A picture is worth a thousand words. And, believe it or not, the odds of a biotech rally may be on the rise. We’ll note right here and now, that it is quite possible that we’re wrong given the potential for nasty earnings surprises or any other external events that develop in the next few days to weeks. But based purely on the technical picture, the sector may be heading for a critical decision point that could deliver a positive surprise in the intermediate term.

This week, we have added a third chart, that of health care villain stock Valeant (VRX). This is the company that is under intense Congressional scrutiny for its business model which is built around buying old drugs and raising the prices multifold. Although it has generated huge profits over the past few years, the company has been accused of “price gouging” and has recently been subpoenaed by multiple state Attorney Generals in the U.S. Read more on this story in our News and Analysis Section.

Our point in including Valeant is to figure out if the stock is being bought or sold based on its current fortunes and whether this is essentially the behavior throughout the biotech space. Interestingly, Valeant seems to be under accumulation. Prices have found a bottom and the Accumulation-Distribution line (lower pane of chart) is very bullish. In fact, the action on Friday, October 16 shows a big rally in the stock, a day in which subpoenas against the company were announced. This positive technical picture could change drastically on October 19, after the company announces earnings.

Our second chart is of the IShares Biotech Trust ETF(IBB), which offers a much broader picture of the overall biotech sector. Here, the story is slightly different, but not much. Where Valeant is under aggressive accumulation, the overall biotech sector, as measured through IBB is under less robust buying pressure and has lagged the S & P 500 since the August 24^th bottom. And on Friday October 16, the IBB close was nearly neutral suggesting that investors are not really sure as to where to go next.

The main point of the chart is the Bollinger Bands (Green solid lines surrounding prices). These lines, above and below prices are shrinking toward prices. That means that a big move is coming in the sector. With most people seeming to be bearish on biotech, the big surprise could be a big move to the up side.

Finally, the chart of the S & P 500 (SPX) suggests that the overall price trend in the short term remains up. Prices have crossed above the 50-day moving average and look ready to test the resistance of the 200-day moving average near 2059.

Putting it all together, the odds seem higher than 50-50 that we can see a rally in biotech as the sector plays catch-up to the rest of the overall market. A great deal depends on what happens to Valeant and the rest of the biotech earnings and guidance that are due to start trickling in over the next 2-3 weeks.

Conclusion

Our advice has changed:

1. Pay close attention to our new Trading Buy Recommendations and our new EBIS picks as we are again looking for the market to start moving up.
2. Monitor the price of all current positions in your biotech portfolio.   Check our weekly updates or any special alerts, if issued, for any changes. If your stocks are holding their own, keep them in your portfolio and add to positions as they re-enter their buy ranges from lower prices as they recover.
3. Earnings season is under way. Pay special attention to your stock’s action in response to earnings. Always monitor your portfolio’s response to the market and to any news events and only sell stocks that are showing significant weakness and fall below their sell stop.
4. Consider using BIS to hedge your biotech portfolio during periods of weakness for the market and the biotech sector. Our July 27^th, 2015 update has an excellent tutorial on how you may go about doing this. Also, see below for our latest BIS recommendation. For further reading on portfolio protection techniques and risk management also consider a copy of Dr. Duarte’s “Trading Options for Dummies.”
5. If you choose to buy new stocks, be cautious. A good method for building positions in a volatile market is to buy small lots of stock over a few weeks to months, depending on the overall trend. When this is coupled with a long term time horizon it’s much easier to weather the volatility.

Trading Recommendations

We have a new trading recommendation below. Otherwise remember the following:

• Trading stocks are only recommended as trades based on technical analysis.
• Trading stocks are not EBIS type stocks. This means that they are more volatile and that any moves by these stocks, up or down, can be very fast and treacherous.
• Follow the trading guidelines and recommendations issued with each stock in detail.
• Trading guidelines are not applicable to our longer term holdings in the EBIS portfolio.

Alert: New Trading Recommendation – Edwards Life Sciences (EW) – Trading Buy up to $156. Sell Stop at $139. For every dollar of price increase, raise the stop loss by $1.

Trading Recommendation – Alnylam Pharmaceuticals (ALNY) – Trading Buy triggered at $85 on 10/9/15. 10/16/15 closing price $84.91 – Sell Stop adjusted to $79. For every dollar of price increase, raise the stop loss by $1.

Trading Recommendation – Alexion Pharmaceuticals (ALXN) – Trading Buy up to $173. Sell Stop at $159. For every dollar of price increase on a closing basis, raise the stop loss by $1.

In Depth: New EBIS (Emerging Biotech Investment System) Pick: Cambrex Corp.

Alert: New Buy Recommendation: Cambrex Corp. (CBM) – Buy Range up to $47. Sell Stop at $39.

Cambrex Corp – Overlooked and Underpriced Generic Drug Manufacturer

Cambrex Corp. manufactures active pharmaceutical ingredients for brand name and generic drugs that treat pain management, cardiovascular, central nervous system, endocrine, gastrointestinal, skin, respiratory and urinary conditions. The company specializes in all areas of development and manufacturing from the transition from research and early stages of FDA approval to the full industrial ramp up stage of drug marketing.   Cambrex offers a huge library of compounds that include commonly prescribed drugs as well as potent anesthetics and mood influencing drugs.

The stock has withstood the recent selling spree in the health care sector and will report earnings on October 29, 2015 before the market opens. In its July earnings call management upgraded expectations and guidance noting that it expected “full-year 2015 expectations for revenue growth in the Innovator category to be between 31% and 34% over last year versus our prior expectations of 27% to 30% growth.”

If there is no earnings disappointment, we would expect Cambrex to move up nicely over the next few months, barring negative external events. The company is well positioned, especially in the current market where high priced drugs are under scrutiny.

Here are the EBIS details:

The EBIS Score for Cambrex (CBM) is + 9 (BUY) based June 30, 2015 data.  

• Cash on hand: (+1) Cambrex reported $62.6 million in cash compared to $26.5 million in September 2014.
• Cash on Hand growth (year over year) (+1): The year over year cash grew by 31%.
• Revenues (present or not): (+1): Cambrex reported $106.635 million in revenues in its June quarter.
• Revenue growth (10% or greater)(+1): Revenues grew nearly 31% on a year to year basis.
• Trailing Total Liabilities/Current Assets (<1=+1 , >1=0): (+1) CBM has a 0.94% ratio, which means that it cover all its expenses in the case of a catastrophic hit to the company.
• Earnings (Present or Not Present): (0): CBM has steadily growing earnings.
• Net Income Growth (Year over Year): (0): CBM had a 18.9% earnings growth year over year.
• Products on the market: (+1): DYAX offers a wide array of products on the market.
• Pipeline Strength: (+1): CBM has several important products in late stages in its pipeline.
• Late Stage Clinical Trials and Product Launches: (+1): CBM has several important products in critical stages

The EBIS system consists of eleven fundamental criteria that are updated every quarter after the earnings results for each company are published. Each criterion gets a value of +1 or zero. A total of 8 or more points earn a Buy rating. A total of 5-7 points earn a Hold rating. Less than 5 points delivers a Sell or Avoid rating. EBIS was introduced in the June 15, 2015 issue of the Biotech Report.

Portfolio Update: EBIS Portfolio in Recovery Mode for Now

Our EBIS portfolio has been more volatile of late. Generally speaking it makes sense to see if these stocks develop some type of sideways pricing action before adding to any position aggressively. Details below:

DYAX Corp (DYAX) – Speculative Buy range changed to $22-25 on October 5, 2015. Original recommendation: September 21, 2015. DYAX bought 10/7/15 at $22. 10/16/15 closing price $28.04. Sell Stop at $25. Dr. Duarte owns shares in DYAX.

DYAX triggered our long entry point on 10/7/15. It remains a speculative buy. Expect the stock to be volatile.

DYAX is getting very close to having a real shot for FDA approval for DX-2390, a treatment of Hereditary Angioedema (HAE), a genetic disorder that occurs in 1 in 10-50,000 people.   HAE causes swelling of tissues in the body in response to antigens. DX-2930 is a monoclonal antibody that blocks kallikrein, a key substance in the chemical reaction in the body that leads to the swelling. In some cases HAE, especially of the tongue or the airway, can be very serious or deadly.   DYAX already has one product on the market, also aimed at treating HAE; Kalbitor.   Sales for Kalbitor in the second quarter of 2015, at $17.8 million, a 7.2% increase measured year over year. DYAX, although having solid fundamentals for its stage of development as a company, is a high risk stock due to its dependence on niche drugs and potential FDA approval issues.  

Masimo Corporation (MASI) – Buy  up to $44. (Buy issued July 20, 2015. MPP: $40.65). 10/16/15 closing price: $41. Stop Loss at $34. Dr. Duarte owns shares in MASI.

MASI will announce earnings on 10/27/15 at 4:00 P.M.

Masimo remains within our buying range and has held up well in a volatile market over August and September. Masimo manufactures equipment modules that monitor vital signs during difficult clinical and logistical circumstances.   Masimo pioneered Signal Extraction Technology (SET) a process that lets the pulse oximeter measure the oxygen content of blood without punctures of arteries at states of low blood pressure, where it become a most critical piece of data.

MASI reported adjusted earnings of 43 cents per share, 13 cents ahead of expectations in the second quarter of 2015, while revenues came in at $ 155 million ahead of the $147.93 million estimate. The company raised its full 2015 guidance to total revenues of $621 million, up from $608 million and earnings per share from $1.48 to $1.51.   The stock remains well within its buying range of 40-44 and keeps a 9.5 EBIS rating based on its June 2015 quarter. MASI is a well run company with plenty of cash on its balance sheet and a growth agenda. We like Masimo because it has innovative products, an excellent growth rate, and a nice stash of cash on its balance sheet which it could use to make acquisitions or to plow into research and development.

Meridian Biosciences (VIVO) Buy up to $21 – 10/16/15 closing price $18.10. Dr. Duarte owns shares in VIVO. Stock initially recommended on June 29, 2015.

Meridian continues its basing action. The stock pays a 20 cent dividend and yields 4.4%.

Earnings/Dividend update: VIVO met its earnings expectations on 7/23 but fell short on its revenues estimates. The company delivered net income of $9.1 million, 22 cents per share on revenues of 48.2 million vs. expectations of 48.9 million.

On September 9, management adjusted expectations for the full year of revenues of $195 to $200 million and expects revenue growth in the 3-5% range with earnings in the .86 to .90 cents range for the full fiscal year. The stock remains near the lower part of its trading range.  

VIVO has a market cap near $800 million but is a consistent money maker. The company develops, manufactures, and markets diagnostic testing kits focused on gastrointestinal infections, virus detection, and parasitic illnesses. It also produces reagents and key testing and DNA amplification and enzyme related materials used in research. It has recently released a new product, the Para Pak single vial transport system for parasite testing which simplifies the transport of samples to the lab by using one vial instead of the more complicated multiple package systems that are currently on the market.

We expect VIVO to benefit from the global immigration trend and the potential for infectious diseases to expand their territory via travel related transmission channels. The company has a well established global platform including a recently opened office in Beijing (January 2015). Dr. Duarte owns shares in VIVO.

Emergent Biosolutions – Hold in the short term. Buy up to $36.

Emergent Biosolutions (EBS) (Buy 5/11/15 MPP* $30.63 – 10/26/15 Closing price $30.96) Dr. Duarte owns shares in EBS.

EBS bounced back on the week that ended 10/9/15. EBS tends to drop on earnings and will report in late October 2015. We recommend patience when considering whether to buy this stock at this point or when adding to existing positions.

EBS reported earnings of 36 cents per share for its second quarter of 2015 beating analyst estimates of 26 cents. Revenues climbed 14% from the year-ago period to $126.1 compared to an estimate of 124.25 million.   The company also announced that it will spin off its biosciences unit, whose focus is oncology to investors.   See our news section for details and commentary below.

EBS announced receiving a $44 million contract from the Centers for Disease Controls to increase the supply of smallpox vaccine. The previous week EBS announced a $19.7 million two year contract from the Biomedical Advanced Research and Development Authority (BARDA) on July 20^th an agency of the U.S. Department of Health and Human Services. EBS also makes BioAnthrax, a preventive anthrax vaccine and is working on a new generation of the vaccine. Dr. Duarte owns shares in EBS.

Update: Trend Following ETF Model

Alert – New Entry point established for PowerShares Dynamic Biotech ETF (PBE) – Buy up to $51. Sell Stop at $46.

Alert- Sell Stop- ProShares Ultrashort Biotech ETF (BIS) up to $32. ProShares Ultrashort Biotech ETF (BIS) – Sell and close out the position at stop loss of $32. (Buy issued 7/27/15 @ MPP* $27.99. 10/16/15 closing price was $34.95.)

*MPP – Median Purchase Price

News Update and Analysis – Valeant Has Private Company. Buyer Beware

Valeant (VRX) has been the butt of sellers and is now getting subpoenaed by law enforcement and faces
Congressional anger and possible legal action. Its shares have been sold off aggressively of late. For more analysis on Valeant shares read our Big Picture segment above.  In fact, as the New York Times and Bloomberg recently reported the scrutiny on drug pricing by pharmaceutical companies is on the rise partially in response to Valeant’s business practices.

Two interesting stories surfaced this week which go along with this new dynamic. First, Theranos, a private Silicon Valley company specializing in blood tests by using finger sticks and smaller amounts of blood than traditional methods of blood collection and analysis, was reported by The Wall Street Journal as allegedly misleading investors and the public.

According to the report, Theranos has only been approved by the FDA to use its “nanovial” system on one blood test while the company has been relying on traditional blood testing systems in its own labs instead of its own “Edison” equipment which is geared to be used in conjunction with its “nanovials.”

The FDA has inspected Theranos’ testing facility and the Centers for Medicare and Medicaid Services (CMS) has audited Theranos. The Journal reported that Theranos will have to resubmit significant amounts of data to the FDA in order to receiver further approval of its technologies as “additional data gathered during the examination were insufficient to prove the accuracy of many of its tests.”

Theranos partners with Walgreen’s Boots Alliance (WBA) stores in what it calls its “wellness centers.” There has been no connection as of yet, of any issues in this story that apply to WBA. According to The Journal WBA referred queries about the situation to Theranos.

The bottom line is that Theranos’ technology allegedly doesn’t seem to do what the company says it does. Yet they seem to have been conducting business as if it did. All is in play at this point and no one knows where the truth lies. Whether that means that there are billing irregularities and fraud charges to come is not clear either. But those are possible extensions of the current them and may be considered as plausible.

Equally interesting is the upcoming fight against ballot measures in California and Ohio to cap drug prices. CNBC reports that California hopes to tie the cost of drugs to the fee schedule used by the V.A. system which is considered below the average government price by 20% on average. The pharmaceuticals industry is arguing that cutting drug prices would lead to lower spending on research and development and would curtail the new number of drugs that will eventually make it to market.

The two stories are significant to investors and the public. For investors, they highlight the pitfalls of investing in companies who aren’t truthful or who use what some may call “nuanced” information about what they do and how they do it. For the public, it’s becoming a dangerous environment where it’s hard to know if they are getting what they are paying for. More dangerous is the notion that if there is a mistake on important diagnostic tests or on drug availability due to pricing pressures or a company going out of business because it is no longer profitable it could be a matter of life or death.

To be sure, there are some allegations, intriguing questions and unresolved issues. It’s unfair and imprudent to say that anything is certain beyond that point. Theranos may be innocent of any wrongdoing. And drug companies may find a way to change their current practices and improve public perception with patients benefiting from any future changes. Yet, in the current environment, we think that the sad truth is that these stories may be the beginning of a new and significant trend where the dominant theme in health care and perhaps in all parts of the economy may be the old standby caveat emptor: BUYER BEWARE.