Every truth passes through 3 stages before it is recognized. In the first, it is ridiculed. In the second, it is opposed. In the third, it is regarded as self-evident. – Arthur Schopenhauer (German philosopher 1788-1860) quoted on July 12, 2010 in the Commodity Trader’s Almanac
In recent weeks, I have been fielding an unusually higher frequency of inquiries about the direction of the market both at the office and in my community. What I’ve been saying since the Dow Jones Industrial Average hit 11,200 is that if the Dow goes below 10,500 it is likely to go down to 9,200. And that if it closes below 9,200, it could very well test 8,200. (Feel free to use similar percentages and equate them to your favorite index/indicator)
Shocking? Who can question that the rally from 6,500 felt tenuous at best all the way up? The simple truth, in this humble opinion, is that the market is looking past the coming round of (likely) solid, stimulus-boosted, performance-enhanced second and even third quarter earnings releases, and wondering what world governments will do to keep it going.
One of my clients runs a “late-cycle” division of a large industrial company and has been gushing for months about how good earnings look for his space, and probably his competitors too, for many quarters to come. I continue to remind him that the new housing that has been the fuel for the bulk of his orders are being built for no one, and that the backlog of orders he sees could go away literally overnight.
BP? Greece? Europe? These are just the types of excuses the market finds to do what it really should do anyway. The stimulus package certainly saved the market and our financial system from ruin for at least a time, but to expect it to get things back on a growth track like nothing ever happened, is a bit ludicrous, don’t you think? That most important underpinning of the market, faith, was shaken to the core in 2008, and really never returned despite the complacency which abounded as the market got back up above 11,000.
Suddenly, cynical ideas that just a few short years ago were considered radical or ridiculous are quickly becoming mainstream, as some average Joes begin to wonder about the origin of money, and realize just how screwed up and rigged the whole system really is.
That the system is built on debt has never been a big secret, and has basically been true since about 1776 anyway. That the government, in cahoots with Goldman Sachs and JP Morgan, manipulates markets and provides liquidity on those crazy down days, is now practically universally acknowledged. That just a tiny fraction of your checking and savings account balance actually exists still seems a surprise to most, but likely to be talked about more if unemployment worsens or cash shortages continue to cut into municipal services and public leisure destinations.
I could go on and on, and risk sounding like some sort of curmudgeon. But despite some doom and gloom, we’re really “glass half full” people. 8,200 is not a prediction, but a possibility that one must recognize. Leviticus Partners covered most of its shorts at 9,999 just last week. We’ll get short again if it moves back up to 11,000 quickly.
There is a long hard road ahead of us, but shorting the market or stocks is not likely the best way to travel it. Smart fund-of-fund managers are talking “Alpha”. Alpha basically means bucking the market and garnering returns regardless of market direction. We’ve got some good names at Leviticus Partners.
Mr. Bernanke has hinted at solutions that he cannot proclaim outright, which are actually likely to be bullish for the market in the long run. I’m talking about the monetization of our debt to China. No one knows when, but someday, the U.S. Treasury will “annex” the Federal Reserve, print trillions of dollars, and the U.S. will be debt free.
The dollar will finally achieve the desired weakness vs. the Chinese renminbi, the market will go to 18,000 and we will all live happily ever after. No joke. Jobs will come back to our shores, but Chinese interests will own us and our companies. So let’s make some dollars on the best small-cap stocks we can find in the meantime, and for the long-term.
Our trio of genomic companies continues to perform well as genetic testing garners more attention. Accelrys (ACCL) has moved from $4.50 to $6.75 on improving quarterly results and a potential merger that looks like it should be very accretitive to earnings per share with. The merger with Symmx (SMMX) was inevitable, and would increase greatly the chance for Accelrys to become the standard for genetic data gathering and pipelining for research labs worldwide. My target price is $9 before year-end.
Caliper Life Science (CALP) has moved from $1.25 to $4 on good results, non-core divestitures, and new product announcements. The company continues to provide essential tools for high-throughput genetic testing and is a likely takeover candidate itself in 2011 if the new plastic chip we mentioned in our last report begins to gain traction at all.
Transgenomic (TBIO) remains a reward/risk extraordinaire. Results have been fairly steady, the company continues to generate positive free cash flow, but we suspect that some uncertainty caused by some Myriad Genetic patents getting overturned has scared some investors away from the space. Our sense is that the new patent rulings may actually be to the benefit of diagnostic companies such as TBIO who do not seem to need to control a patent on a gene itself, and will thrive in the more “open” playing field.
Analyst International (ANLY) does not seem to be working out very well and should be sold if it gets back up around $3.50 per share. The CEO was sacked as it seems he tried to get the company out of technology staffing too aggressively and just as the market for technology and staffing was turning. Traction in the government and municipal marketplace has been fleeting. ANLY could possibly get to $5, but it is one to unload on strength.
Socket Mobile (SCKT) managed to get shareholder approval for a revised stock option plan which was quite generous to management and essentially hosed existing shareholders. Nonetheless, the stock retains at a small market capitalization given the upside and shareholders will win if management wins. This risky stock remains a solid holding as bar-code technology in the hospital setting begins take-off.
Sypris Solutions (SYPR) has been a stellar performer and there is likely more to come if the market can just stay stable. It has moved from $2.50 to $4.65 on no particular news and uninspiring quarterly earnings reports, but there seems to be large upside for their defense electronics and security business. The trucking parts business should be closer to a cyclical upturn. A turnaround akin to the autos could put the stock significantly higher than our estimated break-up value of roughly $11 per share.
Hypercom (HYC) was recommended at lower levels during the despair of 2008. The stock has performed well and still looks good. In fact, the stock looks like a technical monster and has clearly been under accumulation. Although the stock is up over six-fold from the lows, there seems to be room for more. Results have been steady if unspectacular, but there are a number of new products on the horizon and the stock is very cheap as compared to competitor Verifone (PAY). Hypercom is a leader in POS (point of sale) payment solutions for retailers, so results should show improvement if the retail environment continues to hold up and new products such as wireless solutions begin to get traction. The company has a net cash position and trades well under 1 times annual revenues.
The travails of Orchid Cellmark (ORCH) really spells it all out. Orchid is a global provider of DNA identity testing services, with police forces and other government entities as their main customers. Yes, just like on the TV show CSI! Results for the recent quarter were flat and disappointing, and the CEO said: “In the U.S. we are seeing the impact of government budgetary constraints forcing the States to either not process forensic samples or request price discounts from suppliers or both. However, we believe the end result will be an ever increasing backlog of DNA samples, which simply put, will have to be processed.”
Frankly, we thought the guy was just making the usual excuses , until we heard about some of the State Parks and Museums in New York and New Jersey that will reportedly not be opening up for the summer due to lack of operational funding. Of course, criminals left to roam are a bit scarier than a park closing, and the situation shows that the possibility for anarchy is never really that far away.
Mayor Bloomberg is unlikely to use his own funds to save the day so something else has to happen. Some smart people we know are saying that it is only the public sector that is broke, but that the private sector is flush with cash. Perhaps, but with the economy still in a bit of a limp, this imbalance (if it really even exists) is likely to remain unless we see a another round of stimulus that will make Bernanke’s first one look like your first allowance. Short of that, we may need to have the States produce their own paper currencies not unlike the original 13 U.S. Colonies. No, we are not advocating guns and canned food just yet.
The economy of the U.S. will prove resilient, and with some more greasing of the skids (stimulus), small-cap stocks will once again prove to be the best place for your investment dollars in the long-term, but again, the slope is likely to be a little slippery so tread carefully.
Let me sum it up. America will get its mojo back sometime, somehow. Despite structural issues, old-fashioned American ingenuity will spring up again and carry the day. Unfortunately at present, there is a pervasive feeling that “the plane is in the air without a pilot.” This lack of faith probably means that the supposed economic recovery underway is not self-sustainable, so another round of stimulus is likely inevitable.
Second quarter earnings will likely be strong, and result in a powerful rally, fueled in large part by short-covering. Then the market quickly catches itself and remembers that the public sector is insolvent, and the market reveres course again. Here comes “Helicopter Ben” to the rescue. The question is how much will a slice of pizza cost? The good news is, well-chosen stocks are also an inflation hedge, and so astute investors can cover a lot of bases by looking for Alpha.
At the time of publication, officers of the Hirsch Organization were long TBIO and Hutt was long ACCL, ANLY, CALP, HYC, ORCH, SCKT, SYPR, and TBIO
Adam M. Hutt, portfolio manager of New York-based AMH Equity, manages two funds. His flagship fund, Leviticus Partners, formed in the summer of 1996, finished 2009 up about 92%, is now up about 14.5% year-to-date (net of all fees) and since inception has an average annual return of about 26%. His second fund, Equipoint Capital Partners, opened in April 2007, is now up about 0.9% year-to-date (net of all fees) and is up about 23% since inception.
Leviticus is a value oriented long-biased micro-cap fund that offers investors a unique opportunity to access companies that have little or no analyst coverage, achieving superior returns by doing significant research on these underfollowed companies. They focus on companies with little debt that trade at low multiples and have significant upside potential. Equipoint is a more hedged and more liquid version of Leviticus that invests primarily in mid-cap companies.
Mr. Hutt may buy or sell at any time securities mentioned above. Positions his fund or other accounts take may change at any time. Under no circumstances does the information he provides represent a recommendation to buy or sell any security and it in no way constitutes a solicitation for any transaction. Past performance is no guarantee of future results. At the time of publication, the Hirsch Organization, its officers or employees were not investors in Leviticus Partners or Equipoint Capital Partners. Call 845-358-4220 or email service@hirschorg.com for more information.
