Week 17 Performance - Up 4%

Week 17
Dow -0.85%
S&P 0%
NASDAQ 0.88%
LiveRocket 4.04%

YTD
Dow 2.84%
S&P 3.13%
NASDAQ 4.4%
LiveRocket 12.8%

Since Inception
Dow 4.7%
S&P 5.6%
NASDAQ 6.1%
LiveRocket 23.54%

The 2nd down week for the DOW while the NASDAQ continues to climb. In just 2 months, the NASDAQ has separated 1.4%. This reinforces the pro-technology message I have been sharing.
We are entering the end of the quiet period. Pre-earnings announcements will begin to kick in. Last week, Intel started by announcing a big miss – they aggressively lowered sales forecasts. AMD is kicking their ass.

Here’s a re-cap of our week’s performance.
FINANCIALS
GHL got a dose of bad press, but at the same time articles are appearing that say 2006 should be a record M&A year. If I didn’t know better, someone with a grudge against GHL spoke to Barrons. The article was right – GHL is flying high, but if the market is surging this year, that matches expectations.

ET – Another nice 2% rise for the week. Hit a 52 week high AND on strong volume
GHL – Flat after a great week before. But strong resistance to the negative Barron’s article. Maybe the fact that in the last 7 days analysts raised earnings expectations for 2006 by 13% helped.

COMMODITIES & EQUIPMENT
JLG – Up 5% after rising 1.5% the week before. The stock hit a new 52 week. This stock is up 64% since we started tracking in early November. in the last 7 days analysts raised earnings expectations for 2006 by 7%.

GRP – Flat for the week, but a lot of volatility: traded in a 10% range. It’s clearly following oil stocks and I don’t like that. I notice that the market is getting nervous about oil related stocks – even equipment ones.

TIE – Flat after a massive 6%+ ride last week. It hit a new 52 week high. I am concerned that some of its customers (MDR) are showing some slowness.

JOYG (on our watch list) – Up 1% for the week. Another phenomenal earnings release and they were sharply rewarded: they had sagged to $50 pre-earnings before surging back to ~$57. But they are giving it back slowly. I still like them, and do want to buy back in on weakness. Especially if they tickly $50~$52 again.

MDR (on our watch list) – Up 4% on a mixed earnings release. On the one hand, they massively missed sales. On the other, earnings surged much higher than expectations. The drop is related to offshore oil drilling. Is oil drilling slowing – I notice that they still have a backlog of $1.8B versus the $1.2B they had last year. That is a book-to-bill ratio >1, but cancellations can always happen. Bottom line – business is healthier than last year but I wonder about growth. Now here’s the kicker: this earnings release excludes the performance of their subsidiary Babcock and Wilcox. B&W will DOUBLE the total sales.

B&W business has grown 7x since last year, from $67M to $422M for Q4. They have a $2.1B backlog and expect to recognize $1.1B in 2006. In the last quarter, B&W earned $36M. In essence, the company value is about to double and I don’t think that the stock reflects that. In the last 7 days, analysts raised earnings expectations for 2006 by 11%.
We are buying back in.

HI TECH
Positive signs for chip makers. Semi chip equipment book-to-bill for January rose from 0.93 to 0.97. Semiconductor sales are equally strong.

From the Semiconductor Industry Association:
Worldwide semiconductor sales in January 2006 hit $19.66 billion — 7% percent higher than the $18.38 billion in January 2005, according to the Semiconductor Industry Association (SIA). However, January 2006 sales reflected a 1.5% sequential decline from the $19.95 billion reported in December 2005. SIA notes that global semiconductor sales in January historically show a 2.2% average sequential decline following the seasonally strong fourth quarter.

"The new year got off to a good start for the global semiconductor industry with strong year-on-year growth in a historically weak month," says George Scalise, SIA president. "Retail sales, including consumer electronics products, were relatively strong in January and helped dampen the expected seasonal decline in sales. The industry entered the new year in a healthy condition. There are no excess inventories, end market demand remains strong, and capacity utilization rates are very high. There are signs of recovery in the market for networking equipment, and reports from manufacturers of personal computers and cell phones reflect continued optimism."

SIA points out that overall capacity utilization increased from 90 to 92% (emphasis mine) in the fourth quarter of 2005. Leading-edge capacity utilization, meaning facilities capable of producing 0.12-µm and finer geometries, increased from 97 to 99%
Capacity constrained means pricing power. And it takes a while to turn up new manufacturing facilities.

STX – Up 10% after a 6%+ drop last week. I didn’t like last week’s weakness because I saw no reason – same problem this week, I don’t know what is causing the strength. It hit a new 52 week high.
MRVL – Up 2% after a flat week. We need to watch them very closely. They already gave up whatever bounce they got from their earnings release.
TRID – Up 3% since the previous week. Hit a new 52 week high. In the last 7 days, analysts have raised 2006 earnings expectations up 15%.
AKAM (on our watch list) – Down ~4%. I think some locking in of profits is going on. Something worth remarking on is the lack of earnings surprises. They are incredibly predictable – analysts don’t even vary in forecasts. That’s boring.
SNDK (On our watch list) - Everyone is piling into Flash memory because of huge demand: now Sandisk is too - investing $500M with Toshiba. I had hoped that Sandisk would benefit from the low-end flash MP3, but that is sluggish. I don't like the potential overcapacity - while total capacity is constrained, semiconductor companies can change the product mix. For example, fewer DRAM and more Flash memory.

HEALTH
NTRI – Down 10% for the week – giving up almost all of their gains. I still believe that this company is poised for continued success. I think that they will need to show a fabulous quarter this time, and I think they will. I noticed that they are featured again on QVC – a great income source. This is when people start thinking about getting in shape, and NTRI is marketing harder to attract them. In the past week, analysts raised 2006 earnings expectations 12%.

TEVA (on our watch list) - I like this generics company and I like the way more Pharmaceutical companies are suing to stop them. Whenever companies resort to lawsuits as marketing, then they are struggling. And at a certain point, even Congress will begin to notice the flurry of lawsuits designed to achieve exactly one thing - disrupting access to cheaper medications.

GILD (on our watch list) - I like this biotech company. I will probably buy the next time they go below $60


STOP LOSS (new in red)
ET - $23.5
GHL - $62
JLG - $56
STX - $25
GRP - $40
TIE - $39
TRID - none
MRVL - none
NTRI - none

A Brief Overview of The Business Cycle

The business cycle demands attention to housing, finance, and resources. Additionally, we continue to focus on a few select trends: consumer technology and health.

What is the business cycle? The idea that the basic economy moves in a 4 part cycle and that investing can succeed by following the cycle. Here is an approximate way to think about it:
Part 1 – Post recession. Manufacturing is picking up, consumer spending is still uncertain. Corporate fundamentals are stabilizing. Invest in equities. Avoid bonds.
Part 2 – Growth. Demand is strong across all sectors. Interest rates begin to rise. Invest in equities, finance stocks and commodities (companies begin to experience pricing power). Unemployment drops. Avoid bonds.
Part 3 – Coasting. People have bought what they need, interest rates continue to rise to moderate growth. Signs of oversupply and overinvestment begin to show. Unemployment continues to be low. Avoid commodities and start to shift away from equities and towards bonds.
Part 4 – Downturn. Demand is dropping. Interest rates begin to drop. Buy bonds.

As you can see, anticipating the next phase allows one to shift away from softening sectors and into ramping sectors.

I think that we are entering Part 3. Housing is slowing. Consumer durable purchases are slowing. Interest rates are slowing their rise. Commodity prices are starting to soften and consolidations are picking up (a basic way to leverage a cash stockpile and show additional profit growth).

Here’s a great chart of historical economic activity; it shows the biz cycle in action
http://jec.senate.gov/_files/ISM3Mar2006.pdf
Start with the blue line for manufacturing activity: it began slowing in 2000 until bottoming out in 2001. It drifted until 2003 and was strong for 2004. It remained stable and string in 2005 (though not nearly as strong as 2004).
2002~2003 – Part 1. Growth but not solid.
2004~2005 – Part 2. Solid growth. Demand for consumer durables and commodities surges.

Lets shift now to the numbers.
GDP Growth – In Q4 2005, GDP grew at its slowest rate in three years — 1.1%, which is down from 4.1% growth in the third quarter. (Here’s a great chart http://jec.senate.gov/index.cfm?FuseAction=Charts.Detail&Image_id=136)
Before we panic, look at that chart and you’ll see that Q4 is always the weakest quarter. Which makes sense – it’s the big shopping season and manufacturing and inventory buildup peaks in Q3 as retailers and producers stock up. Q3 2005 was quite respectable compared to Q3 2004.

First of all, Q3 was all about dealing with Hurricanes. That cooled as we moved into Q4. Second, consumer spending is slowing. Ummm, that’s exactly what we should expect to see: that’s what the Fed is driving towards. Housing and cars in particular dropped: two sectors sensitive to interest rates. But I think another factor is at work here: buyer exhaustion. Starting in 2001 and accelerating in 2002, consumers were invited to spend spend spend. New cars, new washing machines, new houses. People don’t need to replace all of this new stuff just 3 years later. Come on – did anyone expect this level of spending to continue???

As spending starts to slow, inventory buildsup: bingo! That happened in Q4. Next, excess inventory gets dumped and imports sag a bit.
That will hit earnings – highflying tech stocks will get hit as will any company selling consumer products with overly aggressive expectations. Earnings will grow at slower rates.
We want to find the products where prices are not dropping: Mobile entertainment and home entertainment, Titanium, healthcare.

Our 2006 approach should be that consumers are catching their breath in the 1st half (repairing their balance sheets, paying taxes) and then things will pick up in the 2nd half. We will begin to see lower consumer spending and lower corporate earnings. The economy has plenty of legs and should enter Phase 3 next year. But stock prices will be under threat.

The housing bubble pop will show strongly at the end of the Summer and certainly in 2007. The Housing boom is responsible for ~40% of all job growth in the past 5 years, as well as the bulk of the GDP growth. When that carpet gets pulled out, the economy won’t trip – it will fall.

Against this background are stable growth, stable inflation, and some global growth. Dollar strength will lower commodity prices and oil, but that props up margins only so much (unless you are hugely impacted by imports or commodities – airplanes and trucking, for example).

I am therefore focused on markets that are still showing string growth and stocks that continue to have strong pricing power in those markets.