The Richland Report
August 28, 2005
The Short-Term Outlook: Been down long enough -- time to start covering shorts, and think about going long for a several-week Seasonality Effect-Labor Day-September rally, followed by a drop into October-December lows.
Any long-term (multi-year) study of intermediate-term bullish and bearish market periods, as measured by our favorite short-to-intermediate market timing tool, the McClellan Oscillator, shows that periods when the McClellan Oscillator moves up from below the Zero Line to positive readings above Zero are those when markets are moving up, and are generally favorable times to be invested and long stocks.
Conversely, periods when the McClellan Oscillator drops below Zero into negative territory, and remains there for several weeks, are generally periods when markets are correcting or going down, and are consequently unfavorable periods for buying and owning stocks. These frequently take the form of what Sherman McClellan, its inventor, dubbed Complex Bottom formations. These generally last about 3 to 6 weeks -- occasionally longer.
We are currently finishing the sixth week of the current Complex Bottom formation, the Oscillator first having dropped below Zero on Monday, July 18th. This Complex Bottom has lasted about as long as the average - some would say longer. From the next spike low, based on evidence cited in the paragraph directly below, we would expect the markets, and the McClellan Oscillator to start a final move up -- first up to, and then above, the Zero line and into positive territory. That will mark the end of the Complex Bottom formation, and the beginning of the aforementioned several-week September-Labor Day rally.
Norman Fosback in his classic MARKET LOGIC, and later Yale Hirsch in his invaluable annual STOCK TRADER'S ALMANAC (to which we've subscribed since 1970), both pointed out and carefully documented the Seasonality Effect, wherein the last few days of one month and the first few days of the following month are usually bullish, and are good times to be invested in the market. Additionally, both historic empirical and anecdotal evidence shows that the days around the Labor Day holiday are usually bullish periods in the markets. With the McClellan Oscillator about to complete a six-week Complex Bottom formation and likely turn positive, we don't foresee anything different for the current period.
On our telephone mutual fund switch Hotlines, we've been short -- (with occasional 1-3-day periods when we were long or out of the markets) -- since Friday, July 15th. Today, August 25th, we advised covering (i.e., getting out of) our 100% short positions (75% short Nasdaq 100 and 25% short S&P 500), and taking pilot LONG positions for both Swingin' Riverboat Gamblers and Intermediate-Term Traders. We also reduced our long position in the Rydex Precious Metals Fund to 50%.
Comments and Updates on Recommended Stocks:
Despite the promising potential which may be offered at some indeterminate future time by the introduction of 3G (Third Generation) broadband telecommunications in China, the disappointing price performance and ugly technical chart pattern presented over the past few weeks by Telestone Technologies (TST-Amex) forces us to suggest using it as a source of funds, better placed on a faster and more promising horse. We will no longer be following TST in these commentaries.
While we continue to be concerned by the lack of sponsorship and buying power underneath Guinor Gold Corporation (GNR-TO), and as a consequence the risk of stagnant money therein, we are heartened by the progress being made by the company on all fronts. We strongly recommend logging onto its web site, www.guinor.com.
In the upper left corner, review the slide tour of the properties, and the in-progress dismantling, packing, and barging of the Kelian Plant and Mill for overseas shipment and re-assembly in Guinea, West Africa. We found it quite impressive, and suspect you may, as well.
Today (Thursday, 8/25) brought an announcement of the pricing at $13.50 of an offering of 1,775,000 shares sold by long-term core holding Nastech Pharmaceutical (NSTK-Nasdaq:NM). The bulk of the offering was placed with a knowledgeable, well-known, long-term oriented major institution, with the remaining minor portion taken by two equally well-known already-existing instiitutional shareholders. This offering represented the left-over amount of an October, 2004 previous shelf registration which was recently announced as a public offering, then mercifully and astutely withdrawn due to 'adverse market conditions'. The current well-handled placement brings to the company approximately $23. 3 million, taking the company's cash position (now strong enuf to get out and work fer a livin'), up to an estimated two years at the current burn rate of about $8 million per quarter (which will undoubtedly increase with projected additional scientific personnel to be hired and projects under way), and, if our math is correct, increases institutional holdings to approximately 41%.
Since FDA guidance for Nastech's nasally-delivered parathyroid hormone has indicated that it would require about $20 million to develop, we assume that the proceeds of this placement will go largely toward funding that PTH development. With nasally delivered parathyroid hormone representing a potential billion-dollar market, Nastech has stated its intention to try to develop PTH independently, without the necessity of partnering it. If successful, that alone would take NSTK shares to multiples of their present price. But of course, that's not all -- there is more.
Other events, due this year, should help increase Nastech's cash position, as well. The Peptide YY 3-36 for the treatment of obesity Phase II clinical studies by Merck are almost surely commencing (or have already begun), with a milestone payment of some sort likely involved later this year. FDA approval of nasally-administered generic salmon calcitonin, partnered with Par Pharmaceuticals, is due, as well as at least one to-be-announced partnership. Other events due this year, not necessarily revenue-delivering, but potentially stock-moving, are new feasibility studies and collaborations, updates on existing and ongoing ones for treatment of diabetes, obesity, and anemia, and partnership discussions regarding RNAi treatment for rheumatoid arthritis.
As mentioned earlier, technically we believe it important for NSTK to overcome and exceed the 15.18 level, That would (1) negate the probability of completing the large Head and Shoulder top formation alluded to here previously, as well as (2) invoke the possibility of triggering the bullish shorter-term cup and handle formation, which on a measured move basis would imply a challenge of previous highs at the 16.56 and 19.90 levels.
In the interest of full disclosure, we readily and joyfully confess to prejudice in favor of this company -- its management, science, and stock -- and strong belief in the likelihood of the stock's intermediate and long-term price appreciation over the next few years. We have recommended NSTK since March of 200 at $5.00, even before Dr. Quay joined the company, and own it personal and family accounts. Should this disturb you in any way, we suggest you ignore our buy recommendation - but out of charity, we would also suggest you refrain from selling the stock short.
Long-Term Outlook
As we look at the investment and economic “Big Picture”, we see what we consider to be three significant major changes that, with relatively little fanfare, are currently taking place, or have taken place over the past two years. We believe these changes are so important that they will, to a greater or lesser extent, affect the financial well-being of every American, as well as millions of others throughout the world. As such, we want to again call your attention to them, despite some redundancies and repetitions from prior issues which that may entail, and for which we apologise. The three are --
(1) The transition from primary secular bull market to primary secular bear market :
(2) The transition in investor preference from one asset class (paper financial instruments) to tangibles; and
(3) The transition from the Plateau Period of the fourth U.S. Kondratieff Wave, to stock market and economic decline, recession/depression, and war.
Let’s briefly address these three changes by the numbers.
(1) After 16 years of arguably the longest and strongest secular primary bull stock market in U.S. history, which at its peak saw record over-valuation measurements, in 2000 we began a primary secular bear market.
Beginning in 1982, within the context of a secular bull market uptrend channel, we saw every 3-5 years (averaging 4-4 1/2 years) a cyclical bear market correction low (1982, 1987, 1990, 1994, and 1998). Now, the primary secular bear market downtrend channel will see volatile cyclical bear market rallies, each of which will doubtless be proclaimed as the “beginning of a new bull market” by Wall Street and the financial media. However, the longer-term trend is now down. Down is faster. It’s a traders’, as opposed to long-term buy-and-hold investors’, market. A “Buy The Dips” mentality must be replaced by a “Sell the Rallies” mantra. Market timing, once scorned, is now all-important, while stock selection remains more vital than ever.
This primary secular bear market is likely destined to end no earlier than 2006, with a regression to historic fundamental bear market average valuation norms (10P/Es) in popular market indices probably roughly two-thirds lower than present ones -- i.e., 3650 DJIA, 365 S&P 500. Interestingly enough, from a technical standpoint, measured move objectives on the large head & shoulder tops of both the S&P 500 and the DJIA yield very close to the same downside objectives technically, as do the fundamental historic average bear market norm P/E’s.
(2) Recently, approximately every twenty years has seen a gradual but tectonic shift in asset class preference by investors, from the class they perceive as overvalued, to the one they consider undervalued.
In the early 1940’s, with the DJIA at 100, stocks were seen as being on the bargain table. There was a shift out of tangible assets and cash into paper financial assets. But in the early 1960’s with the Dow at 1000, the shift was back out of paper and into tangibles -- commodities, real estate and collectibles - old autos, coins and stamps, rare books, jewelry, objects d’art, paintings, sculpture - BARRON’S contained a section each week on antiques.
But by 1982, real estate and many collectibles were viewed as overpriced by investors, whereas stocks were considered cheap -- we recall seeing the S&P 500 price/earnings ratio briefly at 7 that year. (Incidental-ly, colleague Peter Eliades [Stockmarket Cycles, (800) 888-4351] reminds us that there appears to be a 20-year cycle in stock lows which, logically enough, coincides with those years, with one theoretically due this year, 2002.)
Today, however, with the S&P 500 P/E still well above 30, and despite a 76% decline in the Nasdaq Index and Wall Street analyst’s propaganda to the contrary, stocks are not perceived as “cheap”, nor are bonds with their miniscule yields. And while certain types of real estate -- housing, for example -- are looked upon as overpriced in many parts of the country, several commodities during the past few years were selling at price levels last seen during the Great Depression.
These, plus the activities at Sotheby’s, Tiffany’s, and the recent popularity of “Antiques Road Show” on television, indicate to us that another shift in investor preference is now under way, out of overvalued paper financial instruments, the symbols of “things”, and into the tangible “things” themselves, probably including gold and silver in their various forms. These are likely to become future “investments of choice”.
(3) Kondratieff is alive and well. The obscure Russian agricultural economist, who authored “Long Wave” theory during the Stalinist era, was sent to the Gulag because his theory of a long (54-70 year) economic cycle in the United States conflicted with Communist dogma, which held that the capitalistic system was inherently self-destructive. But his theory, despite detractors, has proved remarkable prescient.
We are now in the fourth Kondratieff Wave cycle in the United States. Just as occurred in the third cycle in 1929, we have seen the simultaneous collapse (albeit largely unrecognized and unacknowledged as yet) of both the stock market and the economy in the year 2000.
That involved a consequent “falling off the back edge” of the “Plateau Period”, when everything seemed on the surface to be doing well, but beneath the surface things were rotten and deteriorating. What an apt description of recent conditions, and remarkably, those of each of the three prior Plateau Periods, in this country!
If events follow the three previous Kondratieff Waves, a deflationary recession, which we feel we are currently headed into, will be followed by an inflationary depression. Politicians, pressed during a recession with no jobs to be had, and people out of work clamoring the government to “do something”, know nothing else to do but urge the Fed to open the money spigots and flood the banks with money. Fruitless, because there are no credit-worthy borrowers! But all that currency, money and credit finds its way inexorably and inevitably into the system, and you have the classic definition of inflation -- too much money chasing too few goods and services. The dollar becomes toilet paper, and gold and silver, and mining stocks, rise in price.
It’s happened before -- remember “wheelbarrow inflation” in Weimar Germany ? Students of our own history will acknowledge the American Revolution and the Continental Dollar, which was eventually redeemed in gold at two cents on the dollar, leading to the expression, “Not worth a Continental”, still heard today (the post-Plateau Period of the first Long Wave in this country.) Those of us from the South recall stories of our aunts, uncles and grandparents of the bitter days of Reconstruction (the second Long Wave in the U.S.) I still have framed on my office wall Confederate dollars and bonds, once valuable as are our own today, then worthless as a result of the Lost Cause. Southern women.who lost their sons and husbands during that war survived by selling their heirlooms of gold and silver - rings, jewelry, etc. Think similar adversity can’t strike again ? It may be different, but if it has happened before, it could happen again. Pray not.
If history follows suit, the depression will be followed in turn by a war -- a strongly-felt, very patriotic Trough War, so-called because it ocurs at the trough, or bottom, of the Kondratieff economic cycle.
Books could be, and some have been, written on each of these three changes. These Reports to you afford us neither the time nor space to devote to them the in-depth discussions they deserve. Rather, our purpose is simply to alert you to these major underlying investment and economic trend shifts, so that you will recognize and understand them as you see evidence that they are occurring.
What is some of that evidence that you and I are currently hearing and observing?
Layoffs -- for example, Schwab laying off 10% of its workforce. If that’s happening to one of the largest discount brokers, what does it mean for the brokerage industry? Alcatel announces a mammoth layoff . . .
General Electric announces it is combining its appliance and lighting divisions to reduce costs and over- head. What does that tell you? They have no aggregate pricing power -- their ability to raise prices is non-existent. They have to combine divisions, close facilities, fire people. Same with Boeing and the fuselage facility in Renton, Washington -- will it be mothballed? How many other factory closures have we seen?
Banner front-page right 2-column headline in the “Personal Journal” section in the Tuesday September 10 Wall Street Journal -- “FORECLOSURES HIT RECORD LEVELS”. Subheads read, Trouble on the Home Front” and “More Homeowners Fall Behind On Mortgages, Stoking Concerns About Housing Market”.
Wal-Mart and others issuing earnings warnings, or failing to make their numbers - EDS, IBM, Morgan Stanley, Emerson Electric, Illinois Tool Works, Charlotte Russe - and Enron, Worldcom, Global Crossing.
It is in this environment that we must not only, as the Bible says, “...live, move, and have our being”, but also buy and sell, trade and invest, very, very carefully -- and hopefully, profitably.
Good luck, and may God bless you and yours!
Kennedy Gammage
The Richland Report
P.O. Box 222, La Jolla, CA 92038
(858)-459-2611 - FAX (858)-459-2612
