The first week of October witnessed a strong rally in the stock market, offsetting some of the damage done by August’s sudden correction. Of course, the overall market is still more than 7% below where it was two months ago, but it appears to have found a bottom and may be gathering strength for a rally after third quarter earnings have been reported.

However, not all the news will be good, and companies that disappoint – especially high-flying momentum tech stocks – will be punished severely. For that reason I asked Linda McDonough to offer her thoughts on LinkedIn, which we have shorted in the past and believe is once again primed for a fall.

On the bright side, it appears that instead of capitulating after the August correction, the stock market is consolidating which is a far healthier response. Given the recent downdraft in biotech stocks, Dr. Duarte has adjusted his buy/sell target prices accordingly in his Medical Profits Portfolio Update below.

Jim Pearce

The Short Side of LinkedIn

By Linda McDonough

Tumultuous times in the stock market inspire portfolio reassessment.  Obviously it’s best for investors to keep their portfolios pruned during bull and bear markets, but it’s human nature to weld a sharper shear when the screens are covered in red.

When markets are exuberant and being buoyed by fiscal policy, even stocks with high valuations can remain afloat. However, once the market becomes more discriminating, investors need to make sure their holdings are able to live up to their valuations. LinkedIn Corporation (NYSE: LNKD) is one stock that investors should consider trimming or even selling short in their portfolios.  Slower revenue growth across all of its products and increasing expenses are not reflected in its current valuation.

Investors have already had a taste of how quickly this stock can plunge when it missed earnings estimates earlier this year.  The stock cratered 20% in May and then another 10% in a single day in late July when the company reported disappointing first and second quarter results.  Although the stock is down 28% from its 52-week high, it still sells for a PE of 86 despite management guidance for meager earnings growth of 8% this year.

That sky-high PE is likely attached to hopes for a much stronger 2016, the year that analysts’ predict 50% earning’s growth, a number growing increasingly unrealistic based on recent trends.  

We do not argue with LinkedIn’s incredible success at developing a proprietary platform for professional networking.  Early on, LinkedIn recognized the value that human resource professionals and headhunters could extract from its network.  It charged them for access and went on to add Marketing Solutions and Premium Subscriptions as additional revenue streams.

We are even heavy users of LinkedIn, prowling around to follow the career migration of fellow alumni and friends.  Yet it is quite possible to love a product and hate the stock. LinkedIn’s growth is slowing significantly.  The stock will likely go lower as estimates are cut and the valuation is reset.

Decelerating revenue growth is due to several factors.  The most basic and forgivable is the law of large numbers.  LinkedIn grew revenue from $240 million in 2010 to $2.2 billion in 2014.  Growth rates, which had been in the triple digits early on, have crept down over time. However, recent declines have been larger than before and unexpected by investors.  Total revenue growth slowed to 33% in the second quarter, down from 44% at year-end.

Secular shifts in advertising have hurt growth in LinkedIn’s Marketing Solutions product, which derives revenue from display ads, sponsored emails and sponsored updates. This product’s growth slowed to 32% in the most recent quarter, down from 56% in the fourth quarter.  Management blames the move partly on a drop in CPM-based premium ads.  With ad-blocking software becoming more popular (Apple’s IOS 9 released in September allows users to install ad-blocking software) and with consumers more focused on their mobile devices than their computers, the value of these ads is dropping dramatically.

The company’s Talent Solutions product has suffered moderating growth as well.  This product group, which represents more than half of LinkedIn’s revenue, increased 38% in the recent quarter, down from 41% at year end.  However, second quarter results for this product group included revenue from a recent acquisition.  Without this purchase, revenue growth would have been even lower.

Increased competition from new, less expensive talent acquisition sites is hampering growth.  Indeed.com, a site that claims to be the world’s leading job site, charges employers only for those leads that click on a job listing and requires no long term contracts.  TheLadders.com, a job site focusing on higher salaried employees, is free for recruiters and instead charges job seekers a fee. Both of these sites, along with many new sector specific sites, are eating into LinkedIn’s market.

The trick to keeping a stock price up is to manage expectations.  If management guides to lower growth before estimates get ahead of themselves, the less robust earnings growth is easily digested.  Yet nothing gets an investor to hit the sell button faster than management cutting a previously bullish estimate, especially if it is not openly disclosed.

On LinkedIn’s second quarter conference call management delivered such sour news. Only after analysts queried management about estimate changes for a recent acquisition was it revealed that the company had cut its assumption for growth of the basic business.  

Management increased revenue expectations for Lynda.com, the instruction and learning website it acquired in May.  However, overall revenue estimates increased by less than this amount, implying a reduction of expected revenue for the basic LinkedIn business.

LinkedIn’s reported revenue for 2015 is expected to jump 33%.  Yet revenue growth without the benefit of the Lynda acquisition will be 29% for the year and 25% for the second half of the year.  These lower growth rates make analysts’ expectations for 32% growth in 2016 look very optimistic.  

To make matters worse, LinkedIn lost money in the past two quarters based on generally accepted accounting standards.  Even using the adjusted numbers provided by the company, net income has declined sequentially in the past 2 quarters.  

Even if LinkedIn can find a way to grow earnings significantly in 2016, the stock will still go lower as investors adjust its valuation to reflect the more mature phase of the company’s evolution.  If the company is able to grow earnings 40% in 2016 (less than analysts’ optimistic 60% growth but higher than current trends), it will earn $3.00.  A 40 PE on those earnings will drag the stock down to $120, 35% lower than current levels and a real shellacking for those long the stock.

Portfolio Update – Medical Profits

By J. Duarte MD

In this issue:

• The Big Picture: Sucker’s Rally or the Real Thing?
• In Depth: New EBIS Pick – DYAX Corp (DYAX) – Buy Range Adjusted
• EBIS Portfolio Tries To Right Itself. New Guidance Provided.   ETF Sell Alert for
  BIS issued.
• News Update: More Negative News for Biotech

The Big Picture:  Sucker’s Rally or the Real Thing?

In our September 28^th issue we noted that the stock market and the biotech sector were at a point where it was “equally possible” that they could “rebound or fall further” given the heavy selling that had taken place up to that point.  We also noted that there was a possibility of a “great buying opportunity” materializing at some point in the next few days, weeks, or months. 

Well, on October 2^nd, the market staged an impressive turnaround and the bulls seemed to be back in business, at least at first glance.  This week we’ll be following up on how S & P 500 (SPX) and the Nasdaq Biotech Index (NBI) stack up after recent events.

The chart of the S & P 500 shows that stocks seem to have made a tradable bottom.  First note that the index has made what technical analysts call a W bottom, with the first V on August 24^th and the second V on September 29^th. Since then the index has rallied, putting on the afterburners on October 2^nd after a very disappointing employment report, which many seem to think will keep the Federal Reserve from raising interest rates.  But the W bottom also has some interesting findings.  First note that the SPX has crossed above the 15 day moving average (Green line). This is a bullish short term sign.  Next note the MACD histogram (chart beneath SPX with the blue bars) and the MACD indicator (Black line crossing Red line). These are momentum indicators. Notice that the dip in the MACD histogram on August 24 is much deeper than the one on September 29^th. That’s a sign that the second low was not as heavy a blow to the market and that a rally was possible as this marked the panic selling low.  The MACD crossover shows that momentum to the upside has returned and that the odds of higher prices are now higher than those of lower prices, in the short term.  At the same time, the RSI indicator chart above the SPX displays a similar appearance to the MACD histogram with the second low on the indicator being shallower than the first low.   The bottom line on the chart, the ADX line, is heading lower. That means the current trend, a rising trend, is established. 

Now let’s turn to the chart of NBI which has the same indicators. Note that NBI falls short of the S & P 500 on all measures.  It is still below the 15 day moving average. The MACD histogram, the MACD and the RSI indicators are not in the same bullish posture as that of the S & P 500 as their second lows are just as deep as the first low, meaning that the selling pressure is not exhausted and could return with renewed strength at any time.  This is a negative comparison as it clearly shows that the S & P 500 is in much better technical shape than NBI.

Does that mean that biotech can’t rise further from where it closed on October 2^nd? No, it does not. It just means that the S & P 500 has the upper hand at the moment and that even if biotech rallies it may lag the S & P 500 or maybe it will just keep up with its rate of progress.   It’s also important to notice that this could well be a rally in a bear market for all stocks in general. Bear market rallies are head fakes that fizzle out rapidly and turn into losses quickly.  Thus, because of this possibility, there is no point in rushing into this market unless you are a savvy trader who can move in and out of positions quickly.

Another potential problem for biotech, but not necessarily the rest of the market in the near term will be the response to more information reviewed by the mainstream media with regard to drug prices.  For more details read our news and analysis section below.

Conclusion

What should investors look for now? It would be nice to see the S & P 500 blow through the 2000 area and NBI through the 3450 area, which seem to be important points of resistance to the advance.  Your choices are pretty simple.  You can stay patient and manage your current positions or you can take a stab at trading some high volatility stocks if you remain disciplined.  

So for those stocks in your portfolio continue to do follow our recent guidelines:

1. Monitor the price of all current positions in your biotech portfolio. If your stocks 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.”
4. 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.
5. Stay tuned and pay close attention to our weekly updates and any potential alerts that may be issued.

Trading Recommendations

If you are an experienced trader we have two stocks and some guidelines to consider :

• These stocks are only recommended as trades based on technical analysis.
• These 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.
• These guidelines are not applicable to our longer term holdings in the EBIS portfolio.

Trading Recommendation Number 1 – Alexion Pharmaceuticals (ALXN) – Trading Buy at $169-173. Sell Stop at $159.  For every dollar of price increase on a closing basis, raise the stop loss by $1. 

Trading Recommendation Number 2  – Alnylam Pharmaceuticals (ALNY) – Trading Buy up to $88. Sell Stop at $82. For any dollar of price increase, raise the stop loss by $1.

In Depth:  New EBIS (Emerging Biotech Investment System) Entry Adjusted

Alert New Buy Zone:  DYAX Corp. (DYAX) – Speculative Buy Range up to $25.  Sell Stop at $17.

DYAX Corp – A High Risk High Potential Reward Diamond in the Rough

DYAX Corp (DYAX) – Speculative Buy changed to $25 on October 5, 2015.  Sell Stop at $17.  Original recommendation:  September 21, 2015.

DYAX may have found a bottom.  We have adjusted the entry point and the sell stop. 

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.    But it does meet the characteristics of a good EBIS stock, especially since it has lots of cash on its balance sheet and good management.  The company reported some 127 million in cash as part of a 413 million current asset stash on June 30, compared to 110 million in total liabilities and some 22 million in current liabilities. That’s an excellent balance sheet for a biotech company in the research to product transition stage where the huge potential growth tends to start if it is successful.   So barring a major change in its finances and its fortunes, it is likely to have enough cash to withstand an FDA approval disappointment, as a company.  The stock would undoubtedly get crushed if there is a failure at the Phase 3 clinical trial for DX-2390 or the FDA does not approve its drug.

DYAX also has some current momentum in a generally downbeat market, which is a sign of strength.  The company seems to think that it has an above reasonable chance to get DX-2930 approved based on the drug being classified as a Breakthrough Therapy by the FDA.  It has recently signed an agreement with an experienced product manufacturer, Rentschler, a sign that the drug has enough promise to move on to the next step.  Phase 3 clinical trials are expected to start late in 2015. 

Investors should consider the following.   There is no guarantee that DX-2390 will be approved for any condition, or that it will sell well in the current and likely future environment of cost cuts in global health care.  Yet, the company’s cash hoard and the fact that it’s signed on with Rentschler and moving on to Phase 3 with DX-2390 for HAE are encouraging at this point and make for a good very speculative pick.

DX-2390 may also be useful in treating eye swelling related to Diabetes. The company plans to register for FDA approval for that indication in 2016.  It also has two other drug candidates in the pipeline, DX-2507, aimed at antibody mediated diseases and DX-4012, a blood thinner.  

Here are the EBIS details:

The EBIS Score for DYAX is 8 (BUY) based June 30, 2015 data.  

• Cash on hand: (+1) DYAX reported $127 million in cash compared to $32 million in September 2014.
• Cash on Hand growth (year over year) (+1): The year over year cash grew by 396%.
• Revenues (present or not): (+1): Revenues are steady and growing.
• Revenue growth (10% or greater)(+1): Revenues grew nearly 20% on a year to year basis.
• Trailing Total Liabilities/Current Assets (<1=+1 , >1=0): (+1)DYAX has a 0.051% ratio, which means that it could survive a very nasty scenario.
• Earnings (Present or Not Present): (0): DYAX has no earnings.
• Net Income Growth (Year over Year): (0): DYAX  has no earnings growth.
• Products on the market: (+1):  DYAX has one product on the market, Kalbitor.
• Pipeline Strength: (+1): DYAX has a credible pipeline with its DX-2930, DX-2507, and Dx-4012 in late stages of development. 
• Late Stage Clinical Trials and Product Launches: (+1): DYAX is putting together its manufacturing infrastructure for DX-2930 and is planning for Phase 3 clinical trials in late 2015 and into 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 Tries to Right Itself

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:

Greatbatch Inc. (GB) – Buy issued up to $55 on August 17, 2015.  August 17 entry point at the close was $53.51.  10/2/15 closing price $58.43.  New Buy range raised to $62. Stop loss is now $54.  Dr. Duarte owns shares in GB.

Greatbatch skirted with the 54 area on the week that ended 10/2/15.  We still like the stock and are keeping in the portfolio. 

Alert: Stop Loss Added – Masimo Corporation (MASI) – Buy up to $44.  (Buy issued July 20, 2015. MPP: $40.65).  10/2/15 closing price: $39.26. Stop Loss $34.  Dr. Duarte owns shares in MASI.

Masimo remains within our buying range and has held up well in a volatile market over August and September.  It is a crazy enough market though, so we have added a sell stop.  Any sideways action may be used to add to positions cautiously.

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 $21 – 10/2/15 closing price $17.36.  Dr. Duarte owns shares in VIVO.

Meridian is holding up better than other health care stocks.  We remain positive on the stock but would be patient before buying more at this point.  If sideways action starts to develop it may be used to add to shares slowly.

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 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 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 – 9/29/15 Closing price 29.43). Dr. Duarte owns shares in EBS.

EBS showed has been showing some weakness since the week that closed 9/25/15.  There are no major news to report with this company.  We recommend patience when considering whether to buy this stock at this point or when adding to existing positions.  Once the stock starts moving sideways we suggest adding to positions slowly.

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-  Sell ProShares Ultrashort Biotech ETF (BIS) at new stop loss of  $32.  ProShares Ultrashort Biotech ETF (BIS) – Sell and close out the position at  stop loss price of $32. (Buy 7/27/15 MPP* $27.99.  10/2/15 closing price $35.36.) 

*MPP – Median Purchase Price

News Update and Analysis – Gauging New Media Stories about Price Increases by Drug Companies

A New York Times story about Valeant Pharmaceuticals (VRX) and its drug pricing strategies and a second story by Bloomberg that shows that many drug companies have engaged in price increases for medications could add more fuel to the fire and knock the wind out of a potential bounce in the biotech sector.

Last week we noted that the biotech sector crumbled on Monday, September 21, 2015 as Democrat presidential candidate Hillary Clinton tweeted that drug companies were “price gouging” consumers and that she would have a plan by the next day to counter the practice.  Mrs. Clinton proposed a plan that had two major tenets. 1) Limit the out of pocket costs that chronic pain and chronic condition patients would pay per month to keep their medications to $250 per month, and 2) mandate drug companies to put a specific portion of their profits toward drug development.

The sector continued to fall until September 30^th and rallied into Friday October 2^nd.  But as we noted in our “The Big Picture” segment, above, the biotech bounce doesn’t seem as robust as the bounce in the S & P 500.  Now the New York Times, on 10/4/15 published an article describing Valiant’s pricing practices, which are the basis for its business model; buying old generic drugs and raising prices significantly.  More interesting, Bloomberg, in a related article notes that the practice, to some degree is widespread throughout the pharmaceuticals industry and cites Pfizer in detail, as having raised its prices by an average of 9%.

If the biotech and general pharmaceuticals sector manages to not fall apart as the news hits the Monday morning business programs and as it makes its way to newspapers across the U.S., it will suggest that maybe the sector is sold out and that higher prices may lie ahead in the short to intermediate term.

Our conclusion remains the same.  The Affordable Care Act has created an environment where there are insufficient resources to cover all health related illnesses and conditions for all people, in spite of its mandates. Companies with expensive drugs, whether they are high priced drugs for good reason or not, will be targeted either by Congressional hearings, more negative news stories, and if history is any guide, by heavy selling of their stock. 

NASDAQ Composite Index:                                                                       

Friday, October 2 = 4,707.78                                                  

Year to Date = – 0.4%                                        

Trailing 4 Weeks = – 2.4%

Trailing 7 Days = + 0.5% 
            

Weekly Portfolio Performance