonds in the world are not going to save their sorry derriers.   I predicted long ago on the Kudlow Report that the days of the euro are numbered; in truth, the best way for countries like Greece and Italy to rebound is to abandon the euro and devalue.  If the European union persists in enforcing a strategy of fiscal austerity instead of currency adjustments to restore vibrance in the European economy, they – and because America depends on exporting to Europe – and us are doomed to a much slower growth rate.   BEARISH, BEARISH, and BEARISH.

6.     In Asia, at some point, the Chinese economy must stop its export-dependent levitation.  A soft landing would entail the emergence of a robust consumer but policies are not being put into place to make this happen – with those policies being a yuan float coupled with increased health and pension benefits to loosen up savings for consumption.  Ergo, the hard landing scenario is more likely.  This involves interest rate hikes and both monetary and fiscal tightening to fight a spiraling inflation.  A likely result will be the collapse of several asset bubbles, including that in real estate – and no small amount of chaos in the land of unbridled mercantilism.  A Dragonianly BEARISH signal

7.     If – or should I say when – China falters, so, too, will the economies of all of the commodity countries.  These include Brazil, Russia, Australia, and Canada, to name the  most major players.  While Brazil is the most vibrant of the four, as China goes, so goes these countries.  (Canada can fall on both the U.S. and Chinese weakness of course.)    A final BEARISH signal.

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Always a Winner Strategies

Economic & Stock Market Analysis for the Discerning Investor & Executive

www.peternavarro.com

Read it and Reap!

This Week: Cash Call, Part III

Market Pulse

In February, I issued a call to cash based on my reading of the fundamentals of the U.S. and global economy.  In April, I reiterated that call; and with this newsletter I continue to see this as a poor time for retail investors to be in the market.

When I issued my cash call in February, the exchange traded fund for the S&P 500 was at 135.  Over the next two months, it would dip as low as 126 and would then rebound to a top of 136, just one point above the level of when I issued my cash call.  Now, at the time of this writing, SPY has fallen to 127.

I note without pride that this call has been the most accurate of any analyst on Wall Street in 2011 – yet it has been largely ignored by my colleagues in the financial media.  This is most likely because of a strong bias in the media towards bullishness.  (Of course, that was the same damn bullish bias that allowed people to be “surprised” by the collapse of the housing bubble in 2007.  Yes, I called that bubble collapse too as early as the later part of 2006.)

In thinking about the movements of the stock market in 2011, it’s important to see the February to June action as a clear sideways market for longer term investors.  Yes, there was some opportunity to trade some volatility and short term rises and dips, but that’s not what I do in this column.  What I do is handicap the market trend based on macro fundamentals and a read of the technical conditions of the market.

To be clear, from my paradigm, a sideways market indicates disagreement among market participants over the eventual trend of the economy.  It may be that the recent movement down of the market has ended this sideways pattern and a new downward trend has been established, but I’m not ready to make that call.  In truth, despite all the handwringing and hysteria on the airwaves, we have simply dropped back down to the lower end of the sideways trading range we’ve been in since I made my cash call.

So what will determine whether we recede back down into a bear market and recessionary economy or bounce back?  Let’s look at the economic fundamentals that have caused me so much concern since February.

1.     My overriding concern stated more than a year ago is that our investment-led recovery would not enjoy a follow through because of high unemployment, stagnant income, continued foreclosures, and high energy prices.  That concern has now heightened as I’ve watched the ISM manufacturing index – the best indicator of the investment led recovery – fall back into the recessionary range.  In addition, consumer confidence is in the toilet.  Ergo, this is a BEARISH signal.

2.     With the investment-led recovery faltering, we have no more ammunition from either a fiscal or monetary policy standpoint to re-stimulate the economy.  In fact, it’s just the opposite.  We are running high  budget deficits with little stimulative effect – this is largely the product of weak tax revenues due to slower than potential growth and excess government spending on our wars in Iraq and Afghanistan.  On the monetary policy front, Helicopter Bernanke has turned the king over on the chess board – and is left with only a swollen balance sheet and a weakened dollar.       Another BEARISH signal.

3.     Despite a weak dollar, we still run large trade deficits in oil and with China.  With China, the problem is the fixed peg of the yuan to the dollar.  As long as this peg endures, America will surrender almost a point of GDP growth annually to China at the costs of almost a million jobs we fail to create.   This is BEARISH, too; and if there is anything that truly ticks me off both about well-coifed airheads like those on the Sunday Meet the Press type shows as well as my doctrinaire colleagues in the financial press it is the stupid and stubborn unwillingness to realize just how destructive this peg is.  Earth to colleagues – you can’t have free trade in a fixed peg world.  It’s the mother of all oxymorons. 

4.     It is essential that we not forget the contractionary effects on the U.S. economy of the deepening state budget crises that have resulted in contractionary cutbacks in state spending.  Here in California, for example, revenues are falling far short of projections; and the state is likely to have to endure another round of what has already been very steep cuts.  From a macro perspective, that’s BEARISH.

5.     Europe’s sovereign debt crisis is deepening.  Italy and soon Spain will have joined Greece and Ireland as the weak sisters on the continent; and all the euros and Eurobonds in the world are not going to save their sorry derriers.   I predicted long ago on the Kudlow Report that the days of the euro are numbered; in truth, the best way for countries like Greece and Italy to rebound is to abandon the euro and devalue.  If the European union persists in enforcing a strategy of fiscal austerity instead of currency adjustments to restore vibrance in the European economy, they – and because America depends on exporting to Europe – and us are doomed to a much slower growth rate.   BEARISH, BEARISH, and BEARISH.

6.     In Asia, at some point, the Chinese economy must stop its export-dependent levitation.  A soft landing would entail the emergence of a robust consumer but policies are not being put into place to make this happen – with those policies being a yuan float coupled with increased health and pension benefits to loosen up savings for consumption.  Ergo, the hard landing scenario is more likely.  This involves interest rate hikes and both monetary and fiscal tightening to fight a spiraling inflation.  A likely result will be the collapse of several asset bubbles, including that in real estate – and no small amount of chaos in the land of unbridled mercantilism.  A Dragonianly BEARISH signal

7.     If – or should I say when – China falters, so, too, will the economies of all of the commodity countries.  These include Brazil, Russia, Australia, and Canada, to name the  most major players.  While Brazil is the most vibrant of the four, as China goes, so goes these countries.  (Canada can fall on both the U.S. and Chinese weakness of course.)    A final BEARISH signal.

Add this all up, and it is the same damn picture I saw in February, only worse.  I only wonder why this is so damn obvious to me and seemingly so elusive to so many other analysts.  Was not the phrase “it is was it is” invented precisely for situations just like this.

As a final observation, it’s important to separate the fate of the U.S. stock market from that of the U.S. economy in at least one sense:  All of the components of the Dow and much of the S&P 500 consist of multinationals that have offshored much of their production to China and elsewhere; and their revenues are highly dependent on events outside the U.S.  So it is possible to have a U.S. stock market that is stronger than the U.S. economy.  That said, that kind of divergence is likely to be an unsustainable equilibrium over time because the U.S. economy is ultimately too important to global prosperity.

As a final conclusion, the U.S. economy remains in a structural cul de sac.  Consumption and government spending cannot provide the fuel to run our economic engine anymore.  Business investment continues to flee offshore; and our trade deficit is really and truly a vampire sucking the lifeblood out of our economy.

Until the politicians and Meet the Press type pundits in Washington and my financial press colleagues realize this, we will continue to have the wrong debate about what must be done and continue to give the wrong advice to investors.

And by the way, anybody who was surprised by the events of the last few weeks and the market turmoil needs to turn their press pass back in.  That was, in John Barth’s phrasing, a paradigm of assumed inevitability.

 

A loyal reader asked me about TBT – the exchange traded fund to short the long bond.  As you may remember, I was very bullish on TBT last year; but it turned out to be one of my worst trades.

 

The best thing to do when a trade goes the wrong way is to learn from it.  In this case, TBT serves a dual function for me – as both a potential trade as well as a leading indicator of the business cycle.

 

The fact that TBT took a dive provided a very strong indication to me that the economy was slowing back down and the market would turn; that was partly the basis of my cash call back in February, which has turned out to be the right call.

 

Today, TBT remains a technical sell.  Why?  The economy is softening.  China continues to buy our bonds to manipulate its currency.  QE2 from the Fed is not quite done.  That trifecta keeps interest rates down and therefore TBT down near its 52-week low.

 

As to why the economy is softening, see last week’s newsletter.  It’s not a particularly pretty picture right.

 

So I say stay in cash until a bullish market trend reasserts itself.  And watch TBT as a very good leading indicator of any recovery – or Chinese yuan strengthening.

Market Pulse

As loyal readers know, I have been on a bit of hiatus working on my new book (with Greg Autry) called Death by China.   (As you may imagine from the title, it’s a barrel of laughs.) 

On that note, if you live in the Southern California area, we will have the book debut on June 7 at UC-Irvine.  If you live on the East Coast, the debut will be on June 16 at the Washington Press Club.  (Anybody who would like to attend one of those events, drop me an email and I’ll get you the details.) 

With that out of the way, let’s talk some market turkey.  As I bit of history, I issued a cash call the week ending February 25, 2011 and reiterated that call in my last newsletter, which was for the week ending April 1, 2011. At the time of my initial cash call, the Standard & Poor's 500 index as measured by the exchange traded fund SPY was at $132.  As of today, SPY stands at $133.  Whoop de do. 

You can argue and rightly from short term trader’s perspective that by staying on the sidelines, I gave up trading a lot of volatility.  For example, after my cash call, SPY bottomed at $126 on March 16 and went up 10 points by April 29.   So I suppose you could have made a few bucks there. 

But to be clear, short term trading isn’t really my bag.  What I try to do is determine the market trend based on both big picture macro fundamentals and confirming technical indicators – and loyal readers will know that I have done that with some significant success. 

In this case, after a solid move off the March lows of 2009, I saw the market back in February settling into a longer term sideways (and possible down) pattern.  Here is the macro backdrop that now continues to motivate my cash call: 

The fiscal and monetary stimuli in both Europe and the U.S. have largely run their course – and helped stimulate the investment led recovery we have witnessed.  However, that stimuli was not sufficient to bootstrap either consumers or exports up to the status of follow-through on the investment led recovery. The bearish factors in the U.S. now include: 

 ·         Chronically low consumer confidence supported by stagnant income growth, continued high unemployment, a moribund housing market,
 ·         The continued offshoring of business investment to China and elsewhere ·         A squeeze on local and state government spending because of budget crises
 ·         The aforementioned end to the fiscal and monetary stimuli
 ·         Most importantly, the continuation of the large trade deficit with China that saps our economic strength and zaps our manufacturing base. 

In other words, in the U.S., nothing has really changed structurally to breed great optimism. 

The bearish factors for Europe include: 

·         Hey, it’s frigging Europe.  Slow growth is the norm. 
·         The PIIGS remain in trouble, with fiscal austerity measures likely to kick in with a vengeance in Greece, Portugal, and Ireland.
·         The continuation of China’s fixed peg to the U.S. dollar; with a falling dollar, this is killing Europe, which runs an even bigger trade deficit with China than the U.S. The bearish factors of Asia include: 
·         The failure of China to structurally revamp its GDP growth equation to reduce its export dependence and create a more self-sustaining, consumer-led economy.
 ·         The folly of China using higher interest rates and higher reserve requirements to fight inflation rather than allowing the yuan to strengthen.  This is DUMB beyond belief.
 ·         The as yet unrealized fact that Japan’s tsunami is proving highly disruptive to the global supply chain. 

Bottom line: If the U.S. and Europe aren’t strong enough to support China’s growth and China’s consumers aren’t strong enough to buy exports from the U.S. and Europe, it will be difficult for the global economy to boom. 

I don’t see a recession at this point.  I do see the same kind of sub-par growth rates in the U.S. and Europe we witnessed in the last decade and flat market characterized by bursts of optimism. 

So I remain in cash – except of course for my various flings with biotech stocks.  Even here, I remain cautious.  My one big position now is in Cytokinetics (CYTK). So please don’t shoot the messenger.  I have always made my best money in periods where the trend has been strong – and such periods are getting rarer.   So just be patient; and at some point, I hope I will have better news. 

Navarro’s Always a Winner Strategies

(Week Ending April 1      Volume 19, No. 2)

In the last newsletter, I urged a move to cash.  At that point, the Standard & Poor's 500 index as measured by the exchange traded fund SPY was at $132. Since that time, SPY has dropped as low as $126 and closed on Friday at $131. In other words, the market has done a whole lot of nothing since that cash call – and a few days after my cash call, Investors Business Daily changed its bullish call to "market in correction."

These are the times that it is really anybody's guess as to whether the bullish upward trend will reassert itself. On the bullish side, a number of indicators continue to point to a moderate investment led recovery. On the other hand, a variety of factors suggest trouble with all three of the other elements of the GDP equation – consumption, government spending, and net exports.

Consumers are plagued by continued high unemployment, weak home sales, and ongoing foreclosure problems. On top of this, their budgets are being squeezed by higher gas, broader energy, and food prices. While our Marie Antoinette Federal Reserve does not recognize food and energy inflation as real inflation – apparently wanting us to eat cake as our bread and gas prices go up – such non-core inflation is likely to have an impact on consumers moving forward.

On the government spending front, the big news here besides the winding down of at least some of the federal stimulus is a coming contraction in state spending at some of the hardest hit states like Illinois and California. Reduced government spending – whether it is at the government or state level – is contractionary from a macro perspective so we must anticipate this.

Finally, on the net export front, Ben Bernanke's doing his best to trash the dollar and provide United States with a competitive beggar thy neighbor edge abroad. However, China is doing an even better beggar thy neighbor job with it's protectionist and mercantilist policies; because the yuan is pegged to the dollar, no matter how low the dollar goes, our trade deficit with China merely increases. Meanwhile, a weak Europe is unlikely to buy a lot of American exports.

On top of all this, there are geopolitical uncertainties. Will the Jasmine Revolution spread to more oil-producing pro-American countries like Saudi Arabia? Will the Japanese nuclear disaster cripple the global supply chain or, worse, morph into a holocaust meltdown? And with nuclear power likely to share a smaller slice of the electricity generation pie worldwide, will higher electricity prices act as a contractionary force on the world economy?

All these factors are being sorted out by a market now which is showing surprising strength in the face of high economic uncertainty and geopolitical turbulence. This is not a market I yet want to play from a trend following perspective and therefore will continue to stay in cash till the bullish trend firmly reasserts itself. On this note, look for a solid breakout above the $136 mark for SP Y to confirm a bullish uptrend and stay tuned to this newsletter.

In the meantime, I will continue to do what I always do which is to keep a significant fraction of my portfolio in noncyclical biotech stocks. Here's a list of some of my holdings.

The newest member of my biotech portfolio is CYTK, Cytokinetics.  This is the latest new listing from Andrew Vaino at Roth Capital, Wall Street's best biotech analyst. CYTK develops small molecules to improve muscle function for the purpose of treating heart failure and Lou Gehrig's disease. Its clinical data looks promising, it has a good chance of achieving "orphan drug" status which helps with regulatory and clinical barriers, Amgen is subsidizing the development costs so it has a great partner, and the shares appear significantly undervalued. I'm loading up.

I have been doing some short-term trading around Neoprobe (NEOP) with the goal of building a large position in this stock. I sold off most of my position when made my cash call back in February around four dollars and started rebuilding as a stock fell down towards three dollars. I like this one for longer-term.

My longest term position is in LPTN, Lpath.  This is a low volume stock with pretty big price swings but I'm just going to hold my position and wait and see how the clinical trials pan out.

My one "Roulette" biotech is the penny play Advaxis (ADXS.PK), a pink sheet stock recommended by one of my readers. At $.11 a share, it's got little downside risk; and it's the kind of stock that if you get in early and it starts to move, it’s kind of like trading an option with a big payoff.

Last take: I continue to do some short-term trading in TBT, which shorts the long bond. My intention is to build a large position in TBT, but events like Portugal debt crisis in the Japanese earthquake can cause TBT to fall so you have to be careful trading this instrument. Over the long-term, however, I think it will be a home run.

On the book front, my new book (with Greg Autry) entitled Death by China is now available for presale at Amazon.com and will debut around June 1.  Get your order in early please!

Market Pulse: Cash Call, Cash Cow In the last newsletter, I urged a move to cash.  At that point, the Standard & Poor's 500 index as measured by the exchange traded fund SPY was at $132. Since that time, SPY has dropped as low as $126 and closed on Friday at $131. In other words, the market has done a whole lot of nothing since that cash call – and a few days after my cash call, Investors Business Daily changed its bullish call to "market in correction." These are the times that it is really anybody's guess as to whether the bullish upward trend will reassert itself. On the bullish side, a number of indicators continue to point to a moderate investment led recovery. On the other hand, a variety of factors suggest trouble with all three of the other elements of the GDP equation – consumption, government spending, and net exports. 

Market Pulse
I’m issuing a cash call at this point in time – while those with more risk tolerance may consider going short.

As noted in my last missive, I’ve been bullish on the market based on an economy improving at a rate that has been higher than expected.  At this point, I don’t see a recession ahead.  However, there are significant storm clouds on the fundamental horizon that suggest a significant market pullback.

The primary argument right now for a continued bull trend is that the U.S. is a “safe haven” and that investors are “rebalancing” their portfolios to more heavily weight the U.S. and Western economies versus the emerging markets.  I don’t see this as a sustainable proposition – as one CNBC commentator put it, that makes the U.S. market the “prettiest horse in the glue factory.” 

On the bear side, here’s what concerns me.  First, we are already in the middle of a very nasty cost-push inflation squall.  On the food side, we’ve had drought-related wheat shocks in Australia, China, Russia, and the Great Plains area of the U.S. while livestock herds on down as well.  In addition, we are already in the middle of rising energy costs and with the turbulence in the Middle East, this is unlikely to abate. 

Second, the U.S. is entering the next stage of its economic crisis.  This is the fiscal policy shocks that are likely to result as some of America’s largest states face budget crises and implement cutbacks and tax hikes. Third, the U.S. budget remains out of control, interest rates are rising, and this is acting as a brake on the housing market recovery. 

On top of this, I see a lot of the underlying bullish trend in the stock market attributable to robust surges in energy and commodity stocks.  However, robustness in these sectors contains the seeds of any market’s destruction because of the underlying supply side shock implications. In moving to cash, I know I am going a bit against the grain here as some leading economic indicators continue to point to an above trend recovery.  However, the ECRI Leading Index is losing momentum and I’m trying to anticipate the effects of the post-Mubarak world we are about to enter into. 

So in such times, cashing out and sitting on the sidelines a bit is not a bad strategy.  While I will maintain my positions in my small cap biotechs and rare earth stocks, I’m mostly in cash with small shorts on both the Chinese and U.S. markets. 

As a final comment, in my last missive, I recommended buys on CLDA, EK, and FOLD.  While EK fell a few bucks on a negative legal decision, CLDA gained over 100% and is being acquired by Forest Labs as predicted.  As for FOLD, it’s a long term hold and is doing fine.

As to what’s in my portfolio: My biotech longs include: NEOP, LPTN, SBOTF, and SVNT.  My two rare earth plays are GWMGF and GDLNF.   

I’m out of TBT for now having taken some profits and will reload on a pullback down to the $36 range.  I’m  FXP (which shorts China), long SDS (which ultrashorts the S&P 500), and I’m short a sugar buyer play IPSU. If you have an interesting stock for me to run through my screens, send me an email and I’ll check it out.

 

Notice: Because of an impending book deadline, I will continue to publish this newsletter on a less than weekly basis – likely 1 to 2 times a month for the next several months. I apologize for this, but promise to send my subscribers alerts when ever anything really important is in play.

This Week: All That Bull

Market Pulse

The good news as 2011 rolls along is that the economy is looking far better than it did six months ago.  This helps account for the undeniable bullish uptrend of the U.S. market.  As this point, trading with the trend means being on the long side for the foreseeable future.

I can offer three interesting stocks I’ve taken significant positions in, two of which will likely have sharp moves up (or down) within the next week.

The first is Clinical Data (CLDA).  It has an important date with the FDA for the approval of its anti-depressant drug Vilazodone on January 22.  Roth Capital analyst Andrew Vaino handicaps the probability of approval at 75% and if all goes well, this is a $15 stock that should jump anywhere from 50% to 75%.

What’s good about Vilazodone is that it would be the only anti-depressant that doesn’t interfere with sex drive – not a bad niche in a market weighed down heavily by that side effect.  But even if Vilazodone gets approval, CLDA will still likely have to find a buyer among Big Pharma to really see a sustained stock price hike.

I’m cautious about this one because the short interest, though falling, remains high and that often means somebody knows something that isn’t fully disclosed yet.  That said, I’m significantly long this stock.

The second stock of interest is Eastman Kodak (EK).  This is a five buck stock with strong buy technical signals from Market Edge that has an upcoming January 24 court decision on alleged EK patent infringements by Apple and Research in Motion.  A favorable ruling would goose the stock.  But even in the absence of the ruling, EK seems to be coming out of the Stone Age of film into a digital world with some nice products across lines that exhibit some of the technological innovation Eastman Kodak used to be famous for.  Plus, EK has some other patents that it might be able to extract some royalties out of from companies like Facebook.  So I’m long this one as well.

The final stock I’ve taken a significant position in is FOLD – Amicus Therapeutics.  It’s a small biotech with a drug in progress, Amigal, that treats a rare enzyme deficiency disease known as Fabry’s disease.  It’s got a deal with GlaxoSmithKline to develop and commercialize Amigal, it has a strong cash position, and it’s already made a nice little move since Roth Capital initiated coverage on it. 

As for an update on some of my holds: Stellar (SBOTF) is a favorite long term hold – I like the promise of its technology. TBT, shorting the long bond, is another one of my long term holds that I hope to pay for my kid’s college with.

At any rate, that’s all the news that fits for now.  Bon chance.

 

DISCLAIMER: There are often typos in this newsletter and the culprit has to do with the fact that much of it is dictated using Dragon Naturally Speaking. The accuracy rate is quite high, but some silly things do slip through. So if you see something that doesn't look quite right, trust the syntax and make your own internal correction.

Market Pulse

In the last newsletter, I indicated that I was cashing out many of my positions and taking profits “in anticipation of a flat to down US market until the end of December.  I have continued with this process and not been particularly disappointed. While Investors Business Daily declared last week that the upward trend of the market has resumed, I still see it in a largely sideways pattern. Since October 25, the S&P 500 index, as measured by the exchange traded fund SPY, has gone from about 118 to 122 back down to 118 and back up to a little more than 122.  BFD.  It's just not worth the risk to be in the market.

Despite some false optimism about the strength of the US recovery, the latest jobs report brought everyone back to earth. Despite a short-term improvement in the European crisis, the long term suggests many troubles ahead for Spain, Portugal, and Italy while the euro zone itself is more likely to shrink than expand. China continues to boom, but the Chinese central bank continues to raise interest rates. If we've learned anything from the rational non-exuberance of Alan Greenspan here in the US, it is that rising interest rates will invariably choke off any recovery. It would be high irony if China underwent the same kind of housing bubble collapse that the West did – it would likely make what happened in the West look like a stiff breeze compared to a hurricane.

My bottom line is that this is one of those times where it is just very difficult to make money. In such times, Wall Street looks more to me like a roulette wheel than a poker table. During such times, I do not like to sit down and play as the House, e.g., program traders, hedge funds, and the like, typically has the advantage. I have the luxury of doing sitting on cash because, unlike professional money managers who are under constant pressure to continually deploy their capital, I only have to play when I want to. From this vantage point, it's not worth the few percentage points you might gain going into the New Year at the risk of losing substantially more. To put this another way, I prefer to make my money in bunches when the market trend is solid rather than get nicked and cut in any sideways markets.

Navarro's Trading Summary

The little money I do have in play right now remains primarily in some of my small cap biotech favorites. So far, my best trade has been Stellar Biotech.  I got in at around $.40 and after a brief pullback, it's back over a buck. I see this as a long-term play so please don't pump this one on my behalf and then dump it. Do your research, see that it has a reasonable business strategy, and make your own decisions.

As for some other trading highlights, I took profits on my yen short and my long on IMAX, bailing on IMAX because of some concerns raised about their accounting practices that are likely overblown but still capable of battering the stock. I also took some profits in TBT and then promptly reloaded a small position as it fell during this latest European crisis. I will add to this position if either it's swoons once again or develops a strong support level and begins to rise. I am also maintaining a small position in Beazer homes simply because I like it as a canary in the coal mine, a position that will alert me to any recovery in the housing market – a key ingredient of any broader economic recovery.

Lastly, I remain underwater with most of my rare earths positions, but these are small positions and I will hold them to see if this market develops.

Have a great Christmas and Hanukkah! Unless there are important market moving events, I will see you in the New Year.

DISCLAIMER: There are often typos in this newsletter and the culprit has to do with the fact that much of it is dictated using Dragon Naturally Speaking. The accuracy rate is quite high, but some silly things do slip through. So if you see something that doesn't look quite right, trust the syntax and make your own internal correction.

Stock market trend: Up

 I have begun to cash out of many of my positions and take profits in anticipation of a flat to down US market until the end of December. Both tax selling and the taking of profits coupled with uncertain outlooks in communist China and in the PIGG portion of Europe suggest less upside reward than an undeniably strong technical market trend might suggest at this point. Better to be early than late is my motto.

 And speaking of early,I have begun to build a short position in the communist Chinese stock market using the exchange traded fund FXP. Just as I was a bit too early shorting the housing bubble, I may indeed be a bit early on the China bubble. However, here is what I'm seeing.

 First, as my early warning system, I maintain a watch list of 64 Chinese stocks listed on Market Edge. Over the past month, I've noticed a systematic deterioration in many of the stocks. 23 show deteriorating conditions while only six show improving conditions. Of the six with improving conditions, three of them are agricultural stocks.

 Second, from a fundamental perspective, economists within the Communist Party have come to a critical inflationary fork in the road. One fork – the path of contractionary monetary policy, rising interest rates, and price controls – leads inevitably to a business cycle downturn. The other fork – allowing the Chinese currency to strengthen so as to reduce the price of food, commodities, energy, raw materials, and imported consumer and investment goods – leads to a far more stable transition to an economy less dependent on exports.

 It is crystal clear that the Communist Party has chosen the wrong fork. The biggest danger of traveling along the rising interest rate path is to prick the speculative bubble otherwise known as real estate in China – all the while attracting a flood of speculative hot money flows.

 The bigger picture is that communist China cannot continue to experience export led growth catalyzed by American and European consumers. The American and European economies simply don't have the firepower to sustain communist China's growth.

 The last thing I should say about investing in China is that it is far better to play the long side of the communist Chinese market by investing in peripheral plays like Australia, which provides China with many of its commodities, and Germany which provides China with many of its capital goods. However, the main reason I don't like investing in communist Chinese stocks (besides the fact that it is a ruthlessly totalitarian country whose political and military leaders are out to destroy America) is that the vast majority of Chinese companies put creating jobs ahead of making money. That doth not a robust return make.

 Navarro's Trading Summary

 With the big macro picture out of the way, let's finish with a brief discussion of my trading strategies. The last letter I strongly recommended going long the yuan via CYB, short the long bond via TBT, and short the Japanese yen, YCS. 

 The TBT trade turned out the best – it went up six points, and I've taken my profits for now while I wait for the Irish crisis to subside. As I painfully learned during the last European crisis, a flight to the US dollar pushes down bond prices and boost yields – which is exactly the opposite direction TBT plays it.

 I'm also making some modest money on my yen short while I continue continue to hold CYB while I wait, perhaps like Godot, for that bright shiny day when the Communist Party figures out it is in China's best interest to let the yuan go up significantly.

 In terms of the rest of my portfolio, I added two stocks to my short-term trading portfolio based solely on an interesting discussion in one of my MBA classes. The stocks are Imax (IMAX) and Clicksoftware (CKSW). Just be careful with Clicksoftware because it has a small float.

 In my short-term trading portfolio, I also bailed on COIN, which was a failed play on California's failed marijuana initiative and abandoned ship on DirecTV based on growing information that the Internet is becoming more and more of a substitute for cable than simply DirecTV.

 My favorite little penny play and best performer continues to be Stellar Biotech (SBOTF). Profit takers hit the stock fairly heavily for a couple of weeks but it's back trying to inch above a buck. This is a stock to accumulate and forget about for a few years and then likely be very happily surprised.

Since I got into the rare earth bonanza a bit late, my small positions in several stocks continue to be flat to down.  I reiterate that this is a long-term building project. My small positions include ARAFF, GDLNF,GWMGF, and LYSCF.

Finally, my dumb move of the fall quarter is opening up a small position in the uranium stock URZ recommended by a stock site called Ahead of the Herd – I promptly wound up significantly underwater. I still can't figure out whether I have been "pumped and dumped" or whether the site simply made a bad call. If anybody has any information about this stock site, send me an e-mail and let me know whether it has helped you make money or lost money.

Have a great Thanksgiving! And as the ultimate expression of patriotism, go out and buy a bunch of cheap Chinese stuff on Black Friday to put around your Christmas tree. LOL

DISCLAIMER: There are often typos in this newsletter and the culprit has to do with the fact that much of it is dictated using Dragon Naturally Speaking. The accuracy rate is quite high, but some silly things do slip through. So if you see something that doesn't look quite right, trust the syntax and make your own internal correction.

The market remains in an uptrend but it is a “weak dollar” rally, not a “strong economy” rally.  In real, dollar-adjusted terms, the market is closer to flat.  A possible crash triggered by the weakening economy or a currency war is not out of the question.  Don’t fight the trend – but I’m certainly not jumping in on the long side with both feet either.

 China’s recent interest rate hike and Fed Chief Ben Bernanke’s recent QE2 interest rate cut put us on a collision course. You simply can't have one country lowering interest rates in another country raising interest rates when the two currencies are held together by a fixed peg. Something has to give, and I think perhaps that Ben Bernanke is trying to force the Chinese to revalue the yuan because the Fed chairman knows that the White House and Congress don't have the backbone to do it – and the Fed chairman also knows that reducing the global imbalances between China and the US is critical to long-term recovery.

 From an investor's point of view, I see three related macroplays: Long the yuan via CYB, short the long bond via TBT, and short the Japanese yen, YCS.  (I have all three positions)

 The yuan MUST eventually rise and can’t go down so CYB is very low risk.   Once the yuan starts to rise, long bond yields must rise because the Chinese. Buying as many treasuries as they do now. This will cause a spike in TBT.  The yen is grossly over-valued because the yuan is grossly undervalued – it must fall once the yuan starts to rise.

 I continue to allocate 20% or more of my portfolio to small cap, discovery stage biotechs outside the cycle.   I said to get into SVNT prior to an FDA ruling that would lead to a 75% pop.  I said to sell SV is NT after the pop because it might be hard to get a buyer for the company.  Now that SVNT has fallen dramatically because of a failure to find a buyer, I think it is a buy again and has at least a 25% upside. (I bought on drop).

 Right now, my favorite little penny play and best performer is Stellar Biotech (SBOTF) – it has almost doubled since I first noted it in the newsletter.  (Check my previous newsletters for more detail.)   I've also begun to build a position in Direct TV as a long term secular play as satellites spring up all over.

 My other highly risky penny play that is making a very nice move on low volume is LPTN.  If it breaches a buck, it should start to run nicely.

Since I got into the rare earth bonanza a bit late, my small positions in several stocks are flat to down; but I'm not really worried because this is a long-term building project. So far, I have opened small positions in ARAFF, GDLNF,GWMGF, and LYSCF. Only GWMGF is up.  (As previously noted, I purposely stayed away from Molycorp as it is way too expensive.) 

I sold Hovanian for a small loss and reloaded with Beazer, which has better technicals – so that's my play on the housing sector, which I think is at a bottom.

I dumped him my shares in DUSA, MDVN, and TEVA not because I have lost faith in it but simply because I wanted to deploy my cash elsewhere and I didn't see much upside in the near-term.

I also closed my position in QTWW on news that it was going to undergo a reverse stock split. I just hate that crap, and reverse stock splits invariably reduce a stock’s price.

I closed my short position in GameStop with a very nice little profit -- with the market trend robustly up, just don't want to be short now.

I also opened a position in a penny stock called Converted Organics (COIN). It's got excellent technicals and came up on my Market Edge screen. It's a good long-term play on agriculture.

Stocks that I am long:

ARAFF,BZH,COIN,CYB,DTV,DUSA,FEED,GTXO,GWMGF,GDLNF,LPTN,LYSCF,NRGX,SVMI,SNT,

SBOTF,SVNT,TBT,YCS

Here's the lowdown on last week's action from Marketedge: “Stocks continued to march higher last week as both the DJIA and the NASDAQ posted modest gains for the period.… The technical condition of the market was mixed last week as the CTI lost a couple of points, there was considerable deterioration in the Strength Indexes but the Momentum Index remained strong."

Translation: The upward trend remains intact but there's some disquieting underlying technical deterioration that we must take note of.

On the fundamental front, virtually all economic leading indicators are pointing towards a slow growth scenario over the next 12 months, in the range of 2% real GDP growth, which is significantly below our potential output of about 3% to 3.5%. If this forecast holds true, unemployment will remain high, income will remain stagnant, and it is unlikely that consumption will help pull the economy up to full and steady growth.

As for why the stock market is rallying on this lukewarm news, the most likely scenario here is that the market’s upward trend is more an illusion than reality once one discounts for the rapid, recent decline in the dollar.

It's a salacious little menage a trios we have goin gon: The Federal Reserve keeps short-term interest rates low and engages in quantitative easing to lower long-term interest rates and thereby turns on the monetary printing press. The increase in the money supply drives down the value of the dollar. Meanwhile, the Smart Money borrows money at low interest rates and buys stocks, with a heavy skew towards energy and commodity-based stocks which will hold their value through price appreciation as the dollar falls.

In other words, pierce this veil and you see that there's nothing really going on fundamentally to suggest a strengthening economy. Rather, it is more a house of mirrors from the Federal Reserve.

On that note, I used to think that Ben Bernanke was a very smart guy doing a very dumb thing by printing endless reams of money at the Federal Reserve. Maybe he is just Machiavelli. Could this latest move with QE2 and a cheapening of the dollar simply be Beggar Thy Neighbor Ben’s way of stimulating our economy via exports and putting more pressure on the Chinese to let their currency float?   Smart or dumb, Ben Bernanke is playing a very risky game.

So what does all this mean for traders and investors? For traders, there remain opportunities for short-term trading with the upward bullish trend – but be careful, as the technical indicators are suggesting softening.   For investors, despite the upward trend of the market, I remain nervous about fully deploying cash into this market.

Finally, I have to talk (brag?) a little bit about TBT. After lamenting several weeks ago that this has been one of my worst trades – so far – I also indicated that I wasn't really worried about being in the red and that I had adopted a modified "double down" strategy that has involved adding to the position every time TBT (which shorts the long bond) went down.

Last week, that strategy finally paid off as TBT made a nice upward move and put the trade back into the green. The move was all the more amazing in the light of repeated announcements by the Federal Reserve that it would engage in more quantitative easing, which should push long-term bond yields down and prices up and further push TBT down. However, that didn't happen, and the reason I think goes back to the issue of the impact of a falling dollar on the inflation rate and an eventual bursting of the current bond market bubble. So I continue to like the TBT trade. Let's see where it goes.

I opened new positions in several rare earth stocks based on China's export restrictions on its supply – China is the OPEC of rare earths. (See my video about this at TheStreet.com.) This is strictly very high risk, penny stock stuff; and I run the risk of buying late in the run so I am only buying small positions and will only add them as the trade moves in my favor. So far, I have opened small positions in ARAFF, GWMGF, and LYSCF. (I purposely stayed away from Molycorp as it is way too expensive.)  (If any readers have any thoughts on the rare earths stock plays, I'd love to hear from you.)

I also opened up a new position in FEED based simply on technical considerations – this is an agricultural play in China.

Stocks that I am long:

CYB,DTV,DUSA,GTXO,HOV,LPTN,MDVN,NRGX,QTWW,SVMI,SNT,SBOTF,TEVA,VVUS

Stocks I am short: GME.

Updates: I cashed out both DEPO and SNTA with very nice gains -- no news in the nearer midterm future to propel them much higher.  I took a small loss in SOMX – a bad trade where i got sucked into a parabolic move.   I also significantly trimmed my very large position in SNT – I still have faith in it but will only add back to this position as it moves up, which looks like it will take a long while.

Last take: I haven't mentioned previously my long position in DTV. This is kind of like a "Peter Lynch" play – the famous mutual fund manager who used to get his ideas from talking to his children about what they saw at the mall. I'm just seeing a lot of satellite dishes going up.

 

DISCLAIMER: There are often typos in this newsletter and the culprit has to do with the fact that much of it is dictated using Dragon Naturally Speaking. The accuracy rate is quite high, but some silly things do slip through. So if you see something that doesn't look quite right, trust the syntax and make your own internal correction.

Stock market trend: Up

Market Pulse

The good news: The US market indices continue their upward trend last week as the Dow Jones industrial average broke above the 11,000 mark for the first time in over five months. The bad news: this latest market uptrend appears not to be driven by good economic news but rather by an emerging "carry trade" driven by the easy money policies of the US and a number of other countries around the world, including Japan.

The carry trade game here is simply to borrow money from the Federal Reserve or Bank of Japan via low interest rates and invest in the stock market. In this carry trade, the dollar falls and the US markets go up but the net effect in real, dollar adjusted terms is negligible.

From this perspective, any price appreciation in the stock market is merely offsetting negative currency effects. This is hardly a bullish scenario. That's why while this may be a good market for short-term traders, it is a dangerous one for longer-term investors tempted to move cash off the sidelines.

What bugs me about all this is a Wall Street "patriotism" that equates the debasement of the currency and easy money with something it must be good for the country because it's good for the markets. What a crock.

All of this will continue until countries around the world confront China on its mercantilist and protectionist trade policies. China's grossly undervalued and manipulated currency alone is driving the monetary policy not just of the United States but also most of the countries in Asia. A weak Chinese yuan forces Japan, South Korea, Taiwan, and all of China's major competitors in Asia to try to drive their currencies down. Meanwhile, the commodity countries like Brazil and Australia are going bonkers because their currencies are bearing the lion's share of the burden of China's beggar thy neighbor currency regime through currency appreciations of their own – and result in export difficulties.

What I find really irritating as well is the rush of American journalists – Exhibit A is Fareed Zakaria's mindless apology for China in this week's Time magazine – to support Chinese mercantilism and protectionism. It's not even blind ideology on Zakaria’s part. It's just plain arrogance and stupidity. If you get on enough TV shows and get asked your opinion enough, you start to believe you actually know something. My guess, however, is that when the light weight Zakaria is on any TV set, they have to nail his shoes to the floor so he won't float away.

Anyway, that's my rant for the week and I'm sticking to it. The sober analysis is that this is an upward trending market with a wall of worry that is primarily macro-based. Climb it with caution.

Stocks that I am holding: SNTA, DEPO,DUSA,LPTN,NRGX,QTWW,SVMI,SNT,SBOTF,CYB,TBT,MITI,

GME(SHORT),DTV,VVUS,HOV,TEVA,SOMX,MDVN

Updates: I cashed out the rest of my Chelsea – will reload if it dips below $5.  I took a small loss in YRCW, which did a reverse stock split and wiped out all the fun speculation on a penny stock.  I will add to TBT every time it drops a buck.

As a final note, there are often typos in this newsletter and the culprit has to do with the fact that much of it is dictated using Dragon Naturally Speaking. The accuracy rate is quite high, but some silly things do slip through. So if you see something that doesn't look quite right, trust the syntax and make your own internal correction.

<a href=”http://affiliates.wallstreetsurvivor.com/z/228/CD302/"> Try our Free Stock Market Game at WallStreetSurvivor.com.</a>

 

Market Trend: Up

According to Market Edge: “After four weeks of impressive gains, stocks took a breather last week as both the DJIA and the NASDAQ ended the period with minor losses. The DJIA started the week with a 48.22 point (-0.4%) loss which was just the fifth losing session in September. Traders bought the dips throughout the week as the DJIA saw triple digit intra-day swings on both Tuesday and Thursday. Despite several disappointing economic reports, traders kept a bullish outlook throughout the week. For the period, the Dow lost 30 points (-0.3%) to close at 10829, snapping its four week win streak.”

This is indeed either a breather or the knocking of the markets on a glass ceiling otherwise known as a sideways pattern. You know my concerns. While September was as pleasurable as August was painful, there are still some major tests of technical resistance ahead before we can feel comfortable with the idea of an uptrend.

As always, we must look to economic fundamentals to handicap the markets next technical moves. This last week we had a minor drop in the ISM manufacturing index and the leveling off of the ECR I Weekly Leading Index. Meanwhile, consumer sentiment offered a similarly uncertain picture. Based on what we continue to see from the economic data, this is a "watch and wait" period in which short-term traders can try to take advantage of the upward trend an buy-and-hold investors should remain mostly in cash on the sidelines.

With that out of the way, let’s talk about some longer-term business. In the last newsletter, I trumpeted some of my recent calls in the biotech space – PBTH, CHTP, and SVNT were all double- or triple-digit winners. I also trumpeted two of my short calls on Palm and RIMM and a long on Apple at $250 – likewise huge double-digit winners.

Just to make sure that I don't get too full of myself, several readers absolutely hammered me for my short call on gold in mid July and my call to short the long bond in mid April. I think it is worth talking about each of these trades because discussing the gold trade will help remind readers about the importance of managing your trades and taking profits while discussing the bond trade will both underscore the need to cut losses early and to understand from a macro point of view what drives bond prices and yields.

Let's start with my “short the gold market” trade.  On July 15 when I made the call, the exchange traded fund GLL which shorts the gold market as an unleveraged ETF, was priced at $39.78. By July 29, it hit a high of $42.73 – a nice little gain.

At this point, a seasoned trader would've put up stop loss at at least the initial buying price, and such a stop loss would have been triggered as early as August 6 – no harm, no foul.   My point is simply that any stock that you buy whether because of your own research or by reviewing the research of others requires careful money management and risk assessment. If you don't know how to use stop losses and trailing stops and set your stop losses near key levels of support, then you really have no business engaging in short-term trading at all.

So my advice if you are losing money on trades that first went up but then went back down is to do some more research on trading techniques.  In this regard, I can say without too much self-promotion that my book When the Market Moves, Will You Be Ready? Is a pretty good manual on how to trade and manage both your risk and cash..

Now let’s turn to my “short the long bond” trade – arguably my biggest loser in the last several years.  My instrument of choice is an ETF called TBT. Let's break this one down.I first flagged this one around April Fools' Day when the price was just around $50. Unfortunately I wasn't joking about buying this dog because as of now it's down to almost $30. Of course, anybody who rode this from $50 down to $30 really needs to go back to Trade School. The most you should ever lose on a trade is 10%,  In fact, if you manage your money well, you can still make a lot of money even if six out of every 10 stocks you pick are losers.

My logic for shorting the long bond in April was simply this: the economy looked like it was recovering, federal budget deficits were spiraling out of control, and these two factors should have pushed the long bond yield up and prices down. What I didn't bargain for was the financial crisis in Europe that made the dollar a safe haven for global investors – and when I say the dollar, what I mean is that these investors bought a ton of US government bonds after exchanging euros for dollars. This had the effect of both driving the dollar up and bond prices up.

This is hardly the end of the story, however. The TBT trade has continued to grow worse as the economy has softened and Federal Reserve Chairman Ben Bernanke has pledged to engage in so-called quantitative easing to further stimulate the economy.

Quantitative easing is a way for the Federal Reserve to manipulate long bond yields by purchasing US government bonds which are being issued to finance the US government budget deficit. The net result of quantitative easing is to provide long bond holders with a hedge against the risk of falling bond prices. In this way, the Bernanke policy of quantitative easing represents a “Bernanke Put” by providing bondholders with put protection on bond prices just as from the late 90s to the early 2000, Fed chairman Alan Greenspan used a policy of easy money to provide stock market investors with put protection of falling stock prices.

While I know this is going to sound like the stupidity of the 1990s tech bubble, I will now say with no tongue in my cheek that if you liked TBT at $50, you will love it at $30. Yep, I haven't given up on this trade-- although I feel a little bit like the guy in the movie Tin Cup who kept trying to hit the ball over the water.

My reasoning is that at some point bond prices are going to have to plummet and yields are going to have to skyrocket as an era of cheap money, huge deficits (and a possible rising Chinese yuan) put a bloody end to the bond market bubble and the Bernanke Bond Put.

So I have begun to rebuild a small position in TBT and I continue to add a little bit to it every time it drops another point. Call me crazy, but I have no doubt that this trade will eventually pay off big. It's simply a matter of time, and the difference between doubling down on an exchange traded fund like TBT and an actual stock of a company that is performing as badly as TBT is this: the company likely sucks and that is what explains its poor stock performance. In contrast, with TBT, it's only as good or bad as it's macro environment –there are no dumb managers or bad products or anything else to worry about. Because I just don't think interest rates will stay at record lows forever, I going to keep a hand in the TBT game just like I kept trying prematurely to short housing stocks during the housing bubble and kept getting burned – and then one day I didn't.

So that's my TBT story and I'm sticking to it. I'm bleeding a little bit with it, but my biotechs and other trade have more than offset any small losses in TBT. Eventually I think TBT will be a good trade. At any rate, a position in TBT helps keep me in tune with the economy as I have plenty of skin in the game to pay attention.

As a final note, there are often typos in this newsletter and the culprit has to do with the fact that much of it is dictated using Dragon Naturally Speaking. The accuracy rate is quite high, but some silly things do slip through. So if you see something that doesn't look quite right, trust the syntax and make your own internal correction.

 

The upward trend in the US stock market can't be denied – yet I continue to have my doubts and continue to be concerned about another sideways market trap. To understand my concerns, please do the following.

 

Go to Yahoo Finance and pull up the one-year chart for SPY, the exchange traded fund the Standard & Poor's 500 index. You can see in this chart that the stock market is exactly at the spot it was back on January 20, 2010. You can also see that after the market surged off its lows in February of 2010 and peaked in April, it traded in a clear sideways pattern. Now, again we find ourselves at the upper end of the range; and it is useful to ask the question: What will propel this market forward?

 

The answer must of course lay in improving economic fundamentals. So let's do a quick overview using my Always a Winner forecasting model.

For starters, according to the Dismal Scientist website, the ECRI Weekly Leading Index "has been on a more positive trend recently, though is not yet consistent with a stable recovery.” That's good, but still a question mark. 

As another positive, the ISM Manufacturing Index is still comfortably in the expansionary range at 56.3 – so our investment led recovery still has some investment leadership. Consumer confidence rebounded in August – that's good news – but it is still at levels consistent with slow growth. In a similar vein, retail sales have risen for a second consecutive month, albeit at a slow pace. Again some good news tempered with reality. 

The most startling bad news is the horror show that is new-home sales. After spiking in April on the basis of what were then optimistic views of the economy coupled with government subsidies, home sales have fallen off a cliff and now remain at a record low. In fact, this country is adding less than 300,000 new home units a year at the current pace in a country of almost 300,000,000 people.

On top of this, existing home sales are at an 11 year low, with only 4 million units being sold a year. Finally on the unemployment front, this country is generating fewer than 100,000 jobs per month, which is far too low to materially reduce the rate of unemployment. So when we cycle back from this fundamental data to the technical indicators, you can see that there is at least some case to be made for an upward stock market trend – if for no other reason than the risk of a double dip recession seems to be receding and the US economy is plugging, if not chugging, along.  

That said, in order to project from this current short-term upward trend of the market a sustainable bullish move, one would have to heavily discount the coming Obama hammer in 2011 in the form of higher taxes and a greater regulatory burden to be imposed on the private sector. Make no mistake about it, the "passive aggressive" tax hikes the Obama administration will impose are significant – passive because Obama is going to allow the Bush tax cuts to expire, aggressive because ObamaCare and other Obama programs are going to significantly raise taxes. 

So we return to the eternal question posed by this newsletter: What are traders and investors supposed to do?

 

At this point, short-term traders may well be able to take advantage of a continued uptrend; but if it turns out to be a sideways market trap as I fear, only tight stop losses and sound money management principles will save you from the kind of mini-gutting that many traders suffered in the month of August – again refer back to the chart of SPY and you will see exactly what I mean.

 

As for long-term buy-and-hold investors, if you have been simply putting your money on a set of speculations on secular trends that I presented in my video series for the Street.com, you'd be sitting pretty right now. Those speculations, which I have done in conjunction with analysts Greg Autry and Jaysen Harris, included:

·         Shorting Palm at $12 – it went as low as three dollars

·         Shorting RIMM at $70 – he went as low was $47

·         Going long Apple – our call was at $250 and it is now at $292

 

In addition, I have for a long time recommended keeping at least 20% of one's portfolio and small-cap biotech stocks. Many of the biotech stocks – but not all – in my portfolio are based on the analysis of a former student of mine and contributor to my website – Andrew Vaino of Roth capital. Three of the best calls on this biotech front that have appeared in this newsletter include:

 

·         Prolor at 40 cents -- it went as high as seven dollars

 

·         Savient Pharmaceuticals – two weeks ago, I said on CNBC when it was at $14 that if it got FDA approval, it would go above 20 and it has.

 

·         Chelsea Therapeutics – I first mentioned this stock in the newsletter when it was about three dollars. On CNBC 10 days ago, I said it could double if the FDA approved its drug and projected such approval the stock is gotten as high as seven dollars.

 

The only bad news I can report right now about my small cap biotech speculations is that, with the exception of SNT which has an important conference coming up, there are no short-term catalysts on the horizon likely to move any of the ones I'm currently holding – so they are true buy-and-holds. Here's what's in my portfolio currently: 

 

CHTP (I sold half of my position on the FDA news and I'm letting the other half ride for a bit); DEPO,DUSA,LPTN,MDVN,MITI,NRGX,SNT,SNTA.

 

I have also begun building a small position in a company called Stellar, which is a pink sheet penny stock which has an interesting story which I will share with you a future newsletter. (Anybody who has any information on this company, please share with me). I will also be sharing more with you about SNT in the coming weeks as I continue to find this company frustratingly interesting.

 

As a final note, there are often typos in this newsletter and the culprit has to do with the fact that much of it is dictated using Dragon Naturally Speaking. The accuracy rate is quite high, but some silly things do slip through. So if you see something that doesn't look quite right, trust the syntax and make your own internal correction.

  

 

The stock market continues to show technical improvement – even as the economy continues to exhibit fundamental deterioration. On the technical front, Market Edge has its Strength Indices showing improvement while its Momentum Index remains very strong. At the same time, 81 of the 91 Industry Groups followed by Market Edge are rated either strong or improving. This all adds up to a stock market that continues to inch up on weak volume.

 

Because the economic fundamentals do not yet support this early cyclical uptrend, I continue to think it may simply be a sideways market trap. Two things that caught my eye last week included an unexpected drop in Consumer Sentiment and a fallback to zero for the core inflation rate is measured by the CPI. Both are recessionary signals. On the other hand, the ECRI weekly leading index has stabilized and resumed a modest upward trend, which is bullish news.

 

Of course, the big macro puzzle right now is why gold is hitting an all-time high even as deflation continues to loom is a real possibility. My favorite explanation, which I have offered to you before, is that because of the large budget deficits both Europe and the United States are running, gold as slowly and quietly becoming the de facto reserve currency of the world.

 

On other macro notes, we had yet another round of sparring over Chinese currency manipulation, this last week on Capitol Hill. Treasury Sec. Timothy Geithner continues to maintain the untenable position the Chinese currency is grossly undervalued but that China is not a currency manipulator. The only thing clear about the situation is that China continues to benefit from its undervalued currency and its economy booms while America goes bust.

 

The other big news that has important implications for the American economy on the currency question revolves around the manipulation of the Japanese yen by China through its large bond purchases in Japan. These purchases are now forcing Japan to once again intervene in its currency market to weaken the yen – and thereby gain back some advantage against countries like America in China.

 

Given the economic uncertainty, I continue to hold significant fraction of my portfolio in cash while focusing on small-cap biotech stocks for returns based on science rather than the economic cycle. Over the next week or so, one of those stocks – Chelsea Therapeutics – will have its day of reckoning with the FDA regarding the viability of its hypertension drug Droxidopa. As I discussed on CNBC, Roth Capital’s Andrew Vaino is handicapping the odds of success at about 75%. Stay tuned.

 

On CNBC, also said it was time to take your profits in Savient Pharmaceuticals as, after its FDA victory, it has now risen to fair value – and will only rise further if there is a bidding war over the company. While this is a possibility, it may be better to deploy capital elsewhere.

 

On the other biotech fronts, LPTN saw a slight uptick in volume and price for a stock that is incredibly thinly traded. Translation: risk is extremely high but there appears to be some movement on no news. When I see such movement, it often means that something's going on within the company that may soon come to light. Stay tuned.

 

Last take: Be on the lookout this week for my latest video for the Street.com where I will rate Nokia short or long.

 

(My small cap biotech portfolio --   CHTP, CLDA,DEPO, DUSA,LPTN,NRGX,SNTA,SNT)

 

Question for my readers: If any of you have any information about a penny stock called Savi Media (SVMI) please send me an e-mail. The company makes a valve which claims to provide significant fuel efficiency and environmental benefits. If true, this two cents stock should shoot to the Moon. However, that clearly has not been the case. Anybody who can solve this SAVI mystery for me – is a fly-by-night pump and dump company or a misunderstood genius? – I’d love to get your thoughts.

Seeds of Destruction hit the Top 100 on Amazon last week in the business and economics category.  If you want to listen to the Introduction to the book, you can download the audio file from the top of this page.


Newsletter: Temptress

Boy have I seen this pattern before.  IBD confirms a new uptrend.  Market Edge shows a broad technical improvement to the market.  Talking heads say get in while the getting is good – and don’t worry about the weak volume.  Shall I be seduced?

 

I don’t think so.  All I need to do to be convinced that this is another harlot is to look at the one-year chart of SPY.  For starters, you can see a clear range bound market since May. 

 

You can also see that prior to this range-bound pattern, SPY peaked at a little over 120 for the year in April and right now it’s just below the short term high of 112 that it reached in the Summer run-up from July 2.

 

It was that Summer run-up that was the last Temptress that sucked in a lot of retail investors and then slammed them with a sharp 10% decline.  Trust me, only the Big Money Computer Traders are making out like bandits in this kind of sideways environment.

 

So in order to tempt me, SPY has to blow past 120 with above average volume and broad sector support. In order to do that, the economy is going to have to show a lot more strength.  Until then, cash is king.

 

Here are my two main exceptions:

 

#1: Apple remains a solid secular long – see my video for TheStreet.com that has Apple at $350 within a year or so.

 

#2: My small cap biotech portfolio --   CHTP, CLDA,DEPO, DUSA,LPTN,NRGX,SNTA,SNT,SVNT

Here I am, back from a three-week hiatus. You may recall from my last newsletter prior to that hiatus I urged all my long term investors to stay in cash while possibly allocating some portion of their portfolio to biotechs.

 So far, this seems to have been pretty good advice. The stock market had one of its worst months of August ever. Of course, over the past week or so, the market has been rallying so many of the talking heads are all a twitter about the arrival of a new bull market.

 This continues to seem pretty much like a sucker's game to me. To understand why, try this little exercise. Go to Yahoo finance and pull up the three-month chart for SPY -- the exchange traded fund the Standard & Poor's 500 index. If you got suckered into buying the bottom hit on June 6, you would've had a very healthy gain by June 17. However, by July 6, you would've been deep in the red.

  By the same token, if you bought the bottom on July 2, you would have been in great shape right up till August 9 – and then been gutted like a pig.

 Okay, so let's say you were smart enough to buy the dip on September 3 at $105 a share. Now you're up already five bucks and you think you're a genius. But what makes you think that after another run-up, the market is just going to run right back down?

 Please keep in mind, I'm usually not this cynical about the market trend. Usually, it's pretty damn clear whether the economy is, as Bob Dylan might say, "busy being born" or "busy dying." But there is so much uncertainty right now in the economy, that the only really sensible thing for the market to do is to trade in the sideways pattern until things resolve themselves.

 I myself am not particularly in the double dip recession camp. When I see is what we've had over much of the last decade – slow GDP growth well below our potential output. That will in turn mean persistent high employment and stagnant wage growth. How you get a bull market out of that – and the Dow at 20,000 – I really don't know.

 I wish I had better news, but we have to trade or invest the hand that we are dealt – or sit patiently on the sidelines in cash.

 For traders, I myself am growing increasingly disenchanted with a long short strategy unless you have great skills at risk management and rapid trading.

 What happens in a sideways market with a hedge portfolio is that your shorts get stopped out when the market runs up, and your longs get stopped out when the market runs down. All you wind up with is modest losses over a lot of stocks that add up to a big loss – plus a lot of transactions costs.

 So if you didn't make any money over the last couple months in your short-term trading strategy, I'd strongly advise you to hang your cleats and mouse up for a while until this market is easier to make money on.

 As for the long-term investor, I continue to recommend cash for now. I also continue to hold about 20 to 25% my own portfolio and small-cap biotechs. And by the way, I will send you a Special Report on my biotech picks this coming Wednesday based on a conversation I had one of the top biotech analyst in the world – Andrew Vaino of Roth capital. (I did a segment last Friday on CNBC that talked about a few of the stocks Andrew is following, but a lot of the best stocks I could really talk about on TV because their small caps.)

 Last take: my new book Seeds of Destruction with former Bush White House chief economic advisor Glenn Hubbard is now available on Amazon and at Barnes & Noble and, as they say, other fine bookstores everywhere. Please buy this book right away, not because I need your royalty money, but because unless the boneheads in Washington change their policy tunes pretty damn quick, we are going to keep heading right down the tubes.