What is happening in the Market, What are we doing about it? Part 2 of 3

Does the overall market matter to us?
Considering that the Dow has barely moved and we are up 18%+, we have to conclude that it does in the short term but not overall. The Dow has pulled back about 2% but we have lost more ground because of two untimely stock picks (GRP, NTRI) and missing out on the Akamai surge after earnings. The AKAM jump would have brought us a powerful 3% boost this week, so keep the faith.

Our three main areas of focus continue to be technology, energy equipment, and health. We’ve had enough earnings to validate or counter our approach:
TECHNOLOGY IS CRANKING HIGH
The second digital wave is here and kicking in. Call it On Demand Personal Media – digital music/video downloading to a variety of devices: call phones, iPods, and computers.
Start with sales of devices. Best Buy has increased earnings expectations. The systems makers – Apple and Cisco – all reported strong results. I expect Dell will as well. People are buying high end electronics, including $3000 TVs and $300 iPods.
Component suppliers are also announcing strong sales and stronger margins. Seagate, Sandisk and Broadcom for example.
Downloading is taking off.
We are positioned nicely, although we no longer have Akamai. I expect to buy back in to Akamai.

Sandisk slipped this week on ongoing fears of Flash (NAND) memory overcapacity. The proximate cause was Apple announcing plans to drop prices on the low-end iPod Shuffle. Analysts worried about drop in all Flash prices. I think the reality is that this is a product cycle issue. Apple was sold out of the Shuffle over the holidays, so this isn’t an inventory pile-up per se. Apple has post-holidays sales to meet, and the Shuffle was a bit overpriced: a 512MB flashcard runs $25 online while Apple is selling a 512MB Shuffle for $100. (The Shuffle has none of the interface of other iPODS – it’s just a flash card with an on/off switch to play.)
Is fear of oversupply justified? Demand is sure strong. Two months ago supply fears dominated the market. New sources of demand are emerging. The cell phone is adding elements that drive flash memory demand: cameras, MP3, and video TV (ESPN and Sprint announced ESPN live TV cell phones during the Superbowl). Meanwhile, the regular MP3 players will continue to grow. Flash has finally hit a magical price/performance trade off that will drive opportunities. Flash is perfect with devices where size and ruggedness matter – in other words, where a standard hard drive won’t work. New applications could be found in automobiles, for example. And video games. Any energy conscious device will want to move to flash based memory – including Video cameras and notebook PCs.
But Suppliers are charging in.
Recent Sandisk price drops are in response to recent price drops. Sandisk announced during earnings that they would be dropping prices. It may be dropping faster than they anticipated.
However, this is also a product mix issue. Low-end density (i.e. 256MB) Flash memory is softening. Higher end flash is not dropping in price. In fact, the 4GB and 8GB Flash memory prices are up 2% since January.
In the long term, Flash is positioned for amazing growth. In the short term, Sandisk is at the mercy of short term pricing. I think Sandisk can drop costs faster than market prices drop, thereby maintaining margins. If it looks like oversupply is emerging and new devices are not soaking up the excess, we will need to walk away for a while.

Seagate – It’s not a matter of which will win, flash vs hard drives. Hard drives are cheaper per gigabyte, flash is hardier, smaller, and uses less energy. PCs will always be harddrive based, for example. The future will be the end of the DVD and a move to a central jukebox storing music/videos and portable devices that upload a subset of the content. In the near term, notebook computers are continuing to increase their share of total PC sales and there is a shortage of small (2.5”) disk drives.

Akamai – Hey, we were right. Too bad we got hit (barely) by a Stop limit and didn’t buy back in.

ENERGY EQUIPMENT
The premise is that oil prices won’t drop below $40 and commodity prices may soften but remain high enough to continue to justify exploration. As such, equipment seems to be a good play to dodge the pricing vagaries.

GRP, MDR and JOYG are all companies that hit our Stop price limits. I want to see some stability before we buy back in. This is a case of not fighting sentiment. I know these companies have solid business, but we want to get back in when the market shows it agrees.

HEALTH
NTRI has really hurt us – down 20% since purchase. I suspect that this was a case of locking in profits after a major run up. This is a problem with small cap stocks.
But I am staying with them because I think that they are underpriced. When they report earnings in 10 days, they will have ~$0.60 for the year. They will have a 67 P/E while sales are expected to grow 120%+.

I am also looking at TEVA and BRL, generic drug companies. I believe in generics and I suspect Congress will become more inclined to support generics. More immediately, several important drugs are coming off patent this year. The generics have had a good run and softened lately.
Each company has near term catalysts. BRL is targeting Allegra D and the birth control pill Ortho Tri Cyclene. As a company with $450M in sales, the upside potential is strong. They also increased their margins by 2%.
I like TEVA because of their product pipeline but also because of the potential cost savings after they finish the merger with IVAX.

GILD remains interesting as well.

OTHER
We bought E Trade. E Trade’s recent earnings (Jan 23rd) had them beat earnings expectations by 10% with a 22% Y/Y growth.
Ameritrade is a pure play online brokerage, whereas ET is both an online brokerage and offers mortgages. I expect massive re-financing this year, so I see ET as getting a double upside.

A big fact is that trading volume has doubled in the last year. In Millions of shares traded daily, the monthly average is:
Feb-06 2.12
Jan-06 2.23
Dec-05 1.90
Nov-05 2.05
Oct-05 2.26
Sep-05 2.04
Aug-05 1.75
Jul-05 1.78
Jun-05 1.75
May-05 1.79
Apr-05 1.97
Mar-05 1.70
Feb-05 1.46
Jan-05 1.50
Dec-04 1.35
Nov-04 1.38
Oct-04 1.43
Sep-04 1.22
Aug-04 1.16
Jul-04 1.33
Jun-04 1.25
May-04 1.40
Apr-04 1.44
Mar-04 1.40
Feb-04 1.40
Jan-04 1.56

>2.3M <1.15M Avg
2004 0% 10% 1.4M
2005 Jan-June 7% 0% 1.78M
2005 July-Dec 32% 0% 2.05M
2006 69% 0% 2.36M
In 2004, there was only 1 day (Dec 17th 2004) where volume exceeded 2M shares and 10% of the trading days were for under 1.15M shares.
Contrast that with 2005.
In the first half of 2005, 8 days >2.3M shares, no days <1.15M
In the second half of 2005, 32% of the days >2.3M
Not until March 2005 did we start to see volumes >2M shares
By Sept 05, all daily trades are >2M.

What is happening in the Market, What are we doing about it? Part 1 of 3

Are we at an inflection point in the market?
I went back and looked at volatility and created the following analysis.
I tracked the number of days that the Dow high and low moved <100 points, 100-200 points, and >200 points.
Days >200 >100 <100 % TTL Days >200
Feb-06 1 7 0 13%
Jan-06 4 14 2 20%
Dec-05 2 18 1 10%
Nov-05 1 18 2 5%
Oct-05 7 14 0 33%
Sep-05 0 20 1 0%
Aug-05 0 22 1 0%
Jul-05 1 19 0 5%
Jun-05 2 20 0 9%
May-05 2 18 1 10%
Apr-05 11 10 0 52%
Mar-05 2 19 1 9%
Feb-05 1 18 0 5%
Jan-05 2 18 0 10%
Dec-04 1 19 2 5%
Nov-04 2 18 1 10%
Oct-04 4 17 0 19%
Sep-04 0 20 1 0%
Aug-04 1 20 1 5%
Jul-04 4 17 0 19%
Jun-04 0 21 0 0%
May-04 5 15 0 25%
Apr-04 6 15 0 29%
Mar-04 3 20 0 13%
Feb-04 6 13 0 32%
Jan-04 6 14 0 30%

This is I am tracking daily volatility by looking at the difference between the daily high and lows of the Dow. Then I am counting the number of days that the volatility exceeded 200 points. I then look at the ratio of 200+ point days as a share of total trading days.

The period Jan04~May 04 was a period of high volatility. This was also a major inflection point – the Dow had zipped up almost 3000 points.

The volatility neatly tracks large downward turning points in the market.
Jan~May 04 – Market tanked 800 points
July 04 – Market tanked 700 points
Oct 04 – Market tanked 500 points
Apr 05 – Market tanked 800 points
Oct 05 – Market tanked 400 points
Jan/Feb 06 – Market hasn’t moved but has bounced around 300 points 3 times

I also tracked the number of times the Dow closed up or down >100 points.
This happened >20% of the trading days
Jan-May 04 - lots of 30%+ months
Aug & Oct 04
Apr-May 05
Oct 05
Feb 06 (insufficient data to use as a trend)

What are my takeaways:
1. For the past 2 years, volatility is always downward
2. Dow climbs back gradually and steadily afterwards
3. Large intraday fluctuations translate into declines
4. The recent volatility (Jan/Feb 06) has been a combination of sharp and sharp down movements within one month, whereas most upside movement in the past has been more gradual

2004 was typified by a series of 3 month cycles swinging 6% up and down and 2005 was typified by two 6 month cycles ~7% up and down. These track quarterly results quite nicely. It is possible that 2006 will continue this 6 month cycle where we ease back down to 10300 by May and then move again.
But I think we will actually continue to go up or stay flat because 2004 and 2005 were very much influenced by oil shocks. Oil is not going to be as volatile.

http://finance.yahoo.com/q/bc?s=%5EDJUSEN&t=5y&l=on&z=m&q=l&c=%5EDJI
I can't paste a chart, so this is a link to the Dow Jones versus the Dow Jones energy Index.
2001-2002 are pretty much the recession period and beginning of the rebound. At this time, the Dow and the Energy move fairly the same.
2003 is the year of return – the Business cycle is firmly kicking in and both indices are returning to pre-recession levels.
And then things change. Energy surges and the Dow goes nowhere.

http://finance.yahoo.com/q/bc?s=%5EDJUSEN&t=1y&l=on&z=m&q=l&c=%5EDJI
The same chart but at a 2 year snapshot
Energy rose 10% in June 04, and the market tanked July 04
Energy rose a further 15% in Sept 04, and the market tanked Oct 04
Energy was flat until Jan 05, the Dow rose 1000 points
Energy surged 25% Jan-Feb 05 and stays there, Market tanks April 05
Energy surges 40% May – Sept 05, no change in the Market until Oct 05 when the market tanks
Energy softens and drifts Oct – Jan, Market rises

It would appear that the market lags rises in energy prices. As if investors don’t think energy prices will affect profits, and then they realize that the opposite may be true.

I am saying that the Dow has been prevented from rising because of oil prices. If oil goes up, expect the Dow to remain constrained. If oil begins to soften, the Dow will go up. I believe that oil will begin to soften unless Iranian tensions flare up and oil remains high for an extended period of time.

My basis for believing this is that the US Business Cycle is entering the phase of overcapacity and slowing demand. Much of that demand will be replaced by India and China for internal use. But much of China’s demand for commodity is actually to meet worldwide demand for finished goods. If that demand slows, so will Chinese demand for raw materials.

A softening of commodity prices is happening in steel already de to overcapacity.

In general, a softening in the cost of raw materials will boost margins and keep the economy humming along.

So I am concluding
1. Volatility has been a guaranteed negative sign for 2 years (and maybe more)
2. The Jan/Feb 06 volatility seems to be an exception. Volatility without downward movement is a sign to me of an upward inflection point. That the market is testing the downside and snapping back sharply.
3. A lot of volatility and the overall inability of the Dow to move has been partly a factor of oil prices
4. Easing or flattening oil prices will enable Dow upside
5. The quarterly cycling of 2004 became 6 month cycles in 2005 as the market tried to move on longer term trends but oil kept pushing it back down. I'd like to thinkn that we could see a beautiful 6 month cycle.

Investing and Trading

Let's compare the results of two companies that we like, that we owned until yesterday, and that released earnings yesterday.
GRP released strong results: earnings doubled and they are on target to double again.
AKAM released strong results: earnings doubled and they are on target to grow more this year.
However the market treated the results differently: GRP sagged whereas AKAM surged. We were stopped out of both, so we took a loss on GRP and we did not get the surge in AKAM.

Both results were consistent with our expectations. Everything I have been saying about the didgital wave has been vindicated by the Cisco and Akamai earnings releases this week.

From the investing side of things, LIVEROCKET continues to pick companies that have strong and growing businesses.
From the trading side of things, we got stung. As I said yesterday before AKAM's release, the market has not rewarded outstanding results, and AKAM could have dropped. Instead it has surged. The vagaries of the market.

We made money on AKAM, and I still like them. There will be bad days ahead - there always are. We will wait for buying opportunities and jump back in. We may not revisit the level that we got out at, but I think AKAM could double this year, and I want a piece of that action, even if I don't get all of it.

Now, that being said. We have the Marvell (MRVL) results on the way. Looking at the sentiment for Cisco and Akamai, I wonder if savvy buyers are seeing what I am seeing. In other words - Marvell could be a big win and get rewarded accordingly.

Stay tuned.

Sell higher, buy back lower

As a result of our re-imposed stop limits, we got out of the following:
JOYG $52.8
MDR $47
AKAM $21.8
GRP $47.5

I love these stocks, so we are going to buy right back in when they stop crashing.
I continue to see the market not rewarding strong performance. A case in point is GRP. Excellent earnings report today - Earnings up ~250% on sales growth of ~30%. Forecasting a nearly doubling of earnings again this year. The market dropped them 10%.

So we'll get in, but wait for the overselling to end.

Notice the positive movements in ET, SNDK, and STX today?

Impact of Stop limits

Were stocks running up prior to earnings and now easing up post earnings? Did we maximize our returns or leave money on the table?

I think we did just fine.
1. Almost all of our stocks went up dramatically over the past 2 weeks
2. The easing from recent (2 week) highs is ~10%, but we would rarely be able to have taken advantage given our stop loss approach that leaves a buffer of 5%~10%.

I saw the volatility and judged it to be in the 5% range. I made a judgment call that we would not play that volatility – that is, sell high, buy lower. My concern was that this tactic can cause more pain and disruption than it does lock in gains.
To what extent is this true?

These were our stops on Jan 23, 2 weeks ago
GILD - $56 Now trading at $60. We missed out on incremental 7%
MRVL – $60 Now trading at $66.5. No ImpactJLG - $47 Now trading at $54 No impactJOYG -$43 Now trading at $51 No impactMDR - $47.5 Now trading at $47.3. Almost no impactAKAM - $22 Now trading at $22. No impactSTX - $24 Now trading at $24.8 No impactGRP - $48 Now trading at $45. ImpactSNDK - $67. Now trading at $62. Impact

Could we have been more aggressive with our stops? Allowing for a 6% buffer on their highs, what could have happened if we had put stops in and moved them?
GILD – Ran up incremental 7%. Lost $4
MRVL – Ran up incremental 15% to $73 before easing back to ~$67. Could have locked in +$2
JLG – Ran up 8% to $56 before easing to $54. No impact
JOYG – Ran up 25% to $57 before easing to $51. Could have locked in +$2.5
MDR – Ran up 4% to $52 before easing to $47.5. Could have locked in +$1.
AKAM – Ran up 4% to $23 before easing to $22. No impact
STX – Ran up 4% to $26.5 before easing to $25 after paying an $0.08 dividend. No impact.
GRP – Never went up. Stop at $48 would have saved $0.5
SNDK, ET & NTRI – Never set stop

So we could have left the stops and would have lost money on one stock and made money on 4 stocks. The net total was a virtual wash.

The real problem is that 2 stocks we bought went down hard: GRP (-10%, NTRI – 25%).
many people would argue that you don't buy during earnings season. Wrong. As I point out above, almost all of our stocks rose during this earnings season.

But I do not like the market sentiment over the last week and set some tight stops. I like these stocks and plan to buy back in when I see some bottoming out.

Cisco and Carnage in the Market

Cisco's earnings
Good news. The results were solid and earnings were strong. Most improtantly, Cisco reported a book-to-bill ratio >1. In fact, underlying the report was an acclerating sales picture. In light of Juniper's struggling earnings, this is a sign that Cisco is winning the high end router market.

Sure, there were areas that could be picked apart. For example, the Accounts Receivables Days outsanding grew from 31 days to 35. The extra 4 days probably cost Cisco a few million in earnings.

For those who know me from elsewhere, I have commented before that Analysts were hugely overstating the impact of stock option expensing. The longer Cisco remains <$25, the more likely the expensing will be small and diminishing. (It comes down to the fact that the only options of value <$25 are from 1997~1998 and 2001~2005. The 1997 & 1998 options are more critical because of the volume due to the 4 splits. Regardless of the period (1997/98 or 2001~05), the options are barely $10 profit each at most at the strike price and $25 stock price. In effect, there just isn't much options exposure.)

Cisco's results were critical in light of the string of poor results. Commodities have begun their slide, as I predicted they would. That was bad for commodities, but excellent for oil sonsumers and manufacturers. Housing is slowing, which again was obvious, and which is bad for producers but excellent for homebuyers and renters.

Welcome to the contradictory and irrational ways of the market. Yesterday the fear was inflation, and so the market sold. Today, falling commodity prices and potentially falling home prices reduce the potential for interest rate hikes, and so the market sold.

It means that the market is locking in prices. And as always, it will be oversold before it comes back.

The central question we want to answer is have the fundamentals of our companies changed.
Well, in some slight ways, yes.
ET is enjoying a lot of this crazy trading activity.
Oil prices and commodity prices are slipping but remain above the critical levels where equipment demand will slow. Prices would have to slip another 30% for that to happen. Recent oil movements are due more to Iran interference and seasonally warmer weathers. Commodity prices are slipping but I think we have another year before the critical levels are within our sights.
Technology is strong, strong, strong.
AKAM is a who's who of online retailers and online information companies (Apple iTunes, Yahoo, Schwab & ET). I expect upside surprise.
Marvell should be super string based on the larger than expected sales of their end users (iPods, Seagate hard drives, Cisco gear)

So fundamentals remain strong. The only question is the degree to which market sentiment is adding to or subtracting from the stock premiums.

New Stops

Ok, the market is telling us that it agrees with my more worrisome comments.
It is beating up on all stocks. All stocks. This is not just taking money off the table or a technical correction. This is fear.

Cisco earnings release is critical. It could stem the fear or spark a selloff.
Let's hedge ourselves (even though it feels late) to prevent further losses.

These stops are defensive and I really don't want to sell. But if the fire alarm is being pulled and it's time to exit, let's go. (I took the STOPS off 2 weeks ago because I saw the volatility but I am putting them back on because I am seeing a run for the exits)
MRVL $65.5
JLG $53.5
JOYG $52.8
MDR $47
AKAM $21.8
STX $24.2
GRP $47.5
SNDK $61
ET $21
ntri none (this is ugly. I think they are just getting beaten up and will come back swinging, but it may take a few months. I'd rather wait than take the loss)

Week 13 Performance

Performance to Date (since inception Nov 3rd)
(Nov 3rd - Dow closed 10522, S&P closed 1219, NASDAQ 2169)
Broader market gain: 2.6% Dow, 3.7% S&P, 4.3% NASDAQ
LIVEROCKET gain: 19.55%

Performance Year to Date - Up 9.16%
(Dec 30th close- 10717 Dow, 1248 S&P, 2205 NASDAQ. LIVEROCKET VALUE $109,015)Broader market gain: 0.71% Dow, 1.28% S&P, 2.59% NASDAQ
LIVEROCKET gain: 9.16%

Stock Performance Overview
Stock Growth >40% 2 out of 21
Stock Growth >30% 1 out of 21
Stock growth >20% 1 out of 21
Stock Growth >10% 4 out of 21
Stock Growth 5%~10% 4 out of 21
Stock growth 0%~5% 3 out of 21
Stock growth <0% 6 out of 21

Week 13 Performance
Broader market loss: -1.05% Dow, -1.56% S&P, -1.82% NASDAQ
LIVEROCKET loss: -2.1%

Stocks up for week: 1 out of 8 (excludes ET and NTRI added mid-week)

Weekly Performance Overview
LIVEROCKET beat Dow/S&P: 9 out of 13 weeks
Dow/S&P beat LIVEROCKET: 2 out of 13 weeks
LIVEROCKET tied Dow/S&P: 2 out of 13 weeks

New STOPS
AKAM - $21.8

A few comments
We bought NTRI and ET on Wednesday. Sadly, NTRI fell 15% same day. That one stock pushed us under the broader market performance for the week.

What happened and what do we do about it?
First of all, sentiment has shifted a bit away from tech stocks for the moment. Last week NASDAQ was the place to be. GOOG, EBAY, and AMZN missed expectations, and I think that triggered a general pull back from tech.

Sentiment is driving both the excitement and the disappointments. It is 4 weeks before we will see pre-earnings excitement. That means a lot of drifting.

There will be some days that will drive volatility. The market remains concerned about possibilities of more rate hikes and worse. GDP grew at a sluggish 1% last quarter. At the same time, inflation fears are rising: energy costs remain high and the impact is starting to appear in CPI. Also, strong employment figures but dropping productivity suggest that salaries are rising, which could trigger both rate hikes and a drop in margins/profitability. Fears of stagflation are popping up.

Let’s be clear. There will be a slowdown at this point of the business cycle. But I see more positives right now. Manufacturing spending us strong. Consumer confidence remains strong. There is a reason why people are able to ask for a raise. I do expect another rate hike.

Wild cards remain, and most of them are negative.
Positive #1 - By the end of this year, I expect US troop reductions in Iraq. Sure, Defense spending is growing, but the sentiment is a powerful positive.
Positive #2 – Commodity prices will drift down, offsetting inflationary pressures
Positive #3 – The world economy continues to integrate, boosting US exports and business and offsetting inflationary pressures. For example, Chilean agriculture now provides a cheap produce alternative.
Positive #4 – With the housing market slowing, money should flow back to the Equity Market.
Negative #1 – Oil. Iran issues can cause havoc. I don’t know when Caspian Sea oil shipments will kick in, but I think that isn’t this year.
Negative #2 - Housing is slowing down and a bust at the end of the Summer will drive panic. Don’t be fooled by positive signs from housing suppliers like BMHC. BMHC reported increased profits but that doesn’t come from housing demand. Rather it comes from limited supply due to re-building in New Orleans and Florida.
Negative #3 – Slowing economy. As the economy slows, the market will lower expectations and P/Es will slip.
Negative #4 - World demand for US dollars could slip. That would drive up costs of imports like oil.

So the overall theme is a slowing economy with a critical housing bust on the horizon. Other factors can moderate the impact (interest rates, oil, world markets), but the tone is not positive.

Our response is as follows:
Keep the faith. Many of our stocks are up since last week. In fact, we are almost back up to our Week 12 levels (21.5%)
Technology is experiencing a second wave. A friend of mine sent me a heads-up about a company called Modeo. They will be offering TV broadcasts to your cell phone.
Stock market activity is booming and consolidation continues.
Fuel continues to be valuable and we are positioned nicely
Things may bounce for the next 4 weeks on no news. By March, pre-earnings excitement will be kicking in again.

AKAM – They will be announcing tomorrow. I expect some good news but the market has been incredibly unforgiving lately. I don’t like AKAM’s recent softness and want to be sure that we lock in a strong performance. Set a STOP at 21.8. We can always buy back in if they slip.
SNDK – There continues to be some softness here. With cell phone companies gearing up to offer more features and functionality, demand for flash memory has never looked more promising.
NTRI – They committed to 300% growth and have a forward P/E of 30. Enough said.
MDR – Softness from an asbestos bill on the Senate floor. MDR has a subsidiary with exposure to asbestos lawsuits and this bill would offer protection. All Asbestos linked companies are facing similar price pressure.