Author: Amour Gefen

Covestor model: Macro Plus Fundamentals

Disclosure: Long Vertex and Ariad

Since my last update in November, I have been quite pleased with the performance of the model. As of end of day 1/19/12, over the past 90 days the model outperformed the S&P 500 by approximately 3%. Since inception on 3/10/11 the model is down about 9% versus the S&P 500.

We move into the New Year with momentum building in the equity markets. The latest jobs and manufacturing data have been steadily improving, and I’m optimistic that corporate earnings will impress in Q1. More importantly, I believe that the realignment of the model into 2012 should help position us to outperform the general market by being overweight healthcare and technology.

In my last writeup,  I discussed why I believe technology, and more specifically some of this model’s holdings, will outperform for the foreseeable future. This time I want to touch on the other sector I am overweight, healthcare. This sector is quite broad, so I want to focus on biotech and device makers.

I believe many of the smaller, innovative companies in this sector will be acquired by slow growing healthcare behemoths over the next couple of years. The likes of Pfizer, Merck, GSK, etc., will continue to lose patent exclusivity of their drugs such as the blockbuster Lipitor. To make up for lost profits, I expect growing M&A activity in the space. It is very encouraging that premiums being paid are enormous as of late. Take a look at Pharmasset and Inhibitex. Both are Hepatitis C players going for huge premiums, without a current drug on the market.

I would like to focus on 2 biotech companies that we own, Vertex (VRTX) and Ariad (ARIA).

VRTX is the larger of the two, with a game changing Hep C drug, INCIVEK, recently brought to market. The stock has taken quite a hit as of late due to the VRUS all oral phase 2 data. I believe the market is completely missing the mark here by discounting near term cash flows  and the impressive pipeline. Not only does VRTX have the best Hep C drug on the market (beating Merck’s drug handily in market share), but it also has an impressive Cystic Fibrosis pipeline. KALYDECO is the first drug to target the underlying cause of CF instead of just the symptoms. It targets a subset of the CF population with the G551D mutation, approximately 4% of the total population. Ongoing studies look to expand the label to other subsets. Vertex is also developing VX809 and VX661, and both show promise to expand the treatable CF population. With so much “bad” news on the Hep C front baked into the shares, I believe any hiccup from the Pharmasset/Inhibitex drugs should send VRTX soaring. In the meantime, I expect the steady stream of clinical data, the KALYDECO launch, and strong cashflow from INCIVEK to buoy shares. (Data: Vertex investor relations)

Next, I want to discuss oncology drug developer Ariad Pharmaceuticals. ARIA happens to be our best performing stock in the model. Ariad has two drugs which will likely be approved this year. Ridaforolimus is being developed in collaboration with Merck and treats metastatic bone and soft tissue sarcomas. Ridaforolimus is also being investigated in trials for breast cancer and other solid tumors. The other drug, Ponatinib, could be a game changer in chronic myeloid leukemia (CML) and Philadelphia positive acute lymphoblastic lymphoma (Ph+ ALL) by targeting patients who are resistant to current treatments such as those carrying the T315I mutation. Ariad also has a promising drug, AP26113, in phase 1 for non small cell lung cancer. At approximately $1.9 billion, ARIA’s marketcap is pricing in much of the anticipated success, but I believe there will continue to be an acquisition target premium on the shares plus upside from AP26113.

Moving forward on the macro front, there are still many risks to a broad recovery. China could slow down, Europe may experience a more severe recession, Middle East tensions could escalate, etc. So far, the data suggests that the worst fears may be allayed, at least for the time being.

I look forward to listening in on the latest round of conference calls as earnings season is here. Till next time, Happy New Year!