If September turns out to be as “bad” as August, the market is in a lot better shape than I thought. August and September are usually the two worst months of the year, but we closed today with the S&P 500 for August up 2.13%. Maybe I’m still suspicious because I was burned so badly in 2000, when a very nice 6.1% August rally capped a four and a half month recovery from the dramatic March-April decline as the Internet bubble burst. I thought that rally meant the market had stabilized and was starting to look forward to the usual fourth-quarter rally, and I was wrong on both counts. The hanging chad election in 2000 certainly didn’t help, but my experience is that strong markets recover from blows like that, while weak markets cave in as that one did.

So now we have a smaller August rally, but still a rally, capping a two and a half month recovery from the May-June decline. I’m having a hard time believing this can continue. Ernesto missed the Gulf oil platforms, but more hurricanes are coming to run the price of oil and natural gas higher. Of course, we may not even need a hurricane to do the job, with Iran insisting that they have the right to enrich uranium to the 6% level to power nuclear plants, and the U.S. saying there can be no compromise between 6% and the 80% level that would let Iran build a nuclear bomb.

In addition, the market has chosen to ignore the Fed’s statement that pausing was a “close call” at the August 8 meeting, and focus on their comment about the possibility of “economic growth below potential over the next six quarters.” I certainly think they got that right! The very accurate Economic Cycle Research Institute Weekly Leading Indicator peaked in May, and it usually leads a recession by six to nine months with very few false signals:

The remarkable factor here is that stock prices are one of the biggest components of this index, and they are rising… which means everything in the real world must be falling apart to make the overall index fall so decisively.

Others are finally using the “R” word, and with housing spiraling down faster than even I expected, it looks like the recession I’ve been forecasting is inevitable. The theory was that weak housing and high gasoline prices would take the consumer out of the game, but the baton would pass to business spending to keep the economy afloat. With consumers making up 70% of the economy, it takes a heck of an upsurge in business spending to make up for consumer weakness. Now it looks like the baton is about to get dropped. The weakness in revised second-quarter GDP figures for business spending on equipment and software, down 1.6% for the biggest drop since 2002, is confirmed by surveys of reduced spending intentions for the rest of the year.

As for housing, I read about a recent corporate meeting with a large, private California home builder where the young guys, who have been in the business for maybe 10 years, think all they have to do is get rid of the current inventory and then go back to business as usual. All the older, more experienced execs think 2007 will be worse than 2006, and they don’t know yet whether 2008 will be better or worse than 2007. Housing is likely to be a drag on the economy for some time, even after the Fed reverses direction and cuts interest rates.

So at the September 20 meeting, the Fed will again face the problem of a slowing economy with inflation well above their 1% to 2% comfort zone. Of course, it has been above their comfort zone since March 2004, with few signs of a meaningful decline, and that didn’t stop them from pausing in August. Fed forecasts presented to Congress last month predicted inflation of 2% to 2.25% next year, above the top of their supposed comfort zone. It is always interesting to contrast what people say with what they do.

Are the markets setting up for a crash, like 1987 or 2000? Maybe. The last of the shorts are being squeezed out now by this low-volume grind to the upside, and there may even be a continued rally after Labor Day to a double top around 1325 by options expiration on September 16. The higher the market goes in this rally, the more vulnerable it becomes as the bears are forced to throw in the towel. A negative surprise in September from the Fed, a hurricane, Iran, or even mid-quarter earnings updates could set off a sharp decline. We’ll know more after we see how money managers respond after they get back from the beach next week, and we’ll know a lot more by mid-September.

Meanwhile, most of our MegaShift stocks have lifted with the market rally and should report good progress for the September period.

Avian Flu MegaShift

Crucell (CRXL) reported earnings that were below expectations due to the costs of the Berna acquisition and a decision to increase R&D spending. Although the stock dipped for a day, management’s comments on the conference call were so positive that it snapped right back.

Crucell was expected to report sales of $37.9 million with a loss of $13.4 million. They actually reported sales of only $24.3 million and a loss of $33 million. But management reiterated their forecast for full-year sales of $167 million to $193 million, even though they only did $39.3 million in the first half of the year. Obviously, they will have to produce a gangbuster second half.

They expect to do that because the vaccines they acquired from Berna have a strongly seasonal sales pattern. And CRXL is very confident that they will get approval to launch Quinvaxem, their 5-in-1 vaccine for childhood diseases, in September or October, giving them time to sell the seven million doses that Novartis and they have produced before the end of the year.

CRXL also expects to start six Phase I trials in the second half of the year, including a pandemic flu study of the H7N1 avian flu strain and vaccines for tuberculosis, Ebola, a malaria and rabies. By the end of 2006, they will announce results of a Phase I trial in the West Nile virus and a big Phase I/II trial in England in H9N2 avian flu, and they will also announce a development plan for blood factor protein therapeutics. That’s a lot of positive news flow!

With the company forecasting breakeven cash flow next year, the news announcements and especially the approval of Quinvaxem should drive this Netherlands-based stock higher, regardless of what the U.S. market does. CRXL remains a good buy under $28 for my $50 target.

Biotech MegaShift

Biogen Idec (BIIB) announced on Monday that the placebo-controlled Phase II study of Rituxan for multiple sclerosis, which it did with Genentech, hit its primary endpoint — a statistically significant reduction in the number of brain lesions. There were only 104 patients, and the advantage over placebo came as early as 12 weeks after treatment, and continued to get better at the 16-, 20- and 24-week points. Achieving statistical significance with such a small number of patients is remarkable, and bodes well for the Phase III trial.

The company will be presenting at the Thomas Weisel Healthcare Conference next Wednesday with a live webcast, and it may give us a hint on how Tysabri sales are going. Buy the January 2008 $45 LEAP call (YZUAI) up to $12 for a $23 target. The January 2007 $45 LEAP call (IDKAI) is still a good buy, but a more speculative buy up to $10 for my $21 target.

QLT (QLTI) is almost certain to get a hostile bid after their current share buyback at the Dutch auction ends on September 8. I’ve been expecting the company to announce good news after that date anyway, and if they think a bid is coming, they will certainly try to run the stock up in advance of it.

Jim asked: “Why should anyone accept QLTI buy back offer of $7 to 8?”

For those who were thinking about selling anyway, putting the stock up for sale at $8 gets them out a little higher than recent trading. But I agree that this is the wrong time to be selling QLTI — it is better to match your actions to management’s actions. They obviously think the stock is deeply undervalued, or they wouldn’t be buying so much of it back.

Rodney O’Conner, a major shareholder who founded Atrix Laboratories and sold it to QLT, has been trying to negotiate a takeover that would take the company private. He is backed by an unnamed private equity group, and this week The Globe & Mail published the story. Now he says he may make a hostile tender offer after the buyback process is over.

The stock rose a bit on about double normal volume. You should not tender your shares in the Dutch auction, as one way or another this stock is now in play and headed higher. If you want to get in on the fun, I’m raising the buy limit on QLTI to $8 but keeping my $20 target. I would expect an offer from O’Conner in the $13 area, but there are others who would also like to own QLT, including Genentech, which could market their Lucentis with QLT’s Visudyne in a combination therapy. So, I think QLT could see even higher prices.

ViroPharma (VPHM) announced very strong data for their hepatitis C drug, although it was an early Phase 1b trial. This is an oral drug that they are co-developing with Wyeth. In this dose-ranging study of 100 milligrams to 1000 milligrams (1 gram), twice a day for 14 days, combined with pegylated alpha-interferon, they showed whopping viral reductions of 99.95%. There was no evidence of viral rebound, and no dose-limiting toxicities. A pill for hepatitis C would be a blockbuster drug. They plan to start a Phase II trial at 500 milligrams in the fourth quarter. The stock moved up 13% on heavy volume on Tuesday, but VPHM can still be bought under $13 for my $28 target. The stock still trades as if generic Vancocin will be introduced in 2007, which simply isn’t going to happen.

China MegaShift

Huaneng Power (HNP) told the China Daily that they plan to spend $31 billion in the next five years to more than double their generating capacity by 2010. They will install a mix of coal-fired and renewable-energy plants, targeting wind and hydroelectric to produce 10% to 15% of their electricity. Adding another 50 gigawatts of generating capacity that quickly will become a huge effort, and they expect it to boost their annual sales to $17.6 billion from the current $5 billion run rate. That’s a 37% growth rate or 28% if they take an extra year to get there — miles above Wall Street’s 9% expectation for the next five years. Remember that their first green nuclear, pebble-bed reactor plant will be online in 2010, providing them a major expansion route for the following decade. China is desperate for non-polluting electricity generation, and HNP’s pebble-bed plant is the answer.

The stock didn’t budge on this story, which reinforces my belief that Wall Street really doesn’t get it with this company. China can’t grow without power, and HNP is going to provide a lot of the incremental power — not the state-owned industries. Buy HNP up to $30 for my $45 target, and enjoy the 4.7% yield while you wait.

Content On Demand MegaShift

Comcast (CMCSA) is one of the most aggressive bidders in the wireless spectrum auction now underway in Washington. They joined with three other cable firms, Time Warner, Cox Communications and Bright House Networks, to form SpectrumCo. It was thought that they were just trying to run up the prices for the satellite guys, DirecTV and Echostar. But those two dropped out of the auction, and SpectrumCo is still in there as the third-largest bidder at $2.3 billion. They are bidding for New York, Long Island and Chicago, among others. They may be planning a unified service for mobile users that are Comcast subscribers at home, or they may be planning to use their share of the spectrum in their partnership with Sprint. It’s an interesting development, although it’s made some investors nervous that the long-awaited cash flow from the network upgrade spending will get sucked into another round of capital investment related to this spectrum. My take is that Comcast is run well enough to know how to take care of shareholders, while strategically growing the business. CMCSA is a big, safe stock that you should continue to hold for my $62 target.

Telkonet (TKO) has not had a lot of news recently, and it still hasn’t announced the strategic investment that I believe is coming. But I have a received a couple email questions about TKO that I would like to address today.

Jim asked: “Last week you said that assuming no one is short selling TKO, we’ll see why the lenders negotiated a $5 cap on the stock price. Did you mean to say ‘why the borrowers (meaning TKO) negotiated a $5 cap?’”

No, the way these work is that they calculate the average price of the stock over a fixed number of days, and then divide that into the amount of money changing hands to calculate the number of shares that will be given to the lender. The higher the stock price, the fewer shares the lenders get, so they often negotiate a cap, like this $5, to be sure they get at least a certain number of shares.

Laura asked: “Telkonet has already fallen back after the announcement of the Navy contract, and it continues to hover in the same range. Just two years ago Telkonet fell short of analysts’ expectations by 95%!!!! Today, it has the same CEO, appears on no ‘buy’ lists and no one seems to be tracking it. What makes you believe it can get to $15 by the end of this year from where it is now ($2.81). That would be a quintuple-plus in just a little more than 4 months, which seems highly doubtful. Would a strategic alliance cause the stock to ‘pop’ that much?”

The stock could easily double on the strategic alliance announcement, but the key to getting to $15 is in your question — “no one seems to be tracking it.” Depending on who the partner is, TKO could get picked up by one or two analysts for new coverage, and that would push it much higher in a strong bull market, which I am expecting after mid-October. Add the momentum players trying to get some performance into the end of the year, and this could be an explosive situation. Even at $15, TKO will still be a small cap stock with a $750 million market cap, and therefore have a natural constancy of aggressive mutual funds and hedge funds. Admittedly, everything has to go just right to hit $15 by the end of the year, but if it can get much of the way there this year and the rest in 2007, I don’t think many of us will complain.

Continue to buy TKO under $5.

New Energy Technology MegaShift

Fuel Cell Energy (FCEL) announced a technology breakthrough that increases electrical power output by 20% from any fuel cell size. They will deploy it across their product line for commercial introduction by the end of the second quarter of 2007. This is a down payment on their program to increase output by 50% while decreasing costs. The company will announce July third-quarter results before the market opens on September 7. I am not expecting much — a 38-cent loss on about $8.2 million in sales and probably only around 750 kilowatts in new orders. But they should have a large four-megawatt contract with PPL, the Pennsylvania utility, to announce by the end of September. FCEL is a buy up to $11 for my $22 target.

Holly Corp. (HOC) dipped below my buy limit after Ernesto missed the Gulf of Mexico oil platforms, weakening oil prices. This is just what we’ve been waiting for, so if you want to own a refinery (they aren’t building any more of them) with the technology advantage of processing heavy and sour crude, now is the time. Buy HOC under $46 for a move to $60 as oil prices firm up again.

Rentech (RTK) landed another big contract, indirectly. DKRW Advanced Fuels licenses Rentech’s technology, and Arch Coal just acquired a 25% stake in DKRW-AF and announced an expanded coal-to-liquids program. DKRW-AF and Arch are already developing a 10,000 barrels a day project in Wyoming, and now they will expand to two other coal basins. With Peabody Coal partnering with Rentech and Arch Coal partnering with a Rentech licensee, the handwriting is on the wall for the rest of the coal industry. These two giants and industry leaders did all the due diligence, and both picked Rentech technology. RTK is a strong buy under $5, which it just moved over this week, for my $11 target.

Royal Dutch Shell (RDS.A) and Chevron were picked to begin tests on extracting oil from shale in the Green River Formation under Colorado, Utah and Wyoming, according to a leak to The Wall Street Journal. The Bureau of Land Management (BLM) began public consultation on commercial leases last week, according to the Journal. The BLM said the formation has more than twice Saudi Arabia’s total stated reserves. RDS.A is a big, conservative stock with the oil shale kicker, and can be bought on dips back under $66 for my $75 target.