Something Has To Give–Here’s What I Think

Hedging Your Bets With Matt Davio: Summertime earnings
fest!

NOTICE: Just as companies report their earnings, so does my Red Rock Fund. If
you are an accredited investor and would like a copy of the latest report,
please contact me at redrock@peternavarro.com. We are very pleased with our
results year to date and would be happy to share them with qualified investors.

As we bring July of 05 to a close, we see a very interesting earnings season
winding down. August rings in with US Equity markets at a 4-year high, which
Financial TV seems to think this is a good thing. I just see the 4-year interim
high as a bull market run within a bigger picture bear market that still hasn’t
completed its final run to the depths of the subterranean. Let’s look at some
stats:

· The NDX is still down 1% for the year even after the 7% naked bull rush we had
in July. So is tech all that hot?

· The SPX is up nearly 2% now for the calendar year after its 4% move in July.
The larger INDU is now down 1% for the first 7 months of 2005 — this following
a near 3% move in July.

· Oil is now sitting closed over the $60 per barrel monthly closing figure and
is up over 43% for the first 7 months of 2005.

· The housing index HGX is now up a cool 23% for the 2005 run. This seems like
an amazing run for housing — but not really when you view the 10 year T Bills
are still locked in lower than low historical rates, closing @ 4.286% on Friday.
(By the way, this is the highest monthly close we have seen on the 10 year since
November of 2004 while rates are slowly creeping up with or without the Fed’s
efforts.)

So what do all these lovely stats give us? In our opinion we have an overly
saturated housing/real estate market that just can’t lose money for people
piling into the sector. That is until the music stops playing, and to me that
music will continue playing until the silence is deafening.

Greenspan will remain Fed Chairman until January of 06, so I don’t expect much
desired change with his current course of nothing’s new with the interest rates
right up to the point he sails into retirement. I also believe, when history is
written, Greenspan will ultimately be viewed not as an oracle but the creator of
the two biggest asset bubbles in history, that being the US Equity bubble of the
late 90’s and the current Asset Explosion of Real Estate.

By the way, I don’t like the word ‘bubble’ so much as it is over-utilized and
generalized. However, I do believe that the asset class of Real Estate will
ultimately pull back and the false wealth via Real Estate that has been created
over the past 15 plus years of easy leverage, will ultimately correct, more on
the lines of 20-40%.

In this regard, the low interest rates and the lending industry have created an
environment where if you can fog a mirror you can get a no money down mortgage.
It’s just that easy. And don’t worry about the ARM you are in. You can refinance
in a year because your property will go up 20% a year.

I believe this mentality will catch up to overleveraged buyers, just as the
margin call does for equity buyers of the late 90s when prices begin to drip and
buyers dry out. Without liquidity, your prices will be forced lower.

Note that it won’t be higher interest rates that drive housing lower. Rather, I
believe it will be an unforeseen slowdown that has already begun in the edges of
this country, with Boston and California flattening of late. The 3-6 month true
lag in real estate closings is not viewed as readily as it is actually occurring
in markets across the country.

The bottom line: Be careful out there, something has to give, all asset classes
can’t be right at the same time as we have seen for the past 2.5 years. Stocks,
Bonds, Oil, Real Estate, Precious Metals, Commodities, etc. — all of these
asset classes have blindly followed the path of least resistance over the past 3
years due to easy credit conditions and lower interest rates. I truly don’t see
the job explosion in this country nor the wages rising to justify such growth. I
don’t know when the music and the fat lady will begin singing. When the
liquidity valves are closed, and we know these cycles always come to a close, I
would want to make sure some chips are dry as that is when values are truly
found, when fire sales are caused and prices come down.

Navarro’s Broad Market Outlook: The Bamboozled Curtain,
Part Two

Last week, I noted how the financial press got snookered by the Chinese
“revaluation.” This week, there is even more evidence that the very modest
revaluation was the beginning of something bigger but a one-shot deal, where
future shots will be triggered whenever politics dictates.

More broadly, unless the U.S. learns to play the Chinese game of perennial false
promises —we promise to revalue the yuan, we promise to lower trade barriers, we
promise not to subsidize our industries, we promise not to steal your
technology, etc. — our entrepreneurs are going to get whupped by their
entrepreneurs.

As for the market, we are officially into the summer dog days where volume will
likely be light and a trading range is likely to settle in.

Portfolio Musings: Penny Ante Stuff

Damn that Bill Frisky, coming out for stem cell research. He forced me to
reinvest in some stem cell plays, with STEM and ASTM my chosen two this day. I
need to just sit on these stocks for the next several years and not trade them
like orange juice futures.

Closed out CPTCQ.OB again with a small gain as it started to act funky again.
Never know what the insiders are doing and any sign of downdraft can always mean
bad news. Nice product, lousy management. Bailed on VWPT with a small loss as I
indicated I might in last week’s missive — turned out to be a pure mo-mo play
without legs.

Holding ARTX, IBS, NTOP, PDYN — all decent technical plays going nowhere as yet.

Added some drug pennies for longer term: PPHM, PRCS, TRPH — with only TRPH
showing a bit of weakness.

Glad I doubled down on ARDI and now tripled down on ZILA. Finally back in the
ZILA green and like the looks of both, with ARDI having a decent earnings and
ZILA simply a good long term play. In this vein, VION also behaving very nicely
while SVA finally had a decent week again.

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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.