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Beyond a reasonable doubt — recession is upon us

Face the evidence, says this U.S. advisory, the credit crisis is choking the economy and bringing on recession. But there are still good stocks.

Oh boy! More obscure debt instruments! You’ve probably had your fill of ABCPs, CDOs and the whole alphabet soup of SIVs (structured investment vehicles). But we’ve got another one for you: ARS.

This acronym stands for Auction Rate Securities. These are defined as debt securities (what else?) — municipal bonds, corporate bonds, preferreds — for which the yield is reset on each payment date by auction. Brokers bid on behalf of clients and the winners get the same yield — i.e., the lowest yield that triggers the sale of the entire amount.

These securities go mostly to institutional investors or well-heeled individuals. They’re a bit rich for the average investor. Overall, this arcane market, which even many insiders know little about, is worth $330 billion.

So what’s the big deal? Less than two weeks ago the whole market froze up. Several of Wall Street’s biggest investment banks declared that they would not pay the holders of these securities. At least one bank admitted that it had misrepresented them as being virtually the same as cash. A boisterous round of investigations, accusations and recriminations duly got under way.

It’s just one more drop in the bucket, but this bucket is close to overflowing. That’s the opinion of The KonLin Letter, a U.S. advisory that has been predicting recession for many months now. If we haven’t yet met the technical definition of recession, it suggests, we only need to dot a few “i’s” and cross a few “t’s” to make it official.

“The U.S. is in a recession”

Nothing happens in isolation. The crack-up of the ARS market has choked off funding for Silicon Valley start-ups. And there are so many knots in the system now that no one seems to know where the next big snag will pop up.

This advisory makes a figure-by-figure case for recession. “The wave of bearish economic data continues to confirm our prediction since the fourth quarter of 2007… the U.S. is in a recession.”

The Index of Leading Economic Indicators fell for a fifth consecutive month in February, reaching its lowest level in over two years. In the same month, durable goods orders dropped 1.7 per cent and business spending dropped 2.6 per cent, the biggest drop since October.

One statistic may lie, but a chorus of statistics singing in union is harder to ignore. The Insitute for Supply Management (ISM) Index, which surveys purchasing managers across the U.S. to gauge the state of orders, inventories, production and employment, is at its lowest level in five years.

Two more indexes this advisory follows closely are scraping bottom. Both come from branches of the Federal Reserve Bank. The New York Feds Empire State Manufacturing Index hit a record low last month. The Philly Fed’s Manufacturing Index stood at a stark –17.4, the fourth straight month of contraction.

Not least, employment figures show the largest job loss statistics in five years. It may not be a recession, but it sure isn’t good. Something is out of joint when long established companies can’t pay the bills.

Stupidity, greed and wild speculation

100-old CIT Group, a major finance company, had to dip into its $7.3 billion in bank credit lines because it could not refinance debt. Carlyle Capital and Thornburg Mortgage had margin calls they could not meet. “Their AAA-rated securities were considered to be almost as safe as Treasuries, and are suddenly not accepted as good collateral, causing a meltdown with the firms facing bankruptcy.”

The Bear Stearns collapse may have dominated the headlines, but that notorious firm has plenty of company in the “whoops-we-don’t-have-the-money-on-us” game of musical chairs that’s going around right now.

Adds the advisory: “Closed-end mutual funds, hospitals and schools and other municipals are locked in a financial mess, all originally caused by stupidity, greed and the core of wild speculation by the Wizards of Wall Street’s subprime slime that was supposed to be ‘contained’.”

Indeed, the many statements about the “containment” of the crisis made months ago now seem naïve at the very least. But it’s not naïve to believe that there is still money to be made in this market. The KonLin Letter certainly thinks so, and we turn to its Featured Stock of the Month.

Not a one-drug pony

Pharmaceutical stocks are thick on the ground in the microcap world, so it takes a lot of research to separate the contenders from the pretenders. Having done its homework, this advisory thinks Geopharma Inc. (NASDQ-GORX) is a keeper.

The main reason is that the company is not a one-drug pony. It has three divisions: Specialty Pharma, Manufacturing and Distribution. The Pharma division formulates generic drugs for human and veterinary use — and it develops medical devices for oncologists and other medical pros. The Manufacturing division makes generic drugs, nutraceuticals, cosmetics and functional food products for companies around the world.

The Distribution division has two subsidiaries, one specializing in Geopharma’s own dietary supplements and health food products, the other in sports nutrition products, dietary supplements and performance beverages. Many of the health food and nutrition products show up in places like Target, Walgreen, Wal-Mart, Rite Aid and the like.

In short, this company is a going concern, with a lot on its plate (or in its medicine cabinet). It recently got FDA approval to make a drug that treats arthritis in dogs. And it has also acquired patent rights to a diagnostic technology used in the early detection of ovarian cancer. Geopharma now goes to the FDA to win approval for this technology, which uses a simple urine test.

All the company needs to grow now is results, and those have been coming in. Sales for fiscal 2007 were 21 per cent higher than the year before. Revenues slipped in the first month of this fiscal year, largely due to the sale of a subsidiary, but they had risen precipitously in the previous nine-month period. The advisory’s ultimate target for the stock is $7.50 to $8.00. It closed yesterday at $2.50 (up 11 cents from the time this report was published).

It would be nice to report that the pessimists have overstated the case for a U.S. recession, but so far they’ve been as right as rain. All we can say with confidence is that the credit crisis won’t get its tentacles around everyone — and good companies will always find ways to grow.