Growth Report : Growth Report

Gurus Ring the Bell

Ian Wyatt — Tue, 07 Oct 2008 20:13:00 GMT

Gurus Ring the Bell

Ahh, the newsletter crowd is getting bullish. My inbox is full of stock-picking gurus saying now’s the time to be bold and buy stocks. Fear is rampant, they say. Distant relatives are calling in the wee hours asking for advice. The VIX is at an all time high. 59% of respondents to a CNN poll feel a depression is either very likely or somewhat likely.

And you know what? I agree. About being bullish, not about depression.

My trading guru, Benson George, the man behind TradeMaster Daily Stock Alerts saw a silver lining to Monday’s gut-wrenching decline. Namely, the 800 point sell-off came on relatively light volume.

I know, it’s a little difficult to call an 800 point drop orderly, but if there ever was an orderly decline, that was it.

Then there was the substantial recovery off the lows. Clearly, buyers are seeing value at current prices. Now, how long it will take for the buyers to gain the upper hand remains to be seen.

I do know that if Bernanke is trying to prep the market for a rate cut at the upcoming FOMC meeting on October 29^th, he should save his breath. We’re ready. Do it. Do it now.

Victor Sperandeo, of Trader Vic fame, maintained in one of his books that the key to making an interest rate move effective was surprise. Fed moves work best when they are a surprise. And any action that comes during a FOMC meeting is not a surprise.

Bernanke should pull another fast one and cut rates 20 minutes before the market opens tomorrow. That’ll help certain companies’ balance sheets immediately. Bill Gross over at PIMCO wants a full point rate cut. Sounds good to me. At this point, it’s about investor confidence. A big rate cut would definitely help.

A Bottom or THE Bottom?

Of course, I have to hedge my rally call. I do think we’re set for some kind of a rally. But I’m not, repeat not, ringing the bell at the bottom. I’m on record saying that employment has to show improvement before there’s sustainable upside for stocks. And the U.S economy is on pace to lose a million jobs in 2008.

No economy can lose that many jobs and still manage to grow significantly. And don’t forget, consumers don’t have the extra refi cash they used to fuel the last bull market.

In other words, there’s upside for stocks in terms of valuation. But growth? I’m not sold on that one just yet. Still, every one knows the story of how Warren Buffett made his fortune buying beaten down stocks in the 70s.

Earnings Season

I wonder if all the newly bullish realize that earnings season kicked off today with Alcoa (NYSE:AA)? With so much going on, it would be easy to miss. But there’s no way earnings are good. And there may be a few nasty surprise waiting in 10Qs. Because what the heck, when news is already bad, you might as well get it all out there, right?

That’s probably why Bank of America (NYSE:BAC) chose to announce a secondary offering to raise cash at the same time it announced a 68% drop in earnings. You might think investors would be glad that BofA even had earnings.

I can only guess that, somehow, the $10 billion stock offering put a damper on the enthusiasm. And the fact that offering was only two-thirds subscribed probably didn’t help. Neither did the 50% cut in dividend. (Of course, it’s only polite to rein in your own spending when you’re begging for cash, but that doesn’t mean investors have to like it.)

BofA got whacked for better than 24%. And by my rough calculations, that accounts for 20% of the Dow’s drop today.

Here are some stocks I’m targeting for a valuation-based bounce:

General Electric (NYSE:GE) jumps to mind. That stock has hit an 11-year low. It’s important to note that GE has to access the credit markets to fund operations, which could be problematic. But on the other hand, GE’s already done a secondary, and Buffett added some liquidity as well. Earnings are October 10.

Intel (Nasdaq:INTC) quickly recovered from these levels back in 2002. Before that, you’d have to go back to 1996 to find the last time it was under $17. Earnings are October 15.

And Verizon (NYSE:VZ) has hit support at $30 that dates back to 1995. They report on October 27.

I’m sure there are some more speculative stocks that might fare better in a liquidity driven bounce. But for short-term trading opportunities, I favor the blue chips. And for the record, I’d rather buy AIG than anything emerging market related. And I’m not buying AIG.

Best regards,

Ian Wyatt

Chief Investment Strategist

Growth Report

PS – I’m launching a new daily e-letter Monday, October 13, 2008. It’s called 24/7 Investor’s Daily Profit. The website is in place. Feel free to check out the new website, www.247investor.com, and sign up for Daily Profit.

Paulson Asset Management, LLC

Ian Wyatt — Wed, 24 Sep 2008 19:43:00 GMT

Paulson Asset Management, LLC

So now the Treasury has a massive $700 billion bailout plan on the table. The idea is to create a government agency to deal with bad mortgage related debt, sort of like how the Resolution Trust Corp. (RTC) dealt with $394 billion in assets of failed banks during the S&L Crisis in the 80s.

You probably recall how regulators would swoop in on troubled banks, close them down and turn their assets over to the RTC, who would then dispose of them, sometimes for pennies on the dollar.

It was like free money for some savvy investors as they were able to buy assets on the cheap from the RTC. Still, many shareholders in failed banks like Silverado and Lincoln never recovered their money.

That’s got me curious as to how Paulson Asset Management, LLC (PAM) will deal with the mortgage-related assets it takes on. Clearly, some of those assets, like the credit default swap derivatives, are essentially worthless and will remain so.

However, there’s certainly a fair amount of mortgage-backed securities that have been written down to near-zero out of necessity, because no one will buy them now, but will probably regain some value in the future.

After all, why else would PIMCO’s Bill Gross say that he’s expecting to be called by PAM (Paulson Asset Management), to help manage the mortgage-backed assets it buys?

Economic Socialism: Puttin It Mildly

My point here is that we’re seeing much more than economic socialism, or the economic communism that Jim Rogers alluded to recently. This is more akin to Valdimir Putin’s hostile takeover of Yukos Oil.

Politics aside, there’s a profit-motive here. Think about it. The Fed and Treasury lent AIG $85 billion. AIG can either pay up (with 11% interest) or the Fed and Treasury get an 80% stake in the company. And from what I understand, AIG has a matter of days to come up with the loot.

At $5 a share, AIG is worth around $13 billion right now. At the start of the year, it was worth around $130 billion. As of June 30, 2008, AIG had $67 billion in tangible assets, down from $95 billion a year earlier.

Obviously, those tangible assets are worth less than $67 billion now. Nobody will buy them.

But what will they be worth a year from now, after most of the bad debt out there has been exposed and investors can make informed decisions about what’s got value and what doesn’t?

That’s OUR $85 Billion

I suspect that PAM’s stake in AIG could be worth a decent sum in a few years. Same goes with whatever assets PAM’s $700 billion buyout fund targets.

It seems to me, since PAM is using taxpayer money to fund its investments, the American people should be considered shareholders. We should share in the spoils.

Now before you think this suggestion is like investing social security in the stock market, there’s a very important distinction here. For instance, PAM can change the rules anytime it wants to. Stock price going down? No problem. Just make it illegal to short.

The more I think about it this idea, the more I like it. And for the record, I have no problem with Bill Gross as the Chief Investment Officer.

What Will Congress Do?

Now I want to be clear about something. I might sound a little flippant with my suggestions here. But this financial mess is very serious. It’s a massive fraud, and the government’s bailout plan doesn’t mention even the slightest slap on the wrist for the offenders or deal with homeowners problems.

Of course, there will be new regulations. There always are. But they never seem to do what they’re intended to do.

As the panic from last week’s market rout eases a little, and Bernanke and Paulson testify before Congress, Congress seems to be taking a harder line on the bailout plan, which is good.

Because, again, I want to know how PAM intends to dispose of billions in impaired assets.

And what’s more, Bernanke apparently wants to buy impaired assets from banks at a premium to current value, and hasn’t really talked about what he’ll do with them. That’s a problem.

If you remember the S&L Crisis, you’ll recall that there was a lot of criticism as to how the RTC disposed of its assets. Much of it was real estate, and in less than desirable markets, as well. Still, many felt that the RTC sold at prices that were way too low to compensate investors for their risk. (The New York Times reported about a resort with an $8 million book value selling for 695K.)

If Bernanke and PAM buy impaired assets at a premium with no realistic plan of how to monetize them, then they’re simply seeking to recapitalize failing banks at taxpayers expense. If so, this PAM shareholder has to vote no.

So what Should We Do?

I’d tell you to call your Congressmen, but they’re busy. Plus, judging by the tone of yesterday’s Q&A following Bernanke and Paulson’s testimony, I’d say they’ve got the message. Taxpayers are not wild about bailing out banks.

Why not expand the powers of the FHA and let Americans with mortgage problems refinance to a lower rate? At least that would address the “real” problem, which is default and foreclosure.

As far as investing goes, my advice hasn’t changed from last week:

“There’s one asset class I like a lot right now. It’s something of a defensive play, mainly due to the high dividend yield. But there’s also a case to be made for some capital appreciation.

It’s MLPs. Master Limited Partnerships. These companies own and operate pipelines for oil and natural gas, mostly in the Southwestern U.S. These companies have pretty stable revenue streams because they sell capacity in advance. MLPs are required to pay 95%+ of their income in dividends to maintain their tax exempt status. And they rely on credit to expand their operations, and hence, revenue.

Many MLPs are currently trading at 52-week lows. I believe this is because their ability to expand has been impaired by the banking liquidity problems. But these companies have stable revenue and they pay dividends of 6-11%. That alone makes them a good place to park your cash until the markets get better.

Plus, as the lending situation improves over the next few months, you could see as much as 30% gains for the stocks as investors anticipate revenue expansion.”

Here’s the link I posted last week to get my favorite MLPs. Most of these stocks have jumped 10+% since lows last Thursday.

Best Regards

Ian Wyatt

Editor

Big Idea Investor

Panic in the Air

Ian Wyatt — Wed, 17 Sep 2008 13:43:00 GMT

Dear Investor,

Monday’s 500 point drop on the Dow was the closest thing we’ve seen to an outright panic in years. Stock prices have been extremely volatile, and that’s probably going to continue.

Now, before I go on, I’d like to take a quick minute to thank my loyal readers for sticking with me. In times like these, when so many of Wall Street’s leaders have proved to be so reckless, it’s not easy to trust anyone when it comes to your money and investments. I’m flattered by your support.

And I’ll be straight with you – I can’t tell you how much farther the markets will fall (though I have some ideas I’ll share in a moment). I can, however, continue to do the same type of analysis that’s lead to 12 out of 16 winners for my Growth Report newsletter this year.

I can also tell you that the problems we’re facing now will be resolved. We may get a stronger SEC, or more laws to protect investors. But we won’t learn our lesson. We’re dealing with the human element here. We’re only 10 years removed from the Internet bubble and Henry Blodgett’s $400 Amazon target…

Back in the day, investment banks put out analyst reports with pie in the sky stock price targets to lure investment banking clients. In the aftermath of the bubble, a few political bulldogs made quantum-leap career moves by pushing regulatory reform.

Investment banks were forced to separate their research divisions from their investment divisions. And in some cases, that meant separating research from any real income, too.

So now, good research on small cap companies is hard to come by. And Elliott Spitzer’s naked ambition got the best of him just up the street from my D.C. offices.

Same Old, Same Old

It’s almost a perfect replay. Just insert “condo” for “Amazon” and you can pretty much leave everything else in place. Except the stakes are far higher this time around.

Because, this time, it’s mortgages and not just stock.

It’s hard to blame investors for being worried – bad bets on mortgages have put our entire financial system on thin ice.

Well, I don’t mind saying I’m worried, too.

And I’m also mad as hell about it. As far as I’m concerned, Wall Street’s committed every one of the Seven Deadly Sins. And it’s you and I that will pay the price as the government bails them out.

However, fear and anger won’t help any of us be better investors. In fact, if you let fear or anger inform your investment decisions, you’re all but guaranteed to wind up poorer.

Let the Times Make the Man (or Woman)

I never recommend taunting the gods with questions like “How can it get any worse?” I did that once. It didn’t turn out well. Still, with Bear Stearns, Lehman, Countrywide, Fannie Mae, Freddie Mac, and IndyMac gone, Washington Mutual and Wachovia soon to follow, and AIG not looking good either, it’s hard not to wonder how it can get worse.

It’s fine to wonder. Just don’t say it out loud. That’s what really gets the gods peeved.

After Freddie Mac and Fannie Mae got nationalized, a lot of stock gurus heard the proverbial “bell at the bottom” and stated it was time to buy financials.

Not me. And not because I know anything more about the situation than they do. Only because I’ve learned that it can always get worse. (And by the way, I think the gods like that kind of talk.)

I’ve repeatedly stated that unemployment is now the key to finding a market bottom. Financial companies may be done writing off bad debt (though I doubt it). But we’re not getting a sustainable rally until the employment situation reverses. Or at least stabilizes.

Times like these don’t call for desperate measures. They call for rational actions. And I’ve got a pretty rational investment for you, which I’ll share in a minute. But first, I need to make a brief comment on the Fed’s decision to hold interest rates steady.

The Right and Wrong Answer

The FOMC responded to the Bear Stearns crash with a rate cut. That was the wrong answer. Cheaper money didn’t really help the banks. They just ramped oil prices higher and the dollar lower.

This time, the Fed got it right, but apparently for the wrong reasons. The FOMC voted to hold rates where they are, with the understanding that the Fed and Treasury will make special liquidity provisions where necessary.

Just when you think the Fed is getting a handle on things, it comes out and says it’s concerned about inflation. That statement got big “huh?” from PIMCO’s Bill Gross. Gross says we’re clearly in a deflationary environment. And it’s hard to argue.

If banks won’t or can’t lend, then there’s less money in circulation. That’s deflation.

Now, the investment angle I wanted to discuss plays directly on this situation…

Low Price, High Yield

There’s one asset class I like a lot right now. It’s something of a defensive play, mainly due to the high dividend yield. But there’s also a case to be made for some capital appreciation.

It’s MLPs. Master Limited Partnerships. These companies own and operate pipelines for oil and natural gas, mostly in the Southwestern U.S. These companies have pretty stable revenue streams because they sell capacity in advance. MLPs are required to pay 95%+ of their income in dividends to maintain their tax exempt status. And they rely on credit to expand their operations, and hence, revenue.

Plus, as the lending situation improves over the next few months, you could see as much as 30% gains for the stocks as investors anticipate revenue expansion.

If you’d like to get my Top 5 MLPs, just click here. They’re free, you just need a valid email to access the report.

Best Regards

Ian Wyatt

Chief Investment Strategist

Growth Report

Big Oil and Big Brother Google

Ian Wyatt — Wed, 03 Sep 2008 09:44:00 GMT

Big Oil and Big Brother Google

I hope everyone enjoyed their long weekend. I know I did. But I’ll also freely admit – I always look forward to getting back in to the office after a holiday.

The financial markets are the most dynamic of beasts. They give you something new and different to chew on every day. It’s a constantly shifting landscape. On a daily basis, you have to be ready to shift gears quick in response to trader’s fickle sentiment.

For instance, on August 19^th we noticed a pronounced shift in sentiment toward one solar stock, Canadian Solar (Nasdaq:CSIQ). That stock was up 17% in the days following. And you’d think the entire solar sector had received an upgrade.

By August 22^nd, a handful of double-digit gains could have been made, based off that one event with Canadian Solar. Canadian Solar is still holding 10% or so of its gains, while other solar stocks have given all their recent gains back.

Think Long-term, Act Short-Term

Of course, over weeks and months, the recent rally for solar stocks will be just a bump on the charts as longer term business and economic trends play out. I’ve been bearish on traditional “Big Oil” stocks for months. I just can’t see how – with virtually no new discoveries and rising costs – a company like Exxon-Mobil (NYSE:XOM) can see its stock price rise. Record-setting profits or no.

And Exxon recently broke below $80 a share for the first time in nearly 2 years. That was well before Hurricane Gustav was even a blip in the radar.

We’ve been having good results with small, dynamic exploration and services companies all year.

Today, oil prices may be responding to Gustav-relief. But there are much bigger issues for oil prices. Commodities are dropping across the board as the OECD has slashed growth estimates for Japan and Europe to 1.2% and 1.3% respectively. England’s 1.2% estimates appears to be a best-case number, as the OECD acknowledges that the UK economy is looking recessionary.

Surprisingly, the US is doing better than expected. Growth estimates here rose to 1.8% from 1.2%. With a strengthening dollar and rising exports, perhaps the rally that began on July 16 hasn’t been complete folly.

This Time, I’m Cheering for Microsoft

One particularly important-sounding headline that greeted me this morning was the latest in the Google vs. Microsoft heavyweight battle. In case you missed it, Google is launching an Internet browser, called Chrome, to compete Microsoft’s 8^th version of Internet Explorer.

Internet Explorer is the dominant browser with 75% market share. With no vested interest, I’ll usually pull for the underdog. It’s always nice to see the little guy win. Of course you can’t really call Google “little” anymore. This is a battle of titans with Google weighing in with a $146 billion market cap to Microsoft’s $248 billion cap.

We all saw Microsoft crush Netscape. And WordPerfect. And any other company it could. But I’m pulling for Microsoft and Explorer 8 to thoroughly pound Google’s Chrome into the cyber-canvas. And I’ll tell you why.

Google is a remarkable company. It pretty much created the paid search industry. And it’s now a major determinant for all Internet traffic. In other words, if you’re not picked up by Google’s search functions, you ain’t sellin’ squat.

Trust me, I’m in the publishing business and we do much of our work on the Internet. And I consider my relationship with Google downright Faustian. On the one hand, with its paid search results, Google has made Internet advertising simple and effective, albeit a little expensive.

But on the other hand, Google is very specific about the free results that it will display when you search for specific information. In fact, if you don’t construct your website with a Google-approved design, you’ll never show up in their search results, no matter how relevant your solution to a query might be.

Free the Internet!

Google’s strict and mysterious search criteria has spawned legions of companies that do nothing other than try to figure out what Google’s search algorithms are looking for. And of course, those algorithms change every few months.

In a nutshell, Google is attempting to take way to much control over Internet commerce. And it seems to me, if it gets a massive share of the Internet browser market, Internet commerce will become Google commerce.

So how’s Microsoft going to help? Mainly, by keeping what websites we visit at least semi-private. Here are a couple quotes I’ve come across today…

“[the new Explorer’s functions include]…privacy changes that could prevent it [Google] from collecting information related to the effectiveness of its ads, quick-linking to Microsoft mapping and other offerings and a more robust search bar that is also more Microsoft-centric.” -- D: All Things Digital

“Microsoft…released a new version of Internet Explorer last week for testing. The software lets users control whether it saves the sites they've visited.” Bloomberg

We all know that many company websites put “cookies” on your computer when you visit. The cookie can then track your steps and report its findings back to the company for marketing purposes.

Maybe I’m being too Orwellian here, but the thought of Google taking sole control of Internet advertising scares me a bit. If I have to align myself with evil Microsoft to maintain Internet commerce freedom, then so be it. I won’t be using Google’s Chrome browser any time soon.

Friday’s Investors Insight Discussion

As you know if you read last week’s entry, the moderators at the fine website Investor’s Insight (www.investorsinsight.com) asked if I’d be willing to host a live forum discussion event on their website. I agreed and it’s happening this Friday, September 5, from 11:30 am to 12:30 pm, ET.

It’s totally free. All you have to do is sign up with a valid email address at the website. Then you can listen in to the discussion and ask questions if you like. I expect we’ll be talking mostly about my stock-picking machine TRIGR and what investment opportunities it’s been turning up lately. But this is an open forum discussion so you’ll be free to bring up any topics for discussion.

Again, I’ll be hosting a live Internet discussion at www.investorsinsight.com on Friday, September 5 between 11:30 am and 12:30 pm, ET. I hope you can make it, it should be fun, informative and profitable!

Best regards,

Ian Wyatt

Publisher

Growth Report

Biotechs: An Expert Opinion

Ian Wyatt — Wed, 30 Jul 2008 18:09:00 GMT

Biotechs: An Expert Opinion

Bio-tech stalwart Amgen (Nasdaq:AMGN) crushed earnings estimates Monday afternoon (July 28) and raised guidance to boot. The stock was up 4% on Tuesday. Most biotech ETFs were up 1% or so in response.

That lends a little credence to my recent discussion, I suppose.

The two stocks I mentioned last week have put in a mixed performance. Somanetics Corp (Nasdaq:SMTS) has added $1.50 to $22.58. Emergent Biosciences (NYSE:EBS) is up slightly to $13.00.

Of course, it’s only been a week. And a one-week holding period for an individual biotech isn’t enough to make any money unless you’ve got the kind of insider information that, to paraphrase The Steve Miller Band, might get you rich or might get you busted.

Besides, my stock-picking machine is optimized for medium-term holding periods – from a couple weeks to a few months. It’s been about a month since biotech and medical device stocks started moving. So there should be plenty of upside to come.

With that in mind, I thought it might be helpful to turn to an expert in the biotech field to get some further insight into what’s driving the biotech rally and how long it might last. And who knows, we may even get a couple stocks too…

Biotechs from an Expert

My stock picking machine is great at uncovering profitable investments by following money-flows into individual stocks. However, it doesn’t have much to say about monoclonal antibodies or antisense.

We recently interviewed Dr. Fariba Ghodsian, Ph.D., MBA to get her views on the biotech sector. Dr. Ghodsian is currently Chief Investment Officer and Managing Member of DAFNA Capital Management, LLC, a biotech investment fund. Dr Ghodsian previously worked at Roth Capital Partners as Managing Director of Healthcare Research since 1999. She was a senior biotechnology analyst at Wedbush Morgan, Hancock Institutional, and Lehman Brothers.

In 2002, Dr. Ghodsian was ranked among the top five U.S. biotechnology analysts by the Wall Street Journal.

I don’t know about you, but I have no problem calling her an expert on biotechs.

Biotech Buying

Dr. Ghodsian believes that the potential for premium buyouts are one main reason for the strength in biotechs.

For one, big pharma’s pipelines are barren of blockbuster drugs and patents on existing drugs are running out. That’s why Pfizer (NYSE:PFE) is trading at a 10-year low. It’s also why Roche just ponied up $44 billion to buy the remaining shares of Genentech (NYSE:DNA).

A second factor driving acquisitions is the decline of the dollar. Roche is a Swiss company, so it effectively picks up Genentech on the cheap due to the relative strength of the euro against the U.S. dollar.

Thirdly, in the wake of the Vioxx issue, the FDA has gotten a lot tougher in its drug approval process. So if a big pharma is going to partner with, or acquire, a smaller biotech, it makes sense to wait until later Phase trials show some statistical efficacy. It may cost a little more, but it’s also safer.

Dr. Ghodsian believes the biotechs are well-positioned to demand favorable terms in both partnerships and buy-outs.

What to Look For

Cancer, hepatitis C and diabetes are larger diseases seeing the greatest development. The greatest development in smaller diseases include lupus, immune thrombocytopenia purpura, pulmonary arterial hypertension, cystic fibrosis and pulmonary fibrosis.

Another field Ghodsian sees major developments in is rheumatoid arthritis. “There are major advances with oral drugs in development that would be a great benefit for the patients,” she said. Cardiovascular and gout disease are other areas expected to experience major developments.

Ghodsian likes companies that offer a unique product or a unique way to deliver a drug. Stay away from the “me-too” drugs, where other companies have a similar drug. She also examines the company’s market potential and its chances for success. “Obviously the market size of the drug is important,” Ghodsian notes. “But sometimes companies can thrive very well in very limited markets.”

She says the market should be an attractive one where the disease is difficult enough that the insurance companies would be willing to pay a high premium. She points to Genzyme (Nasdaq:GENZ) as an example of that. The biotech company made a billion dollar drug out of orphan diseases by tacking on a high price.

It goes without saying that the drug must also demonstrate a favorable safety and efficacy profile to warrant approval. Good management is key to getting the drug to market.

Ghodsian also examines the company’s financial resources. “Often time’s biotech companies raise too little money, or are sometimes shortsighted when it comes to financing and I think that bites them in the end,” she said. “So a company that is well financed particularly in this market is important.”

Most of the companies in Ghodsian’s universe are not profitable. Some of the companies she invests in are very late stage, while some are more in clinical development. Among specific stocks she favors include, Isis Pharmaceuticals (Nasdaq:ISIS), Rigel Pharmaceuticals (Nasdaq:RIGL) and Pozen (Nasdaq:POZN).

Looking Forward

My stock-picking machine has churned out a few more promising biotech stocks. Next week, we’ll have a look at those stocks. Plus, I’ll take you inside the electronic brain of the machine so you can get a better understanding of how it consistently pulls up profitable investments.

Best Regards,

Ian Wyatt

Chief Investment Strategist

Growth Report

Ian Waytt is the Chief Investment Strategist for the advisory service Growth Report. Growth Report is focused on profitable small-cap companies. For more information, please visit the www.growthreport.com. Ian also writes a free weekly e-letter called Big Idea Investor. You can sign up to get Ian’s weekly commentary here: www.bigideainvestor.com

In Search of a Bull Market

Ian Wyatt — Wed, 23 Jul 2008 15:40:00 GMT

In Search of a Bull Market

It’s an old stock-market saw – there’s always a bull market somewhere. Even though the S&P 500 is down some 16% year to date, it’s easy to point to commodity and oil stocks and say, “See? There’s your bull market.”

Now, I’ve been warning my readers away from Big Oil stocks for over 6 months. But my recommendations of stocks like oil services company like Graham Corp. (NYSE:GHM) have proved that the ever-present bull market hasn’t completely become a cliché.

However, I have something else in mind. Biotechs. Believe it or not, in the midst of the bank meltdown, runaway inflation, and U.S. recession, the Biotech HOLDRs (BBH) is at a 52-week high. Over the last year, the BBH

has established solid support at $160, has broken a strong resistance point at $175, and is currently working on a secondary resistance point at $180.

With an important sector benchmark like the BBH showing strength, it gives the impression that biotechs are breaking out all over. Well, yes and no.

78.9% of the BBH is dominated by three biotech heavyweights – Affymetrix (Nasdaq:AFFX), Genentech (NYSE:DNA), and Gilead Sciences (Nasdaq:GILD).

That’s really not enough of a sample to draw any firm conclusions about the overall strength of the biotech sector. Still, where there’s smoke, there’s often fire…

Follow the Money

About six months ago, my stock research analysts put the finishing touches on a stock-picking machine for my advisory letter, Growth Report. Without going into too much mind-numbing detail, this machine ranks 3,500 small cap stocks on based on 88 criteria every day.

The stocks at the top of the list have received the highest ranking based on relative sector strength, relative valuation within the sector, profitability, growth prospects and several other fundamental metrics, with some technical metrics like momentum and expanding volume thrown in to identify stocks that, in addition to being attractively valued, are actually being accumulated.

As you might expect, the top rankings have been dominated by oil services and exploration companies for months. But there have been a few surprises. We had great success with a few solar stocks back in March. Canadian Solar (Nasdaq:CSIQ) jumps to mind. And there have been a few tech stocks like Netezza (NYSE:NZ). We even caught a 20% run on Green Mountain Coffee Roasters (Nasdaq:GMCR) back in May.

Like I said, there have been some surprises.

About two weeks ago, we started getting a new surprise. You guessed it: biotechs. And since the machine only ranks small cap stocks, it wasn’t picking up on the strength of BBH stocks. Something else is going on. And it could be the fire to the Biotech HOLDR’s smoke.

Why Biotech?

Pharmaceutical stocks are often considered to be recession-beaters because diseases aren’t economically sensitive. But again, there’s something else going on. Biotechs with products in the pipeline are moving higher.

If you’re looking for a sector that has the potential to change our very standard of living at a most fundamental level, there aren’t many sectors to choose from.

Alternative energy is one. There will be some huge winners in this space. But valuations can be extremely rich. And there’s still not much consensus about which technologies will have staying power.

Two years ago, as President Bush was throwing his weight behind ethanol, some of those stocks might have looked like slam-dunks. A quick look at those ethanol stock charts today would give even the most intrepid investor the heebie-jeebies.

Yeah, sure, I suppose there are a few tech stocks out there with life-changing potential. But somehow, I just don’t get fired up by iPhones and NetFlix set top boxes. I guess I’m just a dotcom cynic now.

Oil exploration won’t change our lives dramatically, though there are still some interesting profit opportunities in Canada’s oil sands and in America’s own Bakken oil shale regions.

Follow the Light

Perhaps in these dark economic times, investors are turning a hopeful eye to the one sector that can still fire the imagination that better times lie ahead – biotech.

It seems every day, scientists isolate the genetic cause for another disease. Recently, scientists announced that they’ve discovered a genetic cause for the processing quirks that result in autism.

If you didn’t know, autism now affects 1 out of every 162 kids in this country. It’s a virtual epidemic. Trust me on this one, parents of kids on the autism spectrum will pay dearly to get their children back.

Just today, scientists say they may have isolated a gene associated with a predisposition toward violent crime.

Scientists have already managed to turn ordinary cells into stem cells. So I may not have to rely on a Democratic Administration to push stem cell research forward. And for aging Americans, that’s probably a more pressing issue than hydrogen fuel cells.

Two Biotech Movers

There’s plenty of money on the sidelines, just waiting to be put to work in the stock market. And you won’t find many medium-term investment stories more compelling than biotech.

Don’t worry. I’m not going to leave you hanging. Here are two of the stocks my stock-picking machine has turned up.

The first is Emergent BioSolutions (NYSE:EBS). Emergent BioSolutions has the only FDA-approved vaccine for anthrax. The company is about one-quarter of the way through a $448 million contract with the U.S. government, so cash-flow shouldn’t be a problem anytime soon.

EBS rounded out its anthrax suite with the acquisition of a couple other Phase II drugs. It has a typhoid vaccine in Phase II trials. Plus, it’s a acquiring a recombinant flu vaccine called FluBlok that’s in Phase III trials.

Biotechs always carry risk that trials won’t demonstrate the efficacy of a future product. But with a forward P/E of 13, investors seem to be giving EBS the benefit of the doubt at the present time.

The second stock is Somanetics (Nadsaq:SMTS), a medical device maker. Somanetics makes the INVOS System which monitors blood oxygen levels in at risk patients. It also makes the CorRestore system which is used in cardiac repair and restoration.

I won’t pretend to understand exactly what that means. Quarterly revenue grew at a 39% clip last quarter and earnings grew 26%. The company is doing $42 million in sales and has a strong cash position of $51 million and no debt.

The forward P/E is a manageable 25. And the company has been aggressively buying back stock. Perhaps best of all, analyst earnings estimates for this year and next have been revised higher twice in the last two months.

Maybe it’s a little early to start talking about a bull market for biotechs. But if my stock-picking machine keeps turning up biotechs, Growth Report readers will be among the first investors to get on board.

Ian Wyatt

Chief Investment Strategist

Growth Report