Wednesday, August 31, 2005

9/1/2005 Reversal?


In reversal fashion the S&P500 swam up stream to close at its 50 day moving average (1220) on higher volume. The nasdaq fared even better to cut through its intermediate trend line on heavy trade. This type of market action is indicative of a market turn around. We have to say that we are skeptical, but one thing is for sure, you do not fight the tape.

The S&P500 closed above its last failed rally of 1219 on June 22nd, giving a touch of credibility to yesterday's move. Further the index crossed above the lower end of its trend channel (see our website for a definition of terms) another strong signal.

The nasdaq composite closed well of above the previous failed rally, however, it failed to break through the 2174 level, the lower level of its recent trend channel. The nasdaq's ascend has been far steeper than that of the S&P500, thus the rise of its trend channel may be considered less sustainable.


Hurricane Katrina caused much more devastation than expected. New Orleans, known for its unique character, is perhaps no more. Even more sad are the casualties of the disaster, the lives lost and the people hurt. Our hearts go out to all of those who have been affected by the hurricane and we hope and pray for a speedy recovery or at least the return to some level of normality.

The cost of the damage will run into the many multi-billions of dollars. All of us will be affected in one way or another. New Orleans was one of my favorite places. Some of the world's best food is there and world class jazz is played by street musicians for tips. New Orleans was special. I am going to miss her. We are going to build New Orleans and the communities around her. It will be a huge effort but the people of the New Orleans are up to it. New Orleans may never be the same, however my expectation is that it will be reborn. Yesterday's rally was due in part to the anticipated New Orleans renaissance. The effort to rebuild New Orleans will spawn unexpected growth and will add to GDP. That said, New Orleans re-birth will be a testy process.

Do Not Fight the Tape

On the surface the economy looks like it is weakening, thus the market is suspect. Yesterday's market action went against conventional wisdom (as it often does). Lets take a closer look.

Oil NYMEX (negative minus) $68.94/barrel - First of all oil is spiking and energy costs are rising. When oil rises gasoline costs increase, so do material and electricity costs. Lets put it into perspective. Oil prices are rising in accordance to market forces. If that is the case, one can argue that if market forces are strong enough to move oil higher they must also be driving other aspects of the economy higher as well. And they are. Material costs are up (affecting mfg?), personal income is on the rise and no one can argue that housing has not been strong.

In the past the spikes in energy prices have been blamed as a cause of economic slow downs. Today, Urban Outfitters (11.8%), Men's warehouse (8.5%) and Starbucks (7%) reported strong sales growth for August (no word on future profitability) a good trailing indicator. How will these companies fare against higher oil prices? No doubt costs are rising and are a concern, however, consumers are still spending and business is growing. Evidence that economic forces exceed the resistance of higher energy prices.

10yr Treasury (positive minus) - 4.02% - The rate of the 10yr Treasury is very low causing some to project an inverting of the yield curve (when short term treasuries yields are greater than long term yields). At this point low rates have to be considered accommodative to economic growth, in part increasing economic force. That said, banks are concerned with credit quality and we see evidence that credit is tightening. For example, the last time rates were in this range a fixed rate mortgage was about 5.375%, today the same loan is around 6%. Also, a flat to inverted yield curve curtails banks from borrowing short end lending long, a practice that made money easy. This money tightening has us changing our rating on interest rates from positive to positive minus.

3rd Quarter Earnings (positive) - 16% growth - Thus far there is little in the way of 3rd quarter earnings data. As I mentioned above costs are going to be an issue and unless sales breath is extremely strong, as perhaps it is according to the August retailers reports, earnings will be impacted. Discussions with manufacturing CEO's tells us that net incomes are under pressure due to higher material costs. To further exacerbate the situation the CEO's tell us that they have little or no pricing power. That said, all say that business is brisk and the future looks bright.

We are staying the course at this time. We have lighten long positions and have begun to look at shorting more aggressively. That said, we see long opportunities beginning to develop. Stay tuned as this opportunistic market unfolds to see what we are doing to make money. Visit our website at to view our current positions.

  • MATR - Matria Healthcare is back on our radar screen. The stock's technical characteristics have begun to firm and we are considering re-entry points. From a fundamental stand point we measure intrinsic value at $199/share based on 2006 numbers and current analyst's growth projections.

Sunday, August 28, 2005

8/29/2005 Selling to Accelerate in Certain Sectors


Last week the S&P500 continued to fall further below its 50 day moving average. The benchmark index closed Friday at 1205, near the low of the week albeit on lower volume. The lower trading volume is due in part to the summer holiday season, thus its effect has to be taken on a relative basis. The market is likely to move in a more meaningful way after the Labor Day Weekend when vacationing traders get back to their desks. The nasdaq composite mirrored the S&P500, although it was down less for the week.

Signals for further weakness continue to flash. Many of the recent rally's former leaders have been sold off and broke support levels last week. Further, the VIX closed below 14 (13.79) flat for the period. I would expect a number above 16 before we will see a new rally. Finally, although volume was low for the overall market certain sectors saw multi year volume highs, I will discuss this more later in the post. In addition, oil prices have started to rise steeply again weighing heavily on stocks. I expect the market to weaken further given its technical characteristics. That said, certain defensive sectors may rise. As usual only time will tell for sure.

Residential Real Estate Front and Center

Last week the residential home builders experienced further declines in stock prices falling over 11% from their recent highs. Is this price action a normal correction or something more? To help answer the question consider the following impromptu bullet point summary analysis. I have listed each item with a corresponding positive or negative sign and weight. At the end of the summary I sum the weights to put the situation into perspective:

(+) 3rd quarter new home sales were at record levels, but existing home sales flopped. I rated this positive although it is a trailing indicator.

(-) Executives at Toll Brothers (TOL) have been big sellers of their company's stock this year, accelerating share sales significantly in June and July.

(+) TOL CEO is making comments that support earnings growth.

(+ +) National home inventories remain low according to a study by Harvard University.

(- -) Rises in home prices far exceed the rise in personal income for 2005 putting forth the question of affordability.

(-) Mortgage lenders are nervous as credit quality comes into question.

(- -) As a sector home builders saw the largest level of down volume ever last week. The smart money is selling.

(- - -) Greenspan is warning of a housing ("asset") bubble perhaps telegraphing the Federal Reserves' propensity for further interest rate hikes.

(+ +) The US economy is strong.

(-) Consumer confidence unexpectedly dropped for the end of August.

(- -) Oil prices are at record levels and surging at an increased rate.

(-) Material prices are rising as production costs increase.

(+) = 6 compared to (-) = 12

Obviously the above summary analysis is far from scientific but it does seem that factors are mounting against the home builders. That said, the smart money has already been selling and further downside could be limited by short covering rallies and value investors who may buy at technical support levels. Going against the home builders has been a loosing investment in the past, however, given a relatively low level of short interest and weakened technical characteristics the fund is continuing to sell short certain issues.

  • KBH - KB Home is perhaps the best managed of the residential home builders and the most successful. That said the company may be over exposed to many hot markets especially in California. The company has diversified into other areas, however, pricing power is not what it is on the coasts. Short interest is relatively low at about 3 times daily volume, however, that is lower than last month by 8.6%. We are watching KBH as a possible future short.
  • BIDU - has found some price support at the $71/share level, however, it is impossible to tell how strong that support is at this time. In an earnings release last week the report showed all the attributes of a growing company. Costs are increasing fast but margins have improved (above 70%). Revenue also continue to increase. The lynch pin of the week came on management's perceived conservative revenue forecast, which was for an increase of 19% to $9.6M-$10M for the 3rd quarter. We would feel more confident in the stock if revenue grow in the triple digits. We do not consider BIDU the Chinese Google. Aside from the obvious reasons like revenue and earnings BIDU is structurally different than Google. The company generates most of its income from 3rd party sales, however, online marketing has started to generate customers at an increasing rate (above 128% over last year). Also, the company must comply with the Chinese Government's rules for information flow. We continue to monitor the company for a possible investment. Stay tuned to learn what we do.

We have published the Short Interest Trends for the stocks in our universe. Visit our website to view the reports. Select a company from the home page table and click on "Short Interest" at the company's research page.

Thursday, August 25, 2005

8/26/2005 Short Sale Opportunities


The S&P500 failed to rise above its 50 day moving average on Thursday, a negative sign. Several more days below the intermediate trendline and I would expect this market to head further south. We are already at a point where the market is subject to accelerated declines. I expect this market to move lower barring any short covering rallies.

This market is acting very weak and we have opened several new short positions, albeit small ones. As it stands right now the smart money has already been selling. We have reduced positions and have been taking profits where we can on long positions. As for shorts it is best to be conservative at this time, waiting for a better opportunity. A short covering rally that falls short of 1219 and then retreats would likely have us making additional short sales.

The VIX is holding at the 13 level, although it popped above 14 for a short time this week. If history is any indication the next meaningful rally will come when the VIX pushes above 16. Fear seems to be on the rise but has not yet become pervasive.

Key Factor Monitor

Oil NYMEX (negative) - $67.50 - Rising oil is putting pressure on businesses in many sectors. Material, Retail and Transportation are all on earnings watch.

10yr Treasury (positive) - 4.17% - Rates continue to fall as bond investors smell a slow down. Money is still cheap, however, my banker friends says that they are nervous, especially the ones at very large mortgage companies. Many loans are given to investors based on the equity in the properties that they own. If the bankers feel that the equity is in danger they will tighten credit. I would expect to see this tightening to occur, even though the 10yr treasury rate is low. Rates are a positive for stocks now, however, some credit quality tightening is probably under way at most banks, which is somewhat negative for the stock market.

3rd Quarter Earnings (positive) - The earnings outlook for the 3rd quarter remains positive, but is under pressure. Rising oil prices are adding cost to many business and if credit quality becomes an issue watch out. An interesting side note in this week's housing report was the fact that the median price of housing actually fell from last year (on a nation wide basis) to $203K from $212K; a fact that may mean less equity lending in the future. Less liquidity could mean less spending by consumers down the road, further pressuring profits.

  • BZH - We are shorting Beazer Homes once again. We purposely kept a short fuse on our last stop/loss target ($61) prior to the housing data being released, and we were stopped out on short covering. After the buying subsided we opened the position again. See our website for target details.
  • WFMI - In the past we have lost money shorting WFMI. Yet, the shares are clearly over valued on a fundamental basis yet they have continued to rise. We calculate intrinsic value (IV) to be equal to $104 based on 2006 numbers, considerably less than the current stock price of $130. We feel that the premium pricing nature of Whole Foods would be under pressure as oil prices rise thus affecting earnings. Impromptu monitoring of the stores tells us that there is some slowing. In addition, technical characteristics for the stock have begun to weaken. We have opened a small short position.

Monday, August 22, 2005

8/23/2005 Real Estate Topping Out?


The S&P500 stood still yesterday as it continued to rest on its 50 day moving average. This market gives the appearance that it is holding up, however, weakness abounds. Many previous leaders have fallen and broken their key levels of support. Of late, sessions have started higher then have been met by selling. Although a break down below 1215 on the index has not yet taken hold, if and when it does the market would likely fall swiftly. We are very cautious at this time. We have begun to short some issues as a slow down is being discounted by the smart money.

Party Notes

This weekend I attended a party, a reunion of sorts, with friends, many of whom I grew up with. The guest list was diverse. Friends from all stations of life came together for the night with the most popular discussion of the evening, aside from reminiscing, was real estate. I was surprised to learn that many of my old friends owned more than one home. In fact, several of them held more than three or four homes and were looking to flip them. Some of these real estate investors were contractors others were real estate agents while others where average joes. My point is that everyone was dabbling into real estate, usually a sign of a topping market. Without exception all the investors were hopeful that they would be able to sell their properties, some of them would even be happy to get out with a smaller profit than they expected. Regardless of the real estate demographics this impromptu analysis tells me that the rise in real estate prices is coming to an end. When everyone owns an investment class that investment class tends to become over bought and then subject to over supply. When over supply happens then prices tend to fall. I would say that this is a top, at least for the time being, in the real estate market.

As you know, if real estate prices flatten or fall a bit their change will affect the economy. I am not predicting a doomsday scenario, however, it appears that the economy is setting up for a pull back. All the signs are there: a toppy real estate market, a weakening stock market, a flattening yield curve and higher commodity prices that affect the consumers' ability to spend. That said, corporate profits are expected to rise in the 3rd quarter while business activity looks brisk. We continue to monitor the situation, however at this point it is looking a bit shaky.

Key Market Factors

Oil NYMEX (negative) - $65.5 /barrel - Oil prices remain high after a sharp rise the last couple of weeks. That said, the price is stabilizing, which may be considered less negative.

10yr Treasury (positive) - 4.20% - A fall in existing housing sales has bond investors buying today helping to keep rates low.

3rd Quarter Earnings (positive) - 16.3% - Consensus estimates at this time say 3rd quarter earnings will increase by 16.3% over last year. I am calling this a positive at this time, however, changes in consumer spending, real estate and the above two factors may force analysts to reduce their estimates. I am cautious about earnings at this time and feel that certain sectors will perform better than others.

We are staying the course for the time being. As I mentioned above I feel certain sectors will out perform others. You can see all our fund's positions by visiting

  • APPX - American Pharmaceutical Partners recently broke out from a basing trend, a strong technical sign. In addition, the company's fundamentals have improved as our screen put it in the top 10 of our research universe. We are lightly adding APPX on a pull back below $46.
  • BZH - Beazer Homes has been pressured as housing investors look for a slow down. The slow down comes during the usually busiest time of the year. The stock's price has been resting at its 50 day moving average, until today. We started shorting BZH above $61, see the website for the details.
  • BIDU - bounced today. Could this be the bottom forming, only time will tell but we are interested in BIDU below $80. $66/share would be better and at $56 we would likely buy it. We are watching the technical characteristics at this point to see if the other smart money investors see what we see. Stay tuned to see what happens.

Friday, August 19, 2005

8/19/2005 S&P500 Hangs on at Its 50 Day Moving Average

The S&P500 is currently bouncing around its 50 day moving average (dma), a tipping point of sorts. In a bull market the smart money will usually buy stocks at the 50 dma, however, if those buyers abate the market will be subject to further declines, perhaps to the 200 dma. I would become optimistic if the market experienced a bounce and headed higher from here. Likewise, I would become bearish if the index fell below the 50 dma and held there for more than a few days.

On a positive note volatility has been on the rise of late. The VIX has pushed through 13, a sign of increasing investor fear. A rise in the VIX above 16.5 would likely help the market move higher. In addition, mutual fund flows have been negative for the last few weeks; another positive sign related to investor sediment. All and all market sediment has been negative yet the market has held up pretty well. The next few weeks are going to be interesting for stocks.

Don't expect much movement today, however next week is a different story. Typically the stock market closes flat on options expiration Fridays, and looking at today's market I do not expect any surprises. Starting Monday though I would expect the Key Market Factors (see my last post) to play on the market. Stay tuned as we watch these factors to see how they affect stocks.

Oil NYMEX (negative) - $65.60 - A sharp drop mid week and a sharp rise today still are an overall negative for the stock market going into next week.

10yr Treasury (positive) - 4.21% - Rates have come down from the spike a week or so ago when they rose above 4.40%. Lower rates benefit stocks in this environment.

3rd Quarter Earnings (pending) - I am waiting for more information from corporate executives before setting the tone on earnings. As it stands right now earnings are under pressure due to higher energy costs.

Watch our fund on a daily basis by bookmarking or subscribing to this blog. You can also see all of our fund's current positions and get access to a little research by visiting

  • BIDU - is getting interesting at this level ($80/share). The recent IPO has fallen from a market cap of about $3.94B on its opening day to $2.56B today. To give you a basis of comparative value NTES, a competitor of BIDU, currently has a market cap of $2.29B. Given that Google has surprisingly announced its intention to raise roughly $4B in cash speculators are entertaining the idea that is a Google buy-out target. Only time will tell if a buy-out is in the cards. Whether or not Google makes a move on bidu the fact remains the value of is coming into line with its peers. We are keeping an eye on bidu as it may soon be an interesting addition to our portfolio.

Monday, August 15, 2005

8/16/2005 Key Factors Will Move the Stock Market


The S&P500 continues to move within its trading range of 1215-1235. However, the index has broken from its recent trend channel (RTC) that was set between 7/14 and 8/4, implying the index has some work to do before it can move higher. A break out and close above 1245 on higher volume would go a long way in reviving confidence in the current rally. Conversely, a close below 1226 on higher volume would likely spell further declines and a possible break down.

The nasdaq composite is behaving quite differently than its large cap counter part. The index broke the 2200 resistance level on 8/2 only to realize a topping pattern on 8/3. Since then the nasdaq has fallen in a sharp way, loosing 60 points until Monday when it finally bounced, unfortunately on lower volume. Action in the index has been less than inspiring of late, leaving smart money traders to focus on individual stories.

The market is weaker than it might look. Many leaders have fallen and the indices have shown clear technical signs that the smart money has begun to consider risk. I am becoming more cautious as well, however, I am carefully adding to positions.

Key Factor Watch

In my last post I talked in depth about what I feel are the key factors that will drive the market in the 3rd quarter. As the picture becomes clearer about oil, long rates and 3rd quarter earnings so will the direction of the market, perhaps in an unexpected way. There are not too many investors who think that oil prices won't rise, interest rates are moving lower and third quarter earnings are going to be less than 8%-10% higher than the 2nd quarter. In fact, these consensus scenarios are likely already built into the market. That being the case, notable changes in the key factors above will shake the consensus thinking and swing the market. Therefore, I am going to publish a key factors watch to help me monitor changes in the key factors and their effect on the market.

Oil (negative) - I wrote in my last post that a rise in oil prices would not completely burn the market, however a sharp increase of 10%-15% or more would. Last week oil rose from $60 to $66/barrel, a 10% increase that certainly caught the attention of the smart money. If oil does not correct here I would expect a sell-off in the stock market followed by further weakness.

Long rates (positive) - Greenspan's conundrum continues to confound the market. After a brief rise above 4.45% in interest rates, after the last FOMC meeting, 10yr treasury bond yields have fallen to about 4.21%. Remember a sharp rise in interest rates in a short period of time would be a negative for the market.

Earnings (neutral) - CEO's have given their estimates for the 3rd quarter and growth is likely to continue in the 10%-12% range. Earnings growth is the prime consideration when forecasting stock prices, and the above factors are two driving components in determining that growth. However, many other factors will come into play such as payrolls and market conditions. We will continue to monitor these other factors in the this section of our "Key Factors Monitoring" report.

I am extremely cautious at this point. We are identifying short positions in the event the S&P closes below its RTC (1225) and our fresh long investments have tended to be restrained in volume. Stay tuned and visit this site daily to watch what we are doing. You can see all our fund's positions by going to

  • SNDA - We have recently added Shanda Interactive Entertainment to our fund. As it turned out our timing was pretty good and the stock bounced the day after we entered it. The sector continues to be active as M&A activity continues. Other factors are at play as well. I have included a chart showing the growth in short interest in the stock, click this link to see it This trend may play a part in furthering the stock's recent run.
  • GOOG - No one can argue with Google's stock performance and the future certainly looks bright. However, a recent technical break down and a higher level of competition have investors thinking otherwise. The stock recently fell below its 50 day moving average and failed to bounce above it. Further, it appears that a head and shoulders pattern was built into the stock's chart. We are considering shorting Google, however, there are probably better risks out there. Shorter term traders may be playing from the short side at this time. Another reason that I am cautious about shorting GOOG is that it may soon be named to the S&P500. If news breaks about its addition to the index the stock may rally higher. That said, GOOG short interest has been falling (see chart at for months.

Wednesday, August 10, 2005

8/10/2005 Looking at the 3rd Quarter - Near Term Future of the Market


Yesterday's mid-day break down has significantly challenged the markets' recent rallies. Whether or not this is just a correction or change in trend is yet to be determined, however, many classic signs of weakness were present in the later days of the recent run up in stocks. First, the rally's leaders started to falter about a week ago. When a change in leadership occurs and no new leaders emerge to take their place the stock market generally gets into trouble. The signals intensified yesterday when the general market rallied without the small caps. The DOW and S&P500 were up over 0.7% while the S&P600, a harbinger for leaders, was up only 0.1%. Finally, a failed attempt to build off of yesterday's gains may be a sign that another leg down is in the cards. Higher oil and uncertainty about interest rates and 3rd quarter earnings are likely to force investors to take profits and engender a wait and see attitude.

Certainty vs Uncertainty

One thing the market is certain about is that 2nd quarter earnings were well above estimates. The average S&P500 stock beat consensus estimates by roughly 16%. The rise in earnings surprised most investors and helped to move the stock market higher. Now that the 2nd quarter is history; investors, uncertain about what lies ahead, must speculate about the future. Many money managers that have made good profits this quarter will take some money off the table rather than risk it in the face of the unknown (a bird in the hand is worth two in the bush). This process has been going on through earnings season as evidenced by the many leaders that have fallen from their recent highs.

The smart money knows that the US economy is like a ship; once it gets going in one direction its hard to turn it around. The economy will likely continue to steam forward barring any unforeseen shocks. That said, when a ship hits an iceberg it is likely to sink. I am not suggesting that markets have hit a stopping point, rather I am making a point for consideration as these issues are on the minds of the smart money.

Oil prices rose sharply this week topping the $65 mark yesterday. Fear about supplies and increased demand seem to have speculators back in the market. And why not, with the increased threat of terrorism and growing global demand, the smart money has taken the stance, "if you can't beat them join them". Obviously, the higher oil prices will affect some stocks more than others, especially ones from the retail, transportation and materials sectors. Higher oil prices are likely to put a dent into corporate profits for the next quarter; a fact that has investors worried. I do not think that a gradual rise in the price of oil will derail the economy, however, a sudden 10-15% spike may inspire a new breed of sellers. Look for large investors to become increasingly concerned about how oil will affect profits and the consumer.

Long rates have finally started to rise with rates on the 10yr treasury right around 4.40%, the top level of its recent range. Most investors now feel interest rates are going to move higher as the Fed promises to continue on its measured pace. However, there is a camp that believes rates will top out at the current level regardless of what the Fed does as market forces will keep rates low. If rates do break above 4.5% they are likely to move higher as money managers, forced by technical characteristics, will sell the bond. A sudden rise in rates may shock the market. That said, a steady rise in rates will signal a growing economy with low inflation; a favorite scenario of investors. I look for the market to sell off significantly if the 10yr treasury climbs above 4.5%. At that level many investors will look for the exits and a sharp rise in rates may ensue.

Perceptions about 3rd quarter earnings will drive the stock market for the next few months. The reality is that investors are unsure about how earnings will end up next quarter in part for the reasons I discussed above. I expect that the market will correct in the short term until investors minds become more clear about 3rd quarter earnings. The depth of a correction will be determined by oil and interest rates as the US economic ship is moving full steam ahead. A spike in either oil or interest rates beyond trend is likely to slow the ship and deepen any correction. Also, a terror attack, which is becoming an increasing risk, would be the ice berg I mention above and further stall/stain the market.

In the Focus13 fund we have reduced positions to take profits and also have been stopped out on technical weakness. We are likely to make new investments in the near future as new leadership is developed and perhaps add some short positions as old leaders fall. One big issue not necessarily pretaining to the 3rd quarter is the Highway Bill just signed into law. $280B+ over a number of years will flow through the economy in the coming years. The smart money is taking this fresh cash into account for the next phase in the stock market. In the short term this bill may limit the market's downside.

See our website to watch us in action. On the home page you can see all the fund's current positions with their buy and sell targets. You can also browse our other pages to see our thoughts on the companies the fund follows.

  • SNDA - We started to carefully add Shanda Interactive Entertainment back into our fund yesterday. A recent decline on lower than expected earnings put the shares on sale by over 10%. Normally, I would run from lower earnings but given the M&A activity in the sector and the BIDU IPO, which are driving stock values higher, we feel the stock is under valued. I am carefully adding shares as the nature of a fall, like the one yesterday, is a slower recovery rather than a bounce. That said, if other investors take the same view as we do a bounce is more likely.
  • BIDU - Baidu is still interesting to us but not until the stock settles down, as I mentioned in a previous post. There will be much interest in owning or controlling the company on the part of large media companies. That said, any poison pill tactic taken by the company would be a significant negative short term, however, it is unlikely to deter investors as everyone has their price and poison pills can be dissolved.

Sunday, August 07, 2005

8/8/2005 Correction or Change in Direction


Friday the S&P500 broke below its recent trend line on above average volume. The nasdaq composite also changed course and reacted in similar fashion to the S&P, however on less than average volume. Jobs data and spiking oil were the culprits according to the mainstream media; the smart money knows better. The future of the market is now driven by the answer to the question, "is this a correction or change in direction?".

Although selling was the order of the day, some issues had a bid under them especially at key support levels. For example, Google fought off a fall during the day to rest at its 50 day moving average, a point where the stock bounced 7+ points the last time it touched the intermediate trend line.

Seasonal market weakness and uncertainty about interest rates are sure to provide volatility this week. Although volume on Friday was above average, summer time trading volumes have been the norm. What is interesting about Friday's volume was that with the amount of down volume one would expect a bigger decline, probably over 1% given the liquidity lost by traders on holiday. However, the S&P500 and nasdaq composite were off only 0.6%. Was there some background buying? Maybe. Anticipation about the future of interest rates has traders jockeying for position. Cash continued to rotate out of the financial and retail stocks, while bond investors pulled cash out of the bond market ahead of the FOMC meeting. An almost 20% increase in the value of the VIX ensued as the volatility index continued to rise. Fear is creeping back into the market as most investors do not want to get caught long when interest rates finally turn to the other side of neutral. The smart money is quietly adding shares on the dips, perhaps a sign that the recent sell off is a correction rather than the beginning of the much feared bear market of 2006.

To learn about our fund's positions visit the website

Data Salad

Job creation in the US was up over 200,000, at the high end of estimates but not a surprise. Oil prices continue on the high side, but as I wrote before, due to growing demand and not run away inflation.

Current market logic (forgive the oxymoron) says climbing rates equals a growing economy, therefore stocks will rise. Thus, if the jobs report means that there is going to be more rate hikes then it is a sign that rising stock prices are going to be extended. Obviously there will be a point when rates will tip the economy south, however, lately the stock market has risen in the face of interest rate hikes as their resistive nature is still not enough to stop this economy's electricity.

Higher oil prices are a result of the growing global demand for the commodity. A Globalization fetch is generating formidable waves of economic growth. This growth is likely to continue for some time provided that governments stay out of the way. Higher oil prices will continue to be a result of the global demand until substitutes and/or corrective troughs provide relief. In the end energy will be in growing demand in some form during the next decade, and as energy demand grows so will demand for stocks that shape global growth.

  • GOOG - Google is in the process of redefining many aspects of modern media, especially advertising. First, Goggle's effectiveness is far and away better than other search engines. In an ad hoc study performed by our fund team Google ads increased our test cases' popularity over MSN by a factor of 522 to 15 (Our study with Yahoo is underway). Further, Google is able to attract key talent and is building new businesses. The company continues to eat away market share from mainstream media companies to the point those companies are becoming unprofitable; which may be one reason they are buying GooG stock. Institutions are also buying GOOG and not aggressive growth like one might think, rather 9 of the top 10 holders are value or GARP funds. Another reason we are buying Google is its absence from index funds. Google is not yet a member of the nasdaq 100 or the S&P 500 but is up for consideration for both. When inducted into either or both index fund managers will have to buy the stock to round out their holdings. We calculate intrinsic value (IV) for GOOG to be $427/share based on 2006 numbers. To learn a bit more about our thoughts on Google visit our website at
  • BIDU - Baidu's IPO was the best in recent memory and exhibited similar market behavior to Google on its debut. This weekend much of the mainstream media has cried that BIDU is over valued. The smart money knows that something is only worth what someone else is willing to pay for it. If you are Google what are you willing to pay for the number one Chinese search engine, a company that potentially gives you local knowledge and cultural familiarity with over 200 million Chinese? Or what if you are Microsoft, rift with cash; what are you willing to pay for BIDU given your most formidable foe just captured your General in the region. Or how about all those mainstream media companies who lust for the good old days and would love to be part of the Chinese media expansion. At Fridays' close BIDU's market cap was about $3.9 Billion, which could be considered undervalued by some. I would not be surprised to see the stock price double from here moving toward $8.0 billion in market cap; only time will tell as it all depends on what someone is willing to pay for BIDU. The fund does not own any BIDU but over time, when facts become more clear, it could become part of our holdings.

Tuesday, August 02, 2005

8/3/2005 Break-out or Window Dressing?

Large money investors bought up the market today driving the nasdaq composite to a new near term high. Most of the buying came late in the day as up volume rose above its 50 day moving average. There was some evidence of late day selling though, as many of the leaders reached a high for the day and based there 30 minutes before the close. But new money kept most stocks from falling off the day's highs as selling was met by more buying. Can the market sustain these levels and finally move higher? Below is a summary of where my head is at regarding the markets' direction, however, as usual only time will tell.

The major indices are being tested right here and now. The S&P500 closed the day at 1244, re-establishing its trend north, yet not high enough to mark a new leg higher. The climb in the index has been steady with one step back for every two taken forward. I like this type of movement as it generally portends a more solid foundation from which a bull market can springboard higher. It also helps to limit downside risk as near term support tends to build on the solid footing.

But it was the nasdaq composite that took the leadership role today as it broke from its recent basing pattern to move its rally to the next level. If today's market action turns out to be more than just window dressing the nasdaq composite could move above 2300, with some resistance around 2260. Our fund's screening process has yielded some new names, most of which are from the nasdaq. The extended rally is helping to set up a fresh lot of leaders, a much needed component if this aging bull market is to continue running. To see the fund's positions visit our website at

Several positive technical signs from the VIX and the 10yr Treasury may also be helping stocks at the moment. Movement in the volatility index (VIX) was interesting of late as its moved higher on Monday in lock step with generally higher stock prices. Typically the VIX has an inverse relationship to the market. On Monday the index rose above 12.25, up from 10 just a few days ago. The short term negative sediment is likely responsible for the tight basing pattern and its extension above 12 no doubt helped the nasdaq break to the upside. The index closed Tuesday at 11.75, not too far from the 12 level. A VIX that moves up with the market is a positive sign from my vantage point. In addition, a sell off in the 10yr Treasury has rates near intermediate term highs and is sending some large investors looking better returns. It is likely that a goodly portion of the money coming out of bonds will go into stocks; for now another positive for equities.

As I eluded to in my previous post, I thought that investors would come in at the beginning of the month and put new cash to work in the stock market, on queue they did. Fund managers put the new money up against the wall, now lets see if it sticks. As this market moves higher it appears that the consensus is getting more negative as evidenced by the action in the VIX. Add to that the fact that some investors are changing their asset allocations and rotating cash from bonds to stocks; I feel like the market can move higher. That said, many money managers are on holiday, while others will shy away if third quarter earnings are perceived to be in jeopardy. I continue to rotate in new names as changes occur and new leaders have emerge.

  • COGT - Cogent, Inc. designs and manufactures biometric devices and currently holds the leadership position in this niche market. Based on 2006 numbers we calculate IV to be $60/share with room to grow. The company holds several patents in the area and builds many of its products around its custom Application Specific Integrated Circuits (ASICS), which is another way of saying intellectual property (IP). Technically the stock has firmed up as prices have risen with the addition of fresh investment. In our view the Biometric niche market is growing and is likely to become mainstream within the next 2 years. Not only does the stock stand to benefit from a growing market it also will be come a buy out candidate as large intergrated circuit manufactures look to grow their revenue and earnings. We are buying below $31.5/share and have a near term target of $40/share with a stop loss at $27.5/share.