Last week, I discussed the most likely path for the S&P 500. On Monday, the S&P did exactly as I predicted. The index tagged 1440 right on the button and then sold off as the consolidation process began. Going forward, I expect 1440 to continue to be a barrier for two or three more rally attempts, with at least one of the failures providing the dramatic plunge I mentioned last week. Right now, I think the downside will stop at 1385, 1370 or 1366. But I would welcome a plunge to 1326 to really suck in the bears. Then we will blast past 1555 to record highs as shorts cover, put buyers scramble to unwind their positions and the $4 trillion in cash comes off the sidelines rather than miss the action in the second half of the year. So far, the market is following my script pretty closely, and I like what I’m seeing for the potential effect it will have on our stocks.

A subscriber of mine asked a good question at the Las Vegas Money Show:

Q. “If you are expecting serious economic trouble to begin next year, why won’t the market start discounting that now and just forget the rally–especially if the Democrats look likely to win the White House?”

The short, generic answer to this is that the market discounts about six months ahead, not 12 to 18 months. It is easy to over-think market strategy, especially when we fix our focus on what to expect after what we’re expecting now happens.

The longer and more interesting answer is that Wall Street is just catching on to some crucial changes in the world we live and invest in. During the subprime panic in December and January, technology stocks were slammed because conventional Street thinking is:

• The credit crisis/falling consumer confidence/high oil prices will make the economy slow
• If the economy slows, get out of cyclical stocks
• Technology is cyclical, and volatile
• Sell tech

But during the second panic in March, when most stocks set their lows for the year to date, most technology stocks held well above their January lows. I think Wall Street was starting to catch on, but they still have a long way to go. The changes I am looking at revolve around rapid growth in Brazil, Russia, India and China (the BRIC countries), where the numbers are big enough to make a significant difference, plus fast growth in dozens of other less-developed countries.

In many cases, the growth is being aided and abetted by government policies, and high on their lists is developing a technology infrastructure–networking, technical education and communications–that will give them a competitive edge in the 21st century. That means both businesses and governments outside of the United States are spending a lot of money on technology equipment, software and services, much of it sourced from U.S.-traded companies. Even non-technology multinational companies based in the U.S. are dong relatively well due to the strength in non-US demand, so they have to spend on technology to expand their global operations. I’m not looking for much from the strapped U.S. consumer, but remember that the analog television signals will be turned off on February 17, 2009. Most U.S. consumers are as addicted to TV as they are to coffee and sugar, and they’ll find a way to get a digital flat panel TV before the analog signal goes dark. It may be the only present under the Christmas tree, but it will be there.

At the same time Wall Street is realizing that worldwide technology spending will hold up even as the U.S. goes through a slow growth period, or maybe even a recession. Their fear of the credit crisis has shrunk valuations in the financial sector. As a result, technology recently replaced financials as the largest sector in the S&P 500 for the first time since mid-2001, and it is now clear which sector can lead the market up to new record levels.

But will it happen? I’ve said many times that a solid close over 1440 will “ring the bell” for the next leg up. I’ve also said it’s going to take some work to get there, and that it might not happen, so we will let the market tell us what to do. Maybe the bears are right and this was just another relief rally, like the one from mid-August to mid-October of last year.

But yesterday was a very bad day in the markets, compounding the drops Monday afternoon and Tuesday. I was on a plane on Monday, so as the S&P 500 approached 1440, I sold my call options on the S&P Depository Receipts (SPY) or Spydrs. As I mentioned last week, I was expecting a dramatic plunge back to 1395 or maybe 1350 in a late June/early July summer swoon. After hitting 1440.24–I can’t call them closer than that–the S&P dropped 14 points during the rest of the day, 13 more points on Tuesday, and 23 points yesterday to go under 1395. I doubt this was the big drop, because instead of a sharp recovery today, the S&P is consolidating just under 1395. That tells me the market wants to go lower.

But if we see a further quick drop to 1350 or even 1326, my summer swoon may be here already. This is great news. A market that consolidates by dropping rapidly back to the last support levels scares the bulls, reinvigorates the short sellers and put buyers, and quickly gains the energy needed to move much higher. It’s a much clearer picture than the typical back-and-forth or sideways consolidation that takes a few weeks to play out. It means the next bounce could clear 1440 and be the slingshot that launches the run to new all-time record highs.

I am feeling good enough about this move to recommend a new stock in the Content on Demand MegaShift. I also looked hard at Hansen Medical (HNSN), a robotic arrhythmia surgery company started by the same doctor who founded Intuitive Surgical–I used to hang out in a house on his property in Woodside. It would be a good addition to the Biotech MegaShift, and I’d like to buy it around $16. Another candidate was Stratasys (SSYS), the maker of 3D printing or rapid prototyping systems, where anything under $19 would get me to pull the trigger. But the stock I want you to buy now is Sunnyvale-based Infinera (INFN), a unique chip company that’s growing so fast, Wall Street has underestimated its earnings every quarter since they went public last June.

Shine a Light

In a fiber-optic network, a light signal is sent down the fiber cable. Before the signal attenuates to the point it can’t be seen, it is detected by an optical sensor, converted to an electrical signal, boosted in power, converted back to an optical signal, and sent on to the next processing node. The same process happens whenever the signal has to change its path–that’s why Cisco’s boxes are called “routers.” They route the optical signal in the same way a railroad opens and closes track switches to route trains.

Cisco’s routers are expensive, because it takes a lot of electronic parts to handle the optical signal. Consequently, there’s been a lot of work in the industry on improving the signal and making the optical fiber clearer so data will travel further before it has to be converted, boosted and reconverted.

Infinera was founded in 2000 to shrink that whole optical-electrical-optical process down to a single chip: the Photonic Integrated Circuit. All through the tech recession, venture capitalists poured over $300 million into the company to make the technology work. And they succeeded. One small Infinera module can replace racks of traditional routing and switching equipment. Infinera makes the process so cheap, network designers are now adding more nodes than necessary just to give them more control points to switch or monitor the traffic as it flows over the network.

And it’s fast. They produce chips with 10 gigabyte per second (Gb/s) and 40 Gb/s channels, and they can stack these. They’ll have a commercial product this year that stacks 10 of the 40 G/bs chips to provide 400 G/bs throughput. That’s the equivalent of 85 full-length movies per second. No other company has this technology, or is even close to it. An Infinera network is cheaper, easier to set up and more flexible than the Cisco-Juniper-Ciena-Nortel-Alcatel competition. For a new network, using Infinera is a no-brainer, and that’s accounted for much of their business so far. But the big opportunity is in upgrading all the 600 million miles of existing optical networks out there, as the Level 3s and Googles of the world try to cope with the explosion in video traffic.

Infinera did $58.2 million in sales in 2006 and $345.9 million in 2007. Sequential quarterly growth recently supports my forecasted annual growth rate of 25% a year, although they will have a flattish June quarter following higher than expected March results. Infinera has only 42 customers in total, and their revenues can be very lumpy. In the March quarter, Level 3 Communications accounted for 31% of sales, up from 17% in the December quarter, and INFN has three other customers that each accounted for more than 10% of sales. If we crunch the numbers, at least 61% of sales came from four customers.

But INFN’s customer-base loves its equipment, and as the company’s test sites in the United States turn into large deployments, followed by growth in international deployments, I think Infinera can keep growing their revenues at 25% or more for many years to come. Verizon estimates that global bandwidth will increase 10X every three or four years for the foreseeable future, due to the video explosion. That’s about 80% growth per year, so my 25% per year growth rate forecast is very conservative.. It’s no mystery – video is a huge bandwidth hog, and there’s a seemingly insatiable demand for more and better video applications.

The company guided for $88 million to $90 million in sales in the current quarter, below the consensus for $96 million. Although this hit the stock, looking at the March and June quarters together, they are right on target. Infinera also said they expect to report one or two cents a share in profits, but the consensus is still printed at a loss of one cent. I say “printed” because one source claims the real estimate was four cents, even though it did not show up in the estimate services. The company is in the process of switching from carrying heavy reserves on sales of a “development” product to full GAAP accounting by the March 2009 quarter, and that may be what is confusing the issue. By this time next year, they will be reporting rapid revenue growth with good profitability and cash flow, and the current confusion is just contributing to the buying opportunity.

INFN went public last June at $13, ran up, fell back, and closed today at $13.18. I expect them to announce major contract wins with new customers and beat Street estimates for each of the next four quarters. They’ll do over $400 million in sales this year–the highest Street estimate is $391.6 million–and cross the $500 million mark next year. As you know, I think we are headed for an April 2009 market top and a nasty bear market after that, but INFN is one of the stocks that can keep going up even in a down market. I want you to buy INFN up to $15 for a $30 target in 12 months, and higher levels after that.

Biotech MegaShift

After eight years of an unfriendly administration, whoever is the next president will support funding for stem-cell research. John McCain voted to expand embryonic stem cell lines and is very much in favor of amniotic fluid and adult stem cell research. Hillary Clinton and Barack Obama are even more favorably disposed towards stem cells. That will be good news for Geron (GERN), which needs something to go right.

The FDA told Geron it needs more time to review the clinical trial plans for GRNOPC1, the stem-cell based therapy for spinal cord injuries. Geron said they don’t know yet what the reason for the hold is, but as soon as they get an official letter and meet with the FDA, they will make a statement. I expected the FDA to take longer than the usual 30 days to review all of Geron’s data in their filing to begin a clinical trial, simply because the FDA has little experience with stem-cell therapies and the agency is in one of its periodic go-slow phases. But I did not expect them to put a clinical hold on the filing. This may be administration meddling, trying to keep the issue out of McCain’s campaign, but that won’t work. Geron stock isn’t likely to get any cheaper, so continue to buy GERN up to $9 for my $18 target.

Amgen (AMGN) announced new denosumab results over the weekend. Their drug outperformed Fosamax, the current standard of care for osteoporosis. The year-long Phase III trial included 504 post-menopausal women with low bone mass and “demonstrated superior results for all the primary and secondary endpoints.” Amgen said the study found that women treated with denosumab achieved about 80% better bone mineral density gains than those treated with Fosamax. They will file with the FDA for approval before the end of the year, and the drug should be on the market by the end of next summer.

On the back of that good news, the company sold $1 billion in notes on Tuesday. Even for a big biotech, that’s a lot of money and it could indicate another major acquisition is coming. Hold the Amgen January 2009 $70 LEAP call (VAMAN). Buy the Amgen January 2010 $40 LEAP (WAMAH) under $10 for a $20 target.

Dendreon (DNDN) presented some early, preclinical animal data on D-3263, their drug to treat benign prostatic hyperplasia (BPH). Treatment with D-3263 resulted in a significant 39% reduction in prostate weight compared to the control. The same drug may work against various cancers, including prostate cancer. Of course, the big payoff for DNDN will be the results of the peek at the current Phase III Provenge data in about 120 days. I’m moving DNDN back to a Top Buy under $8 as we get closer to the data release and maintaining my $40 target.

eResearch (ERES) picked Tuesday’s weak market day to announce that their Chief Financial Officer has resigned effective June 17 to move to a privately-held medical company. He was immediately replaced by the Vice President – Controller who has been there seven years, so this will be as smooth a transition as it gets. Still, the stock dropped 90 cents a share on the news. ERES is a Top Buy just under my $16 buy limit for the $30 target price.

Content on Demand MegaShift

Telkonet (TKO) won an energy management contract with Cornerstone Hotel Management as part of Wisconsin’s Focus on Energy incentive program. Cornerstone will install Telkonet’s SmartEnergy system at three of its properties to cut utility bills by eliminating unnecessary heating and cooling of unoccupied guest rooms.

SmartEnergy works very differently from the typical fixed-setback system, in which the temperature is fixed in all rooms. Telkonet’s patented Recovery Time technology, running over their Broadband over Powerline system, enables optimum energy savings without any compromise of guest comfort. Each room’s temperature is adjusted based on many factors, calculating how far it can drift from the occupant’s preferred temperature setting, while ensuring the temperature will return to the occupant’s setting within minutes upon their return. This market is just exploding as the hotel industry and many others face up to out-of-control utility bills, and TKO is moving fast to take advantage of it. TKO remains a buy all the way up to $5 for my $15 target.

UTStarcom (UTSI) reported revenues up 23.1% in the March quarter to $586 million, with a 21 cent per share profit. But they had a 40 cent per share gain from the sale of investments, including one in Infinera, so the operating losses continue. For the June quarter, they guided for $580 million to $610 million in sales (+8% to +13%) with continued poor gross margins around 14%. They’ll have another $30 million to $40 million operating loss. UTSI remains a hold for my $10 target in a better market.

New Energy Technology MegaShift

Oil rose over $135 a barrel this morning for the first time ever. I think we are close to the end of this speculative bubble and we’ll see oil back under $100 sometime soon. Look at this chart of the Bullish Percent Index for the oil sector, which measures how many stocks in a sector are in bullish patterns:

On Wednesday, about 91% of the stocks in the oil sector were moving higher. But this chart can’t go over 100%, and very rarely goes over 90% –for any sector. When everything is this bullish and the stock prices are in a parabolic upturn, a very large decline in prices is due. Look at what happened in January, or July/August 2007.

But calling the top in a parabolic market like this in advance is impossible. You have to wait for it, see the price break, watch the rally back that fails, and then go short as the price falls below the point at which the failed rally started. That could happen now or from $140 or even $150. Until you see it, keep filling up your tank every chance you get, because gasoline prices will keep rising for a few weeks even after oil breaks.

Holly Corp. (HOC) continues to be squeezed by the high price of oil, as the refinery crack spread just can’t widen when the price of raw oil is going up at this rate. But when the break comes, Holly will benefit tremendously. It’s interesting that the psychology now would label $3 a gallon gasoline as “cheap” and that price would make consumers feel better. What a difference a year makes! But that is where we are headed, and if you want to make money off the coming decline in crude, buy HOC while it is under $48 for my $70 target, probably in the next six months.

Ocean Power Technologies (OPTT) won a contract with Griffin Energy to jointly build and operate a wave-power station offshore Western Australia. They’ll start with a 10 megawatt system and then expand it to 100 megawatts, and feed the energy into Western Australia’s main power grid. It costs about 10 cents a kilowatt hour to generate electricity with oil, but only five cents with wavepower. The density and reliability of waves off the Western Australian coast means that a 250-acre area can produce 100 megawatts of power. Buy OPTT up to $20 (almost a double from current levels) for my $40 target.

Robotics MegaShift

iRobot (IRBT) will hold an Analyst Day next Wednesday that might spark some interest. I am reducing the buy limit on IRBT to $15 while maintaining my $30 target. Also kicking myself for not sticking to my informal guideline to wait until I can see at least a double in a year before recommending a stock.

Security MegaShift

Packeteer (PKTR) and Blue Coat Systems received antitrust clearance for the latter’s $7.10 bid for PKTR. It looks like there isn’t going to be another bid, so sell PKTR and redeploy the money into a Top Buy or recent recommendation that will improve your portfolio diversification.

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