The bear market is back

By Bill Fleckenstein

As the earnings blizzard begins to blanket Wall Street, one thing is clear: The results have not been too impressive.

Last week, Alcoa (AA, news, msgs) missed revenues and guided flattish, which caused people to think that perhaps the best has already been seen for the aluminum business. 3M (MMM, news, msgs) also issued a revenue warning. In the once-hot business of homebuilders, Lennar (LEN, news, msgs) delayed the filing of its quarterly report.

Candle maker can't wax poetic

As for the ancillary producers of home products, Williams-Sonoma (WSM, news, msgs) cut its forecast again and Yankee Candle (YCC, news, msgs) cited weakness in its "core gift channel." Thus, the data mount to indicate a slowdown in consumer spending -- which is of course what one should expect when the housing bubble that bailed out the equity bubble unwinds.

Turning to technology, the recent ugliness from Lucent Technologies (LU, news, msgs) portends weakness for the wireless arena; LG Philips' (LPL, news, msgs) disappointment last week dealt a blow to the flat-panel world; and a couple of medium-sized software companies also had problems.

This does not mean that we can't see a bit of a rally next week, as bulls try to practice a variation of denial-bordering-on-amnesia called "last week didn't happen." That mindset was obviously at work last Tuesday: After KLA-Tencor (KLAC, news, msgs) CEO Richard Wallace said that bookings (which, oh, by the way, can be canceled) looked to be higher than forecast, his prognostication launched the Nasdaq and gave a lift to the tape at large. Even Intel (INTC, news, msgs) jumped 2% in five minutes on the back of the KLAC quack.

Pouncing on a prognostication

If such a meaningless rear-view statistic as last quarter's bookings was good enough to turn the tech tape, maybe it was due for a bounce, and this was the scrap of news that provided the excuse. In any case, when news from a company like KLA-Tencor can lift the entire tape -- in spite of what companies such as Alcoa and 3M reported -- that "strength" is more likely than not to be transitory -- and a function of hot money leaning the wrong way.

Crosscurrents aside, there definitely seems to be quite an undertow to the tape. It's entirely conceivable that the Fed-is-done rally may have already come and gone. My reason for saying so? Employment Friday was a radical change from the past decade, as I can't remember the last time weak economic news was sold, rather than bought aggressively (something I expect to see a lot of during the next time down). The fact that it's been unable to rally in the wake of weak-economy (i.e., Fed is done) data means that it is indeed wounded.

Looking askance at Q3 guidance

Nevertheless, I suspect the bulls are still counting on some sort of second-half recovery. (Not only will they not get a second-half recovery, they'll get a second-half relapse.) It's hard to see how many individual tech stocks will escape serious testing. I think that third-quarter guidance for many of the tech stocks that I follow may be on the weak side.

I continue to believe that the bear market that began in 2000 (and has been hibernating for the last couple years) is back. That is the important point for folks to understand. "The next time down" -- being this time -- is liable to be quite ugly, indeed.

House of biotech blues

Now for Nastech Pharmaceutical (NSTK, news, msgs) and the many questions I received from my daily readers about the Food and Drug Administration's rejection of calcitonin -- and what to do about what to do. (Editor's note: Because of the news, the stock opened Thursday down nearly 27% but closed with a 15.7% decline.) Let me say this: As always, it's difficult to make blanket statements. But if one has a full position, there's not much one can do. If one has room to average down, then that makes sense.

However, I think the concept of "full position" (something I haven't discussed previously) is one that people need to consider. In any investment, you have to know how much you wish to own. Generally, it's not wise to go above that amount, especially when the position is going against you.

That said, this rule can be violated when you have a bona fide, rock-solid margin of safety (though the latter can sometimes prove illusory.) Unfortunately, with intellectual property, manufacturing capabilities and future earning streams as the assets for a young company like Nastech, it's difficult to have the kind of margin of safety one would need to have in order to override whatever one thought his positional limit was. Regrettably, I am unable to add to my position, as it is full. (Though I want to buy some LEAPS -- they got away from me on Thursday.) (Discipline is something that one must have in this business. I know -- I learned the hard way.) But if I did not have a full position, I would have been buying with both hands this morning.

As to what happened and what it all means, as I was endeavoring to put my thoughts down, I received a great synopsis on Nastech written by a Ragen MacKenzie analyst named Taunya Sell. Her write-up was forwarded to me by my sister, who is a retail broker at the firm. (My sister was quite a good analyst/portfolio manager herself, before having babies and shifting gears to the retail brokerage business.) So, rather than reinventing the wheel, I am going to include an analyst summary in the Contrarian, for what I believe to be the first time ever in the years that I've been writing my column.

A CFA reports on the FDA and Nastech

"Company Update. Nastech Pharmaceutical (NASDAQ -- NSTK -- $12.35, Buy) Price Target: $22.00 -- $25.00. This morning, Nastech announced that the Company has received notification from the FDA that the ANDA (Abbreviated New Drug Application) for its intranasal salmon-calcitonin product is not approvable at this time. The FDA was concerned about the potential for immunogenicity resulting from a possible interaction between chlorobutanol (a preservative in the formulation) and salmon-calcitonin. It would appear that this could be a theoretical concern, as Nastech did not observe any allergic reactions in the clinical trials the Company performed.

"Firstly and importantly, we believe there is little risk to the Company's other products in development related to this news. Immunogenicity studies are performed on all of Nastech's other products (which use the 505(b)(2) FDA approval pathway), which should tease out the potential for allergic reactions or other related problems. In the event that a formulation caused an undesirable side effect in early clinical studies, Nastech could and would likely change the formulation.

"In our view, this negative news results mostly from ambiguity on the part of the FDA and does not stem from anything related to Nastech's clinical work or program development. To expand on this, there are two pathways for the FDA approval of an already marketed product -- ANDA and 505(b)(2). With an ANDA, the clinical studies can only test for bioequivalence, so other studies, including immunogenicity studies, cannot be done. With a 505(b)(2) pathway, other clinical studies can be performed.

"In February 2004, the FDA accepted Nastech's ANDA for its intranasal salmon-calcitonin product. In our opinion, if the FDA had wanted additional studies to be done, it would have been preferable that the agency not accept the ANDA and instead suggest Nastech pursue the 505(b)(2) pathway for the approval of this product, which would allow for additional clinical testing.

"While this news is disappointing in terms of the loss of near-term revenue potential that Nastech might have garnered from its intranasal calcitonin product, we attributed no value for this product in our model. In our view, the real value in the Company comes from utilizing Nastech's intranasal drug delivery platform in other marketed drugs, with the most important near-term revenue opportunity coming from Nastech's PTH program that is partnered with Procter & Gamble.

"Valuation: We would consider the current market weakness a buying opportunity. There is no change to our rating or price target. Our price target of $22 -- $25 assumes the stock will reflect $2 -- $5 of value for the Company's nasal insulin program over the course of our investment horizon, in addition to our value for what we believe PTH could be worth for shareholders a short time before it is approved for the U.S. market, based on our discounted cash flow model.

"Risks: If side effects, efficacy issues, or regulatory roadblocks prevented PTH from being approved for the U.S. market, we believe the stock price would be severely affected, hindering the stock from reaching our price objective. Importantly, if any serious side effects showed up in Nastech's proprietary drug delivery system, we would expect the stock to be severely negatively impacted, since this is the cornerstone of all of Nastech's clinical and preclinical programs."

I think her comments say it all -- both eloquently and succinctly -- and should answer most everyone's questions.

Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckenstein Capital Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. At the time of publication, Fleckenstein was short Intel and long Nastech.