The Markat
March 3, 2009
Changewave
STOCKS MENTIONED IN THIS WEEK’S UPDATE INCLUDE: Apple (AAPL), Cisco Systems (CSCO), Isis Pharmaceuticals (ISIS), Research In Motion (RIMM), UltraShort Financials ProShares (SKF), UltraShort MSCI Emerging Markets ProShares (EEV), UltraShort QQQ ProShares (QID), UltraShort Real Estate ProShares (SRS) and UltraShort Russell2000 ProShares (TWM), among others.
To view our current ChangeWave Portfolio Buy Lists, click here.
ACTIONS:
IT/Networks
Cisco (CSCO) — lower Buy Under price to $15
Biotech/Health
Isis Pharmaceuticals (ISIS) — remove from “Hold” with a Buy Under price of $12
Beware the Deflationary Wave
Dear WaveRiders,
The scorecard is in and it’s official: Fifty percent of all the stock market wealth that’s been made since 1933 is gone!
But the losses won’t stop there. We anticipate further declines of perhaps another 25% from today’s level.
The collapse of our investment banking and “shadow banking” systems (i.e., GSEs, SIVs, private equity, hedge funds, etc.) that account for more than 75% of all lending and financing in the United States up to 2008, pushed the economy and the stock market off the deep end.
This historic, financial system ChangeQuake has unleashed the most powerful deflationary economic tsunami of the past 70 years. And it’s this deflationary wave that caused us to lower our fair market valuation for the S&P 500 (SPX) to the 500 to 550 range — based on 11 times 2009 earnings of $48 to $52 per share.
As we described last week, the historic bear market trough for the earnings multiple is 11 times, which would mean a decline of 25% or more before we reach the “all hope is lost” bottoming point. And like all real market bottoms, this one will be marked by a historic aversion to stocks.
At that point, nobody will be calling a bottom (though many people undoubtedly will be crying “uncle!”). Folks, it’s going to get as bleak as you’ve ever seen, unless you’re more than 80 years old and went through the Great Depression.
A self-reinforcing asset deflation spiral is our worst fear.
We’ve realized our biggest nightmare — the forced selling of assets into a locked-up market that triggers fire-sale prices and, in turn, creates additional forced asset selling.
Institutions that hold assets with mark-to-market restrictions must sell them to maintain capital requirements. So, they sell and lower the marks, and, in turn, force more selling.
The next wave of equity selling is starting with the Q1 hedge fund redemptions. We estimate $400 billion to $500 billion in withdrawals will need to be paid by April 1. Most hedge funds only allow redemptions on the quarter — and you have to give a 60-day notice.
This amount of selling will simply overwhelm the thin bids in the market. There are literally not enough buyers available to buy up this inventory, that is until it gets discounted to historically low valuations.
The next destructive economic wave is the collapse of consumer credit with the surge of new defaults on prime mortgages held at par value, along with credit cards and home equity lines.
Remember, every 1% of new unemployment adds about 1% of additional consumer loan defaults, and that math has been accurate for decades. With more than 700,000 job losses in February already in the bag, an 8% unemployment and 18% under-employment rate is now a lock.
Another factor is the 10%-plus unemployment coming by early 2010. That means 10%-plus credit default levels. It’s a process that blows up 3 million to 4 million households.
That means we’ll see a new wave of home foreclosures of prime and jumbo mortgages — the types that, up to now, have been holding on for dear life. No more.
Then the collapse of state/local income and sales taxes will rear its ugly head. We already saw a 10% decrease in sales tax collections for December 2008 and January 2009.
Next up is non-withheld income taxes falling off a cliff — as fewer investors have capital gains and small business people have less taxable income.
And finally, there are corporate dividend cuts like the 65% cut General Electric (GE) announced last week. These will start adding up and will further contribute to the decline in the market and the increase in tax shortfalls for the federal and state governments.
So, What’s the Bottom Line?
We are trapped in an asset-deflation death spiral that is feeding on itself faster than the government or Fed is (or can) replace the incinerated capital.
Demand for goods and services worldwide is being destroyed faster than all the stimulus plans combined could possibly make up for.
Preserving wealth and raising cash is the name of the game.
Given all these challenges for investors, it is vitally important that we stay with our depressionary wealth preservation plan.
Thanks to our proprietary ChangeWave Alliance Research macroeconomic surveys, we were first alerted to the recession way back in January 2008. Then, in October and November 2008, our research was crystal-clear that the economy was in the equivalent a swan dive off a high cliff.
Investors who have not followed the Alliance research and our advice since early January 2008 have taken a huge hit to their portfolio as part of the $10 trillion loss in equity. Ten trillion dollars of wealth incinerated in 16 months!
Add $5 trillion in residential real estate equity to that funeral pyre and you have more than 30% of American wealth destroyed during the past two years.
It was our concern about the financial-asset death spiral and its serious risk that made us adamant about adding bear market ETFs of the type that go up in value in a deflating economic world.
While the stock market losses in February 2009 were the worse in 76 years, and the losses in the first two months were the worst in 113 years, our bear market ETFs have scored some solid profits. Since Jan 1, 2009, our returns have been:
* UltraShort Financials ProShares (SKF) — up 90%
* UltraShort Real Estate ProShares (SRS) — up 76%
* UltraShort Russell2000 ProShares (TWM) — up 62%
* UltraShort MSCI Emerging Markets ProShares (EEV) — up 21%
* UltraShort QQQ ProShares (QID) — up 13%
This is the kind of protectionary performance that has enabled us to save some of our portfolios against the ravages of the bear market. And it puts us in a position for huge profits when we finally reach historically low valuations.
Remember that at some point our Alliance surveys will show us that the contraction has troughed, and that the rate of GDP contraction has flattened or turned slightly upward.
That will be our signal to begin accumulating the best of the best companies in the secular growth wave for what undoubtedly will be 100%, 200% and even greater moves to the upside.
Be certain that we’ll be ready to act quickly when that time comes!
CHANGEWAVE ALLIANCE: CORPORATIONS STRETCH THE CYCLE FOR IT SPENDING
IT systems are the lifeblood and connective tissue of every corporation. They link people and enable them to manage their businesses. But, despite IT’s importance to companies, much of the spending on these technologies is still discretionary.
During the past 20 years we’ve heard about the replacement cycle for PCs and other hardware devices, and the need for software upgrades. These days, the capabilities of IT products have advanced well beyond the level most corporations need to efficiently run their operations, and managers are no longer compelled to buy because their IT systems are getting the job done with older equipment and software.
Thanks to the ChangeWave Alliance’s recent quarterly corporate IT spending survey, we’re seeing just how far corporate IT managers can stretch the replacement cycle for these technologies in today’s brutal economic environment.
Slight improvement during the last quarter; glimmer of hope for second half of 2009.
Following the collapse in corporate IT spending we reported on last quarter, it was unlikely that we would see a repeat performance in the current quarter, no matter how bad the economy got.
While the latest Alliance IT quarterly survey projects a slight leveling in the rate of decline for the first half 2009, 41% of survey respondents said IT spending will decrease (or there will be no spending at all) for Q2. Although four points better than in November, it’s a high number. Only 10% said their IT spending will increase, which is unchanged from the previous report.
As you can see from our long-term chart below, IT spending is at historically bad levels, and the small improvements seen in the current survey aren’t a basis for calling a bottom.
For the current quarter (Q1), the earnings picture is weak. A hefty 38% said their company has spent less than planned, while just 7% said they have spent more than planned. No better than last quarter’s results.
Looking at the second half of 2009, there are signs that things may pick up. While 28% said they think their company’s IT budget will be less than the first half of the year, that’s still a 20-point improvement from the previous survey. And while just 14% said they think their second-half budget will be greater than the first half, that is a four-point improvement.
Leading IT companies feeling the pain.
The economic storm is beginning to take its toll on the tech giants. Last week, Cisco (CSCO) laid off several hundred employees in the first wave of a planned cut of up to 2,000 people. Calling the move a “limited restructuring,” Cisco said that more reductions will follow.
Other tech companies have announced staff cuts in 2009. Microsoft (MSFT) said it plans to eliminate 5,000 jobs during the next 18 months, and software maker SAP AG (SAP) plans to reduce its employee count by 3,000.
Last week, Dell (DELL) said its quarterly profit fell by nearly half, and it expects demand for equipment to remain weak in the coming months. The company also raised the cost-cutting target it announced last year by another $1 billion, to a total of $4 billion by 2011.
Dell’s results came a week after Hewlett-Packard (HPQ), the world’s largest PC maker by market share, posted weakening financial results, including a 13% decline in quarterly profit.
Note that our IT spending survey results showed clear signs of slower corporate PC growth for Q1. In an upcoming Weekly Update we will take a close look at corporate PC purchasing, including the economic slowdown’s impact on the major manufacturers.
Because Dell relies more heavily on the computer market than HPQ, Dell is suffering more. Since 2006, when PC market growth shifted toward consumer sales, Dell has unsuccessfully struggled to adjust to the new market reality.
Research In Motion maintains huge lead in the corporate smartphone market.
In the ongoing battle in the corporate smartphone market, Research In Motion (RIMM) holds on to its huge lead in market share of 74%, as you can see in the chart below.
But at 20%, Apple (AAPL) continues to show momentum, gaining 6% in current smartphone market share. Note, however, that three-quarters of Apple’s corporate share is among small- to medium-size companies (less than 1,000 employees), while RIM’s corporate share is heavily concentrated among larger companies (more than 1,000 employees).
Looking ahead, corporate smartphone buying is set to slow in Q2 2009, for the first time since August 2007. Just 33% of respondents reported their company plans to buy smartphones next quarter, a 2% decline.
In terms of manufacturers, RIM remains the dominant player with 77% of corporate planned purchases going forward. Apple follows with 22% — unchanged from previously.
In comparison to PCs and other segments of enterprise IT, demand for smartphones is relatively solid. What’s more, both RIM and Apple are the established leaders in one of the few healthy markets in the technology world.
We recommend that you continue to keep Research In Motion (RIMM) and Apple (AAPL) for the long term.
CISCO ON THE HUNT
Like a destroyer on a mission to take out enemy subs, Cisco has craftily maneuvered into a wide range of market segments. In fact, many of them seem far afield from the switches and routers that still form the bulk of CSCO’s core business. But they have enabled Cisco to extend into new technologies and emerging markets and provided high-growth opportunities.
Cisco described its game plan at the recent Goldman Sachs Technology & Internet Conference as wanting to integrate networks and all of its capabilities in order to revolutionize the space. Basically, the company wants to tie together any device with any media, and then link it all to its capabilities — always, of course, incorporating Cisco’s core competencies like routers, switches, etc.
And as one of the richest companies in the world (with more than $30 billion in cash), Cisco has the resources and firepower to pull it off. But it can only do it by adding companies that will help accomplish the core mission.
Acquisition candidates for Cisco cover a broad territory.
Recently, blog rumors circulated about Cisco acquiring RIM, but that makes about as much sense as ordering steak a la mode.
After meeting with Cisco’s CFO, a UBS networking analyst recently wrote that the company will be looking for technologies that would help in delivery and management of video and multimedia content throughout the home. There are numerous potential candidates that would fit the bill.
In other areas, likely targets are the virtualization software firms VMware (VMW), Citrix (CTXS) and Tandberg, a Norwegian seller of telepresence systems.
Higher-probability targets include software firms BMC (BMC), Salesforce.com (CRM) and Nuance (NUAN).
Cisco’s strategy is incredibly ambitious, but it is one company that has the ammunition to make it happen. With stock values falling every week, CSCO is in comparatively great shape to pick up top technologies at bargain rates.
We believe that Cisco is one of two tech leaders (Apple is the other) that you will want to own once the economic situation begins to improve. Buy Cisco (CSCO) with a new Buy Under price of $15.
CASH-RICH ISIS ON TRACK WITH 2009 MILESTONES
In 2008, Isis Pharmaceuticals (ISIS) was tremendously successful in monetizing key assets:
* ISIS licensed cholesterol drug mipomersen to Genzyme (GENZ) and received $325 million in an upfront license fee and equity investment, with the potential to earn more than $1.5 billion in commercial and developmental milestone payments. It also gets a share of profits on mipomersen ranging from 30% to 50%.
* The company sold its Ibis subsidiary to AMI for $215 million, plus a 5% earn-out on sales of assay kits and services.
* ISIS finished Q4 2008 on a modest note with a loss of $8.7 million, though 2009 promises to be a great year thanks to mipomersen.
* For the quarter, revenue climbed 38% to $29.7 million. Revenue from research and development collaborations more than doubled to $29.1 million from $13 million, but licensing and royalty revenue dropped to $546,000 from $8.5 million.
* Along with mipomersen, which is in Phase III clinical trials, Isis is also developing drugs for prostate cancer, multiple sclerosis and macular edema caused by diabetes, among other products, and its R&D expenses grew to $33.3 million from $23.6 million in Q4.
Higher expenses are causing few problems for ISIS as it continues to ramp up activity. It is loaded with cash and the company expects to end 2009 with more than $550 million in cash — equal to 50% of its current market cap!
2009 has many milestones lined up.
The outlook for 2009 is very positive for ISIS. Several key milestones are on the horizon with the most significant being data from its Phase III study evaluating mipomersen.
Along with its partners, ISIS expects to report data from some of the other drugs currently in its pipeline for a number of different diseases. Additionally, the company will aggressively grow its pipeline by adding three to five new drugs per year, and advancing the drugs currently in its pipeline.
If 2009 is even remotely as productive as last year, then ISIS’ shares will do splendidly. We are removing Isis (ISIS) from “Hold” and recommending that you accumulate shares on pullbacks below our Buy Under price of $12.
FRESH MONEY PICKS
Each week we like to highlight the current best buys in the ChangeWave Investing portfolio. The goal is to make it easier for subscribers, particularly those of you who are new to ChangeWave Investing, to select the current best stocks from among our diverse list of recommendations. Of course, this list will also be helpful to anyone looking for the right stock or two for reallocating funds or making new investments.
Short-Term Funds
Remember that all of our short ETFs are leveraged to profit two times the inverse of the index they mirror. The value of these ETFs will soar when the underlying stocks go down. The downside is they also drop fast when the stocks go against us, or up.
Also, because of the way these UltraShort ETFs are structured, over time they lose a bit of their intended effect of two times the inverse of their index.
This past week, our bear market ETFs rocketed well above our Buy Under prices. However, for now we’re going to hold firm on our prices and suggest that if the stock market performs a dead-cat bounce, then you should look to buy more of these positions. It’s worth noting that since Feb. 9, the S&P 500 is down 20%, so it wouldn’t surprise us if we see a bear market rally soon.
In any case, stick with your current ETF positions and stay tuned for e-mail Alerts from us.
UltraShort Financials ProShares (SKF) — Buy Under $150; aggressive buy below $125
UltraShort QQQ ProShares (QID) — Buy Under $55; aggressive buy below $50
UltraShort Real Estate ProShares (SRS) — Buy Under $65; aggressive buy below $55
UltraShort Russell2000 ProShares (TWM) — Buy Under $75; aggressive buy below $70
Long-Term Funds
As described above, we are looking for the S&P 500 to eventually trade at least 20% to 25% lower from today’s close. Until stocks enter that territory, we will necessarily be ultra-conservative on any purchases.
But there are two stocks that we covered in the week’s Update that we recommend you accumulate on any further weakness:
Cisco (CSCO) — Buy Under $15; aggressive buy below $13
Isis Pharmaceuticals (ISIS) — Buy Under $12; aggressive buy below $10
Hit ‘em straight,
Toby Smith
Executive Editor
www.changewaveseminars.com.
