It is often said that the stock market “climbs a wall of worry”, meaning that a little bad news is necessary to keep investors from becoming overly optimistic and bidding the market up to unsustainable heights. But there also needs to be enough good news to convince investors that everything will ultimately turn out okay. Unfortunately, sometimes the market reaches a point where any news – good or bad – is construed as negative and used as a justification for more selling.

Such is presently the case, as evidenced by last week’s job report for August. Prior to the announcement Friday morning, the expectation within the mainstream financial media was that an increase of more than 275,000 new non-farm jobs in August – i.e., good news – would push the stock market lower since that might induce the Fed to begin ratcheting up interest rates later this month.

Conversely, an increase of less than 225,00 new jobs – i.e., bad news – would convince the Fed governors to delay raising rates until there is stronger evidence of inflationary pressure. So when the Labor Department announced that only 173,000 new jobs were created last month, in theory the stock market should have exhaled a sigh of relief and meandered slightly higher heading into the weekend.

Instead, just the opposite occurred as the S&P 500 immediately dropped more than 1% as soon as the market opened. It now appears any news would have triggered some sort of sell-off in the market, suggesting the only good news is no news at all. But with the Fed scheduled to announce its intentions regarding interest rates next week there will be plenty of news for investors to digest – good or bad.

In the meantime, the heightened volatility creates an opportunity to buy good stocks at cheap prices if you are patient and brave enough to buy when most others are selling. In particular, the biotech sector is even more volatile than the overall market since it is more difficult to evaluate and is valued primarily on the expectation of future events more so than on current performance. For that reasons, as Dr. Duarte describes below an abundance of caution is in order until there if further clarity on the Fed’s actions and how that will carry over to the stock market.

By J. Duarte MD

In this issue:

• The Big Picture: Biotech Sector Chart Review Suggests Caution Is Still Warranted
• In Depth: New EBS Pick – Greatbatch Inc. (GB) Surges Behind Surprise Acquisition
• EBIS Portfolio Alerts: Alert: EBIS Portfolio Pricing Update
• News Update: MD Anderson: Sleeping Beauty Therapy Attracts Biotechs Large and Small

The Big Picture: Biotech Sector Chart Review Suggests Caution Is Still Warranted

First, the overall notion of the chart paints a negative picture. Prices are clearly in a down trend.  The index is trading below its 20 week (dotted green line), fifty day (blue line) and its 200 day moving averages (red line). Furthermore, the 20 day moving average has crossed below the 50-day moving average, a sign that the short and intermediate term trends are likely to have some difficulty in delivering a quick reversal. 

Next, we look at the Bollinger Bands (green lines above and below prices). These lines tell us if there is a potential for a trend reversal or big move when they shrink around the mean in prices, the 20-day moving average, as they did in June 2015 before a short term advance (A).  It is quite evident that the lines are still far away from the mean.  It’s also clear that prices have been unable to climb back above the 20 and the 200-day moving averages, another negative sign. Finally, note that the 20 day and the 50 day moving averages are both sloping down while the 200-day moving average is flattening out. 

These indicators suggest that the best we may get for now in the way of prices is a flattening out or sideways trajectory.  There is no way to know if this is what will happen or when it may come to pass. It is quite possible that before there is any trend reversal we may see a test of the recent lows in NBI, near 3200.  If things change, though, and this is indeed the bottom, our portfolio remains well positioned to capitalize on that.  Subscribers should also know that we are putting together a list of stocks that may be worth adding to our active list in the not too distant future.

Still, current conditions warrant that  that we make no changes to our overall strategy.  We continue to suggest the following:

1. Monitor the price of all current positions in your biotech portfolio. If your holdings are holding their own, keep them in your portfolio.
2. Watch the response of your positions to external forces, especially the Fed, China’s economy, and the current political climate.  Always monitor your portfolio’s response to the market and only sell stocks that are showing significant weakness and fall below their sell stop.
3. 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.”

In Depth:  New EBIS (Emerging Biotech Investment System) Greatbatch Inc. (GB) Holds its own

Alert New Pick Update:  Greatbatch Inc. (GB) – New Buy Range up to $62.  Sell Stop raised to $51.

Greatbatch Surges behind Surprise Acquisition

Greatbatch Inc. (GB) Buy issued at 51-55 on August 17, 2015.  August 17 entry point at the close was 53.51.  9/4/15 closing price 58.04.  New Buy range 58-62. Stop loss:  Raised to 51.  Dr. Duarte owns shares in GB.

Greatbatch surprised the market  on 8/27/15 when it announced that it was buying privately held medical equipment maker Lake Region Medical for $1.73 billion in cash and stock.  The merger expands Greatbatch’s market share in the outsourced medical equipment manufacturing sector to the 10-12% range. It also increases its exposure to big customer names like Medtronic (MDT), Johnson & Johnson (JNJ) and St. Jude Medical (SJM), all big players in the cardiac pacemaker and related areas. 

As we noted in our initial coverage of the stock (8/17/15), Greatbatch is a restructuring story which, at the time we began coverage looked “ready to move higher over the next 6-12 months.”  It looks as if management didn’t want to wait that long to make the stock rise. The company manufactures medical equipment under contract to original equipment manufacturers with a focus on the cardiac pacemaker, orthopedics, and spinal cord stimulation segments.  GB also has a defense contract division, which gives our EBIS portfolio an interesting edge, since Emergent Biosolutions (EBS) is a major player in vaccines and has a large government and military contract base with its Anthrax and Smallpox vaccines.

GB received an 8 EBIS rating, garnering a BUY recommendation.  Now, we have to see what the stock does over the next few weeks to months as the company consolidates its new purchase. We will be paying special attention to the balance sheet and future earnings, as well as how much debt the company has to take on to finance the Lake Medical purchase.  We still like the company because it has proven that it can make money a in a challenging environment.  Yet, it has clearly been busy over the last few months and it has a lot to consolidate.   Consider the following:

1. GB is spinning off its spinal cord stimulator business into a separate company it will call Nuvectra, while it continues to generate revenue from manufacturing the equipment for Nuvectra. It’s uncertain what it GB will do with the spinal cord stimulation business that it will get with the Lake Regional purchase.  Spinal cord stimulation could become troublesome and it may turn out to be a money loser or a reduced revenue generator under the Affordable Care Act, despite the fact that it may be expanding its focus beyond pain management into the treatment of paraplegia.  

This is a key point, though.  Spinal cord stimulation is moving toward a new innovation phase, as implantable devices will be moving toward an external wireless control model based on mobile phones. This means that patients will no longer have to have a battery implanted along with the leads that deliver the stimulation to the spinal cord. What this may have to do with the acquisition remains to be seen. 

2. Prior to the Lake Medical acquisition GB bought CCC Medical, enhancing its cardiac neuromodulator equipment line and has already seen an increase in sales contribution from the acquisition. Cardiac remains profitable for now. We could see a similar situation develop with the Lake Medical acquisition.
3. GB has been growing its orthopedics equipment business. Although the Affordable Care Act could lead to some pricing pressure on this line of products, the demographics for joint replacements are only improving as the population ages. Also, the trauma related product line, including equipment to repair fractures, could benefit from defense related developments in the future if the geopolitical climate worsens.
4. The company is still on schedule to move significant manufacturing capacity to Mexico, expecting significant cost reductions and a positive contribution to the bottom line. This could be a negative in the current political environment but it is something that could lower costs and increase earnings for GB.
5. Most of the company’s product lines are growing except for the vascular related segment, which is separate from its cardiac product line. In its recent conference call, the company cited improving visibility for this line of business in the second half of 2015 and into 2016; as its customers work through inventory and new products are introduced, especially in GB’s catheter line.
6. GB has a strong engineering and design team which is addressing issues in the energy sector, including improving design for batteries and exploration equipment. Any turnaround in energy could also provide a boost to the stock price.

Here are the EBIS details:

The EBIS Score for GB is 8 based June 30, 2015 data, prior to the Lake Medical acquisition.  

• Cash on hand: (+1) GB reported $72.34 million on hand up from $61.58 million in September 2014. 
• Cash on Hand growth (year over year) (+1): The year over year cash grew by 17.4%.
• Revenues (present or not): (+1): The company delivered a small revenue growth rate in its June quarter compared to the year earlier. What is important is that its revenues are not falling even as the company restructures.
• Revenue growth (10% or greater): GB is not growing its revenues currently but has given positive guidance for the second half of 2015 and 2016.
• Trailing Total Liabilities/Current Assets (<1=+1 , >1=0): (+1)GB has a 0.91 worst case scenario ratio. That means it can cover all of its liabilities in a worst case scenario without borrowing money.
• Earnings (Present or Not Present): (+1): GB reported flat earnings growth in its June quarter. Again the company is restructuring and still makes money.
• Net Income Growth (Year over Year): (+1): The company has delivered stable but not growing earnings.
• Products on the market: (+1):  GB has a broad array of products on the market and a broad customer base.
• Pipeline Strength: (+1): GB is working with its customers and has a credible pipeline in place.
• Late Stage Clinical Trials and Product Launches: (+1): The company’s pipeline is nearing launch of new products later in 2015 and 2016.

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 Survives Crazy Market Week – Suffers Casualties Due to Volatility

Alert:  Our EBIS portfolio triggered some sell stops this past week.  Repligen and Bio-Rad have been removed from the portfolio.  However, due to some potential pricing issues in the Flash Crash on 8/24/15 some of the pricing may or may not have been accurate.  Thus, we are not removing Neurocrine Biosciences from the portfolio but are downgrading the shares to a HOLD. See details below:

Masimo Corporation (MASI) – Buy up to $44.  (Buy issued July 20, 2015. MPP: 40.65).  9/4/15 closing price: $39.67

Masimo slipped out of our buying range in the week that ended 9/4/15. It is still acting much better than other biotech and medical stocks and is worth continuing to accumulate at these levels.

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 – 9/4/15 closing price $18.36.

Meridian remained within its buy range on the week that ended on 9/4/15.  We remain positive on the stock.

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.  Management reaffirmed expectations for the full year of revenues of $193 to $200 million. The stock remains near the lower part of its trading range.   Vivo paid dividend of 0.2 per share on July 20^th. The dividend yield is a nifty 4.4%, while the stock price is not particularly volatile. This is a combination which makes having a long term perspective worthwhile.

VIVO has a market cap of $767 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.

Neurocrine Biosciences (NBIX) (BUY 6/16/16 at $46 – 9/4/15 closing price $48.55 – Sell Stop $40)

Alert: Neurocrine is rated HOLD. Neurocrine hit its sell stop on the Flash Crash but we still like the stock as a speculative play and recommend holding on to the shares if you didn’t use the sell stop.  The stock held its own on the week that closed 9/4/15 but due to its inherent volatility is best avoided in the short term. When this scenario changes we will update it.

Neurocrine Biosciences reported a net loss of $24.0 million, or $0.28 loss per share, compared to a net loss of $13.4 million, or $0.18 loss per share, for the same period in 2014. For the six months ended June 30, 2015, the Company reported a net loss of $25.2 million, or $0.30 loss per share, as compared to net loss of $25.2 million, or $0.35 loss per share, for the first half of last year.   Estimates were for revenues of $650,000 and a loss of 29 cents per share. 

The stock has the potential to move to the 55-58 area over the next few weeks to months.  We originally highlighted NBIX in our 5/29/15 update.  We like the stock based on the prospects of its Elagolix drug for treating endometriosis a condition of pre-menopausal women linked to the menstrual cycle and pelvic pain.  Dr. Duarte owns shares in NBIX.  Neurocrine is also advancing phase III clinical trials of its NBI-98854 drug aimed at the degenerative neurological disease tardive diskynesia.   Neurocrine expects further input on Elagolix by early 2016.

Neurocrine is a speculative stock. This is a research stage company with no products on the market but several potential blockbusters at key stages of development and nearing the FDA approval process.

Upgrade: Emergent Biosolutions – Buy up to $36.

Emergent Biosolutions (EBS) (Buy 5/11/15 MPP* $30.63 – 9/4/15 Closing price $32.49) –

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 showed some weakness in the week that ended 9/4/15.  We are still constructive on the stock but are watching its activity very closely. 

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: Our remaining biotech ETF, the ProShares Dynamic Biotech and Genomics ETF (PBE) was stopped out on 8/24/15.  We are removing it from our portfolio for now. That leaves the ProShares Ultrashort Biotech ETF (BIS) as the only ETF in the model for now.  It is rated hold.

• ProShares Dynamic Biotech and Genomics ETF (PBE) (Buy 5/11/15 MPP 55.80 – 8/24/15 Stopped out 48.71. Return (-) 14.55%.
• ProShares Ultrashort Biotech ETF (BIS) – Buy until 29. Stop Loss 27. (Buy 7/27/15 MPP* 27.99.  9/4/15 closing price 32.26.)

*MPP – Median Purchase Price

Dr. Duarte owns shares in BIS.

News Update – MD Anderson: Sleeping Beauty Therapy Attracts Biotechs Large and Small

MD Anderson Cancer Center in Houston is attracting cancer development to its campus.  The cancer specialty center has existing partnerships with Novartis, Juno, and Kite, all players in the highly competitive cancer drug arena.  Most recently Cellectis (CLLS) has joined the group.  MD Anderson is working on what it calls a CAR-T therapy model, in which the companies hope to participate.

CAR-T stands for chimeric antigen receptor T cells. T cells are part of the body’s defense mechanism. MD Anderson has developed a delivery system it calls the Sleeping Beauty gene transfer system which delivers the therapeutic cells to the recipients.  The therapy is used in conjunction with stem cell transplantation for patients who suffer from late stage blood related cancers such as certain types of leukemia and lymphomas.  The results of four CAR-T clinical trials are very encouraging, although it is early in the research. 

Cellectis recently went public and has a proprietary gene editing system that it hopes will improve the CAR-T therapy model further and develop drugs aimed at multiple myeloma and leukemia through its association with MD Anderson.

NASDAQ Composite Index:                                                                       

Friday, September 4 = 4,683.92                                                  

Trailing 12 months = + 2.3%                                        

Trailing 4 Weeks = – 7.2%

Trailing 7 Days = – 3.0%             

Weekly Portfolio Performance