Weekly Research from August 2008

August 24, 2008

LEH’s top peanut hawkers are working the crowd to elicit a white knight as media reports of rising counterparty risk return. Once again, U.S. investment banks are hunting abroad for money. The economic jig saw puzzle continues to frustrate investors as see-saw market action on light volume whipsaws buyers.

The market mayhem provides little incentive for risk. Despite rapid appreciation in July, Financials have failed to attract sustainable buying in August. Q3 is a historically troublesome quarter. September, specifically, has been unkind to NASDAQ. With a backdrop of EPS uncertainty, risk outweighs rewards in many baskets.

Healthcare, following robust early quarter performance, is taking a breather and consolidating gains. Global industrialization continues to increase the world’s middle class, sparking healthcare demand and resulting in rising investment in treatment. In a troubled sea, healthcare is an island. Overweight healthcare through Q3. Big pharma is the next industry to participate, kicking off robust seasonality in September. In election years, healthcare pundits worry over political risk. However, historically, investors embrace healthcare following elections, especially insurers.

The following table shows returns of key healthcare stocks from August of a Presidential election year through the following calendar year ending December. On average, key healthcare names have returned 11.37% of excess to the S&P 500 in the past 5 Presidential Election periods. The basket of names below didn’t post a negative return in any of the periods, with an average return of 28.43%. Historically, the political risk associated with the basket is already reflected in prices going into Election Day.

Returns of Key Large Cap Healthcare Stocks from August of Election year through Following Year
Time Period 8/31/04-12/31/05 8/31/00-12/31/01 8/31/96-12/31/97 8/31/92-12/31/93 8/31/88-12/31/89 Average
JNJ 5.90% 30.70% 36.10% -6.40% 50.90% 23.44%
MRK -23.90% -13.90% 66.40% -26.70% 45.70% 9.52%
ABT -2.60% 30.10% 49.50% 0.19% 50.00% 25.44%
PFE -25.99% -6.48% 113.42% -7.80% 43.51% 23.33%
UNH 88.00% 49.79% 28.75% 78.11% 61.16%
CI 68.10% -2.90% 53.20% 33.00% 30.40% 36.36%
AET 103.70% 18.47% 8.20% 67.00% 27.00% 44.87%
BMY 2.50% 3.40% 123.10% -7.30% 40.60% 32.46%
SGP 14.50% -9.20% 127.10% 20.90% 68.40% 44.34%
GENZ 31.10% 59.50% 16.30% -31.70% 18.80%
AMGN 33.00% -25.50% -7.10% -21.80% 54.50% 6.62%
BIIB -23.70% 48.10% 46.90% -19.30% 13.00%
DNA 89.60% -43.00% 15.50% 56.90% 1.60% 24.12%
Average Return 27.71% 10.70% 52.11% 10.39% 41.26% 28.43%
S&P 500 13.00% -24.30% 48.80% 12.70% 35.10% 17.06%
Avg Excess 14.71% 35.00% 3.31% -2.31% 6.16% 11.37%
Value of $1 through $3.35 $2.63 $2.37 $1.56 $1.41
1988 $1.94 $1.72 $2.27 $1.52 $1.35

Basics sold off ahead of the Olympics on fears of a post-Olympic hangover. Now, as the Olympics close, folks wonder about the impact of restarting shut-in manufacturing. China is already addressing the increase in power demand, instituting another wave of export restriction for coal. Higher taxes will curb Asian supply and support Newcastle prices. Keep a close eye on coal plays and Australian prices to gauge sustainability. M& A continues in coalmining with Severstal paying $1.3bn in cash ($450 a ton) for PA coalminer PBS. Watch U.S. spot coal prices alongside Dollar moves as sustained upside in the Dollar may impact EU driven demand for U.S. mining.

Soybean and corn have both turned up off lows, supporting ag supply. In the first 6 months of 08, Brazil has bought ahead far more fertilizer than last year. We want additional conviction from the DBA, which regained its 200dma this week and is now challenging its 50dma. If the DBA continues up, ag supply will too. Wait for conviction.

Nat gas offers position traders opportunity. Last year, nat gas bottomed in the first week of September, kicking off a 2-month rally. As investors digest global energy demands and levels of GDP risk, nat gas offers significant upside potential. Own high scoring leaders trading above 200 dma’s.


August 18, 2008

Healthcare continues to benefit from risk aversion as investors step aside in GDP sensitive stocks and buy day volumes in oversold sectors remain weak. Industrials and tech also score strong. Financials and basics score weakest. Small cap scores highest.

Overweight healthcare through Q3. The next healthcare industry set to move higher is pharma. Historically, the beginning of September kicks off a rally in drug stocks through February. Biotech, which kicks off positive seasonality in July, has moved up 17.4% (IBB) this quarter and has seasonal legs through next March. The PPH has traded up in 64% of the sessions since July up from 45% in June.

Tech remains hit and miss through the remainder of Q3. Stay focused on high scoring stocks only and let stock scores provide conviction name-by-name.

How much in additional losses remain on bank books? Last week, the WSJ raised questions about WFC’s level 3, mark-to-mystery assets, which climbed $3.3bn to $5.28bn last quarter. Despite the increase in level 3 assets, write-downs were tame. In the post MER self-financed fire-sale world, investors may suffer additional pain. Bank lending requirements in both the U.S. and Europe continue to increase. In the U.S., tighter standards for commercial and industrial lending weigh on GDP. The cost to borrow for companies continues to rise. AIG paid 8.25% for 10 year money and may need to dilute again this year. We remain concerned the energy, as measured in up and down day volumes, associated with the recent rally in financials is fading. The table (above) shows the underperformance of financials so far this month.

U.S. consumer prices rose 5.6% through July, the fastest increase in 17 years. Foreclosures continue to rise and home values continue to fall. Despite the Fed’s liquidity spigot, auto and mortgage rates are climbing. In June and July, gas accounted for 4.4% of consumer spending, above the 3.9% for autos and parts – marking the first time in 26 years consumers spent more on fuel than the vehicle itself. Capacity utilization, which has averaged 81% from 1972-2007, is running at 79.9%. Consumer confidence, however, rose for its first back-to-back gain in 2 years as gas prices fell.

The Dollar posted another solid week, rising for a 5th consecutive week. The UUP is up 8% from its July low with volumes running nearly double July daily averages.

Gold dropped to 8 month lows. China hiked coking coal export taxes beginning August 20th. Australian coal prices will need to rebound to re-energize the basket despite U.S. spot prices remaining strong.

Cooler, wet weather in the Northeast has dampened utility demand and helped fuel the seasonal sell-off in nat gas. Last year, the UNG bottomed in the first week of September (and again in December) as investors begin to bargain hunt on winter utility stockpile builds. Aggressive position traders can consider stepping back into intact leaders and waiting for follow-through.

August 10, 2008


Healthcare is the strongest scoring sector while consumer and basics score weakest. Investors continue to rotate into healthcare and reduce exposure to global GDP risk. Healthcare historically leads in Q3 and so far, healthcare hasn’t disappointed. In the past week, the IYH recovered its 200dma on heavy volume. Biotech benefits as investors reposition EPS risk into news flow risk. The IBB has risen 14.7% this quarter and has traded lower on only 3 days since July 21st. The PPH is beginning to trade higher too, moving up 4.9% this month on rising volumes.

Industrialization of heavily populated developing nations is driving investment in healthcare research and development. A wealthier, longer living population is improving demand for the treatment of chronic disease. Biotech pipelines are increasingly attractive to major pharmaceuticals, prompting recent M&A and boosting takeover premiums. Overweight healthcare for the remainder of Q3.

Large cap stocks post the highest average scores, followed by small cap. The Russell 2K is the first broad market index to challenge its 200dma. The QQQQ is testing resistance, however, the last above average up day on the QQQQ was July 17th.

Financials continue to creep up our sector ranking. Volumes on the major financial ETF’s have been lackluster in August. Financials have moved sharply higher following the regulator inspired short squeeze. Remain focused on high scoring financials and reduce weightings of low scoring as the sector digests resistance. Historically, financials have solid Q3 seasonality. Avoid embracing down-trending financials. Our scores will confirm sustainability – watch individual scores.

Technology remains stock-by-stock. Lackluster Q3 seasonality and EPS risk have weighed on tech during the recent rally. The XLK and SMH have finally begun to trade off July lows. The XLK has yet to have an above average volume up day in August. Remain stock-by-stock in technology and reduce weights to low scoring names.

In consumer, focus on large cap as scores are higher as stocks have benefited from risk reduction. In services, historically an actionable low for Q4 upside in retailers occurs between mid August and mid September.

Basics remain under pressure as investor concern over U.S. growth contagion rises. A post Olympics ramp up in Chinese production could shift supply tightness. Watch closely for commodity import data into China in the final months of 2008. Power shortages continue to support global commodity prices in the face of speculative unwinding. The USDA releases its crop production report on the 12th. Remain on the sidelines until suppliers break current downtrends. Sell volumes in the DBA peaked in the 3rd week of July. Watch for higher volume up days and a continuation of low volume down days. In ’93, the USDA had to reduce its corn production forecast 31% and its soybean forecast by 17%.


August 3, 2008

Healthcare, utilities and basics score highest in our entire universe. Financials, consumer and services score weakest.

Basic industries performed worst in July with the UNG falling 30.43% after losing seasonal tailwinds. The +30 VIX inspired rally produced the greatest monthly return in financial ETF’s. The RKH rose 18.23%. The XLF rose 6.76%. Healthcare was the only basket of technically intact stocks with earnings clarity to perform in July. Historically, healthcare has strong positive seasonality in Q3.

Healthcare is our highest scoring sector. Beta investors have swapped EPS risk for newsflow risk. Despite legislative risk, healthcare, especially biotech have rallied sharply in July. The IBB rose 15.3% last month. Global industrialization is increasing spending on drug therapies and driving R&D. An aging population in developed nations increases the demand for cancer, diabetes and heart disease drugs. The Center for Disease Control has increased its estimates of annual AIDS infection rates from 40k to 56k. Investors will continue to embrace healthcare through Q3. Use down days to buy leaders.

Basics sectors are testing 200dma support levels as investors rotated on Dollar stabilization. The UUP (Dollar) rose 1.33% in July and is closing in on resistance. Watch the Dollar Index carefully as it tests trend lines before committing capital to lagging basics stocks.

The DBA is trading very light volumes. Its last day of above average volumes was 7/23/08. Buyers will wait for conviction and rising volumes. Ag supply stocks offer EPS clarity and can be bought on down days to 200dma support. Investor interest will return on USDA production forecast revisions.

Chinese and Indian coal supplies at utilities remains too low. The pre-Olympic build out of Chinese infrastructure fueled commodity demand. As the Olympics have approached, investors have stepped aside. Watch carefully commodity import data post-Olympics.

Tech remains hit and miss through Q3. In July, the XLK fell 3.5% while the SMH dropped 6.04%. Investors have been unwilling to embrace tech stocks during the Q3 regulator inspired rally. Techs remain weak and stock-by-stock. Own highest scoring only and avoid weak scoring names.

Financials produced sizeable returns in July, however, remain a weak scoring sector. Investors covered shorts on regulatory risk. Historically, bottoms have been elusive when jumpstarted by legislation. MER’s self-financed fire sale does little to stem the wave of write-downs and forces re-valuation for at-risk related investments at competitors. Avoid weak scoring financials and traffic solely in the highest scoring names, which are primarily in small cap.

Consumer and services stocks remain under pressure as job losses increase and wage growth slows. Historically, a better entry into retailers has occurred in late Q3 for Q4 upside. Remain on the sidelines.

Overall, the universe of attractive large cap stocks has not expanded. The number of large cap stocks in our universe trading more than 5% above their 200dma has moved from 52 four weeks ago to 54 last week. The average large cap remains -8.14% below its 200dma. It is too early to declare sustainability of the current rally. The IWM and MDY will be the first broad index ETF’s to challenge resistance. Watch the DJ Transports closely. The IYT rose 0.41% in July and will need to follow through in August for the DJIA to rally further. The final 3 days of July saw the IYT retreat 4.6% on 36% greater volume than July’s average.