*** The following commentary was published for subscribers of Nate’s Notes in Issue #258 on July 15, 2016, and reflects our opinions of both the market and MannKind as of  that date. ***

But what has it got in its pocketses, eh?

                                            – Gollum (The Hobbit, J.R.R. Tolkien)

Your Questions Answered…

As you can see in the performance numbers above, despite a pretty serious hiccup following the Brexit vote shortly after last month’s issue went to press, the markets and our Portfolios have all managed to post some nice returns over the past four weeks!

In addition, as a number of you have pointed out in emails you’ve sent over the past few days, both the Dow Industrials and the S&P 500 (two of the five major indices I use to gauge the health of the overall market – see “Eyebrow Levels” table below) are starting to hit all-time highs… “and doesn’t that mean it is time to be more aggressive with our buying, Nate?”

Given how many great questions have been asked in various forms over the past four weeks, I thought it might be fun to paraphrase the most frequently asked questions and use a Q&A format to share my thoughts in the commentary section of the newsletter this time around…

The first thing I want to do as part of answering the question above is to remind you that while the DJIA and S&P 500 are admittedly starting to push into new all-time high territory, they have only been at these levels for a few days now, and, consequently, I believe it is still to early to know for sure whether the moves represent a bona fide breakout… or merely a “fake out” that will end up sucking one more round of money off the table before the market collapses (an event many doom-and-gloomers are predicting will happen between now and the end of the year).

That being said, if these two indices can maintain their momentum, it will go a long ways towards convincing me that the market may, in fact, be gearing up to give us the final “frothy” blow-off phase of the bull market that, up until now, has been “missing” (which is a misnomer, since, as pointed out before, there is no requirement that a bull market end with this sort of action – it is merely what usually happens)… and, if this is the case, it means the next six months could be surprisingly good ones for the market!

Tempering my optimism, however, is the observation that, while also strong, the Nasdaq and the SOX semiconductor index are both having a much more difficult time making it into new all-time high territory… and, of course, as I have lamented on more than one occasion over the past several months, I remain especially concerned that the BTK biotech index is actually still trading under its one eyebrow level (which leads us to our next question)!

Q. It seems like you put too much weight on the importance of the BTK biotech index, Nate, especially considering how influenced it is by industry- and company-specific “problems”… why do you think it is so important?

A. I think it is important for two reasons.  First, though the proportion of biotech stocks in the newsletter is currently a bit lower than it has historically been thanks to the buyouts of both Cubist and Affymetrix over the past couple of years, it has historically been one of the most well-represented sectors in the newsletter (and will likely continue to be as time goes by), and, consequently, it is important for us to keep an eye on the performance of the sector as a whole since it provides a great “baseline” against which to measure how heavily invested we ought to be in individual stocks from the sector at any given point in time (as you know, “we try to own larger positions in the stocks we like during bull markets, and smaller positions during bear markets”).

Second, while there is no rule that says the rest of the market can only rally if the biotech sector is also rallying, given that there is probably no other sector that is more driven by the emotions of fear and greed than the biotech sector, it means (in my humble opinion) that it is an especially useful gauge of just how euphoric (or not euphoric) investors are feeling – after all, if investors aren’t in the right frame of mind to get excited about the prospects of new billion dollar biotech products, it is hard to imagine them getting too excited about any other sector (which, with a few possible exceptions, will almost certainly not have the same potential for growth as the biotech sector).

Q. I’m not as worried about the BTK as you are, Nate, and I’m concerned we’re going to miss a rally in all the other stocks… how will I know when to start putting money back to work?

A. First off, in the same way that I have encouraged folks to “sell down to their own sleeping point (the levels at which they won’t lose sleep at night worrying about their portfolios)” even if it means sitting on more cash than we are sitting on in the newsletter, if you are feeling more bullish and/or are simply anxious to put money back to work, you are by all means encouraged to invoke the corollary of this maxim and “buy up to the sleeping point!”

That being said, while the fact that BTK is underperforming by such a wide margin is keeping me from being more bullish about the market as a whole, another of our favorite mantras in the newsletter is that we always try to position our Portfolios “based on what the market is actually doing rather than what we think (or are worried) it might do,” and, because two of the five indices are hitting new all-time highs, as you will notice in the list of trades we are making this month, I am willing to take the first steps towards putting some money back to work and am using roughly 10% of our cash position in the Model Portfolio (and a bit more margin buying power in the Aggressive) to add to some of our positions where we are most underweighted and the stocks are showing decent relative strength.

Q. I think the world is falling apart, Nate – doesn’t this mean we should be selling everything and going to a 100% cash position (and/or maybe buying some more gold too)?

A. To be honest, especially in the week or so following the Brexit vote, this was far and away the question I got most often… and, while I completely agree with the idea that it sure looks like there are an awful lot of storm clouds on the horizon, I want to remind you that the market has a tendency to prove as many people wrong as possible… and, especially when it looks like the sky is falling, it has a tendency to “climb a wall of worry,” as the saying goes.

As discussed above, it is still too early to know for sure whether we are gearing up for one of these stealth bull markets or not; however, I think it is important to keep in mind that while it is true that the U.S. economy will not be immune to problems that may pop up in the Asian and/or European economies as a result of the Brexit vote, a slowdown in China, etc., our markets still represent “the cleanest dirty shirt in the hamper,” so to speak, and, consequently, money from around the world will likely flow to our markets as it flees those other markets… and thus, even though it feels like the global economy is on the verge of plunging into chaos (and as just discussed), it is far more important for us to remain vigilant about what the market is actually doing (and stick to our game plan) than it is for us to respond out of fear or panic.

So, to summarize all of the above regarding the market in general before I move on the semi-obligatory MannKind Q&A section of the newsletter, I want to re-iterate that, at least until we get a few more indices hitting new all-time highs (and, even more importantly, get the BTK back above its one eyebrow level!), I cannot help but maintain a slightly bearish stance based on the signals that we got from the Eyebrow Levels table back in January; however, we are significantly underweighted in some of our positions in which the stocks are showing good relative strength, and, consequently, in keeping with my philosophy of always scaling-in (or -out) of stocks in small pieces rather than doing it all in one fell swoop, we are putting a bit of money back to work this month.

In addition to buying these under-represented stocks, because I remain firmly convinced that gold is likely to be one of the big winners over the next several years as central banks around the world struggle to get the genie back in bottle (no easy task, especially since they’re all going to be chasing the same genie!), even though we already have sizable positions, I am adding a few more shares of GLD to both Portfolios this month.

And now on to some of the most frequently asked questions regarding MannKind…

Q. When do you think we’ll start to see in increase in prescriptions for Afrezza?

A. The rollout of Afrezza 2.0 is just now getting underway, and though it is true that educators and sales reps are already starting to visit doctors and clinics, I think it is important to keep in mind that the first call (or even two!) at each location will most likely be almost entirely for the purpose of introducing the product and leaving educational materials.  Once the doctors have become familiarized with the product (and, keep in mind, that MannKind is attempting to focus mainly on doctors who are already somewhat familiar with the product, so this shouldn’t be large of a hurdle), the next step will be for them to start patients on the trial (sample) packs that you’ve probably heard MannKind talking about, and, in most cases, these sample packs (which will not show up as “prescriptions”) will last roughly 30 days.  After this trial period has ended (and assuming the patient has decided to continue with Afrezza), then doctors will start to write actual prescriptions that will show up in the weekly reports… and so, putting all of this together, I think the earliest we can/should be expecting to see a meaningful uptick in prescriptions will be late August or early September (though I’ll bet you dollars to doughnuts that our friends on the short side will spend a great deal of time lamenting “the low prescription rate” every week that goes by between now and then!).

Q. What happens if Afrezza 2.0 doesn’t go as planned?

A. If MannKind is unable to generate some traction for Afrezza between now and the end of the year, it will almost certainly mean the end of the company as we know it – the question, of course, is whether Al Mann’s heirs (who control the foundations that, in turn, control roughly one-third of the stock) will be willing to sell the company at a steep discount to what they thought it would be worth… or if there will prove to be some advantage to allowing it to slip into bankruptcy.

That being said, while I remain optimistic about Afrezza’s chances for success (and have put not only the newsletter’s reputation but a significant portion of my own money on the line as well to back-up this viewpoint), based on some of the emails I have received, I feel compelled to put the following in bold and italics for you: If I am wrong about Afrezza, the stock will likely end up trading much lower than where it is now by the time all the dust settles… and, consequently, I really do mean it when I say “do not own more than you can a) comfortably sleep with at night, and b) afford to lose if it turns out I am wrong (which is always a possibility!).”

Yes, as stated before, given the way things have unfolded over the past 18 months (an apparent lack of effort by Sanofi, a concerted effort by short sellers to drive the price down, etc.), I believe the fact that the stock has traded down to $1 (and the company sports a market cap nearly identical to the one it had when it came public with an unproven product that still had not even passed clinical trials) means that investors are looking at the sort of investment opportunity that only comes along once or twice in most investors lifetimes… but we’re not out of the woods yet!

Q. Out of everything I read on the internet, you seem to be the only one who thinks Afrezza is going to amount to much – what makes you so optimistic, Nate?

A. Though my experiences do not guarantee that Afrezza will be a success, having grown up with a father who was both a Type-1 diabetic and a family practice doctor (now retired), as well as having a great-grandmother who was a diabetic, I can tell you with a high degree of confidence that the benefits that Afrezza provides absolutely represent a significant step forward in terms of helping diabetics manage their “illness”… especially when one realizes that the huge improvements that Afrezza brings on the insulin formulation side can be dramatically leveraged by pairing them with the technology that is being developed in the world of “continuous glucose monitors” these days (and, if history is any guide, is only going to get cheaper, less intrusive, and more reliable as time goes by).  No, Afrezza does not yet have a label that says “ultra-rapid acting” versus “rapid acting” (as is found on the majority of today’s mealtime insulins)… but the data and the anecdotal evidence is there to support the idea that “real-time blood sugar monitoring calls for real-time insulin (and Afrezza is the only insulin that fits this bill).”

In addition, regardless of whether it is on the label yet or not, the fact that Afrezza appears to leave the bloodstream faster than other insulins suggests that it will provide the added benefit of reducing the worry about “stacking” insulin in the body and having to worry about hypoglycemia (low blood sugar), which is a far more serious problem for (and therefore represents a “fear”) for diabetics than high blood sugar (which, at moderate levels, represents more of a long-term – but very real – health risk than hypoglycemia, which can be life threatening).

As I’ve stated before, history suggests that the shift to a “next generation” insulin will take longer than the optimists are hoping… but, at some point, critical mass will be reached, and, all of a sudden, everyone will switch to the new “technology” and start to wax poetics about “how we used to have to manage diabetes before ___ came along.”

Q. Why is Sanofi still involved with Afrezza?

A. To be honest, the entire manner in which Sanofi terminated its agreement with MannKind has been puzzling since it was first announced, and I can’t tell you what is going on behind the scenes.  As you know, I found it odd that Sanofi invoked not one, but two, clauses as part of its right to terminate the agreement, and though the first appears to have resulted in a clear change in the story line at the 90-day mark when all rights to Afrezza were returned to MannKind, there has not been any news at the 180-day mark (July 4th)… which leads us to the next question.

Q. What’s up with “the insulin put”… and will MannKind be getting any extra money from Sanofi as part of a final settlement?

As I mentioned awhile back, one of the clauses of the agreement with Sanofi allowed for MannKind to “put” (force Sanofi to buy) up to $50 million worth of insulin if Sanofi terminates the agreement, and, as many of you have pointed out, we have not heard anything from MannKind yet about how this turned out… which, in turn, has caused many of you to wonder whether there might be “bigger discussions” taking place.

To be honest, your guess is as good as mine – on the one hand, there are reasons to think MannKind will be lucky to “put” a few million dollars worth of insulin to Sanofi, but there are also reasons to believe MannKind might end up with a significantly larger “termination check” from Sanofi, especially if presumed negotiations drag out long enough for MannKind’s sales force to outsell Sanofi’s “right out of the gate.”  It might not happen until the next earnings call, but I am hopeful management will announce a final termination as soon as they are able to.

Q. Why did Mike Castagna present at the Cantor Fitzgerald conference this week when Matt Pfeffer was listed as the speaker?

A. Again, your guess is as good as mine, but between wrapping things up with Sanofi and possibly signing new international partners (which might be contingent on Mannkind “being done with Sanofi” first), I can think of a lot of reasons Pfeffer might have been elsewhere at the last minute… in my mind, the only people this was an issue for were people who want there to be “issues” for investors to be worried about.

Top Picks (for new money this month)

All else being equal (i.e. you already own “pretty much everything” in the newsletter), my top picks for you this month are:

Cirrus Logic (CRUS – $40.16) – Cirrus’ stock continues to exhibit some of the best relative strength in the newsletter, and “strength often begets strength,” as the saying goes.

Electronic Arts (EA – 77.83) – great relative strength here as well, and with Pokemon Go getting off to such a great start for Nintendo, investor interest in “video games” may help to take this stock higher in the weeks and months ahead as well.

MannKind (MNKD – $1.01) – with the sales force now starting to call on doctors, we may start getting feedback about how the rollout of Afrezza 2.0 is coming along in the weeks ahead.

Outstanding Orders

For the reasons discussed above and below, the Model (Aggressive) Portfolio will not make any sales this month but will purchase (2,500) AS Ranger Equity Bear, 300 (1,000) Cirrus Logic, 100 (400) Illumina, 500 (2,000) Perry Ellis, 250 (1,000) Qorvo, and 25 (200) SPDR Gold Trust ETF.  We will use the closing prices on Monday, July 18th, for all transactions.

	current	one eyebrow	two eyebrows
DJIA	18,517	16,750	16,250
Nasdaq	5,030	4,500	4,200
S&P500	2,162	1,950	1,800
BTK	3,164	3,200	2,700
SOX	724	630	580

*Now that the Eyebrow Levels have prompted us to take a more defensive stance in terms of positioning our Portfolios (i.e. we have already done a fair amount of selling), you are encouraged to use the above table as a tool to help you understand where we are at in the current market cycle. As discussed in the March issue, we are still waiting for confirmation that we’re actually in a new bear market, but if/when we get it, we will then start to use the table “in reverse” of how we have been using it for the past several years (namely, it will become a tool for identifying the end of the bear market in future issues).

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