Provided extreme growth, which saw 20% index gains

Provided is a confidential market summary detailing our analysis on current events as well as potential positions we may be pursuing. It is written by the Lead Quantitative Strategist Theodore Weld Smith. It is not to be shared, copied, or exported in any way whatsoever. The SPY is up an astounding 4.2% this year, accounting of a fourth of our annual projections. Even more absurd is that is it up nearly 10% in the past thirty days! Running these numbers can be fun, assuming this sort of behaviour is sustainable, which it isn’t. The NASDAQ rose nearly 80% in the eight months prior to the massive implosion known as the dotcom bubble. There is one simple explanation for such present behaviour: dumb money. Dumb money is categorized by the people buying at the top, and I do not need to explain to you what that means. While we may have had a year of extreme growth, which saw 20% index gains and many 80% individual stock melt ups, that kept a death grip on their cash. Flows into equity mutual funds last year were virtually flat, while bond funds saw $200 billion worth of net inflows. Oil (USO) is quickly approaching the predicted target of $65.00, and potentially going to $70.00. Oil companies such as Occidental Petroleum (OXY) saw such impressive earnings. Gold (GLD) of all things seems to have been moving, as a result of the simple stock market wealth pouring into diverse asset classes. However, the treasury bond market has shown some severe technical mishaps in their long term charts. The 25 year trend lines for the two and ten year bonds entered sketchy territory. The day it happened we sold short the  iShares Barclays 20+ Yr Treas.Bond (ETF) (TLT).  Here’s something else interesting. Walmart, with its 1.5 million employees, the largest employer in the US said it was raising its minimum wage for $9 to $11 because of the tax bill.  This was practically misread by everyone. Here’s what actually happened. A massive fiscal stimulus on top of the highest unemployment rate is creating a shortage of workers. Walmart will be hit by this hard being one of the largest employers. 22.22% is a big jump, meaning real inflation is on the way. Some of the other implications of the new tax bill is that it’ll be harder for Wal-Mart to sell its great deal of products imported from China and Mexico. The CPI December Report was muted at an annual 2.1%. While manufacturing goods have been falling for the past five years, but the prices of services have been are chugging ahead at a 3.0% plus annual rate. However, the overall rate will not be muted when Wal-Mart figures hit in three months. On Tuesday, January 16 at 8:30 am EST, we got the Empire State Manufacturing Survey, as well as Citigroup reported earnings. On Wednesday, January 17 at 9:15 am EST we got December Industrial Production. As well as Bank of America, and Alcoa report earnings. Tomorrow we get the 8:30 am EST release of the Weekly Jobless Claims, and the weekly EIA Petroleum Status Report is our later in the day. On Friday, January 19 at 10:00 am EST we get consumer sentiment. And then at 1:00, Schlumberger (SLB) and Kansas City Southern report earnings. Potential Long Positions Yesterday mid-morning the small biotech sector was hit hard. There wasn’t any news to account for this shift that brought the SPDR Biotech ETF (XBI) down over three percent on the day. Part of this was investors bailing out of high beta sectors of the market due to fears of a potential government shutdown. Program trading also probably played a role. There have been several biotech concerns that had already fallen past where they should be trading at. Yesterday’s decline was another good opportunity to add a few shares in these names that are promising from a longer term perspective. Here are two such concerns I think are currently in the ‘bargain bin’. Genetic testing concern Invitae (NVTA) dropped 15% in trading on Friday then dropped another four percent to open the trading week yesterday. This knee-jerk sell-off provides an actionable opportunity to add a few shares by buying this dip, which is likely to be temporary. Let’s revisit this fast-growing small cap concern below. Invitae is a San Francisco based genetic information company. The company provides a diagnostic service comprising hundreds of genes for various genetic disorders associated with oncology, cardiology, neurology, pediatrics, and other rare disease areas. The company aims to drive down the costs of testing for inherited genetic conditions by aggregated genetic testing. This is a far growing niche in the market. Genetic testing should hit $10 billion in annual sales in five to seven years. The stock has current market capitalization of approximately $400 million.What caused the recent decline was an update on 2017 revenue and conservative guidance from the company for 2018. Management stated it expected to post organic revenue of $59 million for FY2017. This was in the midpoint of the previous range leadership has previously given of $55 million to $65 million. This also does not include the $8 million of sales that two recent acquisitions had in 2017. The company processed 134,000 samples in 2017 above previous guidance of 120,000 to 130,000 samples for FY2017. This represents sales and sample growth of over 125% year-over-year compared with 2016. Then the company said it ‘only’ would grow nearly 80% at the floor of its guidance for FY2018. In the bottom end of range offered the company should process a quarter million samples and delivered revenue of $120 million. Don’t you wish all the companies you have stock in could post that sort of ‘abysmal’ annual growth? I think that the dip caused by this guidance should be actioned by those that believe in Invitae’s long term growth story. It also is quite likely the company just put in a ‘low bar’ that it will able to step over in the year ahead. Also remember the company posted sales of just $25 million in FY2016. Basically quintupling revenues in just two years is hardly anything to sneeze at. Also the law of ‘large numbers’ almost always comes into play for growth stories as it is much easier to double revenues from $25 million than from $60 million. As volume continues ramp up, the cost per sample (see above) will continue to fall. Nothing has changed about the Invitae’s long term prospects. We will add a few shares to my core holdings on this decline as we expect this to be an advantageous entry point when we look back on NVTA a year from now. In essence, we see value in NVTA and we will be opening a long position shortly, (funny, right?). Dynavax Technologies (DVAX) also fell some 15% last week and that weakness continued into trading on Tuesday. I believe most of this was due to the usual hiccups one almost always sees as a previous ‘Tier 4’ concern transitions into ‘Tier 3’. We have seen some of the same sort of trading patterns in the past with names like Acadia Pharmaceuticals (ACAD), Flexion Therapeutics (FLXN) and myriad other biotech and biopharma names. Development and commercialization are two completely different processes and require different skill sets. It is not unusual to see investors move on after a key drug has been approved and as the company pivots to rollout activities. Regardless, here is why we added a few shares. The company’s hepatitis B vaccine ‘Heplisav-B’ is clearly superior to the existing standard ‘Entergis-B’. That compound has been on the market for almost 30 years. Heplisav-B offers 95% protection versus 81% for Entergis-B and is even more effective by comparison in the diabetes subset. As importantly, Heplisav-B can be administered in two doses over a month rather than Entergis’ regime of three doses over a six month period. This should help improve the current rather abysmal compliance rate of ~55%. While it will take a while to go through the processes to get into the providers that buy and administer this vaccine, Heplisav-B should eventually see peak sales just in the United States of approximately $500 million. The CDC (Centers of Disease Control) should give their positive recommendation on this biologic late in February which should boost marketing efforts. The company’s current market cap is under $1 billion. In addition, the company has an intriguing and emerging oncology portfolio led by its compound SD-101. This could eventually be a more valuable asset than Heplisav-B. This compound scored a 100% overall response rate in a very small early stage trial (7 patients) targeting melanoma in combination with another drug. SD-101 is currently in Phase II studies with 30-40 patients. Results should be out mid-year. If successful as is likely, Phase III testing should begin in 2019. Dynavax ended 2017 with just under $200 million and management has stated this was sufficient to get the company into 2019. I think leadership will wait to raise any additional capital until Phase II SD-101 results are released which should cause a rise in the stock. The company also has a Phase II asthma drug it is developing with AstraZeneca (AZN), and its partner is currently leading development on that compound that I not placing any value in my analysis at this time. Five analyst firms currently follow the company. All have Buy ratings on DVAX with price targets from $25 to $30 on this name according to TipRanks. I think that is a fair bogey over the next 12-18 months as Dynavax roll outs Heplisav-B and advances SD-101. Given the shares are now trading under $15.00 a share, this recent dip provides an opportunistic entry point for longer term investors to add a few shares to their core holdings.Potential Short PositionsAfter Blackhawk Network Holdings (NASDAQ: HAWK) agreed to a $3.5 billion buyout offer by Silver Lake and P2 Capital Partners, shares of Blackhawk rose 23.4% on the day of the announcement. If the deal is completed, current Blackhawk stockholders can expect to receive $45.25 per share. The stock is overvalued in the short-term because the stock currently trades at a price ($45.05 on Tuesday’s close) that is too close to its buyout price when the deal is expected to be completed mid-2018. The stock’s buyout price yields a return that is lower than the U.S. six month Treasury bill rate, and doesn’t compensate stockholders for the risk that the deal could fall through. For these two reasons, we are short Blackhawk before the buyout deal is completed. In August 2012, a federal jury found ION Geophysical (NYSE:IO) liable for infringing Schlumberger (NYSE:SLB) unit WesternGeco’s seafloor mapping technology. The jury awarded $105.9 million in damages – $12.5 million in royalties and $93.4 million in lost profits. The district court affirmed the award, added supplemental damages, and tacked on millions in pre-judgment interest, compounded annually. The case then traveled a circuitous path to the Supreme Court and back as the judiciary sorted through a technical question of patent law. The upshot was that the Federal Circuit ultimately affirmed the liability finding, affirmed the $12.5 million royalty award, but threw out the $93.4 million in lost profits as improperly based on overseas services (i.e., as extraterritorial). After another round of lower court hearings on a willfulness enhancement, IO and WesternGeco resolved almost everything earlier this year: IO agreed to pay, and Western agreed to accept, $25.8 million in full satisfaction of royalty damages and associated interest. At the time, IO was not shy about claiming victory. On a May 4, 2017 earnings call, CEO Brian Hanson trumpeted the end of a “long journey” in the litigation and remarked that the company was “excited to put this lawsuit behind us.” The litigation dropped off the radar from most company coverage and analyst reports, and has not come up on the quarterly earnings call since. Left unremarked at the time was a nugget otherwise buried in the 10-Q: the agreement between IO and WesternGeco resolved only the royalty damages, and left WesternGeco with one long-shot opportunity to salvage the full $93.4 million award: a petition to the Supreme Court. On Friday, the Supreme Court agreed to hear WesternGeco’s appeal. In particular, the Court will consider whether the Federal Circuit erred when it sided with IO and threw out the lost profits award as improperly based on extraterritorial conduct. Based on recent patent law trends at the Supreme Court, IO’s odds of prevailing are slim. As a general rule, the Supreme Court reverses more than it affirms, and it really loves to reverse when it comes to the Federal Circuit, which has a dismal track record at the high court. Per a Reuters report, the Supreme Court has reversed the Federal Circuit in 14 of 16 patent cases since 2014. Last term was worse: the Supreme Court reversed the Federal Circuit in all six patent cases it heard. Based on these trends, IO’s odds of taking a Supreme Court loss are quite high. If Western is ultimately determined to be entitled to the full lost-profits award, the total due from IO would be close to $121 million by the time the Supreme Court rules in June. (The district court originally awarded prejudgment interest on the $93.4 million at the prime rate, compounded annually, and would likely do so again on remand, calculated from the time of infringement). A $121 million hit to IO could threaten the company’s solvency. As of quarter-end on September 30, 2017, the company had just $40.2 million cash on hand. It has $28.5 million in second-lien notes about to mature on May 15, 2018, another $120.6 million in long-term debt maturing in 2021, and $10 million due on a credit facility in 2019. Its most recent 10-Q acknowledged that “possible scenarios involving an outcome in the WesternGeco lawsuit” – meaning the lost-profits award – could “materially and adversely affect our liquidity.” In district court, the company’s lawyers were even more blunt: During briefing on the willfulness enhancement in January 2017, the company stated that even a $40 million award “would effectively be a death penalty to ION.” The company added, “ION has already had to lay off half its workforce in the last 18 months; $40 million in additional damages would potentially lead to laying off the other half.” No doubt, IO’s balance sheet and prospects have improved somewhat since that stark January 2017 warning, following cost-cutting, higher revenues, and recovery in the oil and gas exploration sector. But the magnitude of a potential $121 million award would still dwarf IO’s current resources several times over. We are short IO. We are planning to increase our short position in ROKU (ROKU) since opening it in early November, December, and recently in January. CommoditiesChicago Board of Trade soft red winter wheat (SRW) prices began a long-term bear market over five years ago in July 2012.  Since then, prices have fallen by more than 50%.  The good news for wheat growers is that while prices are depressed by 2007-2017 standards, at $4.30 per bushel, they remain higher than levels between 1997 and 2006 when prices fell below $3.00 per bushel (Figure 1).  What concerns many wheat growers, however, is the level of inventory.  Ending-stocks-to-use ratios have rarely been so high.  Will the level of inventories further pressure prices and send wheat below $4.00, or even $3.00 per bushel? Generally, constant dollar wheat prices are higher in years during which ending-stocks-to-use-ratios are low and vice versa (like 2017).  In order words, high levels of wheat held in inventory explain why prices are already depressed. That said, the relationship between the level of ending-stocks-to-use ratio and subsequent price changes is pretty close to neutral.  High level of ending stocks don’t necessarily further depress prices and low levels of ending stocks don’t always cause bull markets.  This makes sense in an efficient market.  Information regarding inventories is quickly incorporated into prices and one cannot gain an advantage by trading off of it subsequently.  That said, there is still one relationship that jumps out regarding the impact of ending stocks: when inventory levels are high, price volatility tends to be low and when inventories are low price, volatility tends to be high.  This makes sense in that, if demand for wheat rises in a high-inventory environment, it can be met quickly by liquidating inventories.  Prices don’t have to soar to incentivize additional production the next season as might be the case in a low- inventory environment. This helps to explain the lack of volatility in wheat options, which currently demonstrate a remarkable lack of worry about the future.  Thus, one bad harvest in places such as Kansas and North Dakota (a plausible event due to such extreme weather conditions) could result in a spike in price. We are considering purchasing Soft Red Winter Wheat Futures. Forex The Aussie dollar to be highly undervalued on a long-term basis. For instance, if we compare the AUD to the EUR, USD and JPY on a long-term basis vs. its peers. In this regard, there is a lot to be said for the AUD having a high margin of safety built in from a long perspective. That is, there is a limit to how much further the currency can fall, but there stands to be a lot of upside. So, could this materialize and is it worth taking a long-term bullish position on this currency? Firstly, even though rates are expected to rise further long-term in the United States, a slower than expected rate of increase has led to weakness in the greenback. Therefore, interest rates are not the only factor at play here. A resurgence of growth in Europe has led to euro strength, while fears of a government shutdown in the United States among other political concerns are also placing further pressure on the dollar at this point in time. Down under, greenback weakness as well as a resurgence in commodity prices have seen the AUD climb to just under US 80 cents. While factors such as commodity prices are fickle to rely on in terms of anticipating long-term trends for the Aussie dollar, gold exports from Australia to China reached a record high in 2017 according to the Australian Govt Resources & Energy Quarterly. With countries such as China increasingly looking to move to a gold-backed currency, Australian gold exports stand to benefit tremendously from this development. Moreover, in volume terms, Australian exports have grown at a pace that is faster than that of global trade growth over the past five years. While a significant portion of this is due to the rebound in commodity-led exports, a significant portion of growth has been services-led. In this regard, while Australian interest rates are expected to remain low and inflation not expected to see 2% until 2019, I take the contrarian view that export-led growth will still lead to a rise in the AUD. To conclude, we see both export-led growth as well as a significant margin of safety built into the AUD as fueling a rise in this currency over the coming years, and we particularly see further near-term strength against the greenback in the coming months. Sincerely,Theodore Weld SmithLead Quantitative Strategist, Weld Technologies