As I said in yesterday morning’s Flash Alert, the market’s action on Tuesday was a picture-perfect setup for the next big upleg. All we needed was a move over 1292 on Wednesday to keep the directional momentum going…and the bulls blew it. We got a new closing low for this correction at 1261.52. I wrote that: “If this is a false move, the S&P 500 will fail at 1292 or 1326, and then drop to close under 1270. You could use a closing stop loss of 1268, or an intraday stop loss at 1263 for protection.” I hope that saved you short-term traders from some of the pain. I went on to say: “But I don’t think you’ll need it.”

Wrong. At least, probably wrong. The S&P 500 is still in the area of influence of 1270, so an immediate reversal next week back towards 1326 could keep the bullish outcome on the table. This morning’s early drop to 1252 and swift rejection of that idea gives some support to the bull case. But that is becoming a longer and longer shot, with a drop through 1257 on a closing basis likely to snowball into a fall to 1210 or even 1152. I still think the 1326 outcome is the most likely, but we have to be ready for the negative scenario all the same.

After the close on Monday, the Dow Jones Industrial Average was down for three consecutive quarters, that’s the first time that’s happened in 30 years. The S&P 500 fell 8.6% just in June, its worst month since September 2002 and its worst June since 1930. The average tech mutual fund is down 13% over the last 12 months, the second-worst performing sector. (Financials, of course, are the worst.) Not a single venture-backed company did an initial public offering in the June quarter, the first time that’s happened since 1978. We are very stretched to the downside, because oil is very stretched to the upside, but today’s new record oil price showed again that these parabolic upturns can go higher and last longer than anyone ever thought. We just have to wait until the market tells us when to make a move.

Subscriber Michael K asked: “I know you believe we are in the trough of a double bottom, and expect a sharp upturn, but isn’t it equally likely that the Fed ups rates next time around sending the market into a lower low?”

Great question. That path is possible, but nowhere near equally likely. Bernanke’s Fed is strongly biased against deflation and downturns, especially when consumers and businesses are so leveraged. A rate increase would have a powerful negative effect on the economy, even if it was just one-quarter point, because it would signal a change in direction that we all know means more increases to come. So I think the odds are overwhelming that they simply do nothing until we see stronger economic growth–and we may not see that for quite some time. In fact, if I’m wrong about the next leg being up, it will be because the economy is much weaker than it now appears, not because the Fed raises rates.

We’re in the quiet period before earnings reports begin, and there’s been very little news. Besides Infinera (INFN) and now Zhone Technologies (ZHNE), we also have not had any negative earnings preannouncements.

Avian Flu MegaShift

Indonesia is refusing to give researchers access to the most recent strains of the H5N1 bird flu virus until the rich nations agree to give it vaccines and antivirals developed for those strains. The country has sent the World Health Organization virus samples from only two of the 16 cases they’ve had this year. They have agreed to sequence the genes and put the sequences in a public data base, but normally researchers need the actual virus sample to develop an antiviral.

The European Union just approved Prepandrix, an H5N1 vaccine made by GlaxoSmithKline. It is based on a 2004 virus from Vietnam, but was able to elicit an immune reaction to other strains of H5N1 in human trials.

I still think that BioCryst (BCRX) will be successful with their intravenous peramivir clinical trials, and have the best antiviral for bird flu. BCRX is a buy up to $8 for my $30 target after peramivir demonstrates efficacy.

Crucell (CRXL) has the best vaccine production platform. CRXL is a buy while it is under $17 for my $35 target.

Biotech MegaShift

Amgen (AMGN) drug sales are outperforming Wall Street’s too-conservative estimates by about 10%, according to industry prescription data. Since the last FDA panel review in March, Epogen June quarter sales are tracking for around $610 million, well over the $555 million that the Street expected. Aranesp sales are doing relatively better, and probably has $405 million for the quarter that ended Monday, versus the $350 million estimate. The company’s third major drug, Enbrel, probably hit $817 million, a tad above the $805 million estimate. All this should translate into another nickel or so on the bottom line, so they should easily hit or beat the June quarter estimate of $1.02. For the year, the company should do $4.30 compared to the consensus for $4.20, and in 2009 I think they will hit $4.50 to $4.60 compared to the consensus for $4.45.

I expect their newest drug, Nplate, to be approved on the July 23 FDA deadline date, with a sizable launch in the second half of the year. In the second half we’ll also see more data from the very successful, pivotal Phase III trial of denosumab for post-menopausal osteoporosis. At 11X earnings, AMGN is the cheapest major biotech stock, and we already know the next two drugs that will revitalize growth. Plus, the Aranesp/Epogen franchise will resume growth from its lower level, and we still have the real possibility that a shortage of donor blood forces doctors to ignore the Medicare reimbursement levels and prescribe more Aranesp or Epogen for anemic patients. Buy the Amgen January 2010 $40 LEAP (WAM AH) under $10 with a $20 target.

Dendreon (DNDN) drew a question from Calvin W.: “I haven’t seen any mention of Dendreon in a while and wanted to ask if your opinion of a positive interim peek was still intact?”

It sure is, Calvin. We are about 100 days away from seeing the Provenge interim results, and I don’t see any reason the numbers should differ from the previous two Phase III trials. This interim peek is powered for statistical significance if the numbers are similar–that is something the bears either don’t understand or deliberately obfuscate. I expect to put DNDN back on the Top Buy list before the announcement. Right now, DNDN is a buy up to $8 for my $40 target after Provenge gets FDA approval.

Isolagen (ILE) completed the efficacy part of their pivotal Phase III study for nasolabial folds, the big wrinkles that run from the nose to the corner of the mouth. The last patient in each arm has completed their last follow-up visit, and we will get the efficacy and safety data in August. I expect one or both of the studies to be positive, so ILE remains a Top Buy up to $1 for a $9 target if I am right.

Sequenom (SQNM) hit a new 52-week high today and has soared far above my target price. Still, I want you to hold SQNM for more gains. I’m not being piggish; it’s just that the stock shows no signs of exhaustion yet. We will be selling it when that moment arrives.

China MegaShift

UTStarcom (UTSI) is selling its Personal Communications Division, which distributes handsets in North America, to a leveraged buyout group for $240 million plus a potential earn-out of $50 million. UTSI will continue to have a handset division that designs phones and sells them to the newly-independent Personal Communications Devices company, as well as directly to carriers around the world. However, I expect them to sell the handset division, too, when they get a chance. They are focusing on their Internet Protocol, next generation networks and broadband businesses, selling primarily to developing countries in Asia, Eastern Europe and Latin America.

During the conference call, they said they are seeing high order growth and 2008 bookings could be 50% higher than 2007. The Personal Communications Division has single-digit gross profit margins, and also required a lot of working capital to manage inventories and seasonal sales fluctuations. Now that it’s gone, they expect the company’s 2008 gross margins to be in the high 20% range. They’re getting $216 million in cash right away, and they’ve already paid their short-term debt down to $35 million, so the balance sheet is going to be much stronger. On the June quarter earnings conference call, I expect them to say they will be cash flow positive for the year, instead of the current guidance for cash flow neutral.

This was an opportune sale at a good price, as they had 14 potential buyers and four offers. I expect to see more slimming down this year. UTSI remains a hold for my $10 target.

Content on Demand

EMC (EMC) owns 85% of VMware (VMW), and both stocks were clipped when Microsoft said it will sell its new Hyper-V server virtualization software six weeks earlier than previously planned. Microsoft priced Hyper-V at $28, compared to $7,000 to $14,000 for VMware. The price tells you these products simply are not comparable, and Microsoft does not offer all the management tools and options that are vital in a mission-critical environment.

My experience with Microsoft is that they never get it right the first time, but they plug away and plug away until they are a serious contender around Revision 3, about three years later. But that was with Bill Gates running the show, and now that he has retired I suspect people will be surprised at how quickly Microsoft flounders. So I’m watching Hyper-V with interest, but I still think you want to participate in both VMware and EMC’s storage subsystem business by buying the EMC January 2010 LEAP call with a $15 strike price (WUE AC) up to $5 for an $11 target.

Harmonic (HLIT) has had fewer PR releases and contract announcements this quarter, and after a good run the stock is weakening again, probably on fears that they are going to miss their numbers. But last quarter the company held their major annual industry event, which accounted for the flood of new product news, and management has not preannounced a miss. Even though worldwide GDP growth is slowing, spending on video delivery infrastructure is going to stay strong because that is the key to cable, telecom and satellite delivery market share for the next decade. Those who don’t upgrade now are doomed, and they know it. HLIT remains a Top Buy up to $12 for my $18 target.

Silicon Image (SIMG) should be a big beneficiary of accelerating digital TV sales in the second half of 2008, as the U.S. gets ready to shut off analog TV on February 17, 2009.

Barry W. asked: “Is there any news there or a change in your recommendation?”

No and no. The first half of every year is a slow news period for consumer electronics, and this year I guess that itself is good news in light of $4.50 gasoline. Consumer electronics and personal computer sales are holding up well–nothing to write home about, but certainly not the disaster the economic bears expected. But building for the holiday season starts in August and then holiday sales come in that will either make or break the year. I’d be more worried about consumer spending on the kinds of devices that use SIMG chips if it wasn’t for the impending termination of analog TV. But as things have turned out, SIMG should be fine. Buy SIMG up to $8 for my $16 target.

Telkonet (TKO) is in two great markets–cheap broadband access and energy usage monitoring/reduction–with dynamic new management and excellent products. So, writes subscriber Rich: “Why won’t Telkonet go anywhere? I just don’t understand why this stock continues to grind lower, when all the fundamental news that keeps coming out is nothing but positive. Is there massive short interest in this stock?”

Yes, there is a big short interest and TKO has a lot of illegal naked shorting. It seems to me a testimony to the SEC’s effectiveness that any naked shorting goes on at all, as it takes less than 60 seconds to find out which accounts have failed to borrow stock to back up their shorts. Since the SEC got rid of the downtick rule, allowing shorting at any time, the stock market has gone down-down-down. They just don’t seem to care about the damage naked shorting causes.

But TKO can overcome this and even turn it into a positive simply by continuing to report positive results and contract wins. Eventually, the naked shorts will have to cover. TKO is a buy all the way up to $5 for my $15 target.

Zhone Technologies (ZHNE) said they did about $40 million in sales in the June quarter, instead of the $44 million to $45 million expected, because they turned down an expansion contract from their largest Latin American customer, which requested “aggressive price reductions.” Lower revenues also mean lower gross profit margins, which are now expected to be 26% to 29%. The company had no time to reduce operating expenses from the $17 million to $18 million range they’d planned, so they’ll report a $7 million to $8 million operating loss on July 22. I also expect them to take a number of writeoffs.

It is time to give up on a recovery for Zhone as a stand-alone business. I am moving it to a hold instead of a sell because I expect the Board of Directors to sell the company this year, which should mean more profits for us. Hold ZHNE for a buyout in the $1 a share area, unless the tax loss is worth more to you than the buyout.

Security MegaShift

American Science & Engineering (ASEI) got a monster $55.1 million contract from Abu Dhabi Customs for a mixture of OmniView, Z Portal and Z Backscatter Van X-ray detection systems to scan containers, cars and cargo trucks at border checkpoints. This one contract equals about one-third of their normal revenues, and is the good side of the “lumpy” order and shipment patterns the company is always warning us about. The stock jumped over $2, but ASEI is still a Top Buy up to $59 for my $93 target.

WiMAX MegaShift

Alvarion (ALVR) won a showcase contract to supply the equipment for the first commercially available WiMAX wireless mobile network. The customer is DigitalBridge Communications in Jackson Hole, Wyoming. That’s where a lot of government leaders and CEOs gather, and it certainly won’t hurt to have broadband-speed mobile Internet access at their disposal. ALVR is a Top Buy up to $11 for my $17 target.