Macro: The Bottom Line (4/28/2014)

Four months, four bogeymen

 

As we round out April, it's an opportune moment to look back at the markets in 2014 so far. And what a year it's been. By all accounts, what we've been through year-to-date equates to nothing less than four months of indecision. It seems like the markets have been picking petty fights all along, with individual sectors going from investor darling one month to bogeyman the next. Here's a quick summary of what's been going on:

Start of 2014: All is fine. Economic data (notwithstanding the brutal winter in the Northeast and Midwest) remains supportive of an upbeat US growth story. 10Y US Treasury yields are at 3%, a level it hasn't seen since 2011.

Late January - Bogeyman #1: EM

All started with Argentina's decision to devalue its peso currency by the most in over a decade. Suddenly, everyone seemed to be talking about the emerging economies' external imbalances, and a new term - "fragile five" - came to replace BRICS as the most in-vogue acronym among EM investors. Investor darlings of the last five years - Brazil, Turkey, Indonesia - remained the focus of attention, but now for precisely the wrong reasons.

February to March - Bogeyman #2: China

China has long distinguished itself from its EM peers in one major way: it runs both a current account and capital account surplus. In other words, there are more funds flowing into the country - whether in the form of export revenue or capital/investment flows - than there are leaving in the other direction. A key beneficiary of this phenomenon has been China's yuan currency, which was increasingly being treated as a sure bet to make money. That all changed when the Chinese central bank (PBOC) decided to shake things up a little, engineering a steep 3% depreciation in the RMB. Throw in some disappointing data - especially PMIs and industrial production - and all of a sudden, the rock-solid China story was no longer what it used to be. The country was no longer the world's growth engine; rather, it was now the home to the world's most bloated shadow banking system on the precipice of collapse.

Late March - Bogeyman #3: Janet Yellen

As we described in our last post on April 14th, new Fed Chair Yellen unleashed an unnecessary bout of volatility in the US rate markets on March 19th by providing a numerical timeframe for a rate hike - a huge no-no for the most powerful central banker in the world. But even worse was the FOMC's attempts to backpedal once they realized the scale of their misstep. In doing so, they essentially threw the credibility of Ben Bernanke's most notable innovation (member-specific quarterly forecasts for rates and inflation) into serious question.

April - Bogeyman #4: Tech stocks

Yep, you've all read about it. April was an ugly month for the Nasdaq, which fell 3 percent. After lurking in the shadows for years, the dreaded "V-word" (valuations) suddenly reared its ugly head. And with earnings season getting off to a start, don't expect the close scrutiny of valuations to go away anytime soon.

So how does one make sense of all this? Which of the four bogeymen ought we to be most afraid of?

 

Unfortunately, these questions don't lead themselves to easy answers. But what we can say is: there's a common thread in all four. If there's been one factor underpinning each of the scenarios discussed above - whether it's boundless euphoria over China and other EMs, or multi-year rallies from US bonds to tech stocks - it's been the perception that Fed money printing would continue ad infinitum. What about the mounting fundamental imbalances underlying these securities (stretched valuations, reckless credit growth in China, current account deficits)? "Not a problem," so the thinking went, "as long the Fed is there as a backstop, there will always be buyers." But now that the FOMC has begun reducing its monthly splurging program (i.e. scaling back QE), fundamentals suddenly can't be shoved under the rug so easily with a Fed-as-buyer-of-last-resort argument. The bottom line: let the four bogeymen of the last four months be a reminder to you that fundamentals matter, and they will matter even more in the coming months. All good comes to those who can differentiate between the good, the bad, and the ugly.

Orphan drug potential

You probably can guess what Orphan drug means. An orphan drug is a medication that has been developed specifically to treat a rare medical condition, the condition itself being referred to as an orphan disease. Due to the rarity of such patients, there is usually not many companies willing to put money into developing them. However, in the US and EU it is easier to gain marketing approval for an orphan drug, and there are usually other financial incentives, such as extended exclusivity periods, to encourage the development of orphan drugs. The price tags for such orphan drugs are often quite high. With easier approval (less costy), longer patent protection, and high prices, orphan drugs have become more and more attractive to companies. Alexion is one of the most successful orphan drug companies. Its only approved drug has a price tag for over $440,000 per year per patient. The market cap for Alexion is over $10 billion with only one drug on the market and its stock price is over $150 at the moment. While I think the stock is too inflated, you can see how far it can go when a pricy orphan drug is in the market without much competition. I know many friends working in Alexion and many of them have become very rich via its stock options and stocks. Good for them!

I found another orphan drug company which may have a similar potential. It is called Aegerion Pharmaceuticals (AEGR), which develops the drug Juxtapid that treats homozygous familial hypercholesterolemia (HoFH), a rare genetic condition that usually affects children. Patients with this disease can have the cholesterol level to ridiculously dangerous levels, and very high cholesterol can cause heart attacks, even in children as young as two. I used to have a colleague who also had this disease. At age around 40, she got a heart attack during vacation and almost died. Fortunately she survived. This disease is so rare that it only affects about 2,000 people in the United States, but the drug costs approximately $250,000 per year, per person. Of course I don't know if Aegerion will become another Alexion but its potential is certainly there. If you are interested in orphan drug companies, you may consider this one.

IMS has ennormous potential

For those friends who have worked in pharmaceutical companies and know what a PSUR is, they must be very familiar with IMS (IMS Health Holdings Inc). One of the main methods to acquire patient exposure to a marketed drug is using the IMS sales data to make an estimate. In other words, IMS is the world's leading provider of sales and market research data to companies in the healthcare industry. IMS has a huge competitive advantage over other such companies. Think about it: you cannot retrospectively create time-related data. Either you have tracked such historical data or you don’t have it. It is that simple. IMS has accumulated a huge amount of healthcare data in the past 70 years, which is not other healthcare information companies can produce when needed. IMS has the data sources from more than 100,000 data suppliers and been working with over 9,500 healthcare professionals in 100 countries. That why IMS can provide the necessary data to customers from doctors and clinical researchers, to hospitals and biopharmaceutical companies, and even health authorities. The uniqueness of IMS in this industry is reflected in the fact that its client retention rate reached an unheard of 99% with an average relation length of 25 years among its top 25 customers. Simply put, no other companies can really compete with IMS when talking about healthcare sales, marketing and utilization data.

That’s why IMS is a company with enormous upside potential. IMS posted a profit of $82 million, with $2.5 billion in sales for 2013. Over the long run, I’m pretty sure IMS will continue to be doing well financially. It has the information products no other people can provide or replicate. IMS has just gone public recently with an IPO price of $20 but as usual it was shooting up quite high on the IPO debut. It is currently trading at $24, which is a bit pricy. Buy IMS at its weakness.

Boost your Microsoft dividend

Recently I notified you that Microsoft (MSFT) had just broken out its 10 year trading range. As I said many times, MSFT is one of the safest stocks in the world you can hold forever. Believe or not, MSFT is one of the only 3 companies in the world with the highest bond rating of AAA (the other 2 are J&J and Exxon Mobile).  And with dividend reinvestment you can become very rich over time. If you have bought MSFT shares, now you can even boost your dividend income since its ex-dividend date is just around the corner. MSFT will pay $0.28 per share for those who hold its shares on May 13 (even if you just hold it one day and sell the next day). I have talked about trading on the great dividend stocks' ex-dividend date before and you may check here my previous blog regarding trading on the Novartis ex-dividend date.

Let's say you have 100 shares of MSFT, for which you will collect $28 for your position and hopefully you will reinvest this $28 automatically when you get it. Now if you buy another 100 shares at the current price around $40 and sell 1 contract of its May 17 $40 call option right away. You will be paid first by $1.1/share (or $110 total).  Two things may happen:

• if MSFT is above $40 when the call option expire on May 17, your MSFT shares will be called away (i.e. some one will buy your 100 shares at the price $40). In this scenario, you will keep $110 clean plus the $28 dividend. This is approximately a 3.5% income for your 100 shares of MSFT in just a few weeks.
• If MSFT is below $40 on May 17, you will still keep your 100 shares for MSFT plus you also get $110+$28 for the trade. You can then sell another round of call options to collect more money from it.

This sounds very little money but over time it will accumulate quickly to become big money. Of course, if you trade with a bit more money, say for 500 shares, then the short-term income is 5 times $138 =$690. Don't forget, if you can do this quarterly, your annual return rate will be close to 15%. Not bad at all with this very safe money-making technique. I'm routinely doing this now to boost my retirement portfolio.

IPO debut for the Chinese FaceBook

Here is the official introduction on Weibo:

Weibo is a leading social media platform for people to create, distribute and discover Chinese-language content. By providing an unprecedented and simple way for Chinese people and organizations to publicly express themselves in real time, interact with others on a massive global platform and stay connected with the world, Weibo has had a profound social impact in China. In March 2014, Weibo had 143.8 million MAUs and 66.6 million average DAUs. Over 70% of our MAUs in December 2013 accessed Weibo from mobile devices at least once during the month.
A microcosm of Chinese society and a cultural phenomenon in China, Weibo allows people to be heard publicly and exposed to the rich ideas, cultures and experiences of the broader world. Media outlets use Weibo as a source of news and a distribution channel for their headline news. Government agencies and officials use Weibo as an official communication channel for disseminating timely information and gauging public opinion to improve public services. Individuals and charities use Weibo to make the world a better place by launching charitable projects, seeking donations and volunteers and leveraging the celebrities and organizations on Weibo to amplify their social influence.

I guess you would agree that Weibo (WB) is a Chines version of FaceBook (FB). The success of FB will likely be copied by WB in China. Think about what Alibaba has done in China, which is the Chinese version of Amazon and Baidu in China, a Chinese version of Google. I don't see why WB will be less successful. Now WB has finally come to the US market and its IPO debut last week. Its share price shop up over 40% on the first day at one point and closed with about 20% increase. Of course, a lot of euphoria has bought into it. I'm sure it will be a bumpy road for WB, just like FB, that its share price will likely be volatile. But take the opportunity if WB comes down some day and get in earlier for a long-term uptrend for it.

Macro: The Bottom Line (4/14/2014)

 

After a couple of weeks of relative calm, markets were back in turbulent waters this past week as a number of factors conspired to re-inject volatility:

 

Nasdaq - who spoiled the party? For all the attention that investors have been paying to the Eurozone, Fed policy, emerging market imbalances etc., the equity markets have shown striking resilience to macro events. Aside from temporary hiccups - like the EM scare in January - stocks have continued to march higher year-to-date in 2014. But in the first half of April, the euphoria suddenly seemed to grind to a halt. The party spoiler was the technology sector: home to some of the market's hottest stocks - including the likes of Netflix and Tesla - and to some of the most outsized rallies. But suddenly, on the eve of the latest round of earnings releases, the 20+ price-to-earnings ratio on the Nasdaq didn't seem so harmless after all. This is especially considering the widening gulf between the Nasdaq and the Dow, where the trailing P/E ratio remains at a respectable 15. The resulting mayhem was relentless, sending the Nasdaq down close to 5% on the month so far.

We on Red Bull will have ongoing coverage of the equity market developments, including how you can make the most out of this latest round of turbulence. But suffice to say on a macro blog: mind your valuations. If there's anything potentially more dangerous to the equity markets these days than Greek profligacy, Senate filibusters, Chinese wealth-management-products-of-mass-destruction, or Vladimir Putin, it's stretched valuations.  

 Yellen & Co. try to make amends - but what does this mean for the FOMC's credibility? In a previous post, we noted how new Fed Chair Yellen had made possibly the most reckless mistake a central banker could make: providing a numerical timetable for a rate hike. Recall how, when pressed on how long the Fed would keep rates at near-zero levels after the end of quantitative easing, Yellen responded with a not-so-ambiguous "about six months". Well, after seeing the resulting maelstrom on the Treasury markets (with especially 0-5Y yields shooting higher), Yellen and team have been in full damage-control mode. This included a decidedly dovish speech by ... you guessed it, Yellen herself ... the week after her "six months" comment. Even more interestingly, the Fed minutes this past week explicitly branded the FOMC's own (more aggressive) rate-hike projections as "overstated." The reverse-jawboning has had the desired effect for now, with Treasury yields falling and the 30Y rate falling to a one-year low.

What does this whole episode tell us? Besides being an incredibly useless piece of market noise - adding absolutely nothing new to our understanding of Fed policy going forward - it leaves an enormous dent in the FOMC's credibility. Who's to believe the Fed's communications - whether it's rate or inflation projections, or its much vaunted "forward guidance" - if they were released only for the FOMC to publicly repudiate them a few weeks later? Far from managing market expectations, these mixed signals only serve to confound them even further. If Yellen truly wants to keep interest rates anchored at low levels so as not to jeopardize the economic recovery, her first rule of thumb ought to be: avoid making unequivocal statements, only to issue equally unequivocal retractions of those statements.   

 

Biggest casualties of the month: equities and the dollar. Biggest benefactor of the month ... Greece!

 

No surprise in terms of the biggest casualties of the month. We just discussed the carnage on the equity markets. And with the Fed's aggressive jawboning, the dollar has had no place to hide. Over the month, the greenback is down versus most of its developed market peers, including the euro, pound, yen, Australian dollar, and Canadian dollar.  

 

But what about the biggest benefactor? As surprising as it sounds, this is no typo. In fact, amid all this mayhem, Greece managed to issue a 5-year bond at a meager yield of 4.95%! Keep in mind, this isn't any borrower coming to market. This is the Greece, a country whose total debt exceeds its annual economic output by 70%, whose shaky government is still struggling to bring tax evaders to heel, and whose growth model is poorly defined at best. Would you really lend to such an issuer?

 

The issue is that in the perverse logic of the financial markets, turbulence in one sector or asset class often turns another sector into a sort of haven. In the context of today, the fault lines of yore - such as Greece - suddenly appear to be a stable source of higher yield, in the face of the abrupt about-face on the equity markets. So the next time you come across an article claiming that Greece has come out of the woods, take it with a grain of salt ...

Time to ride with the Chinese aging population

China is rapidly growing in its economic development  and has drastically changes in the past 20 years. While it is very successful economically, many huge problems have inevitably emerged, one of which is healthcare-related. One particular area that is alarming is the fast increase of cancer patients in China. See some statistics below:

·         The world registered 14 million new cancer cases and 8.2 million deaths in 2012, and the numbers for China were 3.07 million and 2.2 million respectively, according to the World Cancer Report 2014, released by the World Health Organization earlier this year

·         China accounted for about 22 percent of the world's new cancer cases in 2012 and 27 percent of cancer deaths globally

·         In early 2013, an annual report issued by the National Central Cancer Registry estimated there were 3.12 million new cancer cases and 2 million cancer deaths annually on the Chinese mainland, which means one death from cancer every six minutes

With a fast aging population, urbanization and tobacco usage, environmental pollution, food contaminants and a high-pressure lifestyle, this trend is unfortunately going to become even worse in the next 5-10 years. So what does this mean from the investment point of view. Well, the healthcare for managing cancer patients will obviously be very needed but it is currently very much in shortage as you can imagine. China has a large number of cancer patients and the number is increasingly large. The medical resources in the public hospitals are so limited that patients cannot obtain multidisciplinary treatment solutions to effectively manage their illness. If we can find some business involved in this area, the potential will be huge and astonishing. I find one such company actually.

The company is called Concord Medical Services (CCM), which is listed in the US stock market.  Concord Medical operates a network of radiotherapy and diagnostic imaging centers in China. They have just got partnership with global leading investment company The Carlyle Group LP and US hospital MD Anderson Cancer Center to set up cancer treatment hospitals in China that will use multidisciplinary diagnosis and care to cure Chinese patients. Under the terms of its cooperation with Chinese public hospitals, Concord Medical Services now has 144 facilities around China and also owns 52 percent of Chang'an Hospital in Xi'an, Shaanxi province, via an acquisition in 2012. Chang'an Hospital has reached a strategic alliance with Fox Chase Cancer Center to focus on the oncology department. The hospital will be transformed to focus on oncology and other related departments. Foreign investors are particularly interested in Chinese hospitals, which, like hospitals across Asia, offer especially attractive margins. Foreigners are now limited to 70% stakes in Chinese hospitals, but that cap is expected to be removed eventually. Meanwhile, in the Shanghai Free Trade Zone, investors are allowed to set up 100% foreign-owned hospitals. That’s why the prospect is really great for CCM.  Concord Medical Services forecast its net revenue in 2013 was between 930 million and 975 million yuan, representing a 40 percent to 47 percent increase from 2012.

As you can easily understand, this is not a short-term trading idea but a long-term investment. Using dollar-averaging and buy & hold is the best way to invest in this booming business in China. Right now, CCM is experiencing quite significant correction, declining almost 30% in the past month. This is a great opportunity to buy CCM!

Buffett's wisdom- why you should be happy to see your stock price go down

Every year, the master living investor, Buffett, always issues an annual letter to the investors, in which he has a lot of wisdom to show. The following are just a few points he made this year:

Tumbling markets can be helpful to the true investor if he has cash available when prices  get far out of line with values.

A climate of fear is your friend when investing; a euphoric world is your enemy.

Don't feel bad when stocks go down.

Don't go for the quick profit.

As Buffett has said many times, to value investors with long-term investment in solid companies, lower stock prices are a good thing for them. It seems counterintuitive but actually it has great wisdom involved. Let me show you in a real example with Microsoft. Let's say you buy 1000 shares of MSFT and hold it for 20 years with dividend reinvested. MSFT's current price is $40 with annual dividend of $1.12 (2.8%). Assuming the dividend will grow annually at 15% (the average growth rate in the past 10 years for MSFT) and the stock will stay the same at $40. In 20 years, your MSFT position will grow to over $700,000 from the initial $40,000 investment.  By the way, in one more year in the year of 21st, your position will be over $1 million. That's the power of compounding!!

Now let's assume everything stays the same except that the stock price will also increase annually at 5%. You would think that when both the stock price and dividend are increasing, you will be much richer by year 20, right? Wrong! See below. You will only get over $500,000, or $200,000 less than if without the stock price increasing.

 

 

Now let's say the stock price not only does not increase, it actually decreases annually at 0.5% with everything else staying the same. Believe or not, you position size becomes even larger 20 years later to over $800,000.

 

 

You must be puzzled how this can happen? Well, for long-term dividend reinvestment, your ultimate goal is to accumulate as many stock shares as possible so that you will get more dividend  income. When the stock price stays low, your dividend can buy more shares, which over time will allow you amass a huge number of shares. Eventually, with increasing dividend payment from the company, your total value of the position will explode. The longer you hold, the bigger and faster it will expand. As you can see from the first scenario, just by one more year after year 20,  you will be more than $200,000 richer from your position, if everything is kept the same. Believe or not, in Year 25, you will be a $10 million millionaire.

 

So what can you learn from this? Long-term investment in great business with dividend reinvestment is the most effective way to create your wealth. As long as the underlying business is growing and doing fine, you should be happy to see the declining stock price, especially if the dividend keeps growing. Hope this small essay can make you sleep soundly at night during the market crash if you see your stock prices go down with the market. No panic and no anxiety. Isn't it the highest ideal in investment that you don't need to worry about the prices of your holding stocks?

 

 



What's now?

Exactly following my own script, I got my orders filled when the market went down initially after opening the next day (Tuesday), but it shot up sharply later of the day. My call options for SSO went up 65% within one day. I wish I had closed and taken my profits immediately. Unfortunately I didn't get the chance to do so and the market came down dramatically in the following 3 days. I'm under the water at the moment but I have a strong gut feeling that the market has reached or at least very close to its short-term bottom. Likely in the next 2 weeks, it will come back and make a big jump up. You can feel some capitulation today, which is often the feeling at the bottom.

Having said that, I do feel that the market has changed its pattern lately and may very likely experience some significant correction in the next few months. For many years it is the first time that S&P 500 curve has shown lower lows and lower highs. This may be the start of a downward trend. I bet most of you, if not all, have not noticed that the 30 years government bond yield has come down quite a lot, below 3.5% today. This is potentially a big warning sign and it may go down much more, which means the bond price will go up sharply. Usually the stock market will go the opposite direction against the bond market. If you have a lot of speculative stocks, it may be a good idea to take the opportunity of short-term bouncing up to unload some of them. You will need a lot of cash if the market indeed corrects and buy when everyone runs.

Stock markets are very oversold

Well, the stock markets have been sold hard for a few days. Technically they are at some extreme of being oversold short term and likely will bounce back quickly, probably strongly. I expect this can happen as early as tomorrow. For short term trading, buying the leverage ETF, SSO, for S&P 500 is the best bet for short term profits. This will especially good if you can buy SSO early tomorrow, if the market continues to decline a bit at opening. If you cannot trade during the day like me, entering an order for SSO overnight with a price a bit lower than $102.29 (the price at close today) may allow you to get some shares but it is pure luck, since you won't get your order filled if the market opens higher (a good likelihood).

What will happen if your saving interest goes negative?

Have you ever thought about the scenario that you will be asked to pay money to save in the bank? I bet this idea has never occurred to you. You ask: is this possible? Well, a definite YES. The northern Europe country, Denmark, has had a negative interest rate in the past 2 years, i.e. the interest rate is below zero! So what will people do in a negative interest world? Try to think about it by putting yourself into their shoes. If you have to pay to save money, why you want to save money? Doesn’t it make more sense to borrow money to buy stuff? I also think so. Guess what? The Danish people are indeed the most indebted people in the world at the moment. When people are forced to borrow and spend, they will buy stuff like stocks, precious metals and real estate etc to reserve their values. In other words, the below zero interest rate policy will benefit the stock market and commodities in general.

Now this phenomenon is not limited to Denmark anymore. Actually the other European countries are also thinking to follow Denmark’s footstep to cut interest rates below zero, including Switzerland and England. Well, even the whole EU region will come into the negative interest rate world, since the European Central Bank is considering just to do that! So what will happen if more and more European countries go negative interests? Well, logically more people will borrow money and asset values will go up, including stocks. So buying European stocks is one of the logic ways to make money from this emerging development. You may ask: would it be too difficult to buy European stocks? Fortunately there is an easy way to do so: you can buy a basket of European stocks via ETF, FEZ. You may find more details about FEZ from my blog here.

A dream stock for long-term divident reinvestment

Prospect Capital Corporation (PSEC) is a business development company (BDC) that focuses on lending to and investing in private businesses. Prospect's investment objective is to generate both current income and long-term capital appreciation through debt and equity investments.  In layman’s language a BDC is a company which can lend money to small companies when they desperately need the cash. As we all know, borrowing money from banks is not easy with a lot of strict prerequisites. Many small companies won’t meet the qualification and they definitely need some alternatives. BDC is one of them to finance their business need. In return, BDCs will get higher interest rates as their income. To be qualified as a BDC, they need to distribute 90% of their income to the investors. That’s why the yield from such stocks are usually quite high. PSEC is one of the best BDCs out there. Prospect has a large and diverse investment portfolio that includes the debt of about 130 companies including Totes Isotoner, Targus, Water Pik, just to name a few. An additional benefit for PSEC is it positive exposure to rising interest rates with 91% of assets floating rate and 100% of liabilities fixed rate. While the long-term interest rate is extremely low at the moment, it is almost guaranteed that it will increase substantially over time, a lot higher from here. In general, higher interest rates are very bad and negative for business as their borrowing cost will increase substantially as well. But not for PSEC since they actually will benefit from increasing interest rates since they can get more income from the loans they have made or to be made. In other words, the investors for PSEC may get more income over time.  To me, this is a dream dividend stock to own for long-term compounding! PSEC is paying 10% annually to investors with a monthly payment. This already yield may further go up if the long-term interest rate moves high. And the monthly compounding is a very efficient way to increase your share base if you set up a DRIP (Dividend Reinvestment Program) for it. As a general rule of thumb, you can double your money every 5 years if you earn 15% annually with compounding.  Just do the math how soon you can double your money from PSEC if it continues to pay you at least 10% in years ahead.

Mannkind won at today's Adcom!

I'm wrong to bet against Mannkind. At today's Adcom, Mannkin's Afrezza got the advisory board support for a recommendation for approval. While the FDA is not required to follow the recommendation, it often does. But the final say is always at the hands of the FDA. The decision is expected on Apr 15. We will see in less than 2 weeks.