I'd like to pick up where I left off in last week's column and spend a little more time talking about quantitative trading.
At a recent New York conference, investor Jim Chanos noted a couple of anomalies that, in all likelihood, are a direct function of quant trading. They highlight a disconnect between stocks and their underlying fundamentals that only a computer could love.
It turns out there are two -- and for all I know, more -- closed-end mutual funds that own mundane large-cap S&P-oriented stocks: the Cornerstone Total Return Fund (CRF) and the Cornerstone Strategic Value Fund (CLM). Inexplicably, these funds trade at premiums of better than 50% to net asset value. At one point this year, they traded at premiums far higher.
A Renaissance in overvaluation
The connection to the quant universe is that Renaissance Technologies, among the biggest quant hedge funds and certainly a very successful one, is the fourth-largest shareholder in both Cornerstone funds.You have to scratch your head and ask: What is a quant fund doing paying a huge premium for an easily replicated portfolio?
The only logical answer would be that the stock-price characteristics have behaved in a way that makes Renaissance's computer -- which was obviously programmed by someone -- think these funds are a good thing to buy, regardless of the fact that their valuation is beyond absurd. (As an aside, I'm amazed the proprietors of this fund have not sold some shares at that huge premium for the benefit of their shareholders. But that's another topic.)
Meanwhile, a well-placed friend in the quant world pointed out that on any given day, 50% to 70% of stock trading is probably done using a quant strategy of some form. He suggested that folks should think about stocks as financial instruments, looking at volatility, correlation to other stocks, membership in an index and other such characteristics that pertain only to price action.
That's what the computer-driven models at quantitative funds do, setting aside the fundamental questions of what a company actually makes or does and what that business is really worth.
If all that is the case, it explains why, at the margin, the market seems to have become more of a commodity than it has been in the past.
Obviously, no group of operators can change the market's ultimate direction. But they certainly can distort it for a time.
The model of a modern debacle
My friend believes we're getting closer and closer to a moment when quants no longer rule daily trading, as their universe is losing participants that underperform. The ones that remain are desperate, trying feverishly to chase what's working. He contends that the higher the market goes and the faster it rallies, the more certain and ugly the collapse will be.He went so far as to suggest that when this unwinds, some big Wall Street firm will essentially go out of business and that the building it occupies will be, in his choice word, depopulated. When I responded by saying, wow, you're more bearish than I am, he replied: No, it's not about being bearish. It's just a fact.
Aboard the clinical-trial train
Now for a shift to the biotech industry, which, unlike others, should show immunity to the economic slowdown that I foresee. Just as I was getting involved with Nastech Pharmaceutical (NSTK, news, msgs) -- which I introduced to the Contrarian in June 2006 -- it hit some speed bumps.Continued: A chance to deliver
But the company now seems to be in a position where it has a chance to deliver on the potential I saw initially. (And the stock price is lower.)
Recently, Nastech announced it was beginning a short Phase II trial for its intranasal insulin and that it was recruiting for its Phase II trials for PYY, a potential treatment for obesity.
As for osteoporosis treatment PTH, though we haven't heard anything more confirming progress with Procter & Gamble (PG, news, msgs), we also haven't heard anything negative. Given the amount of time that has transpired since the last update on this collaborative effort, I expect that one of these days, we will find out that P&G is moving the program toward Phase III trials.
Turning to carbetocin, Nastech's autism compound, preparations are under way for Phase II trials as well. Having an opinion of how those trials might turn out is foolish. We can only hope that the compound will ultimately help those suffering from the disease and the families that care for them. In addition, there are other compounds in the pipeline, such as osteoporosis treatment calcitonin, which could receive Food and Drug Administration approval one of these days, and intranasal Byetta, a treatment for type 2 diabetes.
Now for the exciting subject of RNA interference (RNAi) therapies, which are designed to stop genetic causes of illnesses. During Nastech's most recent Web conference, those of us who follow the company were scratching our heads about why there wasn't more data given -- considering Nastech's stated belief that its approach to RNAi is novel and will aid in delivery, which is the Holy Grail as far as this promising scientific advancement is concerned.
The company's vagueness appears related to its desire not to divulge too many details, as it continues to file patents.
Delectable intellectual property?
Two RNA-oriented companies, Alnylam Pharmaceuticals (ALNY, news, msgs) and Sirna Therapeutics, the latter now owned by Merck (MRK, news, msgs), have been valued at $1 billion each, plus or minus. If Nastech has a unique approach that's sound and doesn't require using patents owned by Alnylam or Sirna, its intellectual property will be worth a tremendous amount of money. And if Nastech really does have a leg up as far as delivery goes, that would be worth far more.As I noted, much is not known about Nastech's RNAi program. However, the company has said it is working on plans to separate its RNAi subsidiary from the rest of its operations. If so, it will need to file paperwork on the plans at some point. Those documents will have to describe what Nastech is doing in some detail. Thus, the company's filing could be a powerful catalyst for the stock.
The drug of choice: FDA approval
That's not to say that all of the trials of Nastech's compounds will be successful. But the enormous size of the markets it addresses, versus its market capitalization of $350 million, is quite compelling. In short, I feel that we are at a moment in time where the potential for good news dramatically outweighs the potential for disappointment.For anyone who has had an interest in Nastech or thought about the stock, I believe now is the time to investigate further. There's always risk in investing, but I believe the risk-reward and the timeliness of this idea are more interesting than anything I've seen in quite a while.
At the time of publication, Bill Fleckenstein owned shares of Nastech Pharmaceutical.
