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38

“You only find out who is swimming naked when the tide goes out,” Warren Buffett wrote in a 2001 letter to Berkshire Hathaway (BRK.A) stockholders. That’s wildly inaccurate beach advice. However, taken as financial advice, it’s the sort of vague gem that always seems to apply to the crisis of the moment. It’s timeless.
Recommendations to buy particular stocks don’t last nearly as long. Investors who follow t
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he advice of Wall Street analysts should always check the date. Dozens of studies of analyst recommendations published over the past two decades point to two broad findings. First, stocks with heaps of “buy” recommendations attached to them tend to perform no better than other stocks. Second, stocks with recent, positive changes in analyst opinions—to “buy” from “hold,” for example—tend to outperform the broad market over the following year. The difference is timing. Five “buy” recommendations issued a year ago hold less predictive power than one issued yesterday because factors like price/earnings ratios, sales growth rates and economic trends can change sharply in a year.
At least one analyst covering each of the three stocks below changed his or her published recommendation to “buy” (or “outperform”) this week.
Alaska Air
Upgraded to Buy from Hold Sept. 22 Helane Becker, Jesup & Lamont

Alaska Air Group (ALK) flies passengers to almost as many cities in California as in Alaska (and has its corporate headquarters in Seattle). Its sales are forecast to decline 10% this year. That’s not so bad when compared with giant airlines like American and United, whose corporate parents are expected to suffer 2009 sales declines of 17% and 21%, respectively. On Tuesday, Alaska Air lowered its third-quarter estimate for fuel costs and said some key sales measures (sales per passenger and per seat/mile) improved in August from July. A new baggage fee helped. Helane Becker of Jesup & Lamont upgraded the stock, citing valuation in a Tuesday note. Shares sell for less than 12 times the 2009 earnings consensus.
Gymboree 
Upgraded to Outperform from Market Perform Sept. 22Adrienne Tennant, FBR Capital Markets
Just over a year ago this column recommended  shares of Gymboree (GYMB) as a safe haven in stormy markets. They’re up 27%, vs. a 13% decline for the broad-market S&P 500 index. Once a play center and now a kids’ clothier, Gymboree is increasing its sales this year, unlike competitors The Children’s Place (PLCE) and Gap (GPS). In a Tuesday investor note recommending the stock, Adrienne Tennant of FBR Capital Markets wrote that the company is gaining market share because of “compelling” products, that potential exists for sustained sales improvements at longstanding stores and that the stock is still cheap. It trades at 15 times earnings.
Dish Network
Upgraded to Outperform from Market Perform Sept. 22Marci Ryvicker, Wells Fargo Securities

Dish Network (DISH) offers satellite television service that competes with cable and with the satellite service of Direct TV (DTV). Because cable companies sell bundled television, telephone and Internet service, satellite companies must pair with telephone companies to compete. AT&T (T) dumped Dish for DTV earlier this year, so although DTV is expected to increase its sales by 9% this year, Dish’s sales are forecast to rise less than 1%. Perhaps that difference is more than reflected in the two stock prices, though. DTV sells for 19 times earnings and Dish just 10 times earnings. In a Tuesday upgrade note, Marci Ryvicker of Wells Fargo Securities wrote that Wall Street’s expectations for the company are too low and that the share price should rise as the economy pulls out of recession.
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33

For most of this decade, Americans could be counted on to buy more than 16 million cars a year. Last year sales barely topped 13 million. This year industry forecasts call for 10 million.
America’s car makers are thus struggling to survive. On the eve of a government-mandated restructuring deadline, Chrysler was scrambling to partner with Fiat, win cost cuts from the United Auto Workers union in exchange for a big ownership stake and convince debt holders to accept less than they’re owed — and perhaps less than physical assets would fetch in a liquidation. On Mo
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nday, General Motors (GM) said it will cut 2,600 dealers and eliminate its Pontiac brand, and will either sell or close Hummer, Saturn and Saab. It faces a June 1 deadline to restructure, or file for bankruptcy.
I wish both companies success, but for America’s car business to have a shot, policy makers and Detroit executives must come to terms with three ugly truths.

The new sales pace is closer to normal than sickly.

America’s car count has grown well faster than its population over the past half century (see graphic below). Credit two trends: Incentives for house buyers have pushed citizens away from cities in search of affordability, giving them long commutes, while the cost of living has outstripped wage growth, leading to a surge in two-worker, and two-driver, families. But our stock of cars couldn’t grow that fast forever. We’re already well past the point where our cars (close to 250 million of them) outnumber our drivers (just over 200 million).
I’m guessing the bubbly pace of sales we took for normal a few years ago was driven far more by fashion than utility. The suburbs, after all, put neighbors’ cars on naked display. In 2002, the average new car buyer kept his car for just over 49 months. Whether because consumers can’t borrow more or because flashy displays of wealth have fallen out of style, that number has since crept up to 56 months. It can surely climb higher.
Sales of 10 million cars a year are enough today to keep every driver in his or her own car (already an astounding thing), with many of them driving new cars and none driving ones built much earlier than 1990. That’s enough. It’s not like new technology demands a stampede to showrooms. Tree lovers who buck up for a Toyota Prius today will go five fewer miles on a gallon of fuel than I went at age 16 in a Volkswagen Rabbit with a diesel engine. It was made in 1980.

Recent boom years weren’t so great for car makers, and Congress is partly to blame.

General Motors didn’t turn a profit in 2005, 2006 or 2007, years of relative opulence. Even before that, profits came largely from lending, including for houses, and not from making and selling cars. Operating margins for the car business have been more or less in decline since the 1960s. Health-care costs have steadily risen. General Motors famously spends more than $1,600 per car for employee health care.
In the U.S., government payments to the middle class for health care are decried as socialist, but the money is nonetheless needed, so we route payments through employers using a giant tax subsidy, and somehow convince ourselves that we’re more capitalist for it. The money ultimately comes out of workers in the form of lower wages and take-home pay instead of taxes — a subtle enough difference, except the scheme also leaves employers on the hook in the event of a sudden rise in plan costs, which we’ve had over the past decade. Nonunion companies and ones without steep obligations to retirees can adjust. Car makers can’t. On some level, rather than boo them we should applaud them. By losing money to health-care costs, they’ve taken on a responsibility that politicians have shirked.

Jobs worth saving generally don’t need saving.

Over the past year policy makers have lent car companies billions of dollars on the theory that if we keep them alive long enough the economy will pick up and good jobs will be saved. But financial failure for a company doesn’t mean that it ceases operations. Often, it means it drastically shrinks, takes on new management and forces otherwise impossible concessions on its unions and creditors. That might be just what’s called for.
Last week I wrote that what some politicians call extraordinary times, financially speaking, are really a return to normalcy. Personal savings (what consumers don’t spend) has recently risen from less than 1% of after-tax income to more than 4%, but its long-term average is 7%. After-tax corporate profits have fallen from 7% of the nation’s income to 5.1%. Their long-term average is 5%. If sales of 10 million cars a year is the new normal, too, we still need plenty of car workers — just not as many as we have today.
One recent proposal by lawmakers would give $4,000 to $5,000 to a consumer who buys a new car by year’s end. It seems like an easy fix. I can picture cashing my $5,000 check and driving off in a new Ford with the thought that I’ve helped my fellow American earn a decent wage. But giant car incentives will only lure Americans into buying more of something when they don’t truly need it, in the same way that giant house incentives have doubled America’s average house size since 1950, even as families have shrunk.
Better to let the car business shrink to a healthy size, whether through bankruptcy or selling brands and closing production lines. Send more taxpayer cash to Detroit if need be, but use it to help our former car workers find and qualify for good new jobs that need them.
More Cars Than Drivers


Source: U.S. Department of Transportation

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17


In January, I wrote about the “stealth” bull market. It was so stealthy that it ended as soon as I gave it a name. Now we’ve experienced another bull market. I’m calling this one the “Road Runner” rally. It went by so fast that it seemed a dizzying blur.


From March 9, when the Nasdaq Composite closed at 1269, to March 26, when it hit 1587, the index rose just over 25%. The Dow Jones Industrial Average and the S&P 500 each rose more than 20%, the traditional definition of a bull market. This remarkable

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move required just 17 days, the fastest, steepest rally since 1938, which makes it the fastest bull market in my lifetime.


Then, on Friday, the averages plunged.


Last week I mentioned that astute investors following the Common Sense system should be getting ready to sell something. Little did I know that just a few days later the Nasdaq would indeed hit a Common Sense selling threshold, which is a 25% gain from the most recent low, or 1586. That selling opportunity was brief, and I happened to be en route to Boston.


This is the second such brief opportunity this year, the last being in January (see column of Jan. 6). Then too, I wasn’t in a position to take advantage of it. Like most people, I don’t sit glued to a screen with stock quotes; I don’t check the market every day let alone every hour; and my system isn’t designed for split-second market timing. If that means missing a few signals in my system, so be it. I call these thresholds opportunities, not obligations, though obviously there’s no point in having a system if you don’t make a good-faith effort to follow it.


There’s also something a little unsettling about markets that move at warp speed. We’ve experienced the dizziness of free fall; now we’ve been getting a taste of the equally fast ascent. It reminds me that there’s a reason I don’t seek out the thrill of theme-park roller coasters. A 318-point upward move in the Nasdaq in a matter of 17 days is clearly unsustainable, if not quite a mathematical impossibility. While I would have appreciated the opportunity to raise a little cash last week, Friday’s drop actually came as something of a relief. Another rise would have seemed manic, merely setting investors up for another plunge.


Volatility remains high, which has yielded these recent buying and selling opportunities to those following the Common Sense system. Traders love this, since such swings yield higher profits, especially in the short term. I’m not a trader, nor, I assume, are most readers, and I’d be happy with fewer such opportunities. I can remember years which yielded just one or two. Nevertheless, this is the world that confronts us. We might as well take advantage of it.


The standard measure of volatility is the VIX, or Chicago Board Options Exchange Volatility Index. When the index is high, investors expect a high level of volatility. For years the index rarely breached 20. Though it has receded from its extreme highs of last fall, it’s recently been trading in a band of 40-50. The index is misleadingly labeled the “fear index;” since the volatility could as easily be on the upside, it could also be dubbed the “greed” index.


Apart from a broad market indicator, I find the VIX is a useful guide to the premiums investors might expect to be priced into options. When the VIX is high, options are expensive. Just like stocks, I like to sell high and buy low, so when options prices are high, I tend to be a seller.


Last week I mentioned a strategy called “covered calls,” which involves the simultaneous purchase of a stock and selling calls of the corresponding option. Given the recent selloff, that’s proven to be a good strategy. While stock prices may have dropped, so have the corresponding options prices. When you write a call, you receive the cash and your account statement reflects an offsetting debit, which declines as the option price drops. It’s extinguished altogether if the option eventually expires worthless.


Over the years I’ve found it’s also an effective strategy to sell calls on stocks I already own when the Nasdaq Composite hits one of my selling thresholds. That’s especially true if the VIX is elevated and the rally is still in its early stages, both of which are true now. Selling calls gives investors immediate cash as well as the potential for further gains in return for capping those gains at the strike price.


I’ve said before that selling covered calls is a conservative strategy for reducing risk. I never recommend selling calls on stocks you don’t own — so-called naked calls — since you might be forced to deliver those shares at very high prices. Selling a covered call caps your gains; selling naked calls exposes you to potentially unlimited losses.


Given the brevity of last week’s selling opportunity, I haven’t yet had a chance to put this approach into practice. But when I missed the selling threshold in January, I said I was confident another opportunity would present itself eventually. It did. I feel the same way now. And the next time the Nasdaq crosses 1587, maybe it will do so with some real conviction, and actually stay there for more than a few hours. The Road Runner rally may have ended, but the tortoise is still in the race.


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39

Think carefully on this: Are you more or less happy today than a year ago? It might seem an absurd question. In America as in much of the world, stock and house prices have plunged over the past year and jobs have grown scarcer. Yet 35% of people surveyed in mid-April described themselves as “very happy.” That’s the same percent as a year earlier.
The pollster, Harris Interactive, draws a tempting but wrong conclusion from the results. “Money and Happiness
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Really May Not Be Tied Together” reads the title of a report issued Friday. Don’t suggest that to a jobless parent collecting the last of their unemployment checks as their health insurance lapses and their mortgage payments back up.
There’s an important relationship between wealth and cheer, but it’s tricky. In 1972 economist Richard Easterlin, then a professor at the University of Pennsylvania, reported an odd finding from happiness studies compiled from 19 countries since World War II. Within single countries, the rich are generally happier than the poor -- little surprise. But as a whole, rich countries aren’t much happier than poor ones, at least among countries with enough income to meet basic needs. Moreover, as a country’s overall wealth increases, its average level of happiness does not.
The Easterlin paradox has since defined the direction of happiness economics, a chipper-sounding but contentious branch of the dismal science. Researchers have a couple of explanations. One holds that people care more about relative wealth than absolute wealth. For suburbanites, whose success is put on naked display for the neighbors, household income of $150,000, triple the U.S. average, seems meager if the Joneses make $400,000. That would explain why poor countries are as happy as rich ones (so long as they aren’t subjected to too many images of them, perhaps).
Another theory holds that people adjust their ambitions with remarkable speed following improvements in economic circumstances, as in the case of the lottery winner who develops a taste for exotic cars. This “hedonic treadmill” helps explain why more gross domestic product per head doesn’t necessarily bring more smiles per head.
Some economists insist the Easterlin paradox is a flawed finding, and that changes in absolute wealth indeed drive happiness, but with diminishing returns. Politics threatens to creep into the research. If relative income influences happiness more than absolute income, the Dutch might be sensible for forfeiting half their pay to the state in exchange for universal healthcare, pensions, daycare, textbooks, vacation funds and more. If not, low taxes and few social programs are better.
Assuming relative wealth is at least a significant determinant of happiness, America’s “very happy” 35% might be poorer than a year ago, but no worse off than their neighbors. After all, few investment classes and vocations have been spared a downturn. If you’re not already a member of this fortunate bunch, ponder people who’ve got it worse, which, perversely, might make you feel better. Average income in America was $38,615 in 2007. SmartMoney’s marketers tell me readers of this column likely make well more. Average net worth for American households led by persons age 45 to 54 is about $94,000. If you’ve got more, great. If not, think about what you haven’t lost: That figure is down 45% since 2004.
Even if you don’t stack up well on U.S. measures, consider how things look for some peer nations about now. U.S. government debt will soon pass 80% of GDP, but Italy and Greece already owe more than GDP and Japan owes almost double. America is borrowing like mad at the moment, so its net government bond sales will total 12.7% of GDP this year. Britain’s will total 17.9%, reports Barron’s. America’s economy is shrinking, but starting with last year’s downturn and running through 2013, it’s expected to grow by 0.7% a year after inflation, according to the Economist Intelligence Unit. The economies of Japan, Germany, Italy and the U.K. are expected to shrink over the same period.
Things are grim all around. So try your best to have a happy Memorial Day weekend, relatively speaking.
SMARTMONEY ® Layout and look and feel of SmartMoney.com are trademarks of SmartMoney, a joint venture between Dow Jones & Company, Inc. and Hearst SM Partnership. © 1995 - 2009 SmartMoney. All Rights Reserved.

3
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37

A year ago, with the markets and the economy in meltdown, the SmartMoney Power 30 was full of the usual cast of government giants and Wall Street heavyweights: Bernanke, Geithner, Buffett. But as we move to a new phase, a time of slow but seemingly steady recovery, some of the biggest players might seem more on the fringe—academics, advisers, even a lobbyist. What follows is a mix of the famous and not-so-famous, all trying to make sure in their own way that the Great Recession turns into the Great Recovery.


Sheila Bair
Chairman, Fed
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eral Deposit Insurance Corp.
A Republican appointed by George W. Bush to head the federal agency that insures bank deposits and bails out failing banks, Bair, 55, still has a lot of work to do. She has been an outspoken critic of the industry, pushed for more authority to regulate banks "too big to fail" and publicly criticized President Obama's financial-system reform plan, saying major parts of it won't make it through Congress. Next up: dealing with the growing number of "problem" banks, which recently topped 400, and the FDIC's insurance fund-at its lowest level since 1993.

Ben Bernanke
Chairman, Federal Reserve
He might not be a rock star, but he's hardly keeping the low profile many thought he would when he succeeded the more camera-friendly Alan Greenspan as Fed chairman. Bernanke, 55, sat down for an interview with 60 Minutes, took questions from mainstream Americans in a town hall meeting in Kansas City, Mo., and cooperated with a Wall Street Journal reporter on a book-about his role in taming the financial crisis.
The idea behind the unprecedented publicity is to get the average American to understand what's at stake in the Fed's extraordinary efforts to juice the economy. Now that the former Princeton professor has steered us away from a second Great Depression-earning the cheers of fellow economists, if not politicians-he'll face the toughest trick of all as his second four-year term begins in 2010. He has to decide when and how to slow the economy before inflation returns. "Will he have the guts to put the brake on when the unemployment lines are painfully long?" asks James Angel, associate professor of finance at Georgetown University's business school.

Earl Devaney
Chairman, Recovery Act and Transparency Board
A year ago, no one had ever heard of Earl Devaney. Then again, Congress also hadn't authorized a $787 billion stimulus package intended to resuscitate the economy-and with it, a government unit to make sure that money is spent prudently. Now the 61-year-old Interior Department's inspector general has two and a half years and a budget of $84 million to see that the stimulus package does what it's supposed to do. Step one: Get all Americans involved, via Recovery.gov, which lets anyone with Internet access see exactly where and how the money's being spent, down to the most minute details of individual contracts. Then, after essentially deputizing the population as his watchdogs, Devaney and Co. are charged with tracking fraud, waste and abuse-problems they hope citizens will flag as they dig into the data on the site. "Once the American people can see how their money gets spent, we'll never do it the old, nontransparent way again," Devaney says. "The cow is out of the barn. This is the future."

Doug Elmendorf
Director, Congressional Budget Office
The former Harvard economics professor serves as a reality check on government spending, putting a price tag on everything from the tiniest piece of pork to the cost of health care reform-and so he indirectly affects policy (along with the rest of the nonpartisan CBO). After spending much of his career behind the scenes, Elmendorf, 47, says he is learning to "pick my words carefully." Earlier this year, his blunt questions about proposed health care reform bills slowed down Democrats' efforts right before the summer recess and put him at odds with his predecessor Peter Orszag, who is now the president's budget chief. Given the spate of proposed reforms on the table, the drama isn't expected to end any day soon. The tension is just part of the job, says Alice Rivlin, who has held both men's positions in the past, but she adds, both roles "are probably crucial"-perhaps now more than ever. As Congress begins to shift its focus to other issues, Elmendorf says he is building up CBO's ability to analyze financial-sector issues in the wake of the government's deeper involvement-for example, with Fannie Mae and Freddie Mac-which will affect the budget and also will likely push Congress to explore ways to approach the housing market in the future.

The 2009 SmartMoney Power 30



Kenneth Feinberg
Special Master for TARP Executive Compensation
Feinberg doesn't take easy jobs. The Washington, D.C., lawyer has overseen victims' settlements for the 9/11 terrorist attacks and the Virginia Tech shootings. Compared to those grim assignments, judging the fairness of Wall Street executive pay doesn't seem so hard. As the Obama administration's pay czar, Feinberg is reviewing executive and employee salaries and perks at the seven companies that have received "exceptional" government assistance, including AIG, Citigroup and General Motors. Perhaps his most aggressive move to date was pressuring outgoing Bank of America Chief Executive Kenneth Lewis to return $1 million he received this year and to forgo the rest of his 2009 salary and bonus. Corporate America is watching Feinberg closely: At a time when shareholders are loath to award millions to executives at struggling companies and pending legislation would require public companies to submit executive pay to a shareholder vote, Feinberg's guidance on compensation holds a lot of weight. "It certainly takes a lot of the fervor out of the debate," says Scott Talbott, the head lobbyist for the Financial Services Roundtable.

Timothy Geithner
U.S. Treasury Secretary
Wall Street greeted Timothy Geithner's speech on fixing the banking system last February with a 382-point slide in the Dow. Now that the economy has stabilized, his to-do list includes pushing the administration's proposals for financial reform and reassuring countries like China that Uncle Sam is good for his debt. But it's still a rough road. Critics say the administration has failed to live up to its ambitious agenda. "They're letting Congress push them around," says Lawrence J. White, an economics professor at New York University. On Capitol Hill in July, Geithner, 48, acknowledged the backlash to Obama's regulatory plans and pushed for action this year: "If we wait and we try to do it piecemeal, it's going to be much harder."

Valerie Jarrett
White House Senior Adviser
When America's CEOs have something to say to the president, Jarrett can help. Last spring, travel executives upset over Obama's remarks about business travel were surprised to see the president pop in on their meeting with White House economic officials. The visit-and a presidential lunch over the summer with CEOs from Xerox, AT&T and Coca-Cola, among others-were arranged by Jarrett, who also happens to be one of the president's closest friends.
The 52-year-old lawyer once ran Chicago real estate developer The Habitat Co. and sat on various boards, including the Federal Reserve Bank of Chicago and the Chicago Stock Exchange, where she was chairwoman. That experience and her friendship with the president make Jarrett an invaluable bridge between government and business in her role as senior adviser. (Obama has called Jarrett his eyes and ears and said he trusts her completely.) "She's like Warren Buffett-someone who will give you great sound advice," says Ariel Investments founder John Rogers Jr., who grew up with Jarrett in Chicago's Hyde Park neighborhood. "They may tell you something you don't want to hear, but you realize it was exactly what you needed."

Peter Orszag
Director, Office of Management and Budget
Regularly described as tough and disciplined-he has trained for marathons in the middle of the night-Orszag, 40, is one of the leading experts on health care, Social Security and retirement policy. The self-described "supernerd" regularly meets with members of Congress in a frontline role not typical of most economists. But Orszag's flair for adjusting policy to address concerns while still achieving stated goals makes him a valued member at the table, says Robert Greenstein, director of the Center for Budget Policy and Priorities. As the man controlling the nation's purse strings, Orszag tells SmartMoney he "is very concerned" about the nation's record budget deficit. But he says the focus should be the medium- to longer-term deficit, after the economy has recovered. But "key to our fiscal future," he says, is reining in health care costs. After building up health care capabilities as the former director of the Congressional Budget Office, he now finds himself at odds with the CBO over recent health care reform proposals. "Even the best referee sometimes gets things wrong," he says. "And when that happens, it is healthy to point it out."

Elizabeth Warren
Chair, Congressional Oversight Panel
Elizabeth Warren rarely got results like these as a Harvard law professor: Less than a month after taking her new role as lead watchdog over the Wall Street bailout, she slammed the U.S. Treasury for failing to adequately monitor payouts from the Troubled Asset Relief Program and for its secrecy in general, and the department promised more transparency and better tracking of funds. Warren, a specialist in bankruptcy law and consumer debt, isn't stopping there. She's pushing for stronger stress testing of banks and more regulation of products like credit cards, car loans and mortgages through the creation of a Financial Product Safety Commission.
Not everyone's a fan. Warren's proposals have drawn fire from almost anyone with an interest in maintaining the status quo, including the banking industry, mortgage brokers and even the Securities and Exchange Commission. But she says she's not backing down: "I'm not an insider, and I don't need another job," she says, a not-so-thinly veiled shot at what she sees as the revolving door between public office and private industry. "I'm willing to do whatever it takes to raise the issues that I think are important, regardless of who wants to ignore them."

The 2009 SmartMoney Power 30


SMARTMONEY ® Layout and look and feel of SmartMoney.com are trademarks of SmartMoney, a joint venture between Dow Jones & Company, Inc. and Hearst SM Partnership. © 1995 - 2009 SmartMoney. All Rights Reserved.

10

Takeovers and positive clinical results often drive big moves in biotech stocks. For example, Medarex, a human antibody specialist with 40 drugs in trials, traded at $8.40 a share in mid-July when Bristol-Myers Squibb (BMY) announced it would pay $16 for the company. (The deal closed in early September.) Shares of Human Genome Sciences (HGSI) have rocketed to $19 from $2 this year, mostly on a July announcement of positive trial results for a new treatment for lupus, an autoimmune dis
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ease that causes inflammation and tissue damage.
Stock screening software isn’t useful for sorting biotechs by the value of their drug development pipelines, either to investors or corporate suitors. This column tends to pass over small, profitless biotechs because their lack of income tends to eliminate them from most screens. Bernstein Research, a unit of giant investment manager AllianceBernstein, recently used brain power rather than computer power to search more than 13,000 biotechs for companies that seem poised for a takeout or a breakout. I’ve listed their top three finds below, partly to make up for my neglect of the group and partly because Monday’s stock news was dominated by takeovers. The Dow Jones Industrial Average jumped 131 points to close at 9796 after Abbott Laboratories (ABT) said it will buy the drug business of Belgian chemical maker Solvay (SVYSY) for $6.6 billion, and Xerox (XRX) announced a purchase of Affiliated Computer Services (ACS) for $6.4 billion.
Geoffrey Porges, Bernstein’s head biotech analyst, focused his search on the 140 or so firms that trade on North American or European exchanges and have stock market values between $250 million and $5 billion. He zeroed in on 77 research-based companies with novel compounds that might eventually be sold in the U.S. or other big markets and key drugs in late-stage trials. From these, he selected takeout candidates by judging whether their existing partnerships would preclude or allow for a new, lucrative deal. He decided which are breakout candidates by determining whether key trial results are likely in coming months. The results include 28 takeout candidates, 10 breakout candidates and three stocks with takeout and breakout potential, which are listed below.
One caveat: Porges wrote Friday that he has no specific knowledge of takeover discussions, and that the list isn’t meant to give specific recommendations, but to “suggest a set of possible candidates in response to the inevitable question of ‘Who's next?’ for investors to examine more closely and position themselves accordingly.”
Abraxis BioScience

Market Value: $1.42 billion

Los Angeles-based Abraxis BioSciences (ABII) owns Abraxane, a breast cancer drug that studies suggest is better tolerated than Bristol-Myers Squibb’s Taxol. Abraxane received regulatory approval for the treatment of breast cancer in 2005, and is now in late-stage trials comparing it to Taxol for the treatment of a specific lung cancer. The company is trading at barely more than half its value of a year ago. A buyer would secure not only Abraxane, but the “nanoparticle albumin-bound,” or “nab” technology on which it’s based, an asset that could potentially improve the effectiveness of more drugs. Abraxis is forecast to produce $331 million in sales this year, with no profits.
Protalix BioTherapeutics

Market Value: $620 million

Israel’s Protalix BioTherapeutics (PLX) has developed a plant-based enzyme replacement to treat Gaucher’s disease, a condition in which an enzyme deficiency causes fatty material to accumulate in organs. Late-stage results for the treatment are pending, but a suitor might be more interested in the underlying technology. Protalix has developed a method for genetically engineering tobacco and carrot cells to produce recombinant proteins, which can be used to treat disease. A plant source for these proteins could prove cheaper and safer than current animal sources. Protalix has neither earnings nor sales.
Optimer Pharmaceuticals

Market Value: $474 million

Based in San Diego, Optimer Pharmaceutical (OPTR) has developed OPT-80, a treatment for clostridium difficile, an infection often acquired in hospitals that can lead to colitis. Nearly a year ago, Opt-80 proved superior in final-stage trials to Vancocin, which is currently used to treat the same disease and which captures yearly sales of about $250 million in the U.S. The company is currently assembling a U.S. sales force and plans to license the drug in Europe, where a similar trial is in final stages. Optimer is also close to filing for regulatory approval for another drug, which treats infectious diarrhea.
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29

A small pay increase or cut for a worker can make an extreme difference in the amount of pocket money left each month after the bills are paid. For much the same reason, moderate changes in corporate sales can lead to huge swings in earnings. Last quarter, companies in the S&P 500 index reported a 16.5% decline in sales vs. a year earlier. Earnings plunged 39%.
For stock investors, the relative stability of sales makes the measure more reliable than earnings for purposes of deciding which companies are cheap. Run a search for low price/sales ratios and you’ll uncover pr
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omising stocks that a search for low price/earnings ratios might miss. Moreover, according to market researchers like James O’Shaughnessy, who conducted a study of the matter for his investment guide “What Works On Wall Street,” the P/S ratio is a better predictor of stock performance than the P/E.
The companies below have low P/S ratios, stable or growing sales, strong balance sheets and decent dividends.

Boeing (BA) last week announced another delay in the test flight of its fuel-efficient 787 jetliner, which is now two years behind schedule. Qantas, the Australian carrier, cancelled orders for 15 of them. The delays are embarrassing for Boeing, but not uncommon in the industry, and analysts see little danger of customers defecting to its European competitor, Airbus, which is years behind Boeing in development of its competing A350 (although some carriers, like Qantas, might use the delays as an opportunity to put off orders during the current travel downturn). Boeing’s sales are still expected to increase 11% this year, and profits are projected to rise 23%. I recommended the stock in early March as one of “9 Stocks That Could Double Your Money.” It’s up 42% since that column ran but still looks cheap and comes with a 4% dividend yield.
Nothing says “recession” quite like canned chili. While most casual dining chains are suffering sales declines this year, Hormel Foods (HRL) is on pace for a 2% improvement in sales and an 11% rise in profits. The stock has climbed 12% since I highlighted it at the end of 2008 in a search for insider buying, but its P/S ratio still stands at a discount of 25% to that of Kraft (KFT). The company has a pristine balance sheet and pays a 2.2% dividend. It has topped Wall Street’s earnings forecasts in recent quarters by double-digit percentages, suggesting operational momentum that’s catching investors by surprise.

Scott’s Miracle-Gro (SMG) had a painful urea problem when I recommended the stock in July 2008. The nitrogen-rich compound, discarded freely by humans but manufactured by chemical companies using ammonia and carbon dioxide, had soared to $800 a ton on agricultural markets, crimping profits for fertilizer sellers, including Scott’s. A ton of the stuff now costs closer to $250, just in time for Scott’s to lock in new supply contracts. Shares are up 81% since my recommendation, vs. a 27% decline for the S&P 500. Even now, they still look reasonably priced, and while the stock’s 1.4% dividend yield is puny, it’s also easily affordable relative to profits.
Have a look if you like at the table below, which has details on these three and two other companies my P/S search recently turned up.


Screen Survivors


CompanyTickerIndustrySharePricePriceChangeYTD(%)Price /SalesYield(%)




BoeingBAAerospace$42.65-0.050.53.9


KrogerKRGrocery Stores22.23-160.21.6


Ingersoll-Rand Cl AIRDiversified Machinery21.2220.53.4


Hormel FoodsHRLMeat Products34.82120.72.2




Scotts Miracle-GroSMGAgricultural Chemicals35.45190.81.4




SMARTMONEY ® Layout and look and feel of SmartMoney.com are trademarks of SmartMoney, a joint venture between Dow Jones & Company, Inc. and Hearst SM Partnership. © 1995 - 2009 SmartMoney. All Rights Reserved.

11

Low price/earnings ratios are usually easy to find, even when the broad stock market seems expensive. For example, the S&P 500 index has climbed more than 30% in three months and now trades at 22 times trailing earnings, well above stocks’ 137-year average trailing P/E of 15. Still, one out of every eight index members has a P/E in single digits.
The task for investors, of course, is culling companies that seem under-appreciated from ones that deserve their piddling valuations. Often, a single-digit P/E means a company’s earnings are expected to decline. Not all
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declines are equal, though. Some suggest long-term decay. Others are a temporary product of swings in consumer spending or raw materials prices.
Shares of companies that trade cheaply because of expected, temporary earnings stumbles might be just the thing for investors who worry that the broad market is priced for disappointment. Earnings underlying the S&P 500 are expected to grow 9% this year, even though they shrank by 39% in the first quarter. The index’s price of about 17 times the 2009 forecasts suggests investors think reported growth will top the estimate, even though earnings last quarter fell short of forecasts by 24%. By contrast, for the humbly priced stocks to follow, a certain amount of anticipated disappointment is already priced in.

Chevron’s (CVX) earnings are expected to plunge this year but rebound sharply next year. My sympathies to the analysts who must try to assign precise numbers to such forecasts. Last summer crude peaked at more than $145 a barrel. Just before Christmastime it fell below $35. Now it’s over $70 again. Better, perhaps, to focus on the dividend yield, which stands at 3.7%, versus about 2.3% for the broad market.

Carnival (CCL), the cruise line, seems perfectly emblematic of the sort of pricey frolicking the middle class can do without during a recession. The stock is accordingly about half its price of two years ago. Profits are indeed expected to fall 27% in Carnival’s fiscal year ending Nov. 30, but in its past two quarterly reports the company topped estimates by double-digit percentages. Perhaps the outlook is gloomier than the reality. One downside: Management scrapped the dividend late last year.

Archer Daniels-Midland (ADM) buys, stores, processes and ships crops. Over the long term, its usefulness to a hungry planet seems assured. In the short term, its profits can swing with the frenzy of a futures pit. Last quarter the company missed earnings forecasts by 30%. The quarter before it beat by 33%. The stock is nine times forecast earnings for its current fiscal year ending June 30, but 12 times next year’s lower forecast. Still, the higher of the two numbers seems plenty reasonable compared with the broad stock market. Shares pay 2%.
Below are listed these and two other stocks with single-digit P/Es.


Screen Survivors


CompanyTickerIndustryPricePriceChange52 Weeks(%)P/ETrailing12 Months*DividendYield(%)




* Ex. extraordinary itemsData as of June 9, 2009Source: Reuters




Archer Daniels MidlandADMFood Processing28.25-24.779.031.98


CarnivalCCLCruise Lines25.03-32.268.53n/a


ChevronCVXOil & Gas70.19-30.646.953.70


L-3 Communications HoldingsLLLAerospace & Defense74.20-23.369.671.89




Merck & Co.MRKDrugs25.72-30.479.235.91




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6

A PROLIFIC AUTHOR AND MEDIA STAR, NIALL FERGUSON has become one of the most prominent academics in the world. The Scottish-born Ferguson, 45, is a history and business-school professor at Harvard, and holds other high-profile posts at Stanford and at Oxford -- where he earned his doctorate.
Ferguson is a provocative writer. His most recent books are The Ascent of Money (2008) and The War of the World, a study of World War II, published in 2006. He has also done several TV projects, including a multipart series based on The Ascent of Money that will air in July on PBS, the Public Bro
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adcasting System. He is working on a book on Siegmund Warburg, who was an influential British financier from the 1940s through the 1970s.
Barron's profiled Ferguson in a cover story more than two years ago ("Wake-Up Call," March 12, 2007), in which he astutely warned that the markets were too complacent about financial and geopolitical risk. Today, the rightward-leaning Ferguson is cautious on the global economic outlook, worries about Russian intentions in Eastern Europe -- and thinks Britain's Conservative Party may finally win an election in 2010. Ferguson also has a distinctive view on investments, inspired in part by the famed Rothschilds. Barron's caught up with him recently in New York.

Barron's: Is the worst over for the global stock markets and the economy?


Ferguson: It may look that way, but appearances can be deceptive. The stock market has actually tracked almost perfectly its downward movements between 1929 and 1931. Now that doesn't mean that we are going to repeat the Great Depression. I don't think we will, because the policy responses have been different. It would be excessively optimistic, however, to conclude from a relatively small set of green shoots in the economic data that we are all going to live happily ever after. It is certainly way too early to say the Obama administration is right that the economy is going to grow at 3% next year and 4% in 2011. I find that scenario as implausible as a rerun of the Great Depression.

What is the relative position of the U.S.?

It is in significantly better shape than the other major developed economies. The U.S. can run bigger deficits at lower cost, because of its reserve-currency status. The Japanese economy has fallen off a cliff. The German economy isn't a great deal better. These two economies are suffering their worst shock since the 1930s. The contraction in Germany and Japan probably will be roughly twice that of the U.S. Real gross-domestic-product growth in Japan is almost certainly going to be a negative 6% or 7% this year. In the U.S., it is going to be about minus 2.6% for this year.

It is ironic that the U.S. may hold up better.

We have a crisis that was clearly American in origin. It had a Made in America stamp on it, yet it ends up hurting other people more than it hurts Americans. That brings to mind [19th-century Prussian leader Otto von] Bismarck's great line: "God looks after drunks, fools and the United States of America."

When will the recovery come?

Nobody has the faintest idea what next year is going to look like. It isn't clear yet that this is just a common recession. This is probably more like a slight depression. We won't see a big V-shaped bounce. Much of the consumption growth in the decade up to 2007 was fueled by things like mortgage-equity withdrawal. That game is clearly over. Strip that out, and you are looking at an annual economic-growth rate in the U.S. closer to 1½% to 2% than 4%.

What is your disagreement with New York Times columnist and Princeton professor Paul Krugman about massive government borrowing?

This is one of the most interesting questions of the moment. The view of Keynesians, their Econ. 101 textbooks and the Nobel laureate at Princeton is that the world has an excess of savings over investments and therefore the deficit can be almost any size and it will be financed. My sense is that if the U.S. government tries to borrow $1.8 trillion in a year, that is an awful lot of bonds to sell at the same time [as] all the other major governments. It looks to me like a supply-and-demand story, and what tends to happen in those stories, regardless of the macro environment, is that the price of bonds tends to fall. The U.S. 10-year Treasury rate has moved up more than 100 basis points [one percentage point] since January. There is a problem in Britain, where the Bank of England had to protest about fiscal stimulus because it was causing a huge interest-rate problem. It is also happening here.

Are you concerned about the potential for overregulation as an outgrowth of the financial crisis?

My worry is that we end up with an overreaction. Now history is something that gets written in a hurry. The consensus is that this crisis came about because of deregulation in the U.S., and that what we need is more regulation. Whether it is bankers' compensation or derivative markets, there is going to be more regulation. My feeling is that all this zeal for regulation actually grows out of a very faulty analysis. Why do I think that? For one, if this crisis was all about regulation it took a hell of a long time to come about because deregulation began in 1980. And deregulation can't be all bad because lots of good things happened in the world economy after 1980. The second problem is if deregulation was the issue, why was it that the most regulated entities, banks, caused the biggest trouble, and that unregulated hedge funds didn't? Some hedge funds have failed, but there has been no systemic downside to it. And thirdly, the regulatory frameworks are not the same on both sides of the Atlantic, and yet European banks are in as big a mess as the American ones. German banks are the most leveraged on average in the world. Now the Germans have been wagging their fingers at the Anglo-Saxon model, but their model didn't prevent extra leverage in the balance sheets.

What about your native U.K.?

The economic outlook is pretty bleak. The size of these big too-big-to-fail banks like Royal Bank of Scotland is really huge, relative to the United Kingdom's GDP. It creates a fiscal nightmare. The U.K. is taking on an enormous pile of liabilities in relation to its GDP and the existing public debt. The U.K. isn't Iceland. It isn't Ireland. They were the extreme cases where finance was vastly greater than the economy. But the U.K. is closer to them than to the U.S. Americans worry a lot about bank leverage and the scale of the government's financial commitments. But the U.S. is a pretty large economy, and the financial sector never got as big in relative terms as it did in Britain.

Any hope for the U.K.?

I am, broadly speaking, bleak about the U.K. until it gets a new government, and that almost certainly will be within the next year. Then I think we will see some radical reform. The U.K. needs another dose of Thatcherism very urgently, and I'm hoping it gets that. [Conservative Margaret Thatcher was British prime minister from 1979 through 1990.]

Are you saying the British Conservatives may actually win an election?

They can and will. The Brown government is probably the most unpopular ever, and it is really quite spectacular. [Prime Minister Gordon Brown leads the British Labour Party.] The Conservatives would have to screw up on an absolutely epic scale to lose.

What about the rest of the world?

The emerging-market story is actually much more straightforward because there is a real stimulus package out there that is working much better than the U.S. stimulus package: It is the one in China. It is giving a shot in the arm to those economies that supply commodities to China, and they are the markets that have rallied the most since the year began. The Russian stock market essentially is a play on the price of oil. Brazil is partly a food story, and India has done pretty impressively, too. So, if you had to take a view on equities, it would be the BRICs [Brazil, Russia, India, China] over the U.S. There is also a big commodities opportunity there.

Where is the biggest potential source of political instability in the world?

Eastern Europe, for sure. Four governments -- in Latvia, Hungary, the Czech Republic and Estonia -- have already fallen since this crisis began.

Americans aren't focused on that.

It is funny, because the Eastern European crisis not only is economically interesting, but [also is] strategically important: It blows a hole in balance sheets of Western European banks. We have been beating ourselves up here for the way U.S. banks were managed. But Western European banks are in worse shape, and what really is going to hurt them is the mess that is Eastern Europe, from Ukraine to the Baltics, Romania, Hungary, and Slovakia. These economies are in a terrible mess.

Are there political implications?

These new democracies that came out of the collapse of Communism have been pretty solidly pro-American. They are Donald Rumsfeld's famous "New Europe." Well, now they are being hammered by this crisis, and that creates an opportunity -- all crises are opportunities -- for Vladimir Putin and his merry men in Russia to start reclaiming some leverage over what they call the "near abroad." The gas pipeline crisis in Ukraine last January, like the invasion of Georgia, could be a foretaste of an important trend over the coming year, where domestic instability starts to create opportunities for the Russians to regain at least some of their influence in that area.

In writing about the Rothschild family, you have discussed your admiration for their old-fashioned investment approach.

There is no doubt that orthodox notions of portfolio diversification didn't help much in this crisis. There was so much correlation among asset classes last year that it was hard to avoid a pasting. But that old Rothschild model, about a third securities, a third art, and a third in real estate has a certain appeal to it.
Or having some exposure to gold. That is the thing I most regret not having done. When the Bank of England sold a pile of gold in 1999 at an incredibly low price [around $300 an ounce], I remember thinking, "That is a stupid mistake," but I didn't buy any gold. That would have been a killer investment.

Stocks haven't done well since 1999.

You are back to square one if you had bought the "stocks for the long run" story then.

How were you positioned prior to the market meltdown last year?

I didn't have much equity exposure on the eve of the crisis. But I probably had rather more real estate than I wanted, though my strategy has been consistently to buy historic real estate on both sides of the Atlantic. Nothing I own was built after around 1800. There is a premium on things that can't be replicated.

You live now in Oxford.

I divide my time between Beacon Hill [in Boston] and Oxfordshire. And the Oxfordshire house is a 17th-century farm house. The Beacon Hill house is one of the oldest in the U.S. We also have an ancient pile in South Wales, which dates back to the Middle Ages. Most of its structure is 16th century. Now that's a kind of quirky investment, because most properties of this kind aren't very liquid. But I see them as investments for the long run -- I mean, they have already been around for the long run.

Thanks, Niall.

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