Axcelis (ACLS) is another pick from our recent small cap forum in NY. This manufacturer of ion implantation equipment for the semiconductor space has been hurt by the severe downturn in the industry, but has signed several important deals in the recent months and its unique products are winning important new customers, particularly in Asia. The upside could reach 200% or more based on the value of assets. With the stock currently trading at cash, the downside appears to be limited. The presenter believes there is a fair chance the company could be acquired in the next 6-12 months.

Our NY presenter still likes Walgreen. The big issues raised in his presentation last year, a slowdon in store expansion plans and reduction in operating expenses are finally playing out. The company is generating excellent cash flow. The stock is undervalued here, in his view, with the upside into the high $40's.

Moving the Economy Forward

This earnings season, estimates have generally been exceeded, but it's been done by lowering costs, and revenues have often disappointed. One could make the inference that biggest cost cuts usually come on the labor line. If that's true, it would lend support to the argument that the worst of the jobs recession may be over. If companies are lean, will they hire if business recovers a little? Supposing they do, the next question is where will they hire? Domestically, or abroad?

There are some factors affecting this decision that are in more than the usual state of flux this cycle. First, there is the uncertainty of a government far more favorable to big labor than we have seen in years. Second is the potential of higher labor costs due to health care reform, although there is an argument that the costs may actually fall on the very rich and small business, and that big business may actually get some relief.

But direct labor costs are not the only factor to consider when siting employees. The cost of land, or the rental prices of office, retail and industrial space are also important. The real estate crash is a positive for businesses seeking to add new facilities. Local governments may now be in a mood to encourage job creation through tax breaks and administrative simplification. When considering overseas hiring, views of future transportation costs are a factor as well as the outlook for relative future labor price increases and the dollar.

I've thought for years that nationalization of social costs like retirement advantage mature, slow growth industries, who avoid the full cost of these issues on their older workforces. At the same time, young industries are relatively encouraged, as they are not saddled with any costs but their own. It struck me that this might be one of many reasons the US did well with innovation, while we exported jobs in mature industries to other countries. If we start nationalizing a larger proportion of social costs, do we risk eroding these advantages for new industries?

Since growth is a product of the growth of the labor force times the growth of productivity, how do we get real growth by encouraging mature industries, where it's harder to get productivity growth? As we pointed out in an earlier post on China, the Chinese economy gains substantially when labor leaves the farm and comes into the city to join the industrial work force--that worker's contribution to GDP can triple. without any true productivity increase. It's simply a portfolio effect. The US needs to make sure it can get a positive growth effect from shifts in our labor portfolio. National policies need to encourage this process.

Our New York presenter recommended Cleveland BioLabs. This small biotech boasts an impressive pipeline, with the leading drug candidate potentialy offering a fast-acting antidot against radiation, a space where there are no effective treatments currently available. The company has partnerships with world-class research organizations, including Roswell Park Cancer Institute and Cleveland Clinic. As any small biotech, CBLI is a speculative play, but early test results show great potential. The company is also developing a family of anti-cancer agents.

Health Care: Unintended Consequences?

A lot of the debate on a new health care system is based on costs. But what's the impact of 40 million new customers on the system's ability to deliver services? First, a lot shorter wait in the ER as uninsured patients learn to stop using the ER for anything that comes up. But where do those people go, and what happens to their resource usage? The way our health care delivery system is structured, they would go first to primary care providers. Of course, these are the people being most economically squeezed by the current system, and it seems that there's already a bit of a squeeze--that many doctors have decided to become specialists for financial and lifestyle considerations.

If 40 million new customers spent an hour per year with a primary care provider, that would require about 20,000 more primary care providers. Looking at 2006 data on physicians, it looked to me as if there are about 300,000 doctors who could fill this demand. So the new demand would require about a 7% increase in the number of doctors devoted to this service. Since it's plausible that the uninsured have a backlog of unmet preventive care needs, and possibly a greater need for consumer education, time demands could be greater. It's interesting that Massachusetts, which requires health care coverage of its citizens, is also the state with the largest number of doctors relative to the population. There are many states with substantially fewer doctors per capita. Their resources may be more fully utilized. Anecdotally, many of us have experience with primary care physicians who aren't taking new patients.

Complex legislation almost always has unintended consequences. This may be one of them.

Our NY presenter still likes IFSIA and ASCMA as long-term holds, but is not recommending either name at current levels. In his view, both stocks have run up too much too fast.

Flash Trading and Private Property Rights

The investment management industry has a lot at stake in the flash order controversy. The freedom to acquire and dispose of one's property is a fundamental right, and property owners must be allowed to determine the methodology by which they will acquire or dispose of their assets. Have you ever been called by a real estate broker who tells you a home you are interested in will be coming on the market soon? That's a form of flash trading. Long before we had electronic trading, we had block desks. These desks often called customers they believed might have the other side of an order before sending the order to the floor. That's a form of flash trading. On the NYSE floor, a floor broker might decide to leave a small bid on the public order book, but whisper to the specialist that he has an interest in size. The specialist might discreetly shop that interest, or discreetly begin to acquire shares in "stabilizing transactions" in order to accumulate enough shares to make an offer in size. Sounds like flash trading, doesn't it?

After the PC was developed, portfolio managers were able to use optimizers to generate hundreds of orders at a time. The original electronic dark pools, POSIT and The Crossing Network, sprang up to help traders defray the cost of executing these orders. Typically, the order list was shown to the dark pool, and the residual was taken to the floor for execution. Dick Grasso at NYSE argued this created fragmentation (the "F" word) and was bad for markets. We electronic traders argued it was the "S" word--segmentation, or "different strokes for different folks." Investment managers, with a fiduciary obligation to obtain best execution, began to have an increasing number of alternative venues on which to place their orders, and the ability to decide which one was best for each of their orders.

Senator Schumer's "little guy" benefited from this enormously. Years ago the little guy called a broker, who took his order over the phone, then walked it down to the wire operator, who sent it to the exchange. Eventually a report came back to the branch, and hopefully the broker called his client to provide the report. Today's little guy sends the order in on his PC and gets a report as fast as browser can switch to the order status page. And instead of quarter-point spreads, the little guy is paying a penny or two in large-cap stocks. A more robust system for handling institutional orders might mean that a 200,000 share order creates less market impact, which protects the little guy, who apparently can't stand the volatility these orders create. In any case, the little guy's feedback loop on an order today is at worst a few seconds longer than an institution's, rather rather than several minutes.

Thirty years ago, most of the trading happened at the NYSE post or in the upstairs market. The upstairs market was fragmented and tricky, as traders had to figure out who really might have the other side of the trade: Goldman, Morgan, Jefferies, or Cantor, etc. If you guessed wrong you could be embarrassed as someone else found a seller first and sopped up the liquidity you were looking for. That's no less an issue today--which dark pool or ATS has the other side? Flash orders are a legitimate technique for finding the liquidity you need. Any trader knows they aren't for all situations, just as any homebuilder knows some jobs take a hammer, while others take a screwdriver.

I'm dismayed by the knee-jerk reaction by the SEC to all of this. Mary Shapiro must have spent too much time at CFTC, where futures exchanges was monoploy contracts could change the rules at will and the customers were stuck with them. Stocks can trade anywhere, and if the SEC is disregards economic necessity and prohibits what are essentially long-standing, sensible trading techniques, that trading could easily move offshore. It's all a matter of where the servers are. And Shapiro was an SEC commissioner from 1988 to 1994, when the electronic markets were first developing. She should understand that traders are for the most part evolving electronic trading structures that replicate techniques developed in the old Analog" days.

Bottom line--I think it's important that the industry stand up for the fundamental freedom of having the right to acquire or dispose of property as you see fit. If you agree, write your Congressman and the SEC, and maybe let Senator Schumer know you're thinking of moving your firm to New Jersey or Connecticut, or at least moving your executions out of state. If you disagree, let me know why. Maybe you're right and I'm not.