A brief lesson from GDP history

In the fourth quarter of
last year, the GDP growth rate fell to an anemic 1.7%
, sparking fears
of recession. However, all signs are now pointing to a strong rebound in the
first quarter GDP numbers due on April 28th. Based on this anticipated rebound,
there is a growing presumption that the economy is “back on track.” It is
important, however, not to be deceived by robust growth in the possible last
stages of an expansion. The accompanying figures explains why, and why, as I
have been warning, that this economy feels a lot like the 2000 economy.

In the first quarter of 2000, real GDP growth fell from a knockout 7.3% to a
meager 1.0%, sparking fears of recession. However, in the second quarter, growth
bounced back sharply to 6.4% and most everyone once again breathed a sign of
relief. That was premature. By the next quarter, GDP went negative and really
never breached 3% again until the second quarter of 2003.

The possible parallel to the current situation should be obvious. Even if we get
a blowout GDP number for this quarter as a rebound from last (estimated as high
as 5% or more), that doesn’t mean that higher interest rates, higher commodity
prices, a persistent oil price shock, and a slow motion collapse in the housing
sector won’t bring a repeat of the slow-growth 2001 scenario — and validate the
yield curve inversions signaling trouble ahead.

 

This Week’s Market Movers — National Inflation Week

The week will start off slow but quickly pick up inflationary steam. The
producer price index hits on Tuesday and the CPI on Wednesday. At this juncture,
these are two of the most important reports in the data portfolio because the
big question facing the Fed is whether inflationary pressures are getting ready
to burst out of control.

The consensus has the PPI decelerating from last month’s jump to a manageable
core rate. Any upside surprise would send a jolt through the markets.

The CPI is expected to inch upward on the basis of rising medical costs and
diminishing auto incentives. It is unlikely that the CPI will provide any succor
to the “one and done crowd.” Watch this on carefully.

Other reports of interest will be housing starts on Tuesday, which should show
continuing weakness, and the Fed minutes from the last March 28 FOMC meeting —
always an exciting read for the geeks.

Portfolio Shorts and Longs — Know When to Hold’em &
Fold’em

I added nothing this week at took some defensive action, paring holdings in IMAX
and STAA. I’m holding AKSY, a hemodialysis play; Acacia Research
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, a
genetics play; Spherix
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, a biotechy sweetener play, Synergetics
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,
a glaucoma microsurgery play; SVA, the bird flu play; XING, the China mobile
telephone play’ and Xoma
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, which manufactures antibodies and other
genetically-engineered protein products to treat immunological and inflammatory
disorders, cancer, and infectious diseases. My star of the week was DVSA, which
I added to. It is benefiting from the ethanol boom.

I’m remain short QQQQ, and had a week back towards the green. I also continue to
be short the financial sector ETF XLF — and discount all that nonsense about how
higher long term bond yields are going to offer more profitable spreads (hey,
it’s still only 25 basis points).

Davio’s Hedging Your Bets: It’s “Different” This Time —
Or Not!

In 2000, the conventional wisdom said it’s different this time when the yield
curve inverted. The rationale then was it was an “artificial inversion” due to
the low outstanding amount of thirty-year treasuries so no recession would be
forthcoming. We all know what happened then.

Today, we’re again told that it’s different this time. The new rationale is
because China and Japan are buying US Treasuries, they are thereby keeping
yields on long-term paper artificially low. This leads us to ask, If Europeans
or Americans were the ones buying bonds instead of the Chinese or Japanese,
would it still be artificial buying?

The 10-year rates closed Friday at 5.036% and the 30-year is well over 5.12%.
There is a clear “slowing” in real estate nationwide particularly in the fast
moving west coast California markets and southwest Arizona and Nevada along with
some of the stronger east coast markets in Florida, Washington, D.C., and
Boston. Foreclosures are at 20-year highs and in places like Denver, it is
downright ugly. Lending constraints are also beginning to tighten down. The jobs
continue to come in “just right” according to the BLS numbers, but when you dig
down and dirty, most of the jobs appear to be marginal at best, with the service
and Real Estate sectors driving most opportunities.

With manufacturing jobs disappearing and interest rates rising, here’s my
question: Is the growth in Real Estate, which has recently gone parabolic, going
to continue? My bet is not.

Wage growth in the US is flat at best. Higher interest rates will cause some
major economic slowdowns in the next 3 months to a year as rates for ARM’s and
exotic mortgages are reset in a big way.

Consider this: When a 400k home is reset at the higher interest rates of today,
most people will see a full $1,000 a month difference in their payments. Where
will the strapped consumer who used the housing ATM to finance purchases the
past 4 years get this additional income? Maybe they will have to sell that house
and downsize. Maybe, their neighbors will be doing the same thing.

It really is a fine line that the Fed has drawn in some very thin sand. I hope
Ben Bernanke is a true artist because I don’t see how the higher interest rates
and higher commodity price inflation will translate to anything but lower
consumption over the next few years. The parabolic move we had in real estate is
first going to slow and then revert to a mean. In this process, I would not be
surprised to see Real Estate move swiftly down and cause a big ripple in the
economy.

The broader point here is to show that this certainly won’t be the first or last
time we ever hear the term it’s different this time. However, we should be on
guard, because whenever we hear it’s different, it usually isn’t.

Vaino’s Biotech Corner: Celgene (CELG) — A Beaten Down
Value Play?

Things have been ugly for biotech stocks these past few weeks. Biotech ETF IBB
has dropped almost 10% in the past month. The “Market Map” section of the
Markets Data Center at WSJ.com definitely shows rotation out of biotech and
pharmaceuticals and into industrials, telecommunications, and basic materials.
Oil, gas, steel, and gold prices have been on a tear lately.

Biotech stocks should be more dependent on science, that is clinical trials,
than on the business cycle. Typically, they are considered a defensive position
in a bearish market. I’ll leave reading the business cycle tea leaves to those
more qualified. By this I mean the simultaneous shift into industrials and
metals, and out of healthcare, baffles me. What I care about is that this dip
provides some good buying opportunities.

When stock prices of good companies fall for no rational reason, that’s a good
time to buy. Celgene
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is an example of a good company caught in a
market down draft. An article last week in The Wall Street Journal questioning
how much higher CELG can go didn’t help matters. In the last week of March, CELG
was trading 400% higher than in March 2004. CELG traded at $44 on March 31 and
closed at $36.59 on April 11. Ouch!

Celgene is a solid company with a good pipeline. They received FDA approval late
last year for Revlimid, which is a much more effective version of the currently
marketed Thalidomid; and they are also applying for approval in Europe.

Revlimid works by inhibiting the growth of new blood vessels required to support
tumors; my chemistry buddies refer to this as angiogenesis inhibition. Revlimid
has been proven effective to treat multiple myelomas. It also has the potential
to treat a range of solid tumors. Clinical studies in support of this are
underway. I think Revlimid is going to be big, and that it will give Avastin
(from Genentech) a run for the money.

My bottom is this: Stock prices are just future earnings divided by risk. I
don’t think CELG is riskier today than it was two weeks ago. Celgene has been
taken down by an ornery market, not by any weak scientific underpinnings. This
type of irrationality always gets corrected. CELG will report Q1 results late
this month or early in May, and I’m increasing my long position in anticipation.

Peter Navarro is a business
professor at the University of California and the author of the best-selling
investment book “If It Rains in Brazil, Buy Starbucks.” His latest book is The
Well-Timed Strategy.”

Matt Davio is a an avid University of Michigan fan and alum and a managing
partner at the hedge fund, Red Rock Capital Fund. Catch his Daily Blog or send
him an email at redrock@peternavarro.com

Andrew Vaino is a Ph.D. chemist who spent two years at The Scripps Research
Institute in La Jolla, CA, working in the laboratories of Nobel-Laureate Barry
Sharpless and Kim Janda. He currently teaches at The University of Maine, where
his research group is focused on exploring the interface between enzymology,
organic chemistry, and nanotechnology.

Disclaimer: This newsletter is written for educational purposes only. By no
means do any of its contents recommend, advocate or urge the buying, selling, or
holding of any financial instrument whatsoever. Trading and investing involves
high levels of risk. The authors express personal opinions and will not assume
any responsibility whatsoever for the actions of the reader. The authors may or
may not have positions in the financial instruments discussed in this
newsletter. Future results can be dramatically different from the opinions
expressed herein. Past performance does not guarantee future performance.