Sunday, October 30, 2005

Seasonal Factors Favor the Bulls


A volatile stock market tends toward the upside after several false starts. The jumpy market has managed to end on higher highs and higher lows over the last couple of weeks. The S&P500 closed up 19 to end at 1198 on Friday. The 1.6% rise was welcome, albeit on just above average volume. The nasdaq composite rose 1.2% on a bit better volume. Unlike the S&P500 the nasdaq composite did manage to stay above its 200 day moving average. The market's performance has been hopeful but less than inspiring, lacking volume, leadership and breath.

Seasonal Factors Favor the Bulls

It is no secret that the last quarter of the year tends to be the best one for stocks. On average the market rises about three percent during the period. Will history repeat itself this year? Only time will tell for sure but here is some food for thought.

The current bull market is nearly three years old. From a long term technical perspective signals say this market is about out of steam. To make matters more interesting the market has traded in a narrow range for the last year, often a sign of a break-out in either direction. If this market does break out soon, the down side has to be favored given the length of this bull market and uncertainty about earnings growth. However, if the Fed is done raising rates the market may move higher, provided fiscal policy remains neutral or better. As I mentioned before in a previous post we are protecting our positions with puts in certain cases and are carefully rebalancing our portfolios.

A Word About Our Key Market Factors

Our Key Market Factors are telling us to be neutral on this market. Energy prices remain relatively high with oil above $60/barrel. So long as the price stays stable at these levels we are unlikely to get more negative on energy. We would become more positive however, if oil dropped below $55/barrel and stayed there for a while. Rising interest rates have made us negative on the cost of money. We feel that a 10 year treasury above 4.50% is at or above neutral and likely to stimulate more savings than spending among consumers. Earnings have been good this quarter with 68% of the S&P500 beating estimates while 19% have fallen short. Still fourth quarter previews have been conservative leaving investors uncertain about their future. It will be the speculation on the part of the smart money that determines the direction of stocks into the year end and beyond. New leaders are likely to emerge at some point. Stay tuned as we find these leaders first.

  • ZHNE - Zhone remains an interesting investment. Earnings came in flat, which was a victory of sorts given the acquisition of Paradyne. The company has increased its cash position in the quarter by about 25% and revenues have more than doubled, yet the stock trades at about 1/2 its book value and more than a 2x discount to its peers. In our opinion the street views Zhone's business as less than sexy. Although wireline telecom is a dying business Zhone brings new broadband and service life to the thin pair. Zhone's products allow service providers to send voice, data and video through existing phone lines giving customers a competitive choice in many international markets. Zhone now has 640 customers, with no customers having more than a ten percent share of revenue. In fact, Zhone's top 5 customers account for only 29% of the business. In this quarter's conference call CEO Mory Ejabat hinted at the possibility of a tier one customer coming onboard in the next few months. Further, rumors have it that there is a management shake up taking place and the making of a revitalized team is underway. We expected stock price volatility through earnings season and got it with a bit more to come when the lock up period ends in a few days. We are adding shares and remaining patient as we believe this out of favor company is in position to profit in the near future.

Wednesday, October 26, 2005

Is the Market Going to Make a Tectonic Shift?


The smart money waits as the stock market attempts to prove it is ready to move higher before it moves lower. Sure there have been upside days on decent volume, yet the S&P500 remains below its 200 day moving average. Inertia becomes greater the longer the index stays below the 200 day line adding to upside resistance and increasing the chance that stocks will move lower in the near term. Today's action did not help as each time the market attempted to move higher it sold off, ending the day down on higher volume and stinking breath.

Over the last couple of weeks we began asking hard questions about this market and the apparent tectonic shift in progress. We believe that in order to be successful in 2006 fund managers will have to correctly postulate their portfolios around a new paradigm; one with higher rates, a new Fed Chief, an uncertain winter and a possible pandemic. Stay tuned to this blog as we identify the new wave of leaders and usher in opportunities not yet found by the mainstream.

Key Market Factors Begin Meaningful Changes

Capital Markets are being tested right now. The 10 year Treasury closed above 4.50% for the first time since late March. Will the yield continue to rise or will it fall like it did in April? Answer that question correctly and you will profit handsomely. Read on as I will give our perspective on interest rates and the market's other key factors.

First, in order to sum up our perspective and enable the reader to, with one glance, see how we view the current market climate we are adding a Key Market Factors Score to the blog. In short we are adding a number grade to each of the Key Market Factors, which when totaled will represent our perspective. For example, if Oil NYMEX is Negative +, we will assign a number of -1. If the 10 year treasury is Positive -, we will assign a score of +1. When totaled (-1 + 1=0) the result would mean we are neutral on the market. Got it, good, if not read on and it will become clear. For the record the scale is as follows positive + = 3, Positive = 2, Positive - = 1, Neutral = 0, Negative + = -1, Negative = -2, Negative - = -3. A total positive score will mean a corresponding positive perspective, likewise a negative score will mean a negative perspective.

Oil NYMEX - $60.80/barrel - (negative )[score = -2] - Oil prices have fallen from the Hurricane Katrina highs of $70/barrel, however, they are still high enough to tax the consumer. Although we like stable energy prices we feel the market would perk-up if the price was under $55/barrel in the short term. Within the last five trading days the price of oil dipped below $60 showing some promise of relief. Further, higher interest rates are likely to bring the price of energy down. That said, the potential exists for prices to stagnate if a cold winter ensues keeping heating oil prices high. For now we feel the market is impacted negatively from the current price of oil.

10yr Treasury - 4.57% - (Neutral) [score=0] - The yield on the 10 year Treasury note broke solid resistance this week when it crossed the 4.50% level and held. The question remains - is this a short term pop or will rates continue to move higher. Greenspan's "conundrum" may finally be solved as long rates look to be rising in concert with short term rates. On the positive side the yield curve is steepening signaling the economy is expected to grow. The other side of the coin says inflation is rising and growth must be slowed. Only time will tell the future of rates but for now the market is discounting a Bernanke Fed will raise rates and expand the economy.

3rd Quarter Earnings - 17% - (positive)[score=2] - 3rd Quarter earnings are turning out to be positive. In the S&P500 70% of companies reporting thus far have beat expectations with only 14% falling short. Prognosis for the 4th quarter is conservatively positive for the most part with many companies keeping estimates in line with previous guidance. Our surveys report that the economy is growing and companies remain strong with some even having difficulty finding enough qualified employees. Asia is growing ahead of forecast and Europe looks a little brighter than before. 4th quarter earnings show promise, however, other factors of the economy may hamper growth. For now we are positive on 4th quarter earnings.

The KEY MARKET FACTORS SCORE = ZERO, making us neutral on the market. We continue to be busy rebalancing our portfolios. We have started to shift out of interest rate sensitive issues and are looking for companies that will benefit from the changing environment. Airlines and some tech companies have caught our eye and more are in sight. Check our website at to see what we have added and what we have let go.

  • BIDU - reported earnings that crushed their previous year's results. The only problem is that they fell way short of what a "Chinese Google" should be. BIDU lifted 4th quarter guidance by about 30%; which normally would be good. However, the increase amounts to only a few million dollars and is chump change when compared to $100 million type increases more worthy companies produce. I would have been excited by a 200%+ increase in earnings, so the 30% was, well disappointing. is apparently China's number one search engine and most visited website. As far as I can tell from the numbers they are mere mortals with a me too product and adding an old school name to their board only makes matters worse. I will have to see more than so, so before I will be willing to pay the premium put on the stock at the moment. At this point $27/share looks like a fair buy point.
  • MESA - Mesa Air continues to look good even in the face of a negative market. MESA is set to report earnings next week tipping its hand about its latest investments and growing ASM (average seat mile) numbers. Its competitor RJET reported strong earnings today 63% ahead of last year. RJET stock rose 0.06% on solid volume. For comparison RJET has a PE of 9 while MESA's PE is only 7. We see promise for both of these small caps especially MESA and can see $14 a share in the short term based on peer multiples.

Sunday, October 23, 2005

Technical Challenges


On Friday the VIX (the S&P volatility index) closed above 16 for the week, one of only three times this year. Interestingly, each time the VIX has been above 16 a rally ensued. Finally on Monday the S&P500 climbed above its 200 day moving average after a three week stint that put into question the validity of a nearly three year bull rally. Was a VIX above 16 enough to flush out the hot money and make way for investors? Can this market have yet another year end rally? Is there more to go in this bull market? Based on the technical data we use it is hard to say, but if the stock market can move up from here on higher volume probability favors the bulls.

Short term technical signals for both the S&P500 and nasdaq composite point to an oversold market and are at levels where buyers are likely to reign supreme. The question remains: is there enough buying interest this time to drive through staunch over head resistance? Time will tell, but if fundamental data comes in strong backing up the bulls there is probably enough of a technical void caused by three weeks of selling to rocket stocks.

Monday's rally was a significant follow through as many indices gained over 1.6%, albeit on so so volume. If the rally is to continue the first test will come for the nasdaq as it must climb above 2125 in the short run on higher volume to break through some tough resistance. The same is true for the S&P500 at the 1215 level, which has been a real sticky point.

On a longer term basis this market is more over bought than over sold. From a technical perspective I would not be surprised to see a repeat of last year, where a year end rally yields to strong selling at the beginning of 2006. I believe globalization will fuel long term growth, however, the phenomenal growth in Asia and South America is likely to slow as widening imbalances tend to equilibrium. Hopefully, if and when there is a global slow down it comes with a soft landing, but, a market lacking volatility like this one increases the chance of a harder fall. Look for increases in VIX fluctuations as time passes. It would be better to have greater volatility now then to get it all at once. The fund is likely to purchase more protective puts than what we have over the past two years in order to protect profits in a volatile market.

We are in the process of rebalancing the fund. We have been very busy lately as we remove old leaders and shift into future ones. We continue to stay with our strategy/philosophy (visit our website at to learn more). Stay tuned as we make changes to maintain the fund's yields above 50% for the year. You can see what we are doing by visiting our website.

  • BIDU - is set to report earnings on Wednesday and investors are buying now in hopes that the stock will mirror the performance of Google. Shares rose above their 50 day moving average on Monday, a positive sign as the stock has fallen about 50% from its 52 week high. Some analysts call for a $45/share valuation based on earnings growth and market multiples. However, investors see a future significantly above that of market analysts, buying into a faster than estimated 100% 2006 earnings growth. In addition, investors have a buy-out premium on the stock, believing the company could fetch north of $4 billion in an acquisition. At $80/share we believe the stock is fairly valued when compared to its peers; that takes into account accelerated eps growth, market conditions and a buy-out premium. By now should have about 1,000 employees, a ten fold increase over last year. We will be looking for how well management has employed these assets. Further, we are interested to see the progression of search advertising on the site. For now we feel that BIDU promises more short term trading profits than investment opportunities. That can change however, if management can prove it is capable of growing earnings way above consensus estimates.

Wednesday, October 19, 2005



Investors woke up yesterday as an oversold market collided with positive earnings and beige book news. Shorts were squeezed and the longs were paid. The S&P500 closed at 1195 up over 17 points, but still below its 200 day moving average. The nasdaq composite did even better closing at 2091 up over 35 points and closing above its 200 day line.

It is apparent that investors began to speculate earnings were going to be good and inflation would be in check. The smart money dipped its toes into the market starting last Thursday and continued to buy. The market is not out of the woods yet, however, it took a step in the right direction.

We continue to remain cautious although we began to add new positions. This is a tough market as many changes are underway. It will take guts to make some of the hard decisions necessary in order to profit from the future. Check our website at for the details.

Key Market Factors

As expected our Key Market Factors, being in flux, have driven the market. Part of the reason for the recent reversal is the more positive nature of our indicators. Oil has fallen in price. Interest rates, although providing a wall of worry, remain below 4.5% on the 10yr. And earnings are not looking so bad. Below is an evaluation of the status of the factors.

Oil NYMEX (positive -) - $59.55 - Recent hurricane activity in the Gulf drove up prices last week. Obviously, the hot money was quick in and quick out as the storm moves away from oil rigs and prices fell. Further, oil consumption was weaker than expected as inventories grew for the week and gasoline prices fell 6%+ the last few days. Falling demand and growing supplies are firming up the picture for the market as energy costs fall.

10 yr Treasury (positive) - 4.48% - Inflation was on the top of investors minds last week as CPI and PPI came in higher due to the recent hurricanes. However, underlying core inflation seems to be in check and the economy looks to be cooling. Our surveys confirm this reasoning. Resistance at 4.50% continues to stand up and consensus is growing that the Fed can continue to move rates higher at a measured pace without hurting the market.

3rd Quarter Earnings (positive) - 17% - positive earnings continue to come in without surprise. More importantly, 4th quarter projections remain in line for the most part. There are still a fair amount of reports left but as of today earnings are on the rise.

There are many opportunities for the smart money to participate. That said, there is a lot of dog doo out there, so watch your step. We continue to adjust and remain positive on the overall market.
  • MESA - We have begun to add Mesa Air to our fund as the environment for airlines looks better. Falling fuel prices are also having a positive effect on the group. MESA operates flights for United Express, America West Express and Delta Connection. Rising prices and falling costs are a positive for the company in our estimation. Check the website for targets.
  • ZHNE - Zhone will report earnings next week. We feel that costs related to its recent acquisition and reorganization are already built into shares. However, we do expect price volatility around the earnings report, which is typical for the company. ZHNE continues to lag its peers and can catch up as it goes into the better 4th and 1st quarters. The sale of its legacy systems may add a one time pop to earnings. The current stock price is at a level where insiders previously bought millions of shares.

Saturday, October 15, 2005

Core Concerns - Interest Rates and Earnings


Both the S&P500 and nasdaq composite ended the week below their 200 day moving averages, although both indices finished on the way up. Many investors feel with the declines of the last few weeks the market is due for a bounce as stocks became "oversold". However, on a weekly basis the market may not be as "oversold" as it appears. Indicators are at levels not normally associated with a meaningful correction. Only time will tell but I will need to see a bit more technical support before I believe the tape says its okay to buy away.

Core Concerns

Today investors' core concerns revolve around interest rates. The 10yr Treasury has hovered around 4.48% all week, a tick or two below the heavy resistance levied at 4.50%. The fear is if the 10yr yield breaks above 4.50% it will not move lower for some time. Although, inflation fears were quelled somewhat when core CPI was reported last week, all indications are the Fed is determined to deflate asset bubbles floating around the economy and will continue to raise rates. With the inertia of higher rates pulling down growth 4th quarter earnings will be in danger of falling short of analysts estimates. Our studies show that the economy has begun to slow and the smart money has already begun their asset rotations. In the coming weeks we will be keeping an eye on the 10yr as its yield is on a precipice from which a change in trend can occur. If the yield moves above 4.50% for any length of time we are likely to change our investment strategy.

As if changes in interest rates were not enough investors will be fed the main course of 3rd quarter earnings this week as the core of the S&P500 serves up their numbers. As I mentioned in a prior post investors will be less concerned with the actual numbers than with what is said about the future of earnings. Expect future projections contained in the reports to drive the market. Thus far the earnings that have been reported have been pretty good. Again, the question will be can companies keep them growing profits above trend.

In summary we are taking a wait and see approach before leaning into this market. We are waiting for what is said between the lines of 3rd quarter earnings reports and what the tape does before we act. That said, rising interest rates and stubbornly higher energy costs will force us to speculate on the short side if either spikes higher in the short term. Stay tuned during the week to see what we do. You can see our changes by visiting our website at

Wednesday, October 12, 2005

Good News: This Market Looks Pretty Bad


This market looks pretty bad hopefully that is good news. Volatility as measured by the VIX closed at 16.22 Wednesday, which is a five month high. Around this level I would expect a bounce, however, the stock market's breath stinks and selling has been notably fierce. I am not going to rule out a turn around from here but stocks are more likely to see a dead cat bounce if the buyers come back too soon. For all the reasons I wrote about in my last post the projected fundamentals and ensuing technical characteristics of this market seem to be in sync. It is likely the stock market has more down side to go.

The S&P500 closed at 1178, the sixth day below its 200 day moving average. The longer the index stays below the long term trendline the greater the inertia to get above it again. As bad as the S&P500 has been it is not the real story. Small caps and nasdaq stocks have been hit harder. The nasdaq composite is down 9% from its August high with many high beta stocks dropping 15% or more. Former leaders from tech, energy and the homebuilding sectors have been hit the hardest, signaling a change is leadership is coming.

We continue to reduce positions and look for new opportunities. I am reluctant to short until it becomes technically feasible. By that I mean I want to see a bounce and evaluate the situation before we make the investment. The market is in the middle of correcting as the smart money positions itself for the new market realities ahead of it. All our Key Market Factors are in flux and with the addition of some new worries this market is likely to be volatile for a while.

Fed Funds Rate Above 4%

Earlier this year I wrote that if the Fed Funds Rate went above 4% we would likely reduce our stock investments. We still feel that neutral is about 4% and rates above that level will likely slow the economy more. From all indications at this time it looks like we were right. Investors believe that 3rd quarter earnings are going to be fine, its beyond that worries them. Ex-energy the S&P500 is expected to grow earnings about 12% this quarter. At this time analysts are only projecting 10% growth for the same group into next year. High energy costs and the perception of rising inflation are backing them up. Our studies show a notable slow down in the economy. This slow down is likely to continue until rates start to fall. Stay tuned as we navigate through this portion of the business cycle and come up with profitable positions. You can see what we are doing by visiting our website at

  • MESA - The airline group has been beaten pretty badly over the last several years. Most of the majors are in re-organization; now opportunities exist for savvy competitors. MESA is one that looks to be one taking advantage of the situation. We are looking at MESA and calculate its intrinsic value at $19/share (currently it is trading at $9.5/share). If higher rates bring down fuel costs airlines are positioned to profit as consumers have become acclimated to higher prices. We are likely to add a position on a pull back.

Sunday, October 09, 2005

Is it Time for Bold Moves?

Technical Perspective

If you follow this blog you know that the stock market's slide was pretty well telegraphed. Two days of back to back heavy selling in late September set up a consolidation period (probably end of quarter window dressing), a failed rally attempt and more declines last week. Now the S&P500 sits below its 200 day moving average with the nasdaq composite closing in on the long term trend line. Some of the hardest selling in recent memory was executed last week, a sign that market forces are changing and more weakness could follow. Some indicators say that the market is oversold, while others show there are more declines to come. We remain cautious and have reduced many position. Further, we have our eyes on new opportunities both long and short.

Is it Time for Bold Moves?

The smart money is in speculation mode. They will ask themselves the tough questions and are likely to take bold moves in order to be positioned properly. Economic cross currents will collide in the coming weeks as earnings, inflation and energy costs mix to color the future picture for stocks. In addition, other forces are stirring in the back of the mind's of investors: bird flu, terrorism and natural disasters act to change the hue of the stock market.

First, lets consider the latter group. Bird flu is gaining attention as a potential pandemic. Government estimates of up to 1.9 million deaths could result from a US outbreak of the foul threat. SARS quickly clamped down China's economy taking stocks with it. It is feared that a similar outcome could result from a break out of bird flu in any major global economy. Look for the market to be initially shocked if one case is reported in the US, especially given rise of political and media attention. A like response would also occur if cases were reported in any major global economy. I believe the market is yet to discount a bird flu threat, thus look for down side pressure from the disease.

Terrorism is now a market reality and to a certain extent US citizens have become numb to the fact. Depending on the magnitude and logistics of a future terror strike the market is going to act accordingly. I think that some of the market's decline of last week was at least partially attributed to the terror threats in New York and the market will continue to discount an attack more or less depending on the media and the threat.

From a market perspective natural disasters strike hard up front and tend to recover and give back during the rebuilding effort. Hurricane season is nearly over and a major hurricane in the Southeast is unlikely until next year. Barring an earthquake, tornado or other disaster the effects of Katrina and Rita have likely been discounted and perhaps over reacted to by the market. I think the drop in the price of oil and gasoline, in part, is due to a hurricane induced price overshoot.

Far and Away it is the Details in Our Key Market Factors That Will Drive Markets

Without a doubt uncertainty about earnings is what recently drove the stock market lower. Not so much about actual 3rd quarter earnings, rather what might be said (or not) about the future. In my Key Market Factors commentary I address some of the details to be considered for the future of earnings.

Oil NYMEX (negative +) - $61.80 - Higher interest rates and the perception that energy conservation efforts will begin in earnest helped to reduce the price of oil and gasoline last week. Japanese and Korean automakers are stepping up production of hybrid and fuel efficient cars. Only time will tell whether the commodity will drop further, but many energy companies led to the downside last week. If earnings worries were not front and center the recent fall in energy prices would have likely pushed the stock market higher, but that was not the case. Either the market believes that oil prices are going to rise again, which is unlikely given the sell-off in the sector, or stocks are going to be affected by other inflation drivers, which have not risen like energy has. This discontinuity may be due to an asset rotation taking place on the part of large investors. Certainly it means that opportunity exists.

10yr Treasury (positive) - 4.37%- Long term interest rates have risen recently as the Fed appears more hawkish. I thought it was interesting that all Fed Governors came out talking tough on inflation. To me it seemed orchestrated and certainly it affected capital markets. Greenspan seems to be getting what he wants. The talk was enough to squeeze much of the speculative money out of the energy and housing sectors. Although the results are negative for the market in the short term falling energy prices and inflation will strengthen stock prices in the future.

3rd Quarter Earnings (positive -) - 17% - Investors are worried that 3rd quarter earnings are going to fall short of estimates as natural disasters, rising interest rates and a slowing economy have taken their toll. What makes matters worse is the speculation on what might be said about the 4th quarter and beyond; a major reason for the fall in stock prices last week. This week is likely to give a glimpse into what lies ahead for earnings. News from earnings reports are going to drive the market for the foreseeable future. A careful watch of what is happening will give hints about the next business cycle. Stay tuned as we sort through the minutia and make investment decisions for our fund. Visit our website at to see what we are doing.
  • RIO - We are watching Comp Vale Do Rio as the recent decline may be a buying opportunity. If speculators drove up the price of oil beyond its natural value mining stocks stand to benefit. Energy is a major cost for metal producers and profits may accelerate if crude falls further. We sold some shares on technical weakness, however, the stock's technical characteristics look to be strengthening. Visit our website to see what we do.
  • ZHNE - 2.5 million shares of Zhone were quietly traded on Friday, 300% above average daily volume. It appears that the smart money was buying shares on sale. The sector has under performed for a long time, however, it looks to be poised to improve. Jabil Circuits, a large contract manufacturer that specializes in building equipment for the telecom industry, reported solid sales and earnings on September 26. Looking ahead, Jabil said that it was on track to meet analysts estimates. Such activity bodes well for Zhone and others in the sector. We are adding to our position in Zhone.

Tuesday, October 04, 2005

The Smart Money Repositions for 2006


The S&P500 fell hard late yesterday as all of the gains from the last few sessions pulled back to the 1214 support level. A close below this level in the next few days would likely mean further declines. In that case, I would expect a change in leadership and a high level of volatility as large investors build their 2006 positions. The nasdaq composite is in better shape, although it too has fallen below its 50 day moving average. A real challenge for the tech heavy index exists if it fell below 2120.

Based on the magnitude of the sell-off I would say the smart money has begun to reposition their portfolios. The media called it "a sell off on inflation fears", I say it was 3rd quarter earnings jitters and profit taking ahead of a changing business cycle. We are cautiously optimistic however, we have started to make some changes after 10%+ gains to our Focus13 fund in September. Visit our website at to see our current positions.

Below I have listed the top and bottom five performing sectors the last two days. It looks like investors started to move to more defensive sectors as Retail, Metal and Real Estate Operations took it on the chin. Interesting enough Medical Software, Rail and Semiconductor Equipment showed good gains as well as the five below.

Top Five Performing Sectors

1. Diversified Drugs
2. Generic Drugs
3. Building Maintenance
4. Airline
5. Telecom-Fiber Optics

Bottom Five Performers

1. Computer Peripheral Equipment
2. US Oil & Gas Explorers and Production
3. Integrated Oil
4. Commercial Builders
5. Oil and Gas Drillers

  • NTES - Chinese internet stocks have caught the eye of investors. Even though the nasdaq fell sharply yesterday NTES was able to hold on to 2% gains. Recently the Chinese Government announced plans to combat online gaming addition. As a result companies such as NTES have levied, what amounts to penalty points to over active gamers (gamers who play more than 3 hours at a time). By reducing the amount of "experience" points a player could earn after three hours of play Game Providers feel they will reduce over play by patrons. It has been reported that over 41% of all Chinese gamers play for 4 hours or more. Investors are waking up to the value of these stocks. We have calculated intrinsic value for NTES above $270/share and will likely add shares on a pull back. Further, the company is a component the USX China Index, which is traded on the AMEX.
  • BIDU - So far investors see more value than the, "at best" $45/share value Goldman Sachs and others have put on the shares. It appears that many investors are looking beyond near term earnings growth and are betting will grow faster than expected. We continue to value BIDU in a line with its peers. BIDU has recently been added to the USX China Index, thus increasing demand for its narrow float.
  • SNDA - Shanda Interactive Entertainment is the largest Asian Game Provider, yet a diversion between its stock price and its peers' stock price exists. The company appears to be building technical strength as it has based in the $26-$28 range for the last couple of weeks. In addition, the stock has about 3% of its shares sold short. The company continues to add new games and looks to be growing users beyond its peers with 18.5 million paying accounts. We calculate SNDA's intrinsic value at $114/share well above our 2x IV/Mrkt price rule.

Saturday, October 01, 2005

Its All About Earnings


The S&P500 ended the 3rd quarter above its 50 day moving average (dma) bolting from a sound base of support at the 1215 level on Thursday. Friday's close at a minimum gave confirmation of the move as the index stayed above its intermediate trend line, albeit just. Market internals point to a slightly oversold condition probably a product of end of quarter window dressing by institutions. The nasdaq composite acted similar to the S&P500 although its close was just shy of its 50 dma. Like I mentioned in my previous post, if either index can stretch higher in the near term (close above 1245 on the S&P and 2219 on the nasdaq composite) they would complete a "W" pattern, which is considered very positive by many market technicians. As usual the devil is in the details and only time will tell.

Its All About Earnings

Barring a hurricane or other disaster earnings reports are likely to drive the stock market this month and most of next. Now it is analysts expectations and the footnotes that will test the mettle of investors. Two hurricanes, spiking energy prices and rising interest rates have served to slow consumer confidence and dent the books of many businesses. There will be plenty of blame to go around, however, the smart money will be ever vigilant in sorting the true disaster costs from companies that merely dropped the ball. Executives will have to provide tangible evidence for why their bottom lines were temporally affected. Opportunities will exist for investors who are able to read between the lines. Stay tuned as we sort through the rubble and find profitable gems. Visit our website at to see our positions and their targets. Bookmark it, or better yet add this blog to your reader to get updated when changes are made.

As is the case every year expect money managers, especially the ones who manage for government employees, to re-balance their portfolios by October 31st. Opportunities will exist as managers shift assets into issues they believe will lead next year. Energy, healthcare and tech are the favorites right now but there are no guarantees. On the surface we are looking at tech and insurance as possible turnarounds with energy and commodities continuing to draw our attention. In coming posts I will identify some of these ideas, in fact I have included one below.

Key Factor Update

3rd Quarter Earnings (positive +) - 17.6% -Thompson Financial recently upped its earnings target for the 3rd Quarter. Until now we have use 16% as our year over year growth target for 3rd Quarter earnings. Growth in the energy sector has bumped up analysts estimates again. However, if we remove the energy sector from the S&P500 analysts predict 12% growth, which is not bad as it remains in the double digit range. The up coming quarter will be challenging for money managers as the economy has been in flux and much has shifted. I expect that there will be a change in leadership as investors move away from slowing businesses and into up and comers.

We continue to be cautiously optimistic into the end of the year. We believe that it remains a stock pickers market with increased risk and volatility expected through earnings season. We are likely to add protective puts when prudent to protect our profits and shift into new positions as opportunities present themselves.

  • ZHNE - We recently re-entered a position in Zhone Technologies for all the same reasons we bought it before (we were stop out of our previous entry position). From a market technical perspective the company looks to be bottoming out as the stock pushed above its 200 dma on higher volume. However, 3rd Quarter earnings look to be messy due to the acquisition of Paradyne and a re-balancing of its product mix and may spell further downside for the stock. Currently, we feel that the downside is limited. If investors can get beyond the current spat of corporate re-engineering we feel that the stock has a ways to go. First, Mory Ejabat its CEO is a prolific acquirer. His methods are not always pretty, or successful, but he always cuts his targets to the bone and gets a lot for a little. When he is right he is right and some of his previous buys have been monumentally successful. Second, on Friday the company announced the sale of its ARCA-DACS product line to Verilink. What is significant about the transaction is that in the past the line was the company's main source of revenue as newer more market grabbing lines were developed. We view this as a signal that the umbilical has been cut and management has shifted its focus more fully to the next generation and beyond. Third, many of the company's industry peers have had their market caps double or tripled in the last year. Since Zhone took on this relatively large acquisition during that period we feel that investors have taken a wait and see attitude with the stock. Obviously, we are speculating that the company will integrate successfully and skeptical investors will add ZHNE shares to their portfolios. Lastly and perhaps the most compelling reason to own ZHNE is that the market for Zhone's products is growing. In previous posts I discussed the resurgence of broadband; Zhone is smack in the middle of it.