Wednesday, June 29, 2005

6/30/2005 Warning: Fed Ahead


The S&P500 lost some steam today closing at 1199 on meager volume. Average volume has been on the decline the last few weeks. The nasdaq composite closed at 2068 also on lower volume. Although the nasdaq technical characteristics look a bit better than those of the S&P500 neither index has anything to write home about. It seems that large investors are sitting on their hands waiting for the 3rd quarter earnings and the Fed to play out. I wish I could say, with certainty, that I knew the near term direction of stocks but I cannot. That said, here are some interesting facts to digest while we all wait. First, July is a rotten month for stocks, only being up twice in the last ten years. Second, June 30th marks the end of the quarter and the middle of the year. Investors will get to see their fund managers' report cards in a few weeks. Just like in school the managers will be cramming for good grades. Lastly, the VIX closed below 11.6 today not a number consistent with a rally. I am very cautious here and have take profits in many positions during the last market run up. That said, an analysis of intrinsic value has yielded some surprising results.


While looking for some good short sale opportunities I noticed that some stocks that have recently run up are under valued. For example, Aeropostale (ARO) is trading around $33/share, up from $26. It looked like a good short opportunity until I calculated its intrinsic value (IV) to be $53. If interest rates stay low and ARO pulls back I am more likely to buy it long than to short it. A similar example is Marvell Technology, the stock is sitting near its 50 day moving average pulling back a bit from a nice run up to close around $38. It looked like MRVL was ready to give it up, but I calculated IV to be $62 share. If it pulls back I may also add it to the fund. The bottom line is that certain companies are still able to increasingly grow earnings ahead of their current valuations. If the market corrects then there are likely to be buying opportunities. That said, structural issues like higher oil, higher interest rates and a stronger dollar may throw water on the party.

My view is that the fed will raise interest rates a quarter percentage tomorrow driving the federal funds rate to 3.25%. I would not be surprised (although the market would be) if the fed raised rates by a half percent and stopped there. In the end higher interest have hurt the market in the past as investors winced short term. Once they realize that the higher rates are still below neutral investors have stepped back in and continued to buy stocks. I expect more of the same at these levels.

  • GOOG - By the way, Google may be a good short if you catch it right but I am more likely to buy it on a solid pull back. I calculate IV at $457.20/share making it under valued by my estimation. Technical characteristics are firming up too. I may add goog to the Fund if it becomes priced right. You can see all my fund's positions by visiting

Monday, June 27, 2005

6/28/2005 Excess Liquidity


The S&P500 closed below the major support level of 1191 to finish at 1190.81, an overall negative sign. Volume was lighter yesterday than the two previous sessions, however, down volume yesterday was ahead of the up volume seen last Wednesday (the last up day for the index). The technical end of the market has broken down a bit ahead of the FOMC meeting. I am not enthusiastic about the recent market action and several of my key indicators show weakness. That said, the market may pop from here as it is a bit over sold coming into July when fresh cash is likely to come into the market. Also, investor sediment is a bit more negative than last week and may support prices in the near term. I am holding steady at this point with a bias toward shorting and special opportunities.


Fundamentally the market is in economic limbo right now. Uncertainty about higher oil prices, quarterly earnings and interest rates are likely make investors skidish at best. The smart money believes that liquidity from structural changes in global markets will continue to fuel global economic growth for the time being. It seems that the easy cash is finding its way into real estate and business development, which is great for stocks. The problem of course is that once the liquidity dries up the party will be over, interest rates will rise and savings will beget investment. Ergo a recession. When will the demise occur? Many market analysts and experts have been predicting the eminent demise to happen at any moment; I have been hearing this for the past two years, so much for the experts. However, cycles are cycles and the smart money will discount these changes six to twelve months ahead of the event. This fact will also provide worry for the market.

I look for a 1/4 point rise in the fed funds rate Thursday. However, in the past the fed has ended its raising with a larger than expected rate hike. I would not be surprised if the rate is hiked 1/2 percent. In any case, the market is likely to have a negative reaction to the fed action. I am careful right here especially as the fed closes in on 3.5%.

FYI - I have updated the short interest trends charts for the fund's positions. You can see them at

Thursday, June 23, 2005

6/24/2005 Protectionism Schism


Animal spirits spit poison into the markets today. The S&P500 dropped past the 1212 support level to close near 1200 on higher volume, not a good sign. The froth on many leading issues evaporated quickly when oil hit $60/barrel and the smart money ran for the exits. I have been taking profits in many of my positions recently as targets have been reached and/or exceeded. That said, I have been building new positions and am still holding others, albeit at a reduced rate. I am likely to start some short selling if the markets' technical characteristics continue to break down.

On a side note the VIX has been below 12 for several sessions. A level not conducive to a rally.

Protectionism Schism

I am very cautious about today's move as many factors that ill the market have come front and center. High oil prices and the worry about a slowing economy added to the markets' inertia. However, "protectionism", something that I have written about in the past as being an absolute negative for stocks, was hung in front of investors today like a beheaded comrade. Nasty rhetoric from unemployable old politicians reverberated through the media scaring the smart money into thinking that average joe's are dumb enough to go along with the, political "group think". Like I wrote before if the fed funds rate exceeds 3.5% and/or protectionism takes hold I will likely sell all the fund's positions and rethink the strategy, which may not include stocks. I am not alone in this thinking.

  • AMHC - American Healthways continued its decline falling below my target levels. I originally bought AMHC in the upper 20's and sold many shares in the 40's for a good profit. Technical weakness and a falling revenue forecast have me taking profits now. I think that AMHC is a fine company and I may add it again to my fund, however, given its recent performance I feel that I will find a better investment elsewhere.
  • GAP - Great Atlantic and Pacific Tea Company recently reached a multi-year high when it crossed the $29 level. My original investment in the stock was just above $8/share. I built a large position in the stock and have taken profits. However, the short interest is still above 40% and the stock has firmed on stronger fundamentals and technical characteristics. I am likely to add back shares on a pull back as the stock may go beyond the $35/share level.

Sunday, June 19, 2005

6/20/2005 The Trickiest Time of the Year


Friday the S&P500 broke the 1212 level on higher volume, an event I classified as important if the market was to move higher. However, much of the volume on Friday may have been due to technical buying during options expiration rather than large investors adding new positions. The weeks leading up to Friday came on below average volume even as the market moved higher; defining a divergence that is a technical negative for the market.

I am a bit skeptical about the strength of this rally. That said, I am cautiously adding new positions while taking profits in others (see for the details). The reason for this slight optimism is that although up days have come on lower volume so have down days. It is as if investors are at a stalemate, which often ends with the market moving in a positive direction.

The Trickiest Time of the Year

History shows that June is a good month for stocks and July is not. Fundamentals surrounding this period are starting to stack up against the market. Higher oil prices and interest rates will eventually take their toll as well as foreboding about a generally weaker third quarter . That said growth in the US and Asia continues and is driving investment. Traders are starting to speculate the end of interest rate hikes and new leaders have emerged in oil and healthcare.

As I mentioned above I have started to take profits in several positions. Many of the fund's stocks have gained 15% or more since I added them, with some exceeding 100%. My fund's strategy is to turn 20%+ gainers as many times as possible during the year; in 2005 I have been able to make two major turns thus far. I also cut losses quickly. I set a staunch stop/loss level and stick to it, mostly between 5-10% depending on the situation. I have been stopped out of some positions and taken the loss. In some cases though I have protected the positions by hedging. In the case of APPX and EBAY (earlier in the year) this strategy has proven beneficial. Currently I am carefully holding on to reduced positions and adding a few new names.

Stocks like Valero Energy and Comp Vale Do Rio have had solid moves off of recent lows and are poised to base before moving higher. The basing period is often a test of stamina for a stock; if the market moves higher so does the stock. However, if the market moves lower often times the stock breaks down. The next few weeks are going to take careful execution and attention to detail in order to maximize gains. Stay tuned as I maneuver the fund through this critical period, perhaps the trickiest of the year.

  • APPX - American Pharmaceuticals has reached oversold status and may have bottomed out. The fund was stopped out of its position in APPX earlier in the month, but the use of protective puts flattened the position. Healthcare remains a particularly good sector in my opinion and I am cautiously buying shares again as the price has based and fundamental and technical signals are positive. I am shortening my stop/loss level though as investors are not taking chances with the company's current manufacturing issues.
  • AMHC - American Healthways will report earnings after the bell on Monday. I am somewhat concerned about the reaction to the numbers. The company reduced guidance earlier in the month as management anticipated higher costs due to a new pilot program with Cigna. This is a good thing in the eye of most investors and a sell off may prove to be a good buying opportunity. I am careful about what happens to the stock on Tuesday and am adding protective puts to protect the fund's profits.

Wednesday, June 15, 2005

6/15/2005 Good News Bad News


A divergence between price and volume has occurred in the S&P500 over the past month. The index has risen from 1191 to 1206 while volume has been below average. It seems that the smart money is bleeding off shares, taking profits ahead of the typically slower 3rd quarter. Such a divergence is typically a signal that a reversal is on the horizon. That said, most of the selling has come from the tech sector while some groups are seeing fresh investment, namely energy.

My sense is that a break out will occur shortly, up or down. This week is likely to remain flatish as options expire on Friday, after that I will look for a break out above 1212 or break down below 1191 on higher volume to signal the future direction of the market.


It seems that global competition for oil is driving prices higher. The good news is that economic growth is healthy in support of higher prices. The bad news is that higher prices mean lower profits for many companies. The good news is that this means a new cycle for fuel efficient products, which will help to drive new markets over time. The bad news is that there are likely to be bouts of pain for companies (and consumers) that do not quickly adapt. The good news is that more fuel efficient behavior will reduce the need for oil thus dropping prices. The bad news is that... In short there will be a fundamental change in the market. Stay tuned as I will no doubt make lemonade from the lemons.

Currently I am staying the course. I have been stopped out of several positions lately while others have done well. The fund's strategy is still best served by healthcare and we remain over weight the sector. See the fund's website to view its current positions and targets.

Saturday, June 11, 2005

6/13/2005 After It Is All Said and Done


The stock market has reached an inflection point. The recent rally has met its first real level of resistance at the 1212 level (1208 officially). Investors must now weigh the rational and irrational and decide if the market still has legs or if it is going to correct in a meaningful way.

Volatility has come down once again. The VIX pushed above 18 at the market lows in April but has since fallen to weaker levels not typically associated with a rally, closing at 12 on Friday. Extreme bullishness is seen as a negative for the market.

Volume has also dried up in relative terms. There has been a slight divergence in price and volume action over the past week or so. A similar, but much more pronounced, level was experienced in late December (2004). The result was a tumultuous decline.

Traditionally, June has been an good month for the S&P500, up 8 of the last 10 years. As for July and August, FO GET ABOUT IT!. July has been up just 2 of the last 10 years while August did a bit better being up 5 of the last 10. From a historic perspective June has been a good month to reduce long positions and take on short ones.


Interest rates have mysteriously fallen to near record lows. Has the new reality of globalization crept in to change the traditional recipe or is growth slowing and we just don't know it yet. I think that it is a bit of both. Socialist economies like Germany, France, Italy, Spain and others have chosen to stick their heads into the sand and pretend that everything is fine as their growth continues to slow. In the mean time the rest of the world continues to pluck them clean of their old money wealth. More protectionism will only continue to hurt them and quicken the pace of their fall. That said a sick Europe is not good for the rest of the world and will be a drag on global growth. The combination of a weaker Europe and increasingly productive world will serve to keep natural rates low. I believe that the natural rate is somewhere between 4.5%-5% for the 10yr treasury. Rates below the natural rate are a positive for the stocks.

Oil costs are likely to be the "X" factor the stock market. Currently, oil below $50/barrel is positive for the equity market; between $50 and $55/barrel neutral and above $55/barrel is negative. The smart money expects oil prices to remain between $45 and $55 /barrel through the rest of the year. Consumers have begun to change their energy consumption habits as SUV's and other gas guzzlers are traded for more fuel efficient models. (Look to Toyota and Honda to benefit as the American manufacturers, dragged down by union labor, are slow to change.) A rise in oil prices will hasten the transition to a more fuel efficient economy. In the short term oil prices are a negative for the market.

Earnings will ultimately drive the direction of the market and will be reported starting in July. It is widely assumed that earnings growth will slow overall as year over year comparisons narrow, energy costs remain somewhat high and the European economy has slowed. That said, interest rates are low, Asia continues to grow and the American consumer still spends. I believe that 2nd quarter earnings will beat overall consensus estimates, however, there will be casualties that will likely shake the market.

After Its All Said and Done

I continue to believe that Healthcare and certain story stocks are going to out perform the overall market for the remainder of the year. Although growth has sprouted in some tech sectors I feel that the recent rally is premature. I am careful about tech because the 3rd quarter tends to be disastrous for the sector. I will look for bargains but right now I would probably short sell before I buy long in most cases. I do like google but consider it a story stock rather than pure tech. I am waiting for a good entry point before adding it to the Focus13. Click on to see all my fund's current positions.

  • WFMI - Whole Foods has been a stellar performer and nasdaq darling. The specialty grocery retailer has grown quickly, however, I feel that the stock price is stretched. I calculate IV to be $87/share. Further, projected 2005 earnings growth has slowed to 21% and technical weakness is settling in. There is reason to believe that the company's fast growth is causing inventory problems and turnover is not what it should be as high prices have customers taking a second look. I started a short position at $118 with a short term target of $109. See the website for more details.

Tuesday, June 07, 2005

6/8/2005 The Smart Money Takes Some Profits


Although the markets were mixed today many leaders sold off on slightly higher volume, exhibiting a bit of technical weakness. As I expected the 1212 level on the S&P500 is going to be a tough one to crack. The index rose above 1208 yesterday before plunging back below 1200. In a strange way this is exactly how I would expect the market to act, reaching toward a resistance level then consolidating at lower levels where the smart money may be more willing to buy.

Taking Profits

I took some profits today. The fund is up over 30% in the first 5 months of the year. Although I am still bullish on certain sectors I opted to log good earnings. Stocks like GAP and AMHC have increase as much as 100% since my original purchase. To see all the current positions in the fund go to

Oil and Interest Rates

I do not expect oil to go much higher than the current level for the foreseeable future. As I mentioned last week a strong dollar and slowing global economy are likely going to keep prices in check; so far they have. Lower oil will be a net positive for the stock market although the indices many not move in lock step with oil's price fluctuations.

Greenspan still thinks that low long term interest rates are a conundrum. He believes that the global economy has changed and as a result interest rates are acting in an unprecidented way. I see the natural rate as lower than in the past. If the fed raises interest rates much higher (beyond 3.5%) I will have to re-evaluate my current position. Hundereds of millions more people are in the global labor market and increased productivity will keep prices, especially labor prices, down. I think that core inflation is well under control and if Fed funds rate rises above 3.5% the economy may pull back farther.

Lower oil prices and interest rates will be positive for capital markets. I will likely increase my equity investments as oil and interest rates fall. That said, although global economies remain active the current business cycle is getting a bit long in the tooth. A correction within the next year or so in not out of the question.

Sunday, June 05, 2005

6/6/2005 The Smart Money is Buying the Dips


Friday's drop may not have been as painful as it looked. Although the major indices were down so was volume across the board. The S&P500 ended the week at 1196, which was above major support at 1191. The next level of major resistance is 1212. As I mentioned before expect a pause at this level if the market moves higher. A break through above the 1212 level would be bullish for stocks. It appears that the smart money is still buying the dips.

Eyes Are On...

Rising oil prices are likely to get the attention of investors this week especially if it closes in on $58/barrel. I would expect higher prices to be a drag on the market since they would tax the consumer and its inflationary effect may support a more hawkish Fed. That said, a rising dollar should come to the aid and serve to cool prices. If the dollar remains strong I would expect oil to head lower from here. Tanker (oil) fixture trends are down and oil inventories are still rising, eluding to slower demand for oil. If this is the case oil should fall and perhaps offer a short sale opportunity in certain stocks. Keep an eye on the website for changes to my fund's positions.

Allan Greenspan is to meet with Fed Governors on Monday and testify to Congress on Thursday. No doubt speculation about his intentions will play on the market all week. I would expect more volatile capital markets during the period, moving at each release of data as investors speculate ahead of Greenspan's testimony. I am likely to protect some profits with puts if technical weakness creeps in to this week's trade.

  • APPX - American Pharmaceutical Partners has firmed technically. I have moved up my buy target to below $44. LIBM has trended higher showing the best numbers since its recent decline. EPS growth rates remain high and the market for generic pharmaceutical companies is strong.

Wednesday, June 01, 2005

6/2/2005 Smart Money Investors Anticipate to the Next Level of Resistance


The S&P500 popped through its base yesterday closing above 1200 for the first time since March 14th. The jump likely paves the way for the index to move to its next major level of resistance of 1212, where a significant challenge exists. I expect that if the index does move to 1212 it will pause and base for a bit or even correct. Time will tell for sure, however, it should be noted that although the market has been rising volume is slumping off. If this market is to drive much higher it will need an increase in large investor participation.

Money Flow

Capital markets have been active of late to be sure. Money is pouring into US Treasuries as the dollar strengthens and the economy slows. The 10yr treasury dipped below 4% yesterday marking a solid environment for investment, yet the fed continues to raise interest rates. Several months ago I wrote that excessive rate increases by the fed may put the economy into a recession since their effects are not felt for six to ten months after the hike. As the economy slows and long term interest rates fall fed officials, not wanting a recession, will likely stop raising rates sooner than later. In fact, one fed governor hinted that the fed was in its last innings of rate increases. Lower rates will be a net positive for stocks.

If you read this blog on a regular basis you know that I believe the traditional paradigm for interest rates has changed and lower rates will prevail throughout the decade. I would argue that interest rates are already high and the fed should stop raising rates. I am in the camp that believes the neutral rate for fed funds is around 3-3.5%. I will be surprised if the fed moves higher than that and will likely re-evaluate my positions if it does.

I do not believe that the smart money investor is buying the recent tech rally. In many cases, such as that of the semiconductors, I believe the recent run up is due to a technical bounce rather than a change in fundamentals. Manufacturing has pulled back for the last five months and we are likely in the tail end of the hardware cycle. That said, I do favor certain internet plays. I have owned Google for a while in another fund and it has done real well. Since its current IV is less than 2x market price I have not picked it for the Focus13. I am however buying Shanda Interactive Entertainment (SNDA). SNDA has a LIBM which is trending higher and a growing short position. Chinese stocks may also benefit from the rise in the US dollar. Check the website for my latest targets and new positions.

I have included the table below to show May's five best and worst performing sectors. I think that you will find it interesting as it hints to the flow of money into equity investments.

Five Best Sector Performers May 2005

Internet Service Providers 15.1435
Internet Content Providers 13.3627
Retail Shoe 13.1935
Pollution Control Manufacturers 13.072
Metal Product Distributors 12.9854

Five Worst Sectors Performers May 2005

Textile - Household -17.8167
Oil&Gas-Intl -9.5175
Generic Drugs -5.8168
Soap & Clng Prep -3.3938
Metal Ores -2.5220