Last week was the worst start to a year ever recorded in the history of the U.S. stock market. Both the S&P 500 Index and Dow Jones Industrial Average declined by roughly 6%, while the tech-heavy NASDAQ Composite Index fell by more than 7%. In short, almost nothing was spared during the massive sell-off that followed a second round of currency devaluation by China in response to its weakening economy.

The last time this happened back in August a swift stock market correction also ensued, followed by a strong rally as investors came to realize that the Chinese stock market operates very differently from ours. It is much more volatile, both in terms of the frequency and magnitude of its vacillations due in part to shoddy regulation and excessive speculation.

Owners of Apple stock will recall that the first currency devaluation was immediately preceded by the high point for its share price, topping out above $130 in July. Perhaps tellingly, it quickly dropped below $120 in the week’s leading up to China’s startling announcement, suggesting the stock market was trying to tell us something.

I guess we weren’t listening very well, because the same thing happened this time. After rallying above $120 in November, Apple’s share price slid beneath $110 in December in the weeks leading up to China’s second unexpected announcement. From a technical perspective, Apple stock is now behaving as a proxy for the Yuan.

If so, then that raises some interesting questions; would a quick rise in Apple’s share price suggest the Yuan has become undervalued, and/or the dollar is about to fall? And to what extent will Apple’s quarterly earnings release scheduled for the 26^th of this month affect its share price in the absence of any new developments regarding the Yuan?

The stock market as a whole has long been considered a leading indicator of the overall economy, usually rising and falling several months before economic data confirms those directional changes. But now we are seeing an individual stock anticipating a global macroeconomic directional change, reflecting Apple’s immense size and dominance in its sector.

I can’t think of another example of a single company’s stock price performing that same predictive role for the value of another asset class; even the value of huge “super oil” stocks such as Chevron and Exxon Mobil have lagged falling oil prices over the past eighteen months.

I’m not sure what all that means, but it bears watching over the next several months to see if Apple can decouple its fortunes from that of China. Perhaps rumors of a major investment in the automobile industry will soon prove true, allowing its share price to once again rise and fall based on expectations of future profits and not currency values.

By Jim Pearce

Emerging Biotech Investment System (EBIS) Update

By J. Duarte MD

In this issue:

• The Big Picture: The Dragon Wing Effect
• In Depth: EBIS Stalwarts Trigger Sell Stops
• Trading Portfolio: Trading Portfolio Trimmed
• EBIS Portfolio Update: List Gets Trimmed
• Trend Following ETF Model: Short ETF Active as of January 4.
• News and Analysis: Shire Takes Out Baxalta – Introducing our Shopping List
• 2016 EBIS Portfolio Results:
  • Emergent Biosolutions (EBS) (Bought 5/11/15 MPP* 30.63) 1/7/16 Stopped out at $36. Return 17.63%.
  • Masimo Corporation (MASI) –Buy issued July 20, 2015. MPP: $40.65). Sell Stop triggered at $38 1/6/16. Return (-) 6.5%
• 2015 EBIS Portfolio Results:
• DYAX Corp (DYAX) – Position Closed. Company taken over. Originally bought 10/7/15 at 22. 11/6/15 closing price was 34.52. Trade return: 56.9%.
• Trading Recommendation Position Closed: Celldex Therapeutics (CLDX) Stopped out at 16. Recommended 10/26/15. Buy range entered 10/26/15 at 13.22. Total Return 21%.  
• Trading Recommendation Position Closed: Alnylam Pharmaceuticals (ALNY) – Trading Buy triggered at 85 on 10/9/15. Stopped out at 100 on 11/16/15. Total Return 15%.
• Trading Position Closed – Sell Stop Triggered at $78 – Edwards Life Sciences (EW) – (Initially recommended 10/19/15- Bought 10-27-15 at $76.50 post 2 for 1 split). Return 1.96%.
• Cambrex Corp. (CBM) Position Closed– Sell Stop Triggered at $50 on 12/18/15. Bought 10/20/15 at $44. Return 13.6%.

The Big Picture: The Dragon Wing Effect

Investors who follow the tenets of J.P. Morgan investing, “buy when there is blood on the streets,” must be salivating after the start of the new year. And while the current decline in prices is likely to be creating value, a cautious approach may be the most sensible method of proceeding in the short term.   To be sure, the S&P 500 (SPX) and the Nasdaq Biotech Index (NBI) are due for a bounce. When indexes fall outside the Bollinger Bands (green lines above and below the price line in chart below) to the degree seen currently on both the SPX and NBI charts, the chance of a bounce increases, as we saw after the August 24, 2015 crash.

But, this is a different market than what we’ve seen in many years. It could even be the early stages of a bear market. So we will give things a bit of time to sort out before we go trolling for new stocks.   For now we are focused on managing risk. Active investors should have hedged their biotech portfolio with shares of the ProShares Ultrashort Biotech ETF (BIS). Please review the details on this volatile but useful ETF below in our Trend Timing

Fans of Chaos Theory are familiair with the Butterfly Effect where the flapping of a tiny butterfly’s wings are connected to storms and major events in far away regions. But in the Chaos Theory of the investment universe, the week that ended on January 8, 2015 was all about the flapping of the dragon’s wings, as the drama of China’s Yuan devaluation combined with fear of the unknown as the Federal Reserve’s December 2015 interest increase combined to create a whirlwind of selling in the global markets.   What we are seeing at the current moment is The Dragon Wing Effect, which is the Butterfly Effect magnified to the umpteenth power.   And it may just be starting. There are likely to be billions of derivative bets on the fate of China which are still likely to need resolution. Remember the 2007-2008 market and economic crash when investors collected on the derivative bets based on the fate of subprime mortgages.

We have been concerned about the markets since late December 21, 2015. In that week’s issue we noted “the S&P 500 (SPX) has the look of a boxer on the ropes.” And while the market rallied for one more week after we penned those words, since December 30^th the market has dropped nearly 7.5% as measured by the S&P 500 (as of the close on January 8). The Nasdaq Biotech Index (NBI) has fallen 12% over the same period.

This is where things stand at the moment. The combination of higher interest rates, the unknowns about Obamacare, and the 2016 presidential election are creating a climate of extreme uncertainty which will likely lead to violent levels of volatility in the market.   When you add the geopolitical uncertainty of Isis, the declining situation in the Middle East, and the potential for further slowing in the global economy, you have a toxic mix. This is no time to be making big bold bets regardless of the fundamentals of any company.

Take our EBIS Portfolio, where two sound companies, Emergent Biosolutions (EBS) and Massimo Corp. (MASI) triggered their sell stops. These are companies with excellent balance sheets, promising growth prospects and outstanding management. Yet, they got sold along with the market. When these events take place, it makes sense to take cover, make a shopping list, and manage your risk. And while it is possible that these companies may make it back to our active list, at this point we follow our trading rules.

What it means is that discipline and watchfulness are the keys to success as biotech investor in this market.   Here is what to do:

1. Pay close attention to the overall market as well as our new Trading Buy Recommendations and our new EBIS picks and portfolio updates. Remain patient as the market will eventually settle down and become more investable.   But a reliable up trend could still take months to be apparent.
2. Monitor the price of all current positions in your biotech portfolio individually.   Look at each stock separately and keep up with Sell Stops and any trading rule that we include in our recommendation.
3. Pay attention to news items, especially as related to products, mergers, takeovers and geopolitical events. Always monitor your portfolio’s response to the market and to any news events, especially those in health care and only sell stocks that are showing significant weakness and fall below their sell stop.   Keep an eye on news items related to health care. Biotech stocks tend to exaggerate the general trend of the health care sector.
4. Consider using BIS to hedge your biotech portfolio during periods of weakness for the market and the biotech sector. The entry point on BIS has been changed on 1/5/16 to $30-$33 and the entry point was triggered and exceeded. BIS is a hugely volatile ETF and has a new entry point as of our November 9 update. See below for details. Our July 27^th, 2015 update has an excellent tutorial on how you may go about doing using this ETF to hedge your portfolio. For further reading on portfolio protection techniques and risk management also consider a copy of Dr. Duarte’s “Trading Options for Dummies.”
5. Risk is clearly on the rise once again. This means that patience and attention to detail is they key to success. And in this type of market, success means that your portfolio retains as much of its gains as possible. A good method for building positions 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

Our trading recommendations are delivering excellent results at the moment. We added three new stocks as of 11/30/15 and a fourth candidate on 12/14/15. The sell stops on open positions have been adjusted to reflect the closing prices of the week that ended on 12/18/15.  

Trading stocks are only recommended as trades based on technical analysis and momentum.   These are not stocks meant for long term holding periods.

• 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 – Sell Stop Triggered: Otonomy Inc. (OTIC) – Buy Range $27-$30. Initial recommendation for this stock was 12/14/15. Bought 12/17/15 at $27.42. 1/7/16; Sell Stop triggered at $22.90. Return (-) 16.42%.

Alert – Sell Stop Triggered: Invacare (IVC) Trading Buy Range $19-$21. Bought 11/30/15 at $19.70. 12/31/15 closing price $17.39. 1/4/16 Sell stop triggered at $17. Return (-)13.7%.

Waiting to Enter Buy Range Trading Recommendation: Bio-Rad Labs (BIO) Trading Buy Range $137-$141. Sell stop at $132 (Recommendation updated 1/11/16). For every dollar of price increase, raise the stop loss by $1. Bio-Rad is a former EBIS stock which got caught in the early fall selling spree.   The stock has formed a lengthy base and is showing signs of joining the current biotech sector rally. We currently like it based on its technical activity.

Waiting to Enter Buy Range – Trading Recommendation: Vertex Pharmaceuticals (VRTX) Trading Buy Range $115-118. Sell stop at $106 (Recommendation updated 1/11/16) Initially recommended on 10/26/15. For every dollar of price increase, raise the stop loss by $1. Vertex makes a leading cystic fibrosis drug and has steady revenues. Unfortunately it still has more debt than assets so it doesn’t make the EBIS cut. It is a good momentum stock when it gets going, though. And it looks as if it’s ready to join the current biotech rally.

In Depth: New EBIS (Emerging Biotech Investment System) Pick: Novo Nordisk A/S ADR (NVO)

Alert: New Buy Recommendation: Novo Nordisk A/S (NVO) – Buy Range $55-$58. Recommended 12/21/15. Bought at $55 on 12/21/15. 1/8/16 closing price $54.76. Sell Stop $46.

Novo Nordisk A/S ADR (NVO) – An Atypical EBIS Stock with a Focus on Diabetes

Novo Nordisk, became an active EBIS portfolio component on 12/21/15 when it was first recommended. The stock closed 2015 at the upper end of its Buy range of $55-$58 but ran into some selling with the market in the first week of the year. The company is based in Denmark, and its sole focus is Diabetes treatment.  

It is a large cap stock ($144 billion), but it’s not a household word. Yet, diabetics know it because it makes both medications as well as equipment for delivering medication for diabetics. It’s also a mainstream pharmaceuticals company with footprints in hormone replacement therapy, growth hormone treatments and treatments for hemophilia. The company’s Semaglutide drug recently delivered improvement in long term glucose control in a Phase 3 trial. Semaglutide also leads to appetite suppression and weight loss, a key component of the treatment in Type 2 Diabetes.

NVO gets a top shelf + 9 EBIS rating because it’s a well-run company with a single focus and a top entry in all areas of its niche, Diabetes. It is not a small stock, but it is an EBIS stock because of its focus and its ability to deliver. And in a difficult market it could provide a bit of a safety net compared to other more speculative buys.

Here are the EBIS details:

The EBIS Score for Novo Nordisk A/S ADR (NVO) is + 9 (BUY) based on September, 2015 data.  

• Cash on hand: (+1) NVO had $18 billion in cash compared to $13 billion in September 2014.
• Cash on Hand growth (year over year) (+1): The year over year cash was 32%.
• Revenues (present or not): (+1): Cerus reported $8.45 million in revenues in its September quarter compared to $9.587 million a year earlier. The decrease is largely attributed to currency translation and slowing business in Europe. The company is expanding its market share in the U.S.
• Revenue growth (10% or greater)(+1): Revenues grew by 20% on a year over year basis for the September 2015 quarter.
• Trailing Total Liabilities/Current Assets (<1=+1 , >1=0): (+1) NVO has a 0.78% ratio, which means that it cover all its expenses in the case of a catastrophic hit to the company and still have money to regroup.
• Earnings (Present or Not Present): (+1): NVO has very reliable earnings.
• Net Income Growth (Year over Year): (+1): NVO grew its earnings by 20% year over year in September.
• Products on the market: (+1): CERS has products on the market and is making strides in expanding its market share.
• Pipeline Strength: (+1): CERS has one key product in late development 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 Components Hit Sell Points

Emergent Biosolutions (EBS) and Masimo Corp. (MASI) triggered their sell stops in the week that ended on 1/8/16. Both these stocks should now be sold.   Details below:

Alert – Sell Stop Triggered – Emergent Biosolutions (EBS) (Buy 5/11/15 MPP* 30.63 – 1/7/16 Stopped out at $36. Return 17.63%.

Alert – Sell Stop Triggered – Masimo Corporation (MASI) –Buy issued July 20, 2015. MPP = $40.65. Sell Stop triggered at $38 1/6/16. Return (-) 6.5%

Cerus Corp. (CBM) – Buy Range $5-$7. Recommended 11/16/15. Bought on 11/16/15 at $5; 1/8/16 closing price = $5.84. Cerus is a niche play on blood testing. The company has a proprietary system used to test plasma for parasites and viruses. It has been expanding its market share steadily in the last 6-12 months. Dr. Duarte owns shares in CERS.

Meridian Biosciences (VIVO) Buy $18-$21 – 1/8/18 closing price = $18.70. Dr. Duarte owns shares in VIVO. Stock initially recommended on June 29, 2015.

Meridian made news on Friday the 13^th of November when it disclosed a minority stake in Oasis Diagnostics a company that specializes in diagnostic tests that use saliva as the medium for testing. On November 18^th the company received FDA approval for an expanded use of its Illumigene whooping cough testing product, a move that will expand Meridian’s market share and customer base. There were 33,000 whooping cough infections reported in 2014, a 15% increase compared to 2013.

Meridian delivered a mixed earnings report on November 5, 2015, beating on revenues at $47.5 million and missing on its net income by one cent at 20 cents per share. Estimates averaged $46.64 million in revenues and 0.21 cents per share for earnings.   This was a reversal of the previous quarter. The stock paid a 20 cent dividend on 11/12/15 and yields 4.4%.

VIVO 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.

Update: Trend Following ETF Model

Alert – ProShares Ultrashort Biotech ETF (BIS). Bought at $30 on 1/4/16. Closing price on 1/8/16 = $35.73. Sell stop at $32. Recommendation updated on 1/11/16.

PowerShares Dynamic Biotech ETF (PBE) – Bought at $48 on 10/23/15 – 12/11/15 stopped out at $48. Return 0%.

ProShares Ultrashort Biotech ETF (BIS) ProShares Ultrashort Biotech ETF (BIS) – (Buy issued 7/27/15 @ MPP* $27.99. 10/27/15 closing stopped out at $32 – Return + 14.3%.

*MPP – Median Purchase Price

News Update and Analysis

Introducing our Shopping List: Sanofi (SNY) and Regeneron (REGN) Get FDA Promise

As we went to press on Monday, January 11, the news that Shire (SHPG) bought Baxalta (BXLT) for $32 billion hit the wires. This may not be the last deal in the biotech – pharmaceutical sector, which is why we are starting to keep very close tabs on our shopping list which we will update on a weekly basis, as needed.

It’s hard to get excited about biotech stocks in the midst of a major market meltdown. But the market will bounce and thus it’s good to keep an eye on things as prices decline since eventually things return to more normal cause and effect relationships.

This may be the case with a new arthritis treatment Sarilumab, from the Sanofi (SNY), Regeneron (REGN) partnership. Both stocks have been in down trends for the past few months. And the FDA won’t give a decision on this new treatment until late October 2016. But here is what’s exciting.   Sarilumab works where Humira and Enbrel often don’t. That means that it will have a well-defined market and, all things being equal, it has the potential for blockbuster status.

Indeed, this partnership is worth keeping an eye on, especially if you are patient. Put these two stocks on your shopping list.

Shopping List

• Sanofi (SNY)
• Regeneron (REGN)

Next Wave Portfolio— FireEye

By Rob DeFrancesco

Before last week’s sharp pullback for the overall market, FireEye (FEYE) shares had been trying to stabilize in the low $20s. The stock has been picking up some support from Wall Street analysts at these lower levels because of the reduced valuation.

FireEye remains well-positioned in the next-generation security segment, which for 2016 is expected to grow at least 30%, well above the estimated 7% growth rate for the overall security market.

Citi in December upgraded FireEye to ‘Buy’ with a price target of $35 after results from the firm’s survey of 51 chief information security officers showed an overall intent to accelerate security spending in 2016. FireEye performed exceptionally well in the survey because of its strong product and subscription offerings, according to the firm.

At the recent market cap of $2.94 billion, FireEye trades at 3.6 times the 2016 consensus revenue estimate of $816.5 million (expected growth of 30.7%), roughly a 40% discount to the average valuation for its security peer group.

At the start of this month, Summit Research initiated coverage of FireEye at ‘Buy’ with a price target of $35. The firm’s basic argument: sentiment has gotten so negative that the risk/reward balance for the stock is now attractive.

Summit pointed out that even though the company is considered a leader in the advanced persistent threat (APT) detection and remediation markets, ongoing worries about the recent sales execution missteps in Europe (representing 15% to 20% of total revenue) and the third quarter billings shortfall continue to weigh on the shares.

At the Barclays tech conference in early December, FireEye CEO Dave DeWalt said organizations across Europe are increasingly coming around to the idea that more next-generation security solutions are needed to fight advanced cybersecurity threats. After a tough third quarter in which FireEye struggled to finalize some European transactions (especially in the German and French markets), the goal for 2016 is to improve overall deal closure rates via a combination of better sales management and more reps in the field.

In the middle of last month, Evercore ISI started coverage of FireEye at ‘Buy’ with a price target of $39, citing the stock’s more attractive valuation and the company’s increased cross-sell opportunities throughout the expanding customer base. In the third quarter, FireEye added 299 new accounts, up 17% from the year-ago quarter, with 60% of the 10 largest deals in the period coming from new customers.

Evercore ISI believes recent concerns about FireEye getting hurt by increased competition are unwarranted. FireEye in the latest quarter had 10 product lines each with more than $10 million in billings. The company offers organizations a broad platform approach to next-generation security—covering everything from forensics and malware analysis to email, endpoint and mobile protection.

FireEye may need one or two quarters to work through its sales execution issues, particularly as it tries to regain footing across Europe. While there are near-term challenges, the company continues to build a solid subscription business for the long term, as the overall customer renewal rate is above 90% and more than 50% of billings are now recurring (providing a steady stream of cash flow). In the third quarter, deferred revenue rose an impressive 61% year over year to $454.9 million.

I will provide another update on FireEye after the company reports fourth quarter results on February 11.

FireEye remains a ‘Hold’ in the Next Wave Portfolio.

NASDAQ Composite Index:                                                                       

Friday, January 8 = 4,643.63                                                  

Trailing 12 months = – 1.3%                                        

Trailing 4 Weeks = – 5.7%

Trailing 7 Days = – 7.3%