Wall Street Week Newsletter | Episode 12 | Byron Wien, Amy Butte, Michael Cahill

Episode 12 | Byron Wien, Amy Butte, Michael Cahill

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This Week on Wall Street
Markets stage turnaround on Greece optimism, China respite

Despite a sharp rise in volatility, major US stock indexes finished basically flat for the week thanks to Friday’s global rally in response to progress on Greek bailout negotiations and a government-engineered turnaround of China’s stock market meltdown. The S&P 500 rallied 1.2% Friday to climb back above its 200-day moving average , which was breached Thursday for the first time in six months.

Friday’s gains in US markets were dwarfed by the upbeat response from European equities as Greece made significant concessions to creditors in a revised bailout proposal . France’s CAC led the charge with a 3.3% gain while Germany’s DAX rallied 2.9%.

July 4th weekend brought fireworks in Europe as 61% of Greek voters voted to reject the terms of the Eurozone bailout proposal. US stock futures opened sharply lower on Sunday night, but pared losses into the morning. Although the market rally faded into Monday afternoon, there was never any evident sense of panic.

Italy's 4.0% slide Monday highlighted the sell-off in contagion-sensitive European equity markets, but the reaction in peripheral Eurozone government bond markets remained relatively muted. Credit spreads between safe-haven and lower-quality bonds widened but not to the extent many feared.

Tuesday the market took a long round-trip, with the S&P finishing up 0.6% after at one stage being down as much as 1.2%. The reversal occurred despite the fact Greece flummoxed creditors by failing to submit a revised bailout proposal as expected.

A four-hour outage at the New York Stock Exchange Wednesday, a day of historic chaos , added to the intrigue. While speculation raced to the possibility of a cyber attack, due to the fact the problems at the NYSE coincided with outages at the WSJ.com, United Airlines and several other websites, NYSE officials insist the glitch was an internal error rather than the result of an outside intrusion. Cybersecurity stocks surged . The reality intraday hiatus had little effect on the day's trading, demonstrating how the NYSE has been increasingly marginalized , but investors still grew anxious of recent cyber attacks being a harbinger of things to come .

US treasuries also enjoyed a volatile week, initially surging in a safe-haven trade Monday following the referendum results. However, yields were back on the rise Friday after Greece submitted its bailout proposal, with the 10-year yield ultimately settling 0.1% higher for the week at 2.40%.

Meanwhile, light sweet crude oil prices for August delivery tumbled more than 7% for the week to below $53/barrel amid renewed concerns about global oversupply.

Greece

The Greek referendum now appears to have been little more than a political charade as Greek officials, after getting queasy upon peering over the ‘Grexit’ cliff, appear ready to compromise. Greece replaced its controversial finance minister , extended capital controls and began to strike a more conciliatory tone with creditors.

The ultimate deal could end up looking a lot like the one rejected on referendum, with only key differences regarding some pension, fiscal and structural reforms remaining. European financial officials will vote on the proposal Sunday.

The greatest point of contention in the Greek proposal is the requirement for long-term debt restructuring. The IMF and even Germany's Finance Minister Wolfgang Schaeuble have admitted Greek debt is not sustainable without debt forgiveness, but Schaeuble was also quoted as saying debt restructuring would "infringe the system of the European Union." Perhaps the Germans are forgetting the post-war history lesson on debt relief ?

Germany do not want a disorderly Grexit, but also don’t want to set a precedent for the likes of Portugal, Italy, Spain and France to pursue debt forgiveness. The conundrum shines a light on the underlying problems with the Eurozone experiment.

China

The roller coaster in Chinese markets continued this week, with extreme measures finally able to stop the bleeding. China’s Shanghai composite index plunged 30% since mid-June after spiking 150% in the prior 12 months. For some perspective, the index’s decline from highs, in terms of market capitalization, represents nine times the value of Greece’s GDP.

Despite rate cuts and further stimulus from the People’s Bank of China, the meltdown rumbled on early in the week, prompting Chinese officials to institute even more stringent protocols to stem the selling tide. History tells us that while the desperate measures could slow the stampede in the short-term, over the long-run damming the river could simply lead to an even greater flood . (Or might Chinese officials be able to pull off a great escape ?) Band-aids don't fix bullet holes.

The turnaround started Thursday with a nearly 6% bounce, the largest single-day advance since 2009 , as Chinese regulators banned shareholders with large stakes in companies from selling shares for six months and pursued criminal complaints "malicious short-sellers." However, the index’s first weekly gain in three rung hollow, as around half of all listed companies on country's Shanghai and Shenzhen indexes remained halted (down from the intra-week high of around 75%).

The lack of regulatory oversight that led to the initial margin-fueled bubble and air of desperation from Chinese authorities in the response to the crisis has investors concerned about the state of the world’s second largest economy . The economic and market ills in China pose a much greater fundamental threat to global economic growth than Greece.

US economy

The Bureau of Labor Statistics reported a 15-year high in job openings (5.36 million) for May. The ISM services index rose to 56.0 in June, reinforcing the expansion in US economy reflected in the ISM manufacturing survey and recent employment reports. The US trade deficit grew to $41.9 billion in May thanks to weak overseas demand for exports and a strong dollar. US jobless claims climbed 15,000 to 297,000, marking five straight months below 300,000, although both the four-week moving average and continuing claims both climbed.

In June’s Fed minutes , the FOMC acknowledged it was keeping an eye on developments in Greece and China in regard to its rate-setting decision process. However, they didn't see any dislocations yet that would alter the current rate-hike schedule. The IMF and OECD both lowered global growth forecasts in response to the global turmoil.

Corporate news

Microsoft (MSFT) CEO Satya Nadella announced plans to cut nearly 8,000 jobs (6% of the company's global workforce), take a $7.6 billion accounting charge on its ill-fated Nokia acquisition and basically shutter its smartphone hardware business.

Aetna (AET) announced a $34.1 billion takeover of Humana (HUM), the largest-ever consolidation within the health insurance industry, in an attempt to gain improved pricing power following the recent Supreme Court essentially cementing the Affordable Care Act into law. But will it pass regulatory scrutiny ?

Procter & Gamble (PG) announced plans to sell 43 beauty brands to Coty (COTY) for $12.5 billion in order to re-focus its products line on the popular consumer brands responsible for most of its sales.

Week ahead

Tuesday: US retail sales, EU industrial production, China GDP, J.P. Morgan (JPM) and Wells Fargo (WFC) earnings
Wednesday: US industrial production, PPI-FD
Thursday: Philadelphia Fed business outlook, US jobless claims
Friday: US CPI, housing starts

Episode Playback
Wall Street legend Byron Wien shares his formula for success

Did you miss Sunday's show featuring Byron Wien, Amy Butte and Michael Cahill? Watch all segments, extended interviews and web extras at WallStreetWeek.com

Episode Feature
Metabolizing the biotech-tonic shift

Biotechnology has been one of the hottest sectors in the market over the past decade, with the iShares Biotech ETF quadrupling since the beginning of 2011. Legendary investor Byron Wien of Blackstone Group, this week’s guest on Wall Street Week, believes even at current levels, investors are underestimating the transformative potential of biotech innovation.

“Most people still don’t recognize the gigantic implications of this phenomenon,” Wien said. “Major breakthroughs are going to be taking place in cancer, heart disease, Alzheimer’s, diabetes, multiple sclerosis and other diseases.”

The development and approval cycle for drugs has accelerated, and with it the profits of biotech companies. Regulation has also been kind to the industry, with Cowen Group President Jeffrey Solomon declaring on last week’s show that biotech has been the big winner of recent healthcare legislation.

“I think biotechnology companies are actually winners [in the Obamacare Supreme Court ruling] interestingly enough, because the amount of time it takes to do drug discovery and the ability to get reimbursements is actually reasonably sanguine right now,” Solomon said. “I expect there to be something between 2,000 and 2,500 new therapies on the market in the next four years, that will take massive costs out of the system for Alzheimer's, diabetes and certain sub-sectors of cancer.”

The word bubble gets tossed around in the biotech sector due to high growth multiples, but Solomon dismissed that notion.

“A lot of people talk about whether or not there's a biotech bubble. Things have gotten better and a lot of companies have come public. But here are some statistics: Since 2011, there have been about $65-70 billion of equity raised in the public markets, both from IPOs and File-1 offerings for biotech and tools of diagnostics. In that same time period, over $260 billion of M&A has come out of the market. When we talk about how things are valued, just fundamental supply and demand suggests that there's more money walking around today, assuming no new inflows into biotech, which we know is not true, and no new allocations from general funds into biotech, which we know is not true. I'm not saying we can't have revaluations of whole industries, but the biotech trade continues to be a very compelling one, just if based on nothing else other than supply and demand.”

Valuing technology companies has always been a difficult proposition. The rise of the Internet forced investors to construct subjective growth models, and tech bubble bursting in 2000 was evidence that exuberance spiraled out of control. Today investors grapple with the same questions as money pours into Silicon Valley.

Biotechnology investment results can be even more binary. The high costs of research and development (R&D) and make-or-break nature of drug approvals mean small, one-hit wonder biotech companies, while offering high potential reward, carry tremendous risk. Institutional investors in biotech typically speculates on the space through ETFs or a basket of larger companies. Wien believes the potential exists within biotech for humanity-changing disruption.

“Right now there are literally hundreds of small companies working on significant products. Many of them will fail, but a few will change the world the way Google and Facebook did.”

The industry has seen significant consolidation in recent years, creating conglomerates with deep line-ups of cash-cow drugs. Wien likes to invest in larger biotech companies that spend heavily on R&D, but only if those costs remain at reasonable levels relative to revenues. He also emphasizes the need to take a thoughtful long-term view with biotech investments.

“Probably the most valuable thing I can say to you today is this: the core of my investment philosophy is understanding what you own. Pick your stocks carefully, and hold them for a very long time. I've held some of these biotech stocks through '87, '90, through 2000, through 2007.”

Asked by host Anthony Scaramucci about what biotech companies he like most, Wien named Biogen Idec (BIIB) and Gilead Sciences (GILD), which happen to be the most heavily weighted stocks in the iShares IBB ETF at just more than 8%. Gilead, the larger of the two, carries a market cap of almost $170 billion and expects to grow its revenue by around 15% this year to nearly $30 billion. Today, there are 44 biotech companies with market caps over $2 billion. Last year there were 26 and in 2011, 14.

Wien also likes investing in biotech because of its relatively low correlation to broader markets, which is why he felt comfortable holding biotech stocks through painful financial panics. “Picking the right companies can produce impressive returns in a difficult overall market environment,” he said. Even during periods of weak economic growth, low price elasticity for healthcare means demand and cash flows remain fairly steady.

Beyond evaluating healthcare stocks as potential investments, Wien also believes it's important to consider social and economic implications of the biotech boom. Baby boomers, for example, are living longer, healthier lives, further crowding the workforce and exacerbating issues with unfunded liabilities like social security. Biotechnology is changing the world, and if you want to achieve above-market returns, Wien believes you should allocate capital to the sector, as well as consider its broader impact on the world.

Investment Primer
What is technical analysis?

In Episode 12, Byron Wien talks about his use of technical analysis in making investment decisions. While technical analysis, often associated with day trading, is a dirty word to many on Wall Street, Wien believes if used properly it can be a powerful decision-making tool.

Fundamental analysis

Fundamental analysis is a method of attempting to measure the intrinsic value of an asset. Fundamental investors assess factors like earnings, free cash flow, debt, growth rate, dividends and interest rates to determine fair value, which is then compared to the asset’s current price to determine whether it represents an attractive investment opportunity.

Fundamental analysts also analyze economic trends and weigh qualitative factors, such as product quality and management style, in an attempt to make future growth projections. Even though all analysts look at the same data, price targets may vary based on differences in the qualitative, forward-looking variables of fundamental analysis.

Technical analysis

Technical analysis, on the other hand, is a method of attempting to forecast future price of an asset based on historical data, especially relating to price and volume. Technical analysts eschew the fundamental notion of analyzing the underlying business, instead focusing on pattern recognition to construct seemingly favorable risk-reward scenarios.

In essence, technical traders believe fundamental factors are already baked into the price of an asset at any given time, and the only way to gain an edge is to look for favorable entry and exit points based on historical trends. Stock charts are used as the canvas on which technicians look to read and tell the story behind a stock’s movement.

How does technical analysis work?

Technical analysis can be simple or complex depending on the number of factors used in the process. Traders may choose to focus exclusively on price, or incorporate additional indicators such as moving averages, volume analysis and more.

Technicians either conduct automated screens for certain characteristics or peruse charts individually, looking to identify a certain patterns. Ultimately, technical analysts use a collection of indicators to measure factors relating to investor sentiment and behavioral psychology.

A core tenet of technical analysis is the importance of price levels. The two most important price levels are support and resistance. Support is a level below the current price where a stock has historically had difficulty trading below. Resistance is a level above the current price where a stock has historically had difficulty trading above.

A stock could have difficulty trading below support or above resistance, but if its price does breach those levels, the expectation is for additional momentum and the start of a new trend. The majority of technical analysis strategies seek to identify and exploit trends - uptrends, downtrends and sideways trends, which are defined by a series of lows and highs.

Technical analysts also study the volume of a stock, especially relative to corresponding moves in price. If a move in a stock is accompanied by above average volume, it is deemed to have greater significance. Large moves high on above average volume are known as accumulation days, as it appears investors are accumulating a large number of shares (a bullish sign). Large moves lower on above average volume are known as distribution days, as it appears investors could be selling shares back into the market (a bearish sign).

Technicians may use several different types of stocks charts, including line charts and bar charts, but most refer to candlestick charts. Candlestick charts create a more detailed story about the movement of a stock on a given time-frame. On a daily candlestick chart, for example, each candle represents one day, and has a body and a wick. The body of the candle represents the opening price and closing price, with the candle typically colored red for a down day and green for an up day. The wick on each candlestick then reflects the intra-day low and high of the stock. There are schools of highly complex candlestick pattern analysis, but generally candlesticks with long bodies are seen as more significant than those with long wicks, which represent indecision.

Moving averages are another popular tool of technical analysts, creating additional price levels for traders to measure the composure of a stock. Moving averages track the average price of a stock over a given time frame, and are reflected as lines on a chart. For example, a 200-day moving average would reflect the average price of a stock over the last 200 days. Stocks trading above moving averages are generally considered strong, while those trading below moving averages are considered weak. A flat moving average is indicative of a sideways trend, while upward/downward sloping moving averages are indicative of uptrends/downtrends.

As is the case with support and resistance, when a stock crosses above or below a moving average, it is deemed as a potential inflection point. The greater number of days in a moving average, the greater its significant to technical analysts. There are also two different types of moving averages: Simple Moving Averages (SMA), which give equal weighting to price on each day of the average, and Exponential Moving Averages (EMA), which give greater weighting to price on more recent days.

Technical analysts may also use more complex tools like Bollinger Bands, moving average convergence divergence (MACD), relative strength index and other oscillators and indicators.

The big picture: blending fundamental and technical analysis

While there are traders who exclusively operate using technical analysis, established investors who employ technical analysis typically use it in concert with fundamental analysis. While over-trading can adversely affect performance, technical analysis can also potentially help investors improve trade entries, exits and risk management.

In this week’s episode of Wall Street Week, Byron Wien talks about how he uses fundamental analysis and technical analysis to complement each other. For example, if he identifies a strong investment opportunity from a fundamental analysis, he will analyze technical signals in an attempt to buy at the lowest price and/or with the highest degree of confidence.

While technical analysis often associated with day traders, the majority of which dramatically underperform benchmarks, technical analysis can also be conducted on long-term time frames that ignore the short-term noise. Regarding risk management, important technical levels, rather than arbitrary drawdown percentages, can form the basis for stop-loss levels in long-term investments.

Have more questions about technical analysis? Email us at prosper@wallstreetweek.com

Week Links
Wall Street circus

China

Beijing’s Response to Stock Selloff Reveals Deep Insecurity (WSJ, Andrew Browne)

China hackers stole the personal information of about 7% of America from the US government (Business Insider; Natasha Bertrand, Michael B Kelley and Brett LoGuirato)

Europe

Europe is blowing itself apart over Greece - and nobody seems able to stop it (The Telegraph, Ambrose Evans-Pritchard)

A brief timeline of the Greek debt crisis since 2009 (Business Insider, Elena Holodny)

Let’s talk about… the 1953 London Agreement on German External Debts (FT, Joseph Cotterill)

How Iceland Emerged From Its Deep Freeze (NY Times, Jenny Anderson)

Glitch

Glitches Galore: A Brief History Of Technical Problems On Wall Street (NPR, Krishnadev Calamur)

Incentives

Want engaged employees? It’s easy—pay them (Fortune, Rick Wartzman)

This Chart Shows How CEOs Get Rich by Dumping Cash on You (Bloomberg, Alex Barinka)

Policy

Who pays for infrastructure in the United States? (Tumblr, Kristi Culpepper)

Ex-Im Bank’s Bad Rap for Crony Capitalism (BloombergView, Albert R. Hunt)

Analysis and opinion

The Root of Our Problems (The Motley Fool, Morgan Housel)

5 things investors should know, but don’t (Financial Post, Peter Hudson)

Why Momentum Investing Works (A Wealth of Common Sense, Ben Carlson)

Potpourri

The Work We Do While We Sleep (The New Yorker, Maria Konnikova)

Why strong encryption is elementary (CS Monitor, Robert M. Lee)

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