Market Thoughts
February 2006
Review of January
The market started the year in grand fashion, with the month pretty much doing what all
of 2005 did for investors:
S&P 500 (Big)
Price Return:
Energy
Materials
Industrials
Consumer
Discretionary
Consumer Staples
Health Care
Financials
Information Tech
Telecomm Svcs
Utilities
S&P 400 (Medium)
2005
S&P 600 (Small)
JAN
2005
JAN
JAN
2.55%
13.85%
4.67%
-0.45%
3.00%
29.14%
2.16%
0.36%
5.82%
15.60%
6.38%
6.47%
11.27%
52.01%
0.94%
11.03%
8.32%
16.43%
16.58%
9.66%
2005
6.65%
52.18%
7.47%
11.87%
1.72%
-0.17%
1.41%
0.73%
3.19%
3.26%
2.34%
-7.35%
1.34%
4.85%
3.72%
0.38%
-9.05%
12.76%
1.75%
2.96%
2.88%
4.26%
9.06%
-0.50%
3.59%
2.40%
14.90%
17.79%
7.34%
8.37%
-10.59%
6.36%
5.95%
5.68%
7.22%
5.44%
7.46%
1.28%
3.88%
-0.04%
-4.75%
10.96%
-1.93%
-0.42%
-14.73%
4.80%
Old themes reemerged, with Energy, Growth, and Small-Cap being the beneficiaries.
While in large-cap, Value beat Growth, the opposite occurred. Materials stocks performed well,
supported by rising commodity prices. Technology, which I expect to be strong this year,
performed well in Mid-Cap and reasonably in Small-Cap, but Intel certainly hurt the relative
performance in Large-Cap. Consumer was weak, and Financials lagged as well.
Interest rates rose modestly, with the curve maintaining its flatness. Leadership at the
Federal Reserve changed after over 18 years, with the FED going another 25bps (to 4.5%) before
the reigns were headed to Mr. Bernanke. Curiously, they removed the word “measured” from
their directive. Is the end near? Commodity prices were stronger, with the CRB Index rising
over 5%. Gold continued its strong showing, rising almost 10%. Oil too rose over 10%, but
natural gas has been weak due to warm weather. The Dollar was stable relative to the Yen, but
weakened just a bit relative to the Euro.
Alan J. Brochstein, CFA
February 1, 2006
Outlook
The strength that I expected in January materialized, increasing the odds (statistically)
that the markets will have a good year. While I thought that Tech stocks would lead the way,
they are in a distant 2nd place to Energy. I expect that they will take the lead shortly. The 2005
target that just failed for the QQQQs of 43 was achieved early in the month and did serve as
initial resistance. I continue to target an S&P 500 price of 1373 by the end of April and a 14%
return for the year, including dividends. I shared a very detailed forecast last month, and there
are no changes at this time.
Review of Past Focus Stocks
I mentioned last month that I would no longer be updating my thoughts regarding my
2005 picks, but I feel pretty proud of them and want to just mention where they are: ISRG (40 to
now 137), PLXS (16 to now 28), IMDC (60 to now 92) and ADI (39 to 40). Not bad – a homer,
a couple of extra-base hits and a foul-tip!
Last month I shared 4 health-care ideas for 2006. The first was Covance (CVD), which
was at 48.55 and closed yesterday at 56.81. This premier Contract Research Organization
benefits from clinical trial outsourcing, the growth of biotech and small pharma and an increased
focus on drug safety. They had an excellent report and outlook, and I have increased my target
from 60 to 70 over the next year, representing a multiple of 25X 2007 estimated EPS.
Alan J. Brochstein, CFA
February 1, 2006
The second stock is Gen-Probe (GPRO), a company that is involved in bloodscreening and diagnostics (primarily for STDs). The big driver, beyond a robust pipeline of new
products, is the potential to acquire the blood-screening business from its marketing partner,
Chiron, which is being acquired by Novartis. The stock rose modestly from 48.79 to 50.43, and I
continue to target 60 over the next year.
(Intentionally blank)
Alan J. Brochstein, CFA
February 1, 2006
The third stock is Given Imaging (GIVN), an Israeli company that trades on the
NASDAQ and is focused on diagnostic imaging of the gastrointestinal tract. The stock trades at
a steep 49X 2006 projected earnings, but the company could see its earnings come in
significantly ahead of projections. Key product is the PillCam SB, which is for the diagnosis of
the small intestine. This has become the gold standard for unexplained anemia. The company
launched in 2005 the PillCam ESO, which is for diagnosis of the esophagus. While I was
initially skeptical of the potential success for this product, I now fully expect that it will
eventually become the initial diagnosis tool, replacing the EGD (scope). The ESO allows the
great majority of patients to avoid the scope (and the sedation and inconvenience that goes with
that procedure), is economical for the doctor and benefits the insurance companies (they reduce
the number of $1500 facility charges). While this is very speculative, the company has a very
strong balance sheet and is profitable. I think that the company could trade 40X the $1 I expect
them to earn in 2007, suggesting 50% upside potential over the next year. The stock rose
modestly from 26.10 to 26.53 – everyone is awaiting their EPS report next week.
(Intentionally blank)
Alan J. Brochstein, CFA
February 1, 2006
Finally, Salix Pharmaceuticals (SLXP), a drug company focused on the treatment of
gastrointestinal diseases, is poised to reap the benefits of increased exposure (as its market-cap
crosses $1 billion) and a recent merger that gives them another product. The company has two
very strong products, and the recent acquisition gives them a third drug that has a nextgeneration follow-on that is almost certain to be approved by the FDA by March (for
colonoscopy bowel preparation). The stock trades at 21X projected 2006 EPS but is expected to
grow EPS over the next few years in excess of 25% (including an increase in the tax-rate).
Management is very strong, the balance sheet is pristine and the business model (specialtyfocused marketer) is one that makes sense. I believe that the stock, which has recently pulled
back since the merger closed from 22, could see 27 during the coming year. The stock fell
slightly on the month from 17.58 to 17.39.
New Focus Stock
As I mentioned last month, I expect that semiconductors (generally speaking) will
perform well in the first part of this year. The most popular gauge is known as the SOX index,
though it isn’t investable. It is already up over 12% year-to-date. I am recommending this
month that you take a look at SMH, which is an exchange-traded fund (ETF) whose components
come from the semiconductor manufacturers or equipment provider industries. It has lagged the
SOX over the past month due primarily to its heavier exposure to Intel (INTC). Historically, the
two have tracked rather well, though SMH has been somewhat more volatile. Here are the
annual price returns for the last several years:
SOX
SMH
2005 10.7
9.8
2004 -14.7 -19.6
2003 75.7
87.3
Alan J. Brochstein, CFA
February 1, 2006
So, the 10% lag thus far is not characteristic of the history. I like the sector because sentiment is
not very positive, valuation is fair and, fundamentally, the outlook is strong. In a nutshell,
inventories are low, demand is strong and capital equipment requirements are quite high due to
technology changes and capacity expansions. I think that SMH could hit 45-50 by this April,
though a trade below 37 puts up a yellow flag and below 35 a red one. Below are the
components:
HOLDR
NAME
LAST
SMH
Semiconductor HOLDRS
2/1/2006 11:18:00 AM ET
CHANGE
37.61
Detailed Quote
% CHANGE
0.31
0.83
Interactive Charting
VOLUME
GO TO
5,603,600
Download Prospectus
Stocks in Semiconductor HOLDRS (SMH)
Stock
Analog Devices, Inc.
Ticker
ADI
Share
Amount
6.00
Current
Weighting
Last
6.42%
40.23
Net
Change
0.46
Altera Corporation
ALTR
6.00
3.13%
19.59
0.28
Applied Materials Inc
AMAT
26.00
13.14%
19.01
-0.04
Advanced Micro Devices, Inc.
AMD
4.00
4.43%
41.63
-0.17
Amkor Technology Inc
AMKR
2.00
0.30%
5.73
0.10
Atmel Corp
ATML
8.00
0.87%
4.09
0.14
Broadcom Corp
BRCM
2.00
3.61%
67.89
-0.31
Intel Corporation
INTC
30.00
16.98%
21.28
0.03
KLA-Tencor Corporation
Linear Technology
Corporation
LSI Logic Corporation
KLAC
3.00
4.19%
52.51
0.53
LLTC
5.00
4.93%
37.06
-0.15
LSI
5.00
1.22%
9.20
0.05
MU
9.00
3.51%
14.68
0.00
MXIM
5.00
5.46%
41.10
0.06
NSM
6.00
4.49%
28.14
-0.07
Micron Technology Inc.
Maxim Integrated Products
Inc
National Semiconductor
Corporation
Novellus Systems Inc
SanDisk Corporation
Go To
NVLS
2.00
1.53%
28.80
0.45
SNDK
2.00
3.55%
66.67
-0.69
TER
3.00
1.40%
17.49
0.07
TXN
22.00
16.90%
28.89
-0.34
Teradyne, Inc.
Texas Instruments
Incorporated
Vitesse Semiconductor Corp
VTSS
3.00
0.21%
2.62
0.02
Xilinx Inc
XLNX
5.00
3.73%
28.09
-0.07
Technically, the stock is sitting on good support based upon volume at various prices
over the past year. Additionally, I would characterize the price action over the past year as
modestly bullish (higher highs, higher lows.
Alan J. Brochstein, CFA
February 1, 2006
Alan J. Brochstein, CFA
Piedra Capital
Houston, TX
713-622-7625
Alan@PiedraCapital.com
Alan J. Brochstein, CFA
February 1, 2006