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Posted 1/3/2002
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The Speculator
Hedge your bets when you look for miracles
These health-care stocks are trading at a fraction of their highs, and company execs are buying. Chances are they know something you don’t. Here’s a way to cut the risk if they don’t.
By Victor Niederhoffer and Laurel Kenner
After two down years in the market, your retirement portfolio may look as though it belongs in an intensive care unit at the local hospital. Yet the perfect tonic may now coincidentally be shares of sickly health-care companies whose executives have taken the initiative to buy stock when the prognosis for their own success looked the most hopeless.
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We've hypothesized in the past, you may recall, that officers and directors at biotech companies have private information about the potential success of products wending through the drug-approval maze in Washington. After some study, we concluded that it is possible to make what the academics call abnormal returns -- i.e., better-than-average gains -- by using this private knowledge in a systematic fashion.
In a moment we will recommend a portfolio of seven such health-care stocks. But first, a caveat: we continue to wrestle with the desire of many readers, not to mention our editors, for a weekly briefing on which stocks to buy and sell now. We firmly believe that overtrading is the best way to ruin, yet we find the wish for weekly picks understandable. After two down years in the market, many investors are in the painful situation in which we have so often found ourselves -- so beaten down by losses that the last thing on the agenda is to patiently apply sound investment principles.
If we sound more reluctant than usual to make recommendations now, bear these factors in mind:
- The CBOE Volatility Index ($VIX.X) and the stock/bond ratio -- which we have written about in the past -- are relatively bearish right now, as are monthly trading patterns.
- As we've also reported in a previous column, the optimal time to jump into the market is not after two up months such as we've experienced in November and December.
- We live in a time of staff cuts, reduced bonuses, smaller retirement-fund contributions from many corporations and a general reluctance of investors to throw new money at the stock market, which after all has lost two years in a row.
- While we like low-priced stocks, we hesitate to recommend another basket of them now. Last year's 60% gain for companies whose shares were in the bottom fifth of price may have used up all the extra chips that the mistress of markets can throw at this group.
- The "January effect" rally in beaten-down small-caps in 2001 was one for the record books. But you may have forgotten that during the 1990s, the market tended to anticipate the January rally by a month or two. We fear the same might be true this time around.
The list of companies that we plan to go long on, on the basis of their one-year decline combined with insider buying, is in the nearby table. Our short will be in an index-like security called Biotechnology Holdrs (BBH, news, msgs) for a value 25% greater than the market value of our longs. That is, if you were to buy $10,000 worth of our seven longs, then you'd simultaneously short $12,500 worth of the BBH.
The reader should be aware that the hedge is bigger than the investment because the stocks in the portfolio are about 25% more volatile than the average biotech stock. Also, any insider selling would likely prompt us to follow suit.
Miraculous recoveries in 2002?
| Company | Net insider shares bought in Nov./Dec. ‘01 | Price 12/29/2000 | Price 12/27/2001 | YTD Return |
| Genzyme Transgenics (GZTC, news, msgs) | 1,000 | 14.00 | 5.90 | -58.0% |
| Genelabs Technologies (GNLB, news, msgs) | 100,000 | 4.09 | 1.85 | -54.8% |
| Noven Pharmaceuticals (NOVN, news, msgs) | 2,000 | 37.38 | 17.71 | -52.6% |
| Medicines Co . (MDCO, news, msgs) | 5,000 | 20.50 | 11.71 | -42.9% |
| Avant Immunotherapeutics (AVAN, news, msgs) | 2,000 | 6.88 | 3.95 | -42.6% |
| Organogenesis (ORG, news, msgs) | 119,332 | 8.99 | 5.17 | -42.5% |
| RehabCare Group (RHB, news, msgs) | 3,000 | 51.38 | 30.12 | -41.4% |
While this is most certainly a risky play, and not for the faint-hearted or undercapitalized, it seems fair now to point out that we've had an inordinate amount of luck in the past 12 months with similar calculated moves.
- In January we recommended buying a basket of devastated Internet stocks on margin and holding for a short period of time.
- At the start of the year we also strongly recommended buying beaten-down industries, semiconductors and high P/E stocks.
- After the Sept. 11 terrorist attacks in New York and Washington, we bought a basket of depressed stocks with high Value Line ratings.
- In late October, we recommended a beaten-down biotech portfolio with insider buying.
To be sure, we were immeasurably helped by the very welcome reappearance of the January effect and the fact that the average low-priced stock rose some 60% last year. But in more subtle ways we were aided by our meditations on the philosophical front as we developed experimental systems based on baseball, forestry, chess, checkers, tennis, music, physics, decision-making theory, rodeo riding, and population cycles.
Hopefully our patented combination of the sublime and seemingly ridiculous will keep all our portfolios well away from the hospital in the New Year. As always, we look forward to insights, compliments and critiques sent to dciocca@bloomberg.net.
At the time of publication, Victor Niederhoffer and Laurel Kenner owned shares in Genzyme, Genelabs and The Medicines Co.
MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.