Over the past five months, I’ve been telling you that the market has been set up for a serious decline through the end of 2006. If you’ve followed my advice, you should be in great shape to not only weather the storm, but come out the other side on the plus side. However, no matter how prepared we are, it is going to be difficult to watch the market drop double digits in pretty short order. The best defense we have is to understand our investment landscape. To that end, there are a couple of key factors having an effect right now that I want to discuss today.

Earnings, Inflation & PC Sales

Next week begins the earnings deluge, which should be the last chance that the bulls have to push stocks up until September-quarter earnings are reported in mid-October. During this time, I will be watching not only our stocks but all the various industry leaders to see what develops.

So far, earnings season is off to a shaky start. Even though I am negative on the market outlook, I thought that June-quarter earnings would be strong. And with the economy slowing as quickly as it has, I thought at least September-quarter guidance would be cautious, with some companies even expressing caution for the December quarter, too – signaling all is not well in Denmark.

This outlook, of course, isn’t good news for the bulls. It is vital for the bullish case that stocks rally strongly off their earnings reports. Some have — Standard Microsystems was rewarded for good numbers, and KLA-Tencor said orders are strong for semiconductor equipment, which pushed up both it and Applied Materials. But those are very late-cycle, cyclical companies, and it isn’t surprising that they aren’t seeing any weakness yet.

What has been a bit surprising, though, is the revenue misses at Lucent, Advanced Micro Devices, 3M, SAP, Cree, Fastenal and Brunswick, all of which also indicated a disappointing September quarter, too. EMC and Genentech also missed, but they held out more hope for September. Genentech posted a 79% rise in profits and raised its full-year earnings growth outlook, but the stock was pummeled anyway. That may be a sign that we are in an environment where almost no matter what a company reports, the stock goes down.

The background to this round of earnings reports is what the Fed is doing. Chairman Bernanke and friends intend to keep inflation in check, which traditionally means inflicting pain on the economy by making it difficult for businesses to raise prices. If consumers are squeezed to the point where they can’t or won’t pay more, and maybe start reducing their debt instead of borrowing even more to spend, businesses will have to go back to their suppliers to get costs down.

Add that on top of Bill Gates saying that there is only an 80% chance that Windows Vista will be ready to ship in January. This will likely put a real damper on PC and server sales for the rest of the year, with an additional impact on semiconductor sales. It’s no wonder that Dell is at a multiyear low. So far, cell phone sales have held up better than I thought they would, and I will be scrutinizing earnings reports in that area especially close for signs of weakness. The big disappointment at Cree that clobbered the stock today, combined with Samsung’s poor report this morning was blamed on handset sales and price cutting. This tells me that there are inventory problems in the channel. Inventory problems are caused by people not buying. If cell phones are going to follow personal computers into a weak period, semiconductor earnings estimates are much too high, and there is still a lot of pain to come in tech stocks, not to mention the broad market.

So, in this environment, and because it is hurricane season, we’ve been building up only our New Energy Technology MegaShift investments, while holding cash from our February sales of legacy tech stocks. I’m still watching the solar and ethanol stocks for a better entry point, but I think further investments in the energy area should be on hold for now. These companies, as with many of our MegaShift stocks are in the early stages or development stages of their business. These kinds of stocks reward risk independent of the market when the news is good, but can be hit when it isn’t. So, I’ll continue to keep you updated on each of their movements during this volatile time in the market. With that said, let’s take a look at the recent news affecting our MegaShifts.

Avian Flu MegaShift

Along with high energy prices and the drive for alternative forms of energy, one of the surest MegaShifts we are invested in is heavy government spending to prepare for a bird flu pandemic. Yesterday’s news that frozen poultry meat from a bird flu-infested areas of China was smuggled into Michigan for sale to 300 Chinese restaurants and grocery stores brought the story even closer to home. The virus can survive freezing very well — actually, it is the best way to preserve the virus indefinitely. The thawing process completely reactivates it.

However, the story lacks a few important details, so far:

• Federal officials learned of the problem in early June, but didn’t alert state officials until June 20. Why?
• Federal officials seized birds from the warehouse on June 27 and destroyed the meat without testing it first. Why?
• While Federal officials destroyed those birds, they left a portion in the warehouse for "safety reasons." Why?
• State officials learned of the problem on June 22, but state and federal officials didn’t make a second raid on the warehouse until July 6. Why?
• The remaining meat was seized on July 6, but they found that some of the quarantined food had been switched. So, how much of this was sold to restaurants and grocery stores?
• All together about 2,000 pounds were destroyed without being tested. Why?
• Officials admitted that consumers “probably” have eaten some of the poultry, but as long as it was “properly cooked” they should not be alarmed. What are the odds that it was all “properly cooked?” Were all food preparation surfaces disinfected with soap or bleach, as recommended? Did everyone involved in the preparation wash their hands frequently to prevent the spread of any virus, as recommended?

The emergency management coordinator for the Michigan Agriculture Department is sending inspectors to the customers, in hopes of finding some unconsumed poultry that can be tested to “reassure the public.” And in regard to not telling people what was happening, he said: “One of the reasons we haven’t been public is because it’s the USDA’s investigation. The delicate balance of food safety is trying to let people know about threats and risks without unduly scaring them.”

What would scare me is realizing that the state would keep it secret for three weeks that contaminated poultry might have made it to some grocery stores and restaurants. “Delicate balance,” indeed. Sadly, this is probably what we can expect from our “leaders’ in future bird flu incidents — we will find out too late or not at all about these situations.

After last week’s confirmed outbreak in Spain, the UK decided to stockpile 10 million doses of a bird flu vaccine — not for people, but for chickens. That is the surest way I know to make the H5N1 virus mutate into a vaccine-resistant form. China is making the same mistake. The Chinese government also said that they will boost health care spending in rural areas by $1.25 billion, in part due to H5N1. That comes to 10 yuan per person, which is not enough to buy a box of aspirin, even at Chinese prices. Hospitals in China require families to deposit the estimated cost of treatment in cash before they will admit a patient.

Meanwhile, the death toll continues with an 18-year-old woman in Egypt, and a 3-year-old girl in Indonesia. The deputy director of the United Nations Food and Agriculture Organization is realistic. At the Geneva bird flu conference, he said: “Highly pathogenic avian influenza poses a continuing threat and we must brace ourselves to go on fighting it, quite likely for years.”

We’ll be out of these stocks at significantly higher prices before then, but this should make it clear that avian flu truly is a MegaShift, not a fad. In order to make more Tamiflu, invented by Gilead Sciences (GILD), Roche will be shipping oseltamivir, the active ingredient, to a Cardinal Health plant in Germany to make gelatin capsules of the drug. More production equals more royalties for Gilead. GILD will report earnings after the close on July 20, and I am expecting strong sales of Truvada (which combines Viread and Emtriva in a single pill for HIV) and the weaker U.S. dollar to drive revenues and earnings above the consensus for $662 million in sales and 53 cents a share in earnings. September-quarter guidance should also be above consensus as Tamiflu royalties flow through with a one-quarter lag, and the company may raise its guidance for all of 2006.

Yesterday, Gilead and Bristol-Myers got U.S. approval for Atripla, the HIV three-in-one, once-a-day combination drug of Truvada and Sustiva, and that is the end of near-term pipeline news. Now, it is just a question of rolling out the new combination drug, which will be available within seven business days for $1,151 a month wholesale, and collecting accelerating Tamiflu royalties. Gilead and Bristol-Myers are negotiating with Merck to sell Atripla outside the U.S., and once they have a deal, they will file for European approval. The FDA said that they will consider Atripla for use in 15 developing countries, many in Africa, under President Bush’s five-year, $15 billion program to treat two million people in those countries infected with HIV.

Continue to buy the January 2008 $50 GILD call LEAP (YGDAJ) under $16 for my $30 target. The January 2007 $60 call LEAP (GDQAL) is a higher risk and higher return buy under $9 for a $20 target.

BioCryst (BCRX) presented Wednesday at the Untergerg, Towbin Emerging Growth Conference, and the webcast is archived on the company’s web site at www.biocryst.com. BCRX is finishing Phase I trials for peramivir now, with the goal of being in Phase II trials in the U.S., Europe and Asia during the coming flu season, with both intravenous and intramuscular formulations. Peramivir has been studied in over 1,500 people to date, and it has been the subject of more than 20 peer-reviewed papers. It outperforms Tamiflu in mice, and we will see how it does in human trials.

In addition to peramivir, in the next 12 months BCRX expects to initiate pivotal trials of Fodosine in T-cell leukemia and cutaneous T cell lymphoma (CTCL), initiate Phase II trials of BCX-4208 in psoriasis with Roche, and initiate Phase I/II trials of BCX-4678 in hepatitis C. As you can see, this is not a one-trick pony. BCRX is a Top Buy up to $19 for my $30 target.

Crucell (CRXL) announced Invitrogen as a technology partner in providing cell-based vaccine production systems. This is the first of many partners Crucell will assemble to deliver the equipment and services that will completely change the way vaccines are made and used. CRXL remains a Top Buy up to $28 for my $50 target.

Biotech MegaShift

Biogen Idec (BIIB) will report earnings on July 26 before the market opens. They hired away the president of Schering-Plough’s research institute to be president of R&D at Biogen. Coming after the March hire of a top cancer drug developer from Amgen, BIIB obviously plans to keep up the new product pace.

Genentech’s June-quarter report included a very strong $526 million of Rituxan, a good $15 million to $20 million above the consensus. Rituxan is a Biogen/Genentech drug, so this bodes well for Biogen’s June-quarter sales. The extra sales of Rituxan should cover some of the pre-launch expenses for Tysabri. The January 2007 call (IDKAI) is a Top Buy up to $10 for my $21 target. And, the January 2008 contract (YZUAI) is a good buy up to $12 for a $23 target.

Metabolic Pharmaceuticals (MBP in Australia, MBPLF on the pink sheets) announced in a peer-reviewed paper published in Experimental Cell Research that their collaboration with Neuron Pharmaceuticals discovered a new class of therapeutic brain peptides, Neural Regeneration Peptides. These peptides regenerate nerves in cases of peripheral neuropathy (a failure of the nerves that carry information to and from the brain, which results in pain or numbness.), often caused by diabetes or chemotherapy. There are no existing drugs that treat this condition — only the symptoms are treated.

Metabolic will start two Phase 2A trials of its pain drug this quarter. The obesity drug remains in Phase 2B dosing trials. Buy MBP below 75 Australian cents, or MBPLF below $0.56, looking for a $4 target over the next few years.

ViroPharma (VPHM) hosted a conference call this morning to discuss their recent scientific supplement filing to their petition for a stay of action regarding the new FDA rules for generic Vancocin. They put up several arguments in three areas, but the real purpose here is to raise the possibility of illness or death from a generic that is not thoroughly tested. That puts the FDA in a very exposed position if a badly-performing generic got to the market. When bureaucrats are in an exposed position, they usually give up. That’s what I expect this time, and that announcement alone would double the stock. Buy VPHM up to $13 for my $28 target.

China MegaShift

China’s stocks are getting hit hard because many companies are doing initial public offerings, which drains capital from the market. A lot of these are state-owned banks, which are about the worst-managed black holes for capital on the planet right now. But the suckers love ‘em, and as long as they pop for the first few days, that’s where the action is. Meanwhile, already-public stocks are slip-sliding away.

The economy continues to roar along, with a new record monthly-trade surplus of $14.5 billion in June. That guarantees continued fiscal and monetary pressure from the central government, as well as continued international pressure to let their currency float up. At some point, we will want to get heavily reinvested in China to benefit from the rising yuan, but not yet. We should wait for further government actions to slow the economy, and expect a stock market decline in the U.S. to have a magnified effect in Asian markets.

Huaneng Power (HNP) has a tough time going up when the price of oil is soaring, as the government regulates electricity prices and has been slow to raise rates. A slowdown will benefit HNP and let them get caught up on rates versus costs. Continue to buy HNP under $30 for my $45 target, and don’t forget their showcase “green nuclear” generating plant is under construction.

UTStarcom (UTSI) may benefit from what looks like a much slower than expected rollout of third-generation (3G) cellular service based on the CDMA standard. UTStarcom’s PAS system equipment lets carriers provide wireless service for less than 20% of the cost of 3G cellular. Meanwhile, they are installing Internet Protocol TV networks (IPTV) in several Chinese cities.

I had a question from Paul: “What do you think about IPTV as a technology? Specifically, what do you think about eWAN 1 (EWAN.PK)? The company plans to offer global access to ‘unbundled channels’ via the Internet and their proprietary technology. Does this sound like a winning idea?”

eWAN 1 owns a cable system, and they plan to rebroadcast that over the Internet to a set-top box that they have developed for TV sets and a mini set-top box for computers. It’s an interesting idea, but this is a five-cent stock, up from half a cent this time last year but down from 14 cents in March, with a total market capitalization of only $370,000. eWAN 1 says that they offer customized next-generation solutions to major corporations across the U.S. in the areas of high-speed Internet access and data warehousing, as well as video services. That’s a lot for a very little company, especially one with no current financials. I would rather own UTSI. Buy UTSI under $9 for my $15 target.

Content on Demand MegaShift

Harmonic (HLIT) said that they will report earnings on July 26 after the market close, and they made no negative preannouncement. Today they announced that a new direct-to-home satellite TV service launched in Australia, using Harmonic’s MPEG-2 compression and multiplexing solutions. It’s always hard to call Harmonic’s earnings, because they and we never know what will be accepted in time to be booked as revenues, and their customers are very large with lumpy shipment schedules. However, I suspect that they will beat the consensus expectations for $60.5 million in sales and a 2 cent per share loss. Buy HLIT up to $6 for my $12 target.

I had a subscriber question on Portal Software (formerly PRSF, but now acquired by Oracle). Steven asked: “I missed the sell on Portal Software. Oracle said it had received enough shares of Portal to proceed with its acquisition of the company. For those who still own PRSF, what should we do?”

Just tender your shares. This was a cash acquisition, and Oracle put money in the bank to cover untendered shares.

I also had a question on Silicon Image (SIMG) from Rich: “Michael — just read a report on baystreet.com regarding SIMG. They just downgraded the stock to a #4, or DANGEROUS/HOLD, claiming their profit outlook is weak. That flies in the face of yesterday’s positive earnings news and forecasts emanating from their annual analyst day. What gives?”

This downgrade was made by www.newconstructs.com, which runs a computer model to make their ratings. Their model is based on historically reported information, not on forecasts. They picked up the negative cash flow from investments in the March quarter and said: “Economic profits are not positive.” They divided the last four quarters of earnings, including the March-quarter non-recurring loss of 10 cents per share, into the current price and concluded: “The valuation is expensive.”

However, I think the company will report 16 cents a share this quarter, and then 20 cents for the holiday-influenced September and December quarters. That’s 69 cents for the year, and 13.5X this year’s earnings seems dirt cheap for a company growing 20% to 22% a year. Buy SIMG now that it’s finally come down under my $10 limit, and look for an $18 target after the holiday season. Newconstructs can then upgrade the stock due to their positive cash flow and strong earnings.

Telkonet (TKO) got a reiterated buy recommendation from JMD Securities this week, calling the recent weakness a buying opportunity for a $6.25 target. They pointed out increasing business at the Microwave Satellite Technologies subsidiary, as well as sales of Broadband-over-Powerline systems to the U.S. government. The letter from the government covering the EDS systems still has not been received, nor has there been a strategic financing announcement or a new CFO appointment. These are the reasons the stock has drifted lower, and the first two should be resolved within 30 days and the CFO within 90 days or so. TKO is a Top Buy up to $5 for a $15 target after these issues are resolved.

New Energy Technology MegaShift

With the price of oil soaring to new records due to kidnappings in Nigeria, bombings in Mumbai, a shooting war between Israel and Lebanon, and uranium enrichment in Iran, the energy sector is one hurricane away from completely disconnecting from the rest of the market. After last year’s hurricane season, we can be sure that hurricane is coming, which is why I want you to build a significant stake in these stocks now. Even in a bad down market for everything else (perhaps caused in part by soaring oil prices that tie the Fed’s hands), I expect all of these stocks to be substantially higher by mid-October.

Connacher Oil & Gas (T.CLL) was hit a bit but bounced right back after Shell Canada said that expanding the Athabasca Oil Sands Project would cost billions of dollars more than earlier estimates due to increased costs of labor, materials and equipment. Some companies building projects at the end of the decade are even worrying about greater competition to hire a work force from another major construction project, the 2010 Winter Olympics in Vancouver.

But Connacher is OK because the further along a company is with their project, the better off they are — and Connacher will be producing substantial oil by the middle of next year. Today, they received final approval for their Great Divide Oil Sands project, and they expect to construct their plant and drill the first 15 pairs of wells in the September and December quarters, which will produce oil for six to eight years. (The whole project should last for at least 25 years.) They’ll start their 10,000 barrels a day plant during the second quarter of 2007, about four months behind schedule due to the length of the regulatory review.

Connacher also added 15% to their budget to cover increased expenses — a far cry from Shell’s “billions of dollars.” They will invest in a pipeline to their Great Falls, Montana refinery, which along with a few other new items increased the budget another 14%. The company will raise $165 million in project financing and to repay the bridge loan they used to buy the refinery from Holly Corp.

In a direct comment on what Shell said, management of Connacher pointed out that:

“The company wishes to distinguish its Great Divide project from the large mining
projects which have been the topic of extensive press commentary in recent days and weeks. SAGD projects, such as Connacher’s 100%-owned Great Divide, will have much shorter lead times with much lower overall capital requirements, smaller vessels and greater efficiency in comparison to the announced large-scale mining ventures.

“Many of the popular press articles and some comments on rising costs in the oil sands by some more engaged analysts or investment industry spokesmen have failed to make this distinction.

“They have also failed to identify and distinguish the different comparative operating cost regimes for SAGD operations and mining. SAGD plants will increasingly be accompanied by an emphasis such as that adopted by Connacher, emphasizing a modular approach to plant construction. SAGD plants also have a smaller environmental footprint and should be able to avoid many of the diseconomies that may characterize more remote and larger scale mining operations.”

Connacher also said that they are doing more evaluation work to find more drilling spots in the Great Divide project, and they will be announcing results of those studies between now and yearend. I expect them to find many more opportunities to either increase daily production or extend the life of the project, with each positive announcement pushing the stock higher. T.CLL is a Top Buy up to $4.50 for my $7 target, as they start to produce oil from Canadian tar sands using their steam-assisted gravity technology.

I received an email from John: “I haven’t seen anything on refineries. Are there any stocks you like with an edge in this area? I have read that capacities in this country are very limited, and with demand rising throughout the world I have to wonder as to the position there in as well.”

John, that was behind my recent recommendation of Holly Corp. (HOC), which specialized in refining sour or heavy crude. Many people don’t know that when Saudi Arabia says they can expand production to help keep oil prices down, it isn’t quite true. The oil they would go after is very sour, and not many refineries can handle it. HOC gave us a few days to get in, and then took off. I’ll raise the buy limit on HOC when it retreats a bit, so you get a second chance to get on board. For now, continue to hold HOC for my $52 target.

Plug Power was victimized by HBK Investments, a hedge fund that sold the stock short to drive down the price before investing in a private placement. I often talk sarcastically about the mysterious drops in stock prices that happen before these deals. I’m not surprised it happened; I’m just surprised they were caught. The SEC seems to be catching on, as they have fined Langley Partners and Knight Capital’s Deephaven Capital Management $22 million for the same game. I’m just sorry they don’t bar these folks from the securities business for life.

Three other hedge funds are being investigated: Alexandra Investment Management, Gryphone Partners and Cornell Capital Partners. Remember that last name when we get to the MobilePro update, below. I think PLUG has a good suit against HBK.

In happier news, the company installed two GenCore backup fuel cell systems at the headquarters of the New York State Energy Research and Development Authority. Buy PLUG up to $7.50 for my $15 target after the hurricane season and more new order announcements.

I received an email from Jake regarding Rentech (RTK): “How does their technology compare to Headwaters (HW) for producing synthetic fuels? Thanks for your great work.”

Thanks for the comment, Jake. Headwaters is very dependent on revenues from entities that convert coal dust into a synthetic fuel briquette to be burned by utilities, using Headwaters technology and chemicals. This is a business that depends on tax credits tied to average oil prices, and they expire at the end of 2007. Many producers can’t claim the credit when oil is over $58 a barrel, so they shut their plants and stop buying chemicals from Headwaters. That’s why HW hit a new 52-week low today.

On the other hand, Rentech converts coal into oil products like diesel and jet fuel, and can do so at the equivalent of $35 a barrel oil. It is a very different business. Buy RTK up to $5 for my $11 target. 

Video iPod MegaShift

This MegaShift is getting very interesting. Apple’s stock is getting clobbered because analysts are cutting estimates due to soft iPod sales. Apple hasn’t introduced a new iPod in more than nine months, and you know why. The Burst.com patents I told you about, followed by the lawsuits between the two companies, mean Apple can’t introduce the next video iPod until the issue is settled. I have no idea why Steve Jobs is being so stubborn over this, as he could just buy Burst.com and get his money back licensing their technology to others.

(By the way, I know you are being urged by others to buy Apple right now. Don’t do it yet. I know this will sound far-fetched, but Sarbanes-Oxley is a rough piece of legislation on any director that still thinks the good ol’ boy network runs Corporate America. Steve Jobs is caught in the options backdating scandal, and there’s a real chance the Board will have to remove him as Chief Executive Officer. That would devastate the stock, and it’s just not worth the risk when we are facing 90 more days of a bear market.)

One of the “others” Burst.com already licensed is Microsoft, for a cool $60 million. And now we know why. The jungle drums are very strong that Microsoft will introduce a music player and a music service before the holiday season to compete with Apple’s iPod and iTunes. The digital player will have a Wi-Fi Internet connection, so owners can download songs without being connected to their computer.

Apple has 77% of the $4 billion U.S. market for digital music players, with SanDisk second at less than 10%. iTunes has 72% of the music download market, and Microsoft’s Music Store has 3%. After six years of trying, Microsoft has decided it can’t rely on SanDisk, Creative Technology or any of the other companies that use its software to make any meaningful challenge to Apple’s dominance. They had high hopes for Samsung, but that company now is supplying the semiconductors for some of Apple’s upcoming iPods. So, it hired some heavyweight music executives and committed to doing the job itself.  There is a very good chance Microsoft will use PortalPlayer (PLAY) as the supplier for the audio and integrated video chipset. The Microsoft player is said to have a much better video screen than the video iPod, so PortalPlayer’s higher quality technology would really shine.

Of course, Apple needs to introduce new models by October in order to have a decent holiday sales season, and I still think one will be a much more advanced video iPod also based on PortalPlayer’s integrated chipset. Right now, I’m looking for an opportunity to double down on PortalPlayer, so be ready for a Flash Alert when it is time to move..

One of the really tantalizing questions is whether Microvision (MVIS) will get a screen contract on a high-end Microsoft product, or on a competing Apple product. Bill Gates has publicly said that he loves the Microvision technology. Recently, Microvision has not only slipped below $2 to a new 52-week low, but it also now has a warrant that started trading on May 31 (MVISW).This warrant could become very attractive in a market meltdown. If and when the time comes, I will send you a Flash Alert to jump back into MVIS and pick up MVISW.

You may be wondering why I’m not suggesting that we buy Microsoft. I’m not making this a recommendation for the same reason I didn’t recommend Apple — we’ll make more money on the parts suppliers than the audio player manufacturer. Plus, Microsoft has one more shoe to drop when they delay Windows Vista and Office 2007 again.

WiMAX MegaShift

Craig McCaw, the cellular telephone pioneer and billionaire, just closed the biggest venture capital round ever — $900 million, led by Intel Capital, which put in $600 million. It was the largest investment ever by Intel Capital. Motorola invested, too.

Is WiMAX real, or what? McCaw had planned a $400 million IPO for Clearwire Corp., his WiMAX network startup. He took the venture route instead.

Sean Maloney, the Intel executive VP and general manager who often talks to us at the Intel Developers Conferences, said: “Wi-Fi has become an essential part of people’s lives. WiMax is next. It is rapidly moving from a technology initiative to real deployments. This investment in Clearwire will lay the foundation for high-speed mobile broadband services across North America.”

Intel also announced a dual-mode WiMAX chip that supports both the fixed and mobile WiMAX technology standards, and unveiled the newest version of their Rosedale WiMAX chip for residential modems. All three WiMAX equipment stocks — Alvarion (ALVR), Airspan (AIRN) and Terabeam (TRBM) are now Top Buys.

MobilePro (MOBL) restructured their convertible debt with Cornell Capital Partners (see the Plug Power write-up above for more about an SEC investigation of Cornell) in what I think is a dangerous way, so I am moving the stock to a Hold.

This is a $15 million convertible with a 7.75% coupon, issued in May 2005. MobilePro now has the right to make payments in either cash or stock, which management positioned as a positive. However, beginning September 1, they agreed to make weekly principal payments of $250,000, plus interest. I estimate that at the end of June they had about $2 million in cash, so I would expect them to make many or most of these payments in stock.

The stock that is used for payment will be valued at 27.5 cents a share or the average of the two lowest volume-weighted average daily prices during the five days before the payment, whichever is less. That gives Cornell Capital an incentive to short the stock, drive it even lower, take more and more shares every week, which drives it lower yet, and eventually take the company away from the current shareholders. That’s very similar to what the SEC is investigating Cornell for already. I thought managements had gotten hip to these toxic convertibles, but apparently not. Cornell Capital now beneficially owns about 5% of MOBL stock and does not have a board seat, so it will be difficult to tag them with negotiating an insider, sweetheart deal that hurt the other shareholders. But maybe the SEC investigation will cause them to behave.

Why not sell right away? Because in the exact same situation with Corvis a couple of years ago, I did recommend selling right away. Management of Corvis found cash elsewhere, made the convertible payments in cash, and the stock doubled. The other terms on this restructuring are more onerous than in the Corvis case, but they primarily relate to redemption.

MobilePro might be able to make these payments out of cash flow. For example, this week they signed a deal with FSH Communications for local exchange services that should generate about $12 million in revenues a year. MOBL also has numerous operations and assets that could be sold to raise cash to make these payments, so I don’t want to cut and run at this point. But until we see the other shoe drop — management’s plan to avoid making these payments in stock — we can’t continue to buy it. Hold MOBL. I am also suspending the target price until we get more information on management’s plans.

Market Outlook: Testing the Limits

The Fed is like a two-year-old child that keeps pushing and prying until something breaks — the bond market, the stock market, the real estate market, the commodities market or the economy. All they had to do was hint at an interest-rate pause at the July meeting, and commodities rallied in a shot. That is not what they wanted to see. Fed Vice-Chairman Donald Kohn gave a speech to the British House of Commons in which he said: “I think we are very well aware in the Fed that there is some risk that we would tighten policy more than necessary and that it might induce weakness in the economy… [but] there is a greater risk from not tightening.”

The big difference between the Greenspan and Bernanke Fed is going to be published inflation targets. This is Bernanke’s pet project, and I identified it as the most important issue as he was being confirmed. It is the same policy the European Union follows, and I call that evidence that it is a failed policy.

The Fed should be looking at leading indicators to have a hope of coming up with the right policy, because their interest rate changes don’t impact the economy for six to 18 months — inflation is a lagging indicator. By publishing an inflation target, they are locking themselves in to letting a lagging indicator determine monetary policy, which itself will have a lagged effect on the economy. In periods of slowing economic growth, like now, inflation stays high for a while and will prevent the Fed from acting quickly enough to reverse course. But if you think this is bad, wait until you see what happens coming out of a recession, when the Fed keeps pouring on the coal as the economy accelerates, because the printed inflation numbers are still benign from the recession. We’re entering a much more volatile world than today’s VIX Index (the volatility index) would lead you to believe.

Bernanke’s strength was just solidified by President Bush’s most recent nominee to the Fed, Fred Mishkin. He is the co-author of Bernanke’s economics textbook, which goes on at length about the importance of central bank policy targeting inflation, with published upper and lower bands of what inflation should be.

They may also change the preferred measure of inflation, from Greenspan’s Personal Consumption Expenditures to the Bureau of Labor Statistics’ “harmonized” inflation, which is calculated the way the European Central Bank does it. Most people don’t know that the rest of the world calculates inflation differently, which is one of the biggest reasons European real GDP growth has seemed so much lower than the U.S. growth for the past few years.

They also don’t know that the Personal Consumptions Expenditure deflator excluding food and energy — so-called “core inflation” in the U.S. — gives the lowest possible picture of inflation. Both the PCE and the Consumer Price Index have been very tame, while “harmonized” inflation has been booming along in a way most people who actually buy things can relate to. It has become a joke that our government reports very low inflation, while the prices of goods and services are jumping. But the Fed is not laughing — they know the “harmonized” numbers show a major problem, and that may be a main reason they sound so hawkish on inflation.

Given this data, there are two likely scenarios: Either the economy is going to slow sharply enough to bring inflation down, or the Fed is going to keep raising rates until something breaks and forces the economy to slow. Neither scenario is good for the bullish case. I continue to think that the S&P 500 has a date with destiny at 1185 in the near future, and 1040 or worse in October. From current levels, that’s a 5% drop followed by another 12% decline. The best way to preserve and grow your money in this environment is to continue to hold a comfortable amount of cash, and if you are underinvested, focus on the energy technology stocks first.

 Print This Post