As the old year passes, it’s time to look forward to what will be happening in all of our MegaShifts in 2007. So, I want to discuss that topic in both this week and next week’s issues. This week, I want to first set the stage by talking about the major technology trends that will impact the economic and market environment for the next year or two before taking a look at a couple of our MegaShifts.

My economic forecast is pretty simple: sub-par GDP growth in the first two quarters of 2007, followed by accelerating growth for the last half of the year and 2008. “Sub-par” could still mean a mild recession, as in two quarters of negative growth, but it really doesn’t matter, because unless we have an energy price disaster, the Fed will eventually cut rates a bit and restart growth. In fact, even if there is an energy price disaster, Helicopter Ben will certainly continue to shower the economy with money, even if he doesn’t cut rates.

With business slowing as it is right now, capital spending budgets will be set conservatively for next year. In fact, capital spending should slow for the next three quarters. I think Windows Vista hardware upgrades will be a bright spot that keeps budgets from dropping significantly.

With that background, the best areas for investment will be those that can continue to show strong revenue growth. When everything is growing, it can be hard to stand out, but in 2007 we will see a real separation between maturing companies and wannabees on the one hand, and companies with real revenue growth on the other. Obviously, that is good news for almost all of our MegaShift stocks.

There are also a number of new or revitalized technology areas that I’ll be watching in 2007, many of which we already participate in. The whole Web 2.0 concept of social networking and user-driven content is accelerating, and one of the technologies it is driving is video over the Internet. This is a technology and a trend that has been growing from a small base for more than five years, and now it is ready to take off. It is part of a much larger trend, which is the effective use of the Internet — that great, free, universal, global network that links us all together socially and intellectually. And even that is taking place in the environment of a rapidly expanding Internet infrastructure, which includes everything from Google buying up thousands of miles of dark optical fiber to the new Internet Protocol 6 that starts serious deployment at the government level in 2007.

In the New Year, there are two major trends in semiconductors that will be worth watching. One is phase-change random access memory (PRAM). It will completely replace flash memory, dealing a special blow to Toshiba and SanDisk. PRAM uses a heat-sensitive chemical now used in rewritable disks to make memory that stores data 10X as long as flash memory and runs 30X faster. It is a Samsung innovation, with the prototype demonstrated in September and first devices available in 2008. That means 2007 will be the design-in phase, and I expect to hear rumors of flash memory losses and PRAM wins all year long.

The other semiconductor technology that I’ll be watching is the micro-electro-mechanical system (MEMS) chip. The best current example is the Texas Instruments digital light processing (DLP) chip with its masive array of tiny mirrors creating a TV image. Although the process of making MEMS chips is not easy, there are so many possible applications that I expect to see entire companies dedicated to making MEMS chips.

The white LED product from Cree (CREE) and Philips Lumiled are closely related to semiconductor manufacturing and 2007 should see this market take off. As I mentioned last week, I am looking for an entry point on Cree that discounts the poor results that they will show for the next three quarters.

In computing, the 2007 story is going to be Windows Vista and Office 2007. As you read the stories, remember that it is standard procedure for pundits to say the rollout of a new system is “disappointingly slow” and for Microsoft to have lots of bugs and security problems in the initial product. We are bound to see these kinds of stories in the first few months of next year, but by the end of the year, I think we will look back at the Vista rollout as a major event for 2007. I expect personal computer sales to be up 15% or more by the end of the year, because half of the computers already installed can’t run Vista, and the owners of most of the other half don’t want to go through the self-inflicted wound of trying to upgrade their operating system. It’s just simpler to buy new hardware with Vista already installed, especialy as Intel leaves the Pentium generation behind and moves on to the Core generation of microprocessors. Currently, the Core Duo dual-processor chip is the standard desktop processor, but by mid-2007 the Core Quad four-processor chip will be the sweet spot.

In communications, we all know that 2007 will be a huge year for wireless. The phone companies are selling wireless access to the Internet, and WiMAX is finally ready to really accelerate on the coattails of the $3 billion multi-year network rollout by Sprint Nextel. There will be new versions of Wi-Fi, too. But an interesting and overlooked area is the continued installation of fiber optic to the curb systems, both by phone companies (even those also committed to wireless) and cable companies completing their system upgrades. Of course, both wireless and fiberoptic technologies are being deployed around the world, not just in the U.S. Voice over Internet Protocol (VoIP) will continue to replace traditional telephone technology worldwide, in both the established phone companies and via new competitors.

The hottest area in communications is video, whether downloaded over the Internet, sent to a cell phone or personal media player, or just on a website. Google’s $1.65 billion purchase of unprofitable YouTube and Apple’s upcoming iTV video streaming/control box for your living room are just two examples of what’s coming as the analog TV signal goes dark in early 2009.

Popular Mechanics provides a Top 10 Technology Trends list at the end of each year. Many of them are gee-whiz ideas that make great stories but really are years away, while some are right on. Phase-change random access memory, the flash memory killer, is on their list this year. So is Body Area Networks (BAN), an idea that has been around for 15 or 20 years, but may soon see the light of day. A German startup, ImCoSys, says their new cell phone can send a weak electrical current, only a fraction of an amp, along your skin to control things like automatically logging into your PC as soon as you touch the mouse, or unlocking your car doors when you touch the handle. There may be secure identificaiton applications, too, that could attract some Homeland Security funding.

One software trend that is about to explode is software as a service, as exemplified by Salesforce.com. Instead of selling software to the corporate IT manager, Salesforce.com sells a hosted service directly to the user in sales or customer service. Our government has imposed so many new requirements on businesses in areas like hospital outcomes or storing and recalling emails for legal discovery that software as a service is sure to grow dramatically.

Another factor that will dramatically accelerate the adoption of the software as a service model is offshoring. The service is hosted, and in the Internet world it really doesn’t matter where the server is located. By locating offshore, companies can throw more people power at customer service and software upgrades for the same number of dollars. The Gartner market research firm says 30% of new software purchases will be delivered as a service.

In storage, Popular Mechanics also mentioned the “data cloud” that puts all of your files, music, photos and videos on centralized data servers with Internet access. The data cloud follows you wherever you go, and you can access it with whatever device you want. There’s a huge amount of storage wasted today in all the new electronic devices, PC back-up drives and so on. If it all sat on Google’s rumoured Gdrive, professionally secured and backed up in real-time, there would be much less need for redundant storage. Devices could be smaller and lighter, carrying only enough local storage for current projects or trips. While it is possible to put a data cloud together today, it is expensive and secure backup roughly doubles the cost. We may see the Gdrive, or something like it, by the end of 2007.

The bottom line is that 2007 is going to be a great year for new technology in many areas, almost regardless of what the economy does. It would take a very deep recession to stop this juggernaut, and with the Fed continuing to flood the economy with money, that just isn’t going to happen yet. So, let’s take a look at the individual MegaShifts in light of my outlook for 2007. This is Part I, and I’ll wrap up next week with the rest of the MegaShifts in Part II.

Avian Flu MegaShift

I still think it is inevitable that bird flu will be found in the U.S., and that it will mutate into a strain that is easily transmitted from person to person. Both of those things could have happened in 2006 and are even more likely to happen in 2007. But as I’ve been saying neither has to happen for us to make a lot of money in the stocks, as government demand to stockpile antivirals and vaccines drives up revenues at all three of our stocks.

BioCryst (BCRX) reported Fodosine data from three trials at the American Society of Hematology (ASH) annual meeting last Sunday, and the news was good. Fodosine treats certain types of leukemias and lymphomas. The first results were from a mid-study look at a Phase I/II trial of oral Fodosine for refractory (not responding to treatment) cutaneous T-cell lymphoma. Of the 34 patients evaluated, 14 had partial responses and three had complete responses, for an overall response rate of 50%. Those are good numbers for advanced lymphoma, and the safety data was good, so BioCryst will now start a Phase II trial.

The second trial was a Phase II study of patients with clinically active relapsed (it came back), refractory T-cell leukemia. Nine of the 50 patients had a complete response — a remarkable result. Even better, Fosodine restored normal blood cell development during the treatment, which means it may be useful as a targeted, less toxic therapy to treat the disease. BioCryst will do a “pivotal” Phase IIb trial, which means if they get similar results, they will file for approval.

The third trial was a Phase I safety study for relapsed, or refractory, B-cell acute lymphoblastic leukemia. As usual, the safety data was fine, and they saw some evidence of positive activity. Phase I trials are too small to say much more than that, but the company said that they intend to continue trials with Fodosine for this indication.

While I think the stock is worth more than its current price just based on their avian flu potential, there’s a lot more going on here. BioCryst is the best-situated stock in this MegaShift to make us a lot of money in 2007, as they complete their Phase II clinical trials of peramivir for both seasonal and avian flu. BCRX is a Top Buy all the way up to $19 for my $30 target.

Crucell (CRXL) got approval to start a Phase I safety trial of the malaria vaccine it is developing with the National Institutes of Health. This vaccine can be produced using Crucell’s cell-based technology, and would have a huge market if successful. CRXL remains a buy under $28 for my $50 target.

Gilead (GILD) announced good results from its Phase III trial of inhaled aztreonam lysine to treat people with cystic fibrosis who have lung infections. The drug allows them to stop antibiotic treatment for a month or more, in order to avoid developing a tolerance or sensitivity. The primary endpoint was postponing the time needed for inhaled or intravenous antibiotics, and they met it. Full results will be reported soon at a scientific meeting. Because this trial was done under a Special Protocol Assessment, Gilead should be able to file for approval.

The stock has been strong, and if you bought the January 2008 $50 LEAPs (YGDAJ), continue to hold for my $30 target. If you hold the January 2007 $60 contract (GDQAL), the LEAPs are in the money, but you may have a tax loss. Sell the January 2007 LEAPs now, and roll the proceeds into the January 2008 $50 contract.

Biotech MegaShift

In 2007, we should have a fully-functioning FDA and get numerous important drug approvals. In a big bull market, like the one I am expecting, defensive areas like health care normally go up, but underperform more cyclical areas like computing. However, biotech drug approvals will move a stock in any kind of market. With Acting Commissioner Andrew von Eschenbach finally approved by the Senate, 80-11, with only one Democrat voting against him, an uncertainty that has lasted for nine months should shortly come to an end.

Affymetrix (AFFX) is below my buy limit due to a Wall Street Journal Online story rehashing the Affymetrix/Illumina situation that I’ve discussed here before. There was nothing new in the story, so take this opportunity to buy AFFX under $24 for my $40 target.

Biogen Idec (BIIB) and their partner, Genentech, both fell after the FDA issued a warning to doctors that two patients taking Rituxan for lupus died from a rare brain disease. It is much too early to tell if there is any direct connection between the drug and the disease, as it often happens that these patients are on a cocktail of drugs and over-the-counter medications, and it could be an interference issue as it was with Biogen-Idec’s and Elan’s Tysabri. Rituxan is not approved for lupus, and the off-label lupus market is relatively small, so I think we should wait for further information before making any moves. I do not think Rituxan will be taken off the market. Rituxin was previously linked to the same rare disease in AIDS patients, and its label already carries a warning. Also, the FDA said the disease has occurred in lupus patients who have been prescribed other immunomodulator drugs besides Rituxin.

Last Friday, Biogen-Idec and Elan filed for a label expansion for Tysabri to cover Crohn’s disease, an inflammation of the digestive tract that causes pain and diarrhea in about one million people worldwide. Continue to buy the Biogen-Idec January 2008 $45 LEAP (YZUAI) under $12 for my $23 target, or higher.

eResearch (ERES) got an upgrade from Friedman Billings this morning, stopping the slide in the stock. I don’t think there is any fundamental change in the market or the company’s outlook, so this probably puts a floor under the stock. As they convert their high order rates, and now large backlog of business into revenues, the stock should recover quickly. Buy ERES all the way up to $16 for my $30 target as drug companies accelerate the required cardiac safety testing of all drugs currently in clinical trials.

Geron (GERN) said that preclinical work on its telomerase inhibitor drug showed that if the drug is given to knock out telomerase in tumors, it then makes the tumor cells more vulnerable to radiation. Longer-term use of the drug has been shown to slow tumor cell growth rates and dramatically reduce the ability of the cells to form new colonies.

This is very early work, of course, but is another indication that GERN may have the silver bullet for cancer. Buy GERN under $9 for my $18 trading target, and much higher levels as their anticancer and stem cell programs mature.

Market Outlook

After the S&P 500 breaks through a barrier (like the 1415 level), it tends to run up quickly, and then slowly give back ground to the breakout point. The purpose for that slow decline is to build up energy for the next move up, as some traders sell and some investors take the opportunity to get out stocks at better prices than they have seen. While this is complicated a bit by the approaching end-of-year tax deadline, so far this looks like a textbook dip back to 1415, to be followed by a final run up to the 1440 target. That easily could happen by the last trading day this year, December 29, and would set us up for a 150 point decline or worse to start the New Year.

I’ll keep an eye on these critical balance point levels like 1415, because if it does not hold we will know that there has been a real change in the underlying dynamics of the market. Likewise, if the market can just sail through 1440 I would say the two-year tech bull market has begun, and there won’t be any huge setbacks in the near future. So, while I am watching all this carefully, there is no change to my outlook yet.

Today is the Winter Solstice, so happy solstice to the pagans and druids out there, and Happy Holidays to all. I’ll be back with Part II of the 2007 MegaShift outlook on schedule next Thursday. Have a great time this weekend, be safe and remember to surprise a stranger with an act of kindness.