Last week, I said that Thursday’s retest of the 1250 breakout level from above was just business as usual, assuming the market didn’t break back down. It did break down on Monday, and on Tuesday morning’s S&P 500 rally back to 1250, I was shaken out of my long index calls position. I actually felt good about it for about three hours, and then–woosh! These attractor/repeller levels can pull stocks up and then repel them back down with equal force…or they can pull stocks up, hold them for a bit to consolidate, and then act as a springboard to blast them higher. That’s what happened in the last hour on Tuesday, and was confirmed by yesterday’s action. Today included a dramatic last-hour decline to shake out the bulls, but as long as we stay above 1258 to 1261, I think we are headed straight for the 1326 and 1440 levels. From there, we will see if new highs are in the cards.

The S&P 500 should earn about $90 this year and $95 next year, so it is selling for 14X earnings. That is less than the long-term average, and in a low interest rate environment an 18X multiple would be fully valued. So assuming the market doesn’t overshoot, as it usually does, the fundamentals support a move to 1710. So does my fractal analysis. I am using that as a target for next April, until something happens to change the earnings or interest rate outlook, or the market itself shows it does not have the energy to go that high. But with $4 trillion on the sidelines in cash and money market funds, record short selling and poor investor sentiment, it looks to me like the energy is there right now. We’ll see if this is the real breakout, after so many false starts this summer, and also if it goes into a parabolic rise.

The phantom “recession” continues to confound the market, with this morning’s announcement that real GDP was up again in the June quarter, at a 1.9% annual rate. And this was “disappointing” to economists looking for a 2.3% growth rate. How can growth in GDP “disappoint” in a recession? The weakness in the economy is obvious in the slow growth numbers, but it is not accelerating to the downside as it usually does in a real recession. I told you the reason for this months ago: Big recessions develop out of inventory overhangs, and this slowdown was the most-advertised in history, so all the manufacturers cut back in advance. The “disappointment” in today’s numbers was that inventories did not increase faster–yet that is precisely what we would like to have happen to avoid further weakness ahead. Even in this environment, except for the financial companies, returns on equity and profit margins are still well above average. Again, with the exception of financials, balance sheets are holding strong. Non-financial sector earnings have been above the consensus, thanks in great part to the energy companies, and are up about 10% year-over-year. Most likely, whichever candidate is elected President will have a Democratic Congress and a second fiscal stimulus package bigger than this summer’s giveaway. I know there is an argument for a couple of down quarters, but it’s getting more tenuous by the day. If oil prices do what I expect and head back to an $80 to $100 range based on peace in Syria and Iran, I think the recession crowd will have to ‘fess up that they blew it.

Turmoil in the Financial Sector

Of course, the banks and related financials are still in deep do-do. Housing prices have a ways left to fall. The National Australia Bank wrote off 90% of its U.S. conduit loans, a shocking number that, if applied to the U.S. banks, would result in many, many failures. The NAB said they have experienced 55% losses on their AAA-rated American housing loans so far–a loss far larger than that in any developed country since the Depression (and probably longer). I’m not sure the FDIC has enough money to fund all the losses in accounts under $100,000. About 39% of all bank deposits are over $100,000, and those would be toast in most of the smaller banks. Of course, the taxpayer will bail out the FDIC if it comes to that. But $1.3 trillion in write-downs is a big pill to swallow, and it is going to be messy.

It may seem strange to contemplate a parabolic stock market upturn in the face of such turmoil in the financial sector, but the Fed’s solution to almost any problem is to create more money, which sloshes into financial assets first and then flows into the real economy. These days, “financial assets” does not include anything real-estate related, except for the Fed’s direct bailout of banks and brokers who want to trade their worthless paper for cash. Meaning, most of the money will flow into the bond and stock markets, keeping interest rates low and putting intense pressure on the bears or those with high cash positions. That is the stuff parabolic upturns are made of.

Just in passing, I noticed that when Iranian President Mahmoud Ahmadinejad said that Iran now has 6,000 centrifuges–double prior estimates–he added that Iran would be open to a “new approach” from the U.S. in seeking a peaceful resolution to the nuclear issue. I still think an agreement is coming in the next 90 days, funded by Saudi Arabia. It also looks like the Israel/Syria peace agreement is on track to be announced before the Israeli Prime Minister leaves office in September.

New Recommendations

In the market directly ahead, we can afford to own more aggressive stocks. I’m ready to pull the trigger on CREE (CREE) after their August 12 earnings call, as I expect them to guide below the high end of Wall Street estimates for the September quarter, which would knock the stock down into my buy range. Two other stocks that have come down sharply, yet are very well positioned, are NetLogic Microsystems (NETL) and Canadian Solar (CISQ), and I want to recommend both today.

Content on Demand MegaShift Addition:

NetLogic Microsystems (NETL) is a 13-year old semiconductor company headquartered in Mountain View, CA. They make knowledge-based processors and network search engine products for the kinds of systems Packeteer makes to optimize routing the traffic flow. Services like Voice over Internet Protocol (VoIP) and Internet Protocol TV (IPTV) need these chips in order to give priority to the packets of data that must arrive smoothly to create acceptable quality in conversations (VoIP) or video (IPTV). Their processors are used throughout the Internet infrastructure, and can be found in routers, switches, wireless equipment, network security appliances, datacenter servers and network storage devices.

The bad news about their market is that it can take quite a while to win a design and then see the equipment go into production. The good news is that once they are designed in, it is not easy for a competitor to unseat them. With the explosion of voice, video and data services (VVD), the demand for their processors is growing very rapidly. Revenues in the March quarter hit $34.2 million, up 46% from the prior year. In the June quarter reported last Thursday, they did $36.5 million, up 41%, and booked 40 cents a share pro forma, ahead of the 37 cent consensus. They did $109 million in sales in 2007, and should hit $150 million this year and $200 million in 2009. I think they can grow 25% a year for the next five years, which is well above the consensus outlook for 15% growth.

My 2009 revenue estimate is above the consensus, as is my $1.90 earnings estimate. The consensus is at $1.77. The stock is trading at only 18.4X the 2009 consensus estimate, and I think it can trade for 25X my estimate, or $47.50. I want you to buy NETL under $33 for my $47 target by next April. This may well turn into a stock that we hold for several years, unless it goes nuts to the upside.

New Energy Technology Megashift Addition:

Canadian Solar (CSIQ) makes photovoltaic (PV) solar modules for residential and commercial use. It’s not an oxymoron to see “Canadian” and “Solar” together, in spite of their long, dark, cold winter. Canadian Solar sells both standard products to distributors and system integrators all over the world, and custom products to manufacturers that incorporate them in products like bus stop lighting or car battery chargers. Although the company is located in Ontario, Canada, the founders are Chinese and the company does quite a bit of work in rural China. They also get about 15% of their revenues from Spain, which has been going through a drawn-out process of lowering their subsidies for solar installations. That has been pressuring CSIQ stock in the short term, but the long term outlook remains very bright.

Solar power will at least double every two years for the next decade. Utility grid-connected PV grew 83% worldwide in 2007 to 8.7 gigawatts, with Germany accounting for about half of that due to their extensive subsidy program. This demand has been met by new manufacturers entering the business and existing producers doubling their capacity or growing even more. The result? Solar cell production has doubled in the last two years.

But there are shortages in the industry due to a lack of crystalline silicon, the raw material for PV wafers. In 2007, the demand for silicon hit 75,000 tons, but production was only 40,000 tons. The price for solar silicon has soared, which keeps the price of PV panels high. The bottleneck hasn’t been the solar cell fabricators, but the raw material, the crystalline silicon.

Last year, the demand for silicon rose to 75,000 tons, but production was only 40,000 tons. Contract prices are up to about $45 a pound, with spot prices as high as $135 a pound. The silicon shortage has been so bad that a solar stock goes up more when a company announces a supply contract than it does when they announce a customer contract. Stocks of thin-film solar companies like First Solar and Energy Conversion Devices have done very well because that technology uses little or no silicon.

All that is about to change. The semiconductor industry requires ultra pure 99.999999% (eight 9s or 8N), or even purer 9N silicon, to make chips. Solar cells require only 99.9999% (6N) purity, so they have been able to use or reprocess scrap silicon from the semiconductor companies. There is also metallurgical grade silicon used as an alloy by the steel industry, which is only 98% or 99% pure. Metallurgical grade silicon can produce 8N silicon using a gas reactor called the Siemens process. But a Siemens process plant is very capital intensive and expensive to build, takes a long time to get operational and then is expensive to run. Plus, the 8N end product is unnecessarily pure to make solar cells.

I am interested in Canadian Solar because they reclaim their own polysilicon from scrap. The company operates one of the largest silicon reclaiming business centers in the world, buying and processing ingots, pot scraps, tops and tails, side wall pieces, broken wafers, reclaimed wafers and broken cells. They have an international team that does nothing but procure, reclaim and supply silicon material to their PV factories. Their costs are lower and their supply is more certain than most of their competitors.

In addition, there are several alternatives coming along that will be even more efficient, and CSIQ could adopt any of them in the future to supplement their reclamation program. Renewable Energy Corporation of Norway has a technology called fluidized bed reactors, which uses much less power than the Siemens process, although it also requires expensive catalysts. They have become the largest supplier of solar silicon in the world, and will double their capacity by the end of the year. Globe Specialty Metals, Dow Chemical and Advanced Metallurgical Group are working on upgrading metallurgical grade silicon using pyrometallurgical processes that are not as capital intensive as the Siemens process.

But the really interesting technology is coming from Reaction Sciences Silicon Products, a private company put together by the MIT grads who won the 2007 MIT Ignite Clean Energy business plan contest. They take waterglass, an inexpensive solution of silica dissolved in water, and use a series of reagents to extract pure silicon. Chemical silicon purification costs about one-third of the Siemens process, in part because it can be tuned to produce 6N instead of the more expensive 8N silicon. The factory costs only 10% of a Siemens process plant and can be built in 15 months instead of two or three years. The pilot plant in Pennsylvania will start running this quarter, and factories using Reaction Sciences technology are now being built in Alabama, Europe and China. This has the potential to drop the cost of silicon PV modules from today’s $2.70 to $3.50 per watt down to $0.75 to $0.90 per watt. Below $1.00 per watt, PV is cost-competitive with conventional utility plant costs, without any need for subsidies.

CSIQ stock is down from $51.80 in June to $ 28.83 today, mostly on worries about what Germany and Spain will do with their solar subsidies, but partly due to the rapid drop in oil prices over the past few weeks. The company grew revenues 344% in 2007 to $302.8 million, and will more than triple sales this year to $910 million. In 2009, I am projecting growth will “slow” to 100%, and the company will do $1.8 billion. This is one of the fastest-growing companies in the world, and in the solar industry.

Today, you can buy into this growth at less than 13X this year’s earnings of $2.25, and only 7.2X my 2009 estimate of $4.00! For those of you who only look at trailing 12 month earnings, the stock is selling at 37X the reported 78 cents. But they will report June quarter earnings on August 13, and I am looking for 48 cents versus a loss of 11 cents last year. That will add 59 cents to trailing 12 month earnings, bringing them up to $1.37 and taking the P/E ratio down to 21X.

Canadian Solar is one of those companies that is growing so fast that no one believes it can continue. Yet they are a low-cost supplier in an industry that is doubling every two years, and should be able to keep up their blistering growth rate for years to come. I want you to buy CSIQ up to $31 for a $65 target by next April.

Earnings Results Are In

In addition to these two new recommendations, we had many companies reporting results this week, and a few conference calls to catch up on. Let’s get started.

Biotech MegaShift

Affymetrix (AFFX) reported last week, and I covered the results but said I wanted to analyze the situation further and go through the conference call. I’ve since done that. AFFX said they missed the quarter due to weak spending by pharmaceutical companies, yet their arch-rival Illumina had a great quarter. As a result of their poor execution, AFFX has two-thirds the revenues of Illumina but only one-tenth the market capitalization.

Sure, AFFX will go up in a strong market, but other stocks will fly. Maybe Agilent will buy them out, but aside from that, I just don’t see a catalyst. So I want you to swap AFFX for a stronger stock. If you want to stay in the Biotech MegaShift, eResearch (ERES) or Rochester Medical (ROCM) would be good candidates. You can also look at the updated Top Buys list for a swap idea.

Amgen (AMGN) had a good quarter and Wall Street moved the stock up to a 52-week high. Although sales barely grew to $3.76 billion, that was better than Wall Street’s expectation of a small decline to $3.58 billion. Aranesp sales hit $825 million, down 13% from last year but less of a decline than Wall Street feared. Epogen sales were unchanged at about $622 million. Combined sales of Neulasta and Neupogen rose 15% to $1.2 billion, and sales of Enbrel, the rheumatoid arthritis drug, rose 2% to $841 million.

Amgen’s cost control measures boosted pro forma earnings to $1.14 a share, well ahead of the $1.02 estimate. The company raised the 2008 revenue guidance range from $14.2 billion to $14.6 billion up to $14.6 billion to $14.9 billion. They raised the 2008 earnings guidance range from $4.00 to $4.30 per share up to $4.25 to $4.45 per share.

The company had some additional positive data on denosumab, their potentially blockbuster osteoporosis drug that could be on the market in 2010. This morning, the FDA issued their new “black box” warning for Aranesp and Epogen, saying the drugs are not indicated for patients undergoing chemotherapy who have the potential for successful treatment, because of the risks involved. This was expected by me, Wall Street and the company, and was factored in to their upward guidance.

AMGN stock finally is going in the right direction, and with the buyout of Genentech, I think dedicated biotech sector money will flow into AMGN. Hold the Amgen January 2009 $70 LEAP call (YAAAN), which is beginning to rebuild value. The Amgen January 2010 $40 LEAP (WAM AH) that we bought under $10 with a $20 target is now over $25. I am raising the target to $35.

Sequenom (SQNM) reported second quarter results yesterday after the close. Sales grew 25% from last year’s June quarter to $12.8 million, but they lost 21 cents a share, worse than the 15 cent consensus expectation. They are getting a good response to their contract research offering, but that has a lower profit margin than selling MassArray supplies. For the full year, they left revenue guidance at $50 million to $53 million (up 30% from 2007), but raised their net loss guidance from $30 million to $33 million up to $34 million to $36 million. The stock was flattish today, as the Street is focused on the robust test results so far for their Down syndrome diagnostic test.

We’ve held SQNM far past my original $12 target, and we are up 372% in just over a year, as of today’s close. I originally recommended it as a second gene-chip stock to go along with Affymetrix, and given the loss we are taking in AFFX today, I want you to take your profits in SQNM. We may be back to the stock next year, as the Down syndrome research progresses.

ViroPharma (VPHM) reported record Vancocin sales of $65.4 million versus $56.1 million in last year’s June quarter, clobbering the consensus expectation for $59.2 million. Earnings per share fell to 30 cents from 39 cents last year due to a doubling in R&D, but that also was well ahead of expectations for 26 cents. Management raised their 2008 revenue guidance to $220 million to $240 million, up from $210 million to $235 million. The lower end of the new guidance is above the consensus for $218 million.

R&D doubled as they completed enrollment in the Phase III trial of maribavir (now named Camvia) in stem cell transplant patients and continued enrollment in the Phase III trial in solid organ (liver) transplant patients. They said they will present the first stem cell transplant trial data in the March quarter, and will file for approval in the U.S., Europe and Canada in the September 2009 quarter. We can expect the drug to be on the market around mid-2010.

On the conference call, they said the acquisition of Lev Pharmaceuticals will close by the end of 2008, and they were very upbeat about the prospects for approval (the Advisory Committee voted 21 to 0 for approval). This is an important drug that can be sold by their current Vancocin sales force to the same customers. VPHM has been a Top Buy up to $12, and it just went over that price today. I’m leaving it on the Top Buy list for now, and increasing the buy limit to $13 to give you a last chance to get on board for my $25 target price.

Content on Demand

Personal computer shipments grew faster than expected in the June quarter, driven by strong demand in emerging markets and price declines in the U.S. The Gartner market research firm said worldwide shipments grew 16% to 71.9 million PCs, far above their 11.2% forecast. IDC, another major technology market research group, reported a 15.3% increase to 70.6 million computers. The CRIB countries–China, Russia, India and Brazil–had very strong shipments. Even in the U.S., where growth was supposed to be almost invisible at +2% due to the financial sector implosion, PC manufacturers cut prices and sold 4.2% more PCs. After Intel (INTC) reported June quarter profits up 25% due to strong global demand for microprocessors, it was pretty clear the researchers’ forecasts were too low.

Gartner analyst Mika Kitagawa attributed some of the surge to ongoing trends: rising shipments to emerging markets like China, Brazil, India and Russia; and the increasing number of computers per home thanks to the popularity of laptops. The power of the laptop segment was evident a day earlier, when chip maker Intel Corp. said second-quarter profit jumped 25 percent on ballooning global demand for the processors that serve as the brains of notebook computers.

But the researchers still don’t get it. In June, both Gartner and IDC increased their outlook for PC growth this year due to strong demand for laptops worldwide. But Gartner’s analysts have not increased their outlook further because they are worried about the impact of rising oil prices on manufacturing and shipping. I guess they haven’t noticed that oil prices are now falling. As for IDC, their analyst was even less optimistic and said, “We’re waiting for PC shipments to slow down.” Perhaps a man named Godot will buy the last PC this year.

Akamai (AKAM) reported in-line earnings of 41 cents a share after the close yesterday, but fell slightly short on revenues, reporting $194 million compared to the $197 million consensus, and said the economy is starting to bite them. They guided for 39 cents to 40 cents a share in the September quarter, below the 42 cent consensus, and cut their full-year guidance slightly from a range of $1.68 to $1.71 down to $1.63 to $1.69. That’s a drop of 2% in the earnings outlook, but today the stock dropped a whopping 25% or $7.95, taking $1.34 billion off the market capitalization.

Hmmm, a 25% stock drop based on a 2% annual earnings guidance reduction? When they just reported year-over-year revenue growth of 27%? And guided for “depressed” annual earnings growth of 28.4%?

They added 53 new customers in the quarter, bringing them to a record 2,725 under long-term services contract at the end of June. That’s recurring revenue, folks–they don’t have to go out and sell those people again in the current quarter. Akamai is benefiting now from the explosion of video on the Internet. Next will be the explosion of online multiplayer games. Akamai already has contracts for Nintendo and Microsoft’s online communities.

After today’s beating, AKAM sells for less than 14X this year’s “depressed” earnings, and the company will grow 25% to 30% a year for several more years. This is ridiculous. I am making AKAM a Top Buy up to a reduced buy limit of $30, but not changing my $60 target.

Harmonic (HLIT) posted a strong quarter, and I put an analysis on my blog. Check it out now if you haven’t yet seen it.

Now for the good stuff that the public doesn’t get to see. Using the high end of my earnings and P/E range, HLIT would get to $22.50, well above my $18 target. That’s nearly a triple from today’s close. Street expectations for the next two quarters will be easy to beat. Business and guidance will stay strong as the video rollout continues. In fact, cable companies now plan to replace all their set-top boxes with units that can decode both MPEG-2 and MPEG-4 compressed video, and Harmonic is the leader in compressing video for both standards. HLIT is extremely cheap and remains a Top Buy up to $12 for my $18 target.

Motorola (MOT) sold more phones than expected in North America, kept its #3 worldwide ranking behind Nokia and Samsung, and posted a small profit for the June quarter. Sales fell 7% to $8.1 billion, but that was well above the consensus expectation for $7.7 billion. They earned two cents a share pro forma, again soundly beating expectations for a three cent loss. Management said the September quarter would be breakeven to plus two cents even on seasonally slightly lower revenues, and then the December period will be better on the top and bottom line. They forecast six to eight cents profit for the year; Wall Street was at three cents.

MOT shipped 28.1 million phones in the quarter, above the consensus for 26.6 million. On the conference call, management said they will launch 50 new phones this year, including “advanced handsets,” a code word for Apple iPhone competitors. Half of their phone portfolio in 2009 will be high-speed phones, up from 15% this year.

Wall Street like the news and bid the stock up 13%. The company still plans to spin off the mobile phone business in the September 2009 quarter, and they are going to get the division straightened out before they do it.

My original recommendation, the Motorola January 2009 $17.50 LEAP call (new symbol: MOT AW) is essentially worthless, and we will sell it in December for a tax loss. I still think you can buy the January 2010 $10 LEAP call (WMA AB) for a new or averaged-down position. They closed at $1.48 today and would be worth $7.50 at a stock price of $17.50. I think we’ll see that price long before expiration.

Zhone Technologies (ZHNE) reported the poor quarter that I discussed with you previously, and I said I wanted to go over the financials and through the conference call notes again before deciding what to do. I think their revenue miss was a one-time event, and they are taking steps to show positive EBITDA in the December quarter. However, the September quarter will be hit with restructuring expenses. NASDAQ has given them until December 8 to get their stock price back above $1. Normally, a company would just make the mistake of doing a reverse merger, only to watch the stock slide off again. In this case, I think there’s a good chance the Board will throw in the towel and sell the company in the next few months. If not, we will have time to sell the stock after the reverse split and still take the tax loss this year. ZHNE remains a hold, and I am using $1 for the target price in a sale.

WiMAX MegaShift

Alvarion (ALVR) reported June quarter record revenues of $69.7 million, up 21% from last year. Of that, WiMAX revenues hit $38 million, about 55% of total revenues and up 36% from last year. They did three cents a share pro forma, right on the consensus estimate, in spite of taking a pasting on currency conversion. The shekel was up 6% against the dollar in the June quarter and 12% year to date. Alvarion is moving some R&D to Romania to cut costs, as Israel gets to be too expensive.

The company said that there are some minor delays in committing to new networks from some of their customers, but their OEM partners like Nokia are bringing in lots of business, and their recent deal with Nortel will help open the telecom carrier market. Management said that on balance, current customers are expanding their networks, bookings are strong, and the pipeline of potential new business is large and growing. They indicated they now expect to hit the upper end of their revenue guidance range of $275 million to $300 million for 2008.

For the September quarter, revenue guidance is $73 million to $77 million, about equal to the consensus for $74.7 million. They expect pro forma earnings to be two to six cents a share, again about equal to the five cent consensus. All in all, it was a decent quarter. ALVR remains a Top Buy up to $11 for my $17 target.

Yesterday was a very good consolidation day, and the S&P closed up 80 points in one week without a meaningful pullback. Yet, I am not hearing much talk of this being the beginning of a lasting rally–good news for contrarians. I like moves that start in “stealth mode” and travel a good way before most investors even notice the direction has changed. That’s how most relentless “slingshot” moves start. Better yet, they tend to carry much further than the consensus expects. Today’s retest of the 1250 breakout level from above is just business as usual, and assuming we don’t break back down, will be soon forgotten. The reason given for the drop, a steeper-than-expected drop in existing home sales, did not even surprise my cat.

Before we get into “slingshot” territory, though, there are a couple of items that could lead to a correction. Let’s hit a couple of them now so that you’ll be prepared.

In last week’s Radar Report I explained how the peace initiatives between Israel and Syria, and between the United States and Iran, would bring the price of oil down dramatically and spark a major stock market rally. That process is underway, though Wall Street hasn’t completely figured out why oil prices are in free fall. This is the time of year when one stray hurricane could cause a temporary, albeit painful, spike in oil prices. But that would be a short-lived blip in a price trend that is headed much further down. What we need to do right now is follow the downward trend, recognizing that there will be periodic little rallies back to significant breakdown levels. The oil markets will tell us when the downtrend has ended.

Speaking of corrections, the Conference Board consumer sentiment number will be released next Tuesday. This is a truly meaningless number, but it absolutely has the potential to rattle the market for at least a day if the number is bad. I think the news could be on the bad side because other consumer sentiment surveys show another recent weakening. The headline take on the Conference Board survey will be that it is at a 16 year low.

However, let’s keep in mind that the S&P 500 has gained an average 18.9% in the six months following extreme lows in confidence like the one we’re about to see (1975, 1980, 1992). As long as the S&P keeps clearing resistance levels and then successfully retesting them as support levels, then the market is telling us it is ready to continue its upward pattern.

The stock market hit an all-time high just nine months ago, and the decline since then has not even retraced 50% of the previous rally from the 2002 lows. So, isn’t it is interesting that so many investors are totally convinced that a disastrous, Depression-level economic wipe-out is inevitable, or even that the apocalypse is upon us? It looks like we will march on to 1326 on the SPX, so while we’re not going to let down our guard, we’re in a good spot in the market. In fact, depending on how quickly we get to 1326, this initial rally could extend all the way up to 1440 so quickly that the $4 trillion in sideline cash may not even have a graceful opportunity to enter the scene. However, knowing that there could be a rally, I highly suggest you take the opportunity to be fully invested and ready for the upcoming joy ride. Let’s cover a few more news tid bits and then we’ll get right into the specifics of what you should buy now.

Peace, It’s Wonderful

Regarding my “outrageous” prediction of an impending U.S.-Iran détente, I found an interesting nugget going all the way back to January 23, 2008. On that day, Secretary of State, Condoleezza Rice, gave a keynote speech at the famous World Economic Forum in Davos, Switzerland where she made a surprisingly friendly gesture to the Iranian regime. She said that in this last year of the Bush administration, the United States and Iran could move towards a “new, more normal relationship.” A few weeks ago, the countries negotiating with Iran in Paris signed a memorandum of understanding, and Secretary Rice also signed it, even before the U.S. said we would send someone. The Iranians were stunned. I wasn’t.

Don’t listen to the blather and saber-rattling you will hear from both sides as negotiations continue. This week Condi said Iran was “not serious” at the weekend talks. She says that for public consumption, using the press as a negotiating tool. It’s all part of the process, and Saudi Arabia is willing to pay pretty much whatever it takes to get Iran to back off.

Collateral Damage from the Housing Bailout

It looks like Congress will give Treasury Secretary Paulson the laws he needs to bail out Fannie Mae and Freddie Mac, but, in doing so, they accidentally killed any hope for a housing recovery anytime soon. Paulson promised the Fed and the Comptroller of the Currency that he would “examine the books” of Freddie and Fannie, neither of which has filed audited statements in several years. With a straight face, Paulson told Congress that Fannie and Freddie have adequate cash reserves to withstand further drops in the housing markets. At exactly the same time, the top budget analyst for Congress said the bailout will likely cost taxpayers $25 billion. Please note that (1) they are bailing out the bondholders and stockholders of Fannie and Freddie, causing the stocks to double in a week, and (2) the odds that the pair’s losses are held to $25 billion are very low. The Office of Federal Housing Enterprise Oversight, which oversees Fannie and Freddie, said that the two lenders may need to write down billions more, as the $217 billion in private-label subprime and Alt-A loans they hold get hit in the housing slump. Fannie and Freddie were not allowed to originate this junk, but they did buy some of it. I suspect the losses will hit $50 billion to $100 billion just on this part of their portfolio.

With the losses and foreclosures spreading outside the subprime/Alt-A cesspool, you just have to look at the numbers for proof. Freddie and Fannie hold over $5 trillion in mortgages, and about $7 billion of already-foreclosed homes. That’s equal to the amount of foreclosed property among all the rest of the banking system combined. Recovery rates on these loans are around 50% after expenses. If 2% of their portfolio winds up in foreclosure (and I think that is way low), then over $100 billion goes into foreclosure and half of it goes to money heaven. Add that $50+ billion to the other $50+ billion they’ll lose in the subprime/Alt-A paper, and it looks like taxpayers will be on the hook for at least $100+ billion.

Secretary Paulson’s testimony that he may not have to use the lending and investment authority was a flat lie, and he knows it. Bill Gross, the bond guru at Pimco, said, “It is impossible for Freddie and Fannie to raise capital without help from the government. Let’s be blunt: To the extent the Treasury suggests they’ll never have to use their authority, that’s a sham. It’s fallacious to suggest that the agencies could issue capital, preferred stock, without the co-participation of the Treasury. I don’t think that’s possible.”

But don’t worry. The government doesn’t have any money to bail out Freddie and Fannie anyway, because it is running huge deficits. So they will sell debt to get the cash, and our children and grandchildren will be the ones that fund the shareholder and bondholder bailout–with interest, of course. Not us. Good thing so many of them can’t vote.

And here’s a surprise: Freddie and Fannie spend more money on lobbyists than any other two companies in the U.S. Although the word “criminal” comes to mind, I think “moron” better fits the situation. In this same bad bill, the “crimorons” eliminated the FHA seller’s down payment assistance program that allows a home seller to pay the buyer’s 3% down payment. Only 1.5% of these loans default, but the politicians just took all these folks out of the demand pool for houses. That ought to extend the price declines and pain, perhaps to the point that–gasp!–Freddie and Fannie have to be bailed out.

SanDisk, and More Thoughts on Intel

I was rereading the Intel (INTC) conference call and poking into their results a bit deeper (yeah, it’s my idea of fun), and found a few tidbits to discuss. Then SanDisk (SNDK) reported the crummy quarter I expected, gave the crummy guidance I expected, and the stock got killed. Yet SanDisk is going to be one of the biggest beneficiaries of the new Mobile Internet Device (MID) market that Intel is enabling and pushing. Opportunity knocks.

First, Intel “beat” the consensus and talked about the strength in various parts of their business. But I noticed that they reported only $96 million in restructuring and asset impairment charges. Their guidance, and the consensus, was for $250 million. They also had a 31% tax rate for the quarter, versus the 33% guidance. These two items accounted for a positive increment of three cents a share, which is exactly what they “beat” analyst expectations by. Regardless, business really was strong in all sectors and geographies, including the U.S., and the outlook remains bright.

In 2009, Intel will move to 32-nanometer processes, dramatically extending their manufacturing lead over everyone except Taiwan Semiconductor and IBM. But every time Intel introduces a new technology, they always take a small hit on gross profit margins. Part of this is due to moving R&D expenses from General and Administrative to Cost of Sales, but it’s also brought on by the real costs of starting up something new. Of course, the tremendous cost saving they’ll get in 2010 and 2011 will make the investment worth it. Currently it’s just a timing issue; something to be aware of when we decide what to do with the LEAP options.

Another interesting topic was the company’s chipset sales. The chipset surrounds the microprocessor, and they get purchased and soldered onto the motherboard four to six weeks ahead of the microprocessor. That way, the vendor (usually in Taiwan, Korea or China) has motherboards ready to configure and ship as soon as an order comes in. Intel’s record chipset orders and shipments in the June quarter suggest strong microprocessor shipments in the current quarter. Additionally, chipset demand has stayed strong in July so far.

The third interesting thing about the conference call was the emphasis Intel put on their new Atom processor, where shipments are accelerating very rapidly. Although there are several applications for Atom, most of the design wins are for Mobile Internet Devices. MIDs, as they’re often called, are not full-fledged laptops–they are much smaller and lighter, and you wouldn’t want play a video game or watch a movie on one. But they are far more useful than a smartphone or Personal Digital Assistant for surfing the Internet, doing word processing or spreadsheets, as well as connecting to email. MID are already successful in Asia, and I think will make good penetration into the U.S. and Europe.

Most MIDs are too small and do not have enough battery power to run a hard disk drive. Instead, they use semiconductor flash memory, to create a “solid state disk drive.” There’s no disk, of course, but there is a pile of flash memory–much more than you would find in an Apple iPhone or iPod, for example. The leading manufacturer of flash memory is SanDisk.

Flash In a (Frying) Pan

I’ve been avoiding flash memory since I suffered a loss with Lexar Media, which bought their chips from Samsung. Samsung’s arch rival is Toshiba, and SanDisk is partners with Toshiba in a huge flash memory fabrication facility. The flash memory business has been terrible for two years, with overcapacity, and brutal price competition overweighting very strong unit growth in bits and chips. Flash is used for the “film” in digital cameras and camcorders, for USB memory sticks found in laptops, cell phones, PDAs and video game consoles, and in specialty applications requiring removable storage. But any fab that can make DRAM memory can make flash, and some like Micron make a lot of flash. The profit margins may be crummy, but they are doing a lot better than DRAM.

SanDisk has been a heartbreaking stock over the last couple of years. It was in the mid-$50s in the middle of 2006, and got a little play at the end of the year when they started shipping specially labeled memory cards for the Nintendo Wii. In early 2007 they introduced, “the largest capacity on the world’s smallest flash card for mobile phones,” a four gigabyte card that could store 1,000 digital songs or 2,000 high-resolution pictures or eight hours of video. But by mid-2007 SNDK was still stuck in the mid-$50s, just as profit margins in flash memory were about to shrink to the vanishing point.

By the end of 2007, SanDisk was regularly disappointing Wall Street with poor results due to pricing pressures, and the stock was in a sickening decline to $20 at the March 2008 lows. Most analysts gave up on it in 2007, and it had very few friends by March. A dead-cat bounce with the market took it up to just over $30 in May, but then it caved again as the market headed south and broke $20. After the close on Monday they announced yet another weak quarter, and the stock plummeted as low as $13.06 on Tuesday, trading almost 50 million shares. I thought everyone knew that the June quarter was terrible for flash memory, as prices were weak through the whole period. It sure wasn’t a secret, but apparently some on Wall Street don’t get the full picture with flash pricing trends until the quarter surprises them.

SanDisk announced a 1% sales decline from last year to $816 million, while the consensus was looking for 9.6% growth to $906 million. The company lost 10 cents a share pro forma, where analysts were expecting a 13 cent profit. Flash prices fell 55% year-over-year and 15% from the March quarter, even as flash megabytes increased 120% year-over-year to an all-time record, and grew 14% from the March quarter.

But the most recent consumer surveys show another round of fear and weak confidence, so the company guided well below the already depressed consensus. Management is looking for September quarter sales between $750 million and $850 million, far below the $1.09 billion consensus. They expect another sharp drop in prices, and may have a zero product gross profit margin. They are reducing capital expenses by delaying some factory upgrades and expansions.

Meanwhile, Apple’s new 3G phone is soaking up lots of flash memory. Apple sold about a million phones in the first weekend of the new phone’s release alone, and rumor has it they ordered 50 million eight-gigabyte flash chips from Samsung. That follows a 25 million chip order in June. Samsung has been trying to reduce the oversupply of flash, and a 50 million chip order would soak up a lot of their capacity and inventory, which would help pricing and SanDisk. At the same time, if Intel is right about the blistering growth of Atom processors for the MID market, the September quarter will mark the launch of solid state disk drives as a significant new application for flash memory. SanDisk is likely to outperform its guidance by a substantial margin, and in the better stock market I foresee, we should be able to get an easy double from SNDK–maybe a triple by next April. That’s too sweet to miss.

The risk here is that we are buying a falling knife, and I debated long and hard about holding this recommendation back until we get a successful retest of that $13.06 low. Certainly, that is the safest way to enter the stock. But unless the Conference Board consumer sentiment number next Tuesday really rattles the market, such a retest might come as a drop from the high teens to $15 or so–above the current price. Hard book value, after adjusting for a one dollar per share inventory write-off that I am expecting this quarter, is around $15.70.

The company is expected to do $3.4 billion in sales this year and lose 10 cents a share. I think solid state storage can push them a bit over $3.5 billion and to small profits. Next year’s consensus estimate is $3.5 billion and 35 cents, but that is too low if the pricing environment get better. I think they will do $3.8 billion or so, and earn 60 cents or more. So, I want you to buy SNDK up to $15 for a $32 first target early next year, or maybe after the October conference call. If you want to be cautious, use a multiple buy strategy to take a one-third or one-half position now, and the next bite whenever the retest bottoms out.

Earnings are really starting to flow now, and will be the main topic of the next few Radar Reports. But, as always, other important things are happening. Let’s review them.

Biotech MegaShift

Affymetrix (AFFX) just reported results, and I’ll be on the conference call right after this goes out. They did $86.9 million in sales and lost four cents per share before an additional one cent restructuring charge, much worse than consensus expectations for $92.2 million and breakeven. In the press release, management said that due to weakness in pharmaceutical revenue, they are reducing guidance for 2008 revenue to be between$365 million and $370 million, excluding the $90 million legal settlement from Illumina. They will have a loss before accounting for the one-time royalty payment. They are consolidating manufacturing into three locations to improve operating profitability. It looks to me like AFFX may have lost its way. I am moving the stock to a Hold until I can analyze the situation further, and listen to the conference call.

Amgen (AMGN) will report next week. With Swiss drug maker Roche taking advantage of the weak dollar to offer $43.7 billion for the remaining 44.1% of Genentech that they don’t own, there is one less major biotech for the big funds to buy when they need exposure to the sector. Continue to hold the Amgen January 2009 $70 LEAP call (YAA AN) and buy the January 2010 $40 LEAP (WAM AH) under $10 with a $20 target.

ViroPharma (VPHM) had an inconclusive outcome from the two-day meeting of the Advisory Committee for Pharmaceutical Science and Clinical Pharmacology. It is clear the FDA is determined to find a way to approve generic versions of drugs like ViroPharma’s Vancocin that act locally in the gastrointestinal (GI) tract. In theory, the FDA has moved past the question of clinical trials, taking the position that they are not needed, and a way needs to be found to establish bioequivalence just using lab (in vitro) methods. But it became clear during the panel meeting that no one knows how to do that yet. With the FDA stubbornly insisting on only in vitro testing, they are now playing into ViroPharma’s hand. There will be no generic version of Vancocin in 2008, and maybe not in 2009–which was the original date I and everyone else expected it. So, aside from knocking the stock down 50%, the whole in vitro generic issue turned out to be meaningless for the company. Pathetic.

The FDA will debate how to get confidence on the comparability between in vitro bioequivalence testing and clinical efficacy and safety trials, and eventually get to a solution. But the problem with GI drugs is that they act in a constantly changing environment. Unlike other sites of drug activity, the GI tract goes through highly variable states even in healthy people. The committee seemed to be leaning towards the idea of a very broad panel that would test different dissolution media across a range of pH levels and other variables. A generic would have to show comparability to the innovator drug across the entire panel. That could be harder than just doing the clinical trial.

Vancocin treats c. difficile infections, and although the committee did not want to focus on any one drug, they listened to testimony from Dr. Dale Gerding, a preeminent expert on c. difficile. Dr. Gerding made four main points:

1. the incidence of c. difficile is increasing
2. there has been rapid and widespread emergence of the highly virulent BI/NAP1/027 strain
3. there has been an increase in the severity of c. difficile with higher levels of morbidity and mortality associated with the disease
4. there are several drugs in development for c. difficile which are also designed to be locally acting and not systemically absorbed

Dr. Gerding also pointed out that no in vitro model has been developed for a c. difficile infected GI tract, and the potential effect of this pathologic condition on the efficacy of a drug or formulation, is uncertain. Dr. Gerding concluded that because Vancocin is the only approved therapy for c. difficile and is heavily relied on for cases of increasing severity, any potential generic copy of the drug should be very carefully assessed to confirm that it has equal efficacy so that patients are not unnecessarily put at risk. Although the FDA seems determined to not require clinical trials to approve a generic of Vancocin, it was Dr. Gerding’s opinion that a comparative trial with approximately 100 patients in each arm would be required to show that two drugs are delivered to a site of action with the same clinical outcome.

I doubt Wall Street will ever again pay for Vancocin, even though it throws off a tremendous cash flow for ViroPharma. But the acquisition of Lev Pharmaceuticals provides a near-term catalyst to move the stock, and the ongoing Phase III development of maribavir adds a mid-term catalysts. VPHM is very cheap and remains a Top Buy up to $12 for my $25 target price.

China MegaShift

We sold our Chinese stocks last year, and China is down about 46% this year. It is one of the two worst performers among the world’s two largest stock markets (India is the worst). But I am not ready to go back in yet. The U.S. recession is biting into Chinese exports. At the same time, Beijing just began a massive shutdown to clear their polluted air before the Olympics. Half of the vehicles are off the roads under odd day/even day driving rules. About 300,000 heavy polluting, aging industrial trucks, many of which operate only at night, were completely banned for the duration. Many highly polluting factories have been shut, and the chemical plants, foundries and power plants left open have to cut emissions by 30%. The only practical way to do that is to shut down for 30% of the time. All dust-creating construction in Beijing itself has been shut down.

I still think we’ll see some pea-soup air during the Olympics. I remember landing in Xian about 11 a.m., and it looked like dusk. The pilot advised us to hold a handkerchief over our mouths and noses while we walked across the tarmac from the plane to the terminal. More important, these extraordinary, drastic measures are sure to hurt GDP and corporate earnings in the current quarter. The central government may or may not implement the rumored crackdown after the Olympics are over, but I think we can wait for it to see if we get a better entry point.

Content on Demand MegaShift

EMC (EMC) reported an excellent quarter, but 85%-owned VMware (VMW) disappointed. While those owning VMware directly suffered a 14.9% loss during the day yesterday and closed down 2.6%, we made 13.7% as EMC moved up to $14.17 on over 108 million shares.

VMware reported revenues up 54% to $456 million, virtually spot on the consensus of $458.6 million. They hit the pro forma consensus for 23 cents a share right on the button. That was up 54%, and they had over $100 million in free cash flow in the quarter. But guidance was conservative and tanked the stock. After the recent abrupt change in CEOs at VMware, it was not surprising to hear cautious guidance. New CEOs don’t come in and say, “Why, things are much better than we thought and we’ll have to raise guidance thanks to the efforts of the CEO we just fired.”

So they explained that when they fired the CEO two weeks ago and said 2008 revenues would come in “modestly below” their prior guidance of 50% growth, what they meant was 42% to 45% growth. Wall Street did not think that was a “modest” shortfall. At the low end, that would be $988 million for the second half of the year, up only 28% from last year.

VMware talked a lot about the weak economy, which is becoming known this quarter as “the economy ate my homework” excuse, but the CFO was pretty straightforward on the conference call:

“First, customers are subjecting their large enterprise agreements to a longer review process, particularly in the U.S. and to a lesser extent, in Europe. We are convinced this is due to the uncertain macroeconomic conditions. We continue to close deals in spite of these challenges, although sometimes smaller in size, and have closed a number of ELAs [Enterprise-Level Agreements] early in the third quarter that slipped from Q2.

“Second, in certain cases, customers are deciding to forgo the discount associated with buying for longer term deployment and purchase product in each shorter term needs. That said, customers continue to purchase our products, because of their quality and the acknowledged return on investment they represent.

“We also recognize that Microsoft will be seeking to displace our VMware infrastructure in certain accounts. They have only a subset of the product solution we have, and their product is of necessity much less mature, and we intend to further our value proposition.

“We are not aware of having lost any deal to them but there is a potential that their marketing and sales efforts will slow decision cycles while customers sort of the facts for themselves.”

Recent surveys of data center and IT managers do show that VMware’s ESX virtualization software is feeling the pressure from Microsoft’s new Hyper-V virtualization product, as well as the Citrix product and even a free virtualization offering from Sun Microsystems. VMware blamed the economy for customer delays, but I’ll bet there are a lot of Hyper-V, Citrix and Sun evaluations in process. ESX is a far more attractive product, but people have to do their evaluations and justify their choice to the higher-ups. The slowdown in business software spending that has hit almost every other company did not impact VMware while they were the only game in town, because ESX demonstrably saves money and is an easy sell in a cost-cutting environment. Now that the low-priced spread is available, though, VMware can expect slower evaluations and tougher negotiations on prices. About 45% of all potential buyers now list “price” as their #1 factor in making a decision–last year, that was closer to 25%. “Price” is now the second most important factor only behind “performance” at 58%. Also, a year ago about 80% of them said they would choose VMware for future buys, but now only 68% are that sure, with 21% saying they will look at Microsoft’s Hyper-V, a double from just 10% last year. VMware’s market share fell from 70% three months ago to 64% in the most recent period, while Microsoft picked up one point to 23%, Citrix picked up five points to 31% and Sun picked up five points to 13%. (The market shares add up to more than 100% because some companies use more than one vendor, typically in different subsidiaries or divisions.)

Nearly half (46%) of VMware’s customers say they are very satisfied, although that is down 10 points from the beginning of the year, and may relate to the founding CEO’s abrupt departure. Sun Microsystems is second for “very satisfied” at 19%, followed by Citrix and Microsoft at 17%.

The real key to our investment in EMC, and therefore in VMware, is that VMware is much more than a virtualization company. As the new CEO said on the call:

“First of all, VMware is more than a hypervisor company, and I really want to stress this point. VMware is one of the few companies that can really aspire to become and be one of the strategic IT and software vendors.

“It all started with the layer of software that we call the hypervisor in the late 1990s and early 2000, and that today is really an enabling technology. That layer of software that we call the hypervisor, which isolates operating systems from the underlying hardware, is really just a means towards an end. And that end is really providing a much broader set of software solutions that allow customers to not only use their hardware much more cost effectively and with greater scalability but allow them to aspire to have datacenter solutions that are fundamentally more manageable, more reliable and more flexible.

“Others in the industry have referred to this as the datacenter of the future, and VMware has the privilege to be right at the center of that transition, as we take people towards this fundamentally more flexible, cost effective, manageable vision of the future.

“So today, we are actually selling much more than a hypervisor. We sell a suite of software that we refer to as VMware Infrastructure, and this is what customers really pay us for. This is a suite of over 20 products today and is on this extended suite of software where the bulk of our focus and effort is.

“Moreover this suite of software has become a real ecosystem where you have over 700 third parties, partners that work with us to extend the value of that suite of software, and it means that it has become a true platform.

“In addition to having the opportunity to really deliver on the data center of the future, VMware sits at the cross currents of two other great trends that are unfolding in our industry. One of those is applying a lot of the same infrastructure and techniques to deliver a much more effective desktop management, removing one of the big headaches for IT, but also to reach towards cloud computing.

“In cloud computing, the new opportunities are going to open up and it turns out many of the same technologies that we have been pioneering in this data center of the future effort, applied directly in the cloud. So VMware is thus fortunate to be at the intersection of these three major trends in our industry.”

Based on the reduced revenue outlook, VMW should do 95 cents a share this year on $1.9 billion in sales, and $1.30 next year on $2.5 billion. At $36 the company has a 27.8 P/E ratio for a 33% growth rate. Their total market capitalization is $13.8 billion, or 5.5X next year’s sales per share. That’s moderately undervalued.

Which brings us to EMC (EMC), which has a total market capitalization of $29.3 billion. This is including their $11.8 billion worth of VMW stock. EMC reported sales up 18% to $3.67 billion, a modest $100 million above Wall Street’s average forecast. But they did 24 cents a share, clobbering the 17 cent consensus estimate. Business stayed strong for them, especially outside the U.S., and they see no reason to reduce expectations. This was the 20th consecutive quarter that EMC grew sales by a double-digit percentage. That’s an admirably consistent performance for a high-tech company.

Management raised their 2008 sales guidance a bit to “more than $15 billion” from the $15 billion they previously forecast. They kept their 2008 profit forecast of 78 cents per share pro forma, which matches the consensus. I think we picked the right horse here, and I expect VMware to do extremely well over the next few quarters even if they slowly lose some market share to the low-end solutions. Buy the EMC January 2010 LEAP call with a $15 strike price (WUE AC) up to $5 for an $11 target.

Infinera (INFN) reported a better June second quarter than recently expected, and the stock moved up more than $1.50. On a GAAP basis, revenues climbed 176% to $161.1 million with profits of 44 cents a share. However, the more accurate pro forma results count only invoiced shipments, and on that basis, revenues grew 32% to $90.8 million and earnings hit 11 cents, up from four cents last year. The consensus estimate after the company’s negative preannouncement was $89.2 million and one cent a share.

Two positive data points: the adjusted gross margin rose two percentage points from the March quarter to 47%, and Level 3 Communications accounted for only 21% of sales, down from 31% in the March quarter. As their sales base spreads out, due in part to their important new products, their reduced guidance for the year is looking pretty easy to beat.

On the conference call, the company’s CEO said, “Industry analysts now estimate the total optical market at about $15 billion. Infinera is now addressing the DWDM, or dense wave division multiplexing segment of that market, which we estimate is $6 billion in size. The optical market remains a large opportunity, and we’re addressing it with differentiated technology, and with a significant competitive advantage.”

The negative preannouncement was a major disappointment caused by their over-reliance on Level 3′s orders, but I think the company is diversifying their customer base as rapidly as possible. INFN remains a strong buy up to $15 for my $30 target.

QuickLogic (QUIK) reported June quarter results at the high end of guidance, but then guided for lower than consensus revenues in the current quarter. I think there were good reasons for the pattern. They did $8.7 million in sales, down 21% from the first quarter of 2008 due to lower revenues from end-of-life products. They were up 4% from last year’s second quarter of 2007 because a $2 million increase in new product revenue offset the decline in end-of-life products. The pro forma loss was three cents a share, better than last year’s six cent loss, and a penny worse than the March quarter’s two cent loss.

The disappointment was in expected new product revenue for the September quarter: $1.2 million, to $1.6 million. There are two high-volume programs going away as the customers migrate to new products, while many of QUIK’s recent wins will just be starting their volume ramp for the holiday selling season. Management said this would be the low quarter for new product revenue, and they may be estimating too low because they will only commit to what they have in hand today. Customers easily could call in rush orders for products that beat initial sales expectations, but QUIK management would rather leave that good news for the September quarter conference call. They did say on the conference call that end-of-life products will be flat for the next few quarters rather than continue to decline, so we should see good sequential growth in the December quarter.

They continue to win lots of designs incorporating their Customer Specific Standard Parts, and their new Visual Enhancement Engine (VEE) technology launch was a big success in Asia. The VEE technology is designed to improve contrast and color for cellphone handset displays under any ambient light condition, including direct sunlight. Handset displays have a very low color range compared to TVs, so when they are showing made-for-TV video, the dark colors tend to look black and the light colors get too bright or wash out completely.

The most common display control technology used today is Content Adaptive Backlight Control, which is primarily designed to reduce power consumption in low light conditions. It isn’t as effective as VEE in saving battery life, and it does nothing to improve picture detail or cope with high ambient light conditions like direct sunlight.

Global Histogram technology is better than simply adjusting the backlight, but it also does not compensate for high levels of reflected ambient light. It is a global algorithm that makes the same change to every pixel, whereas VEE looks at what the pixel is trying to display. Consequently, Global Histogram control usually leaves many pixels below the threshold of the reflected light, and they completely wash out. It also has problems with edge contrast, so everything looks cartoony, especially in the mid-brightness area that often contains the actors and actresses. VEE suffers from none of these problems, and lets handset manufacturers produce good looking displays that can be seen under any lighting condition. It’s going to be a huge winner for QUIK.

The company has realigned itself to their CSSP model, which means getting involved with the customers earlier in the design process, and at higher levels than engineering. QUIK has replaced their sales force and, as an important secondary benefit, cut their breakeven point from $12.5 million a quarter to $8.5 million a quarter.

Of the new application opportunities they are engaged in, 57% are for smartphones, portable media players, navigation devices and data cards. The remaining 43% are for portable consumer, portable industrial, medical, military and other applications. The number of opportunities has increased 140% since the end of 2007, and two-thirds of these are with Tier One and Tier Two accounts that would take at least 500,000 parts per year. There are 21 specific applications for VEE, most with Tier One smartphone manufacturers. The first VEE design win goes into production in the December quarter, and will offer perfect video even in direct sunlight. Apple has to do this!

QuickLogic is on the verge of a huge success. Looking backward, it makes some sense for the stock to be under $1.40–after all, they guided for a poor quarter. Looking forward, though, this is one of the stupidest mispricings I have ever seen in the stock market. I don’t know if it is even worse than TowerStream (TWER), but it’s right up there. QUIK is a pounding-the-table Top Buy that will triple to my $4 buy limit, and then double from there to my $8 target–and I’ll bet I raise that when we get there.

Silicon Image (SIMG) reported a good quarter just after today’s close, with a conference call scheduled later this afternoon. The company did $70.1 million in sales and seven cents a share pro forma, better than consensus expectations for $67.6 million and four cents a share. In the press release, management pointed to another strong gross margin performance this quarter at 58% of revenue. They guided up to $75 million to $77 million in sales in the current quarter, compared to consensus expectations for $75.2 million, and $284 million to $289 million for the year, compared to the $283.3 consensus. Gross margins should stay in the high 50s. With the transition to digital TV imminent and the global holiday season product build coming up, buy SIMG up to $8 for my $16 target.

Zhone Technologies (ZHNE) had the expected poor quarter, booking $40.1 million in sales compared to $43.0 million in the March quarter and $44.1 million in last year’s June quarter. Recall that their largest customer in Latin America demanded “unacceptably aggressive price reductions late in the negotiations over a multi-million dollar expansion” and Zhone walked away. Management said their fundamentals in other markets remain strong.

They made it a “kitchen sink” quarter by writing off a bunch of goodwill in the June quarter, producing an $80 million nominal loss. But their version of pro forma results, which is pro forma earnings before interest, taxes, depreciation, amortization (EBITDA) and stock compensation expense still showed a $5.2 million loss, thanks to the Latin American mess.

I want to go over the financials, which are quite complex this quarter, and go through the conference call notes again, but I am about ready to give up on ZHNE. My main question is what it is worth in a sale, and whether that is a big enough carrot to make us hold on to the stock. For now, continue to hold ZHNE, and I am suspending my $4 target price.

New Energy Technology MegaShift

I said in the July 14 Flash Alert that the backside of a parabolic upturn often shows a steeper drop than the incredible rally that topped out, and it looks like oil is going to follow that pattern. Even after the biggest weekly drop in oil prices ever, most commentators and analysts don’t believe it. They’ll start carrying out the hedge fund bodies soon, and our friend Mr. Pickens may be in that parade. He is very long and, for the moment, very wrong.

As happens at the end of every parabolic move, analysts are looking for a reason to explain the drop. Some point to the 2.9 million barrel jump in gasoline stockpiles, when only a 0.5 million was expected. This supposedly shows that the pinched American consumer is cutting back further on fuel. Demand for gasoline over the four weeks ended July 18 was 2.4% lower than a year earlier, with prices up maybe 70%. I’d call that a minuscule response, but if an unexpected extra 2.4 million barrels of gasoline (we burn that every six hours) can bring oil down $20 a barrel, so be it.

Some point to the liquidity problems and failure of oil and asphalt transportation and storage provider SemGroup LP . Four subsidiaries of the financially troubled company filed for Chapter 11 reorganization on Tuesday due to major losses on oil futures contracts–almost certainly long bets. The market believes there are more SemGroups lurking in the corners.

Others point to the Congressional investigations of the oil futures market, trying to pin the blame on anyone but the politicians who have not crafted an intelligent energy policy. Limit the number of contracts! More disclosure! More oversight! A bigger bureaucracy, that’s the ticket!

Here’s the number of barrels of oil that speculators actually take delivery of: Zero. If they don’t take delivery and store it, then it has to come on the market, doesn’t it? For every speculator that buys, there’s a seller–usually another speculator. Or a big oil company, laying off price risk. This is a $1.4 trillion per year market, and you can bet Congress will regulate it without understanding it, creating the usual stream of unexpected consequences that require expanding the bureaucracy even more. Why? Because their Gallup Poll approval rating is down to a 34-year low at 14%, they are about to go on their August recess, and their voters are peeved about gasoline prices and ready to vote for change. So Pelosi’s Dictum rules: It is better to do something stupid than nothing if it mollifies the voters.

If Congress does something, oil probably will fall to $100. If they do nothing it may fall to $80. I’ve seen credible arguments that it is headed for $50, but I think that would take a substantial additional slowing in U.S. economic activity that really tanked the Chinese and Indian economies. The price of a barrel of oil should equal the cost of producing the most expensive, marginal barrel of oil needed to meet global demand. The Energy Information Administration says the oil market has a small surplus of existing production, and the Dallas Federal Reserve says the most expensive barrel of oil needed to meet global demand is being produced today at just $50. I think it is more likely that the Dakotas and Pennsylvania shale oil, and mined Canadian tar sands oil, is the marginal barrel, at around $70 in production cost.

Connacher Oil & Gas (CLL.TO) produces for less than that due to their advanced technology. The stock drew a good question from Dan P.: “With your belief that oil prices may go back to $100 or less, are you still good on $9 for Connacher Oil & Gas?”

Yes, Dan, because Connacher can find and produce oil for something like $50 to $60 a barrel. They make good money at $80 oil, and they rake it in at $100. Anything over that produces a tsunami of cash, and I think over the 20 to 50 year life of their prospects, oil will average way north of $100 a barrel. Buy CLL.TO up to $4.50 for my $9 target.

Robotics MegaShift

iRobot (IRBT) reported June second quarter results last night and held their conference call this morning. The company had some good news: Revenues were up 42.9% to $67.2 million, their 16th consecutive quarter of year-over-year revenue growth despite our soft economy. That was substantially better than guidance. First half sales were up 44% from last year. The home robots division almost doubled its sales in the first half to $71.8 million. Foreign sales accounted for 40% of the home robots total, so they are getting traction outside the U.S. They lost 22 cents a share, though.

Management reaffirmed guidance for $295 million to $305 million for the full year. They also announced a PackBot 510 order from the U.S. Army totaling $17.5 million. This was the fourth order under their $286 million contract, which will deliver more than 220 additional robots to the Army by December 31, 2008. The PackBot 510 can investigate suspicious objects, identify roadside bombs and other improvised explosive devices, and uncover unexploded ordnance while soldiers stay at a safe distance.

iRobot should have a strong second half due to the holiday season, even though consumer spending in the U.S. will be depressed. Buy IRBT while it is under $15 for my $30 target.

Security MegaShift

SiRF Technology (SIRF) also reported after the close, and the conference call starts in a few minutes. They did $63.1 million in sales and lost 19 cents per share pro forma, down from last year’s $70.6 million with a 23 cent per share profit, and compared to consensus expectations for $62.1 million and a loss of 13 cents a share. In the press release, management said: “Newer products are showing good design win traction, but we continue to be cautious in our outlook due to economic uncertainties and challenging competitive environments.” SiRF is a very cheap stock, with little price risk while they get it turned around, so you can continue to buy SIRF up to $8 for my $20 target.

WiMAX MegaShift

TowerStream (TWER)has been weak and Edwin L. asked: “I am wondering if TWER is still a stock you wish to hold or if there is a new sell point from your perspective. It has been beat up badly. Should we just cut our losses after such a hit or do you still see upside, and, if so, how much?”

I not only want to hold it, I want to take the whole company private and divvy it up among New World Investor subscribers. TWER management looked at the economic storm coming and asked the question: “How can we get to positive cash flow and profits just with the resources we now have, without needing to raise any more money that might not be there when we need it?” And they decided to continue to negotiate their leases in new cities, but stop their expansion and focus on selling into their current nine major markets until they hit their financial goals.

Good on them, as the Aussies say. I only wish all tech companies were so well managed. The economic problems have blocked all their wannabe competitors from getting financing, giving them room to get profitable and then build out the next 11 cities from internal cash flow. It costs about $1.5 million to build out and turn on marketing in a new city. They will march steadily forward until they own the wireless broadband market in every major American city. You gotta love it. I labeled TWER my #1 idea for 2008. At this point, as I said, it’s a toss-up as to which is stupid cheaper, TWER or QUIK.

I want you to own them both, in size. Buy TWER for a 400% move up to my buy limit at $6, and then about another triple to my $16 target. You can retire on these two stocks from these levels.

* * * * *

Subscriber Bob had a forward-looking question: “Are you advising we continue holding your Top Buys right through the Bear?”

What a great question! When the real bear market starts next April, I will cut the current Top Buys list back to only those stocks than can go up in a depression. There aren’t many. I will then add a number of Exchange Traded Funds that either go up when a market goes down or gives you participation in a sector that goes up in a depression. I expect to see roaring inflation in financial assets as the dollar plummets, accompanied by a depression in the real economy as the baby boomers start retiring in earnest and the credit mess implodes on Chairman Bernanke.

This is nothing more than what Great Britain went through when they handed the job of factory floor to the world to the United States, around 1900. With intelligent policies–a stretch assumption, I know–our country can come out of it just fine. I think it is to be looked forward to rather than feared. After all, Jolly Old is a darn nice place to live and visit. No reason we can’t wind up in the same position.

Last Monday, I sent you a Flash Alert that said, “At the bottom of bear markets, we often see these historic bailouts–Penn Central, Continental Illinois, Chrysler. Now you can add the Bear Stearns bailout, which created the first bottom in March, and the Fannie/Freddie bailout, which will create the second bottom today.”

I was off by one trading hour. Monday’s 10-point decline in the S&P 500 set up a test of the major support at 1210 on Tuesday, including a spike down to 1200 in the first hour of trading that was quickly rejected. From there, the Index went on a tear to 1234, retested all the way back to 1215 by the close, and then used yesterday to cement the upturn in place.

Listening to the Market

I know you are feeling like every stock is getting killed, tech or non-tech. The market’s overall losses are terrible, and the bad news from the financial sector just keeps getting worse. Every new stock you buy drops. Every stock you meant to sell on an up day and didn’t, drops. The most interesting sector in the world, technology, seems to be in a cyclical decline. You can’t even feel safe with energy stocks, because oil prices are plunging. If you diversified overseas, whether into a CRIB country (China, Russia, India, Brazil) or just Euroland, you are getting thrashed. Your 401-K feels like a 201-K, on its way to a 101-K.

Most people feel that way. But whether these people are permabears, or Jim Rogers, a famous commodities trader, furiously angry at the Fed for bailing out Fannie and Freddie, or just dazed and confused, figuring stocks will probably drop another 10% just because they can’t see any scenario that would lead them to call a bottom here, they all have one thing in common: They are not listening to the market.

Mark Twain famously said, “Whenever you find yourself on the side of the majority, it’s time to pause and reflect.” Right now, the overwhelming majority is bearish. So, taking a cue from Twain, it is time to ask ourselves the key question at turning points, “What could happen to make the consensus outlook wrong?”

The surprising answer is: Peace. We are about to see a very public meeting of the minds between the Israelis and the Syrians, with numerous photo ops for government leaders of both countries. At the same time, we are about to get a much more private meeting of the minds between the U.S. and Iran. (No photo ops for than one.) These two events will be behind the temporary $30 to $40 pullback in oil prices that I mentioned in the Flash Alert.

We’ve just had the biggest two-day drop in crude oil prices since January 2007, cracking major support at $136. Why? Well, because the news about these two major events is starting to leak out. Yesterday’s stock market rally was driven in part by the same forces.

Why peace and why now? Simple, oil over $120 puts about a billion dollars a day in Saudi Arabia’s pocket. That gives them lots of extra money to play with, and they want two things: Somewhat lower and stable oil prices, so the world will slow down on finding alternatives to oil; and peace, so the ruling family can stay in power. The Saudis are funding the peace agreements, by sending money to Syria and Iran if they agree to play nice. Lots of money.

Oil Price Drop: Anything But Graceful

Can you imagine the impact a $40 drop in oil prices back to $100 will have on the equity markets? How about $20 in a single day? Oil has been in a parabolic uptrend, and the backside drop from the peak of a parabolic uptrend is often steeper than the rise. It could happen quickly–too quickly for the $4 trillion in excess cash in money market funds, mutual funds and brokerage accounts to get invested gracefully. These moments are best described as all the elephants trying to get through one door at the same time. The put buyers get wiped out overnight, then the highly leveraged hedge funds that are heavily net short, then the less leveraged and less short funds go under next–you get the idea.

The action in the financial sector yesterday was a microcosm of what is coming in the general market. One bank, Wells Fargo, reported earnings three cents or 6% better than expected, and the financials jumped 12.3%, their biggest up day in 19 years. The big drop in crude prices offset a higher than expected inflation number, leaving a level playing field for the bulls to take the Wells Fargo results and run for a touchdown. They were unstoppable–take a look at a one minute chart of yesterday’s trading.

I’ve been working on Dawson Geophysical (DWSN) for a new energy recommendation, but I’ve put that on hold until oil is back under $100–or maybe $80. Sounds impossible, doesn’t it? Read again what Mark Twain said, and apply it to oil prices. As I said in the Flash Alert, I think the commitment to alternative energy and oil sources is unstoppable at this point. But that is not the first place Wall Street will turn when they think it’s time to get back into cyclical and growth stocks.

In yesterday’s Congressional testimony, Chairman Bernanke’s imaginary Fed tightening, bruited for later this year, dissolved into a puddle of reality. If he can’t tighten, inflation will have to stay above their “comfort level” for the third or fourth consecutive year, and the dollar will muddle along until next April or so. The S&P 500 needed to clear 1245, and then close over the big resistance level at 1258 to keep this rally going. It did that today, and I expect we’ll run back to our old friend 1326 in a hurry, maybe in one day, and then on to the really big test at 1440. Clearing 1440, especially if oil prices are in free-fall, would be the “tell” that we are going to see new record highs by the end of the year.

Intel’s 40th Anniversary

Meanwhile, as the Intel (INTC) earnings report showed, the rest of the world is still growing. I want to focus on that report and the future for Intel and microprocessors. Tomorrow is Intel’s 40th anniversary as a company, and almost the 38th anniversary of the venture capital investment we made in them at American Express Investment Management. It’s an opportune time to look at the big picture.

Intel reported a 9% year-over-year revenue increase to $9.47 billion, comfortably above the $9.3 billion consensus. They hit 28 cents a share, up 27% from last year and two cents over the consensus. Then they guided for $10.0 billion to $10.6 billion in sales for the current September quarter, also well above the $10.0 billion consensus.

The stock only moved up a little on these stellar results, and thereby hangs the tale of why Wall Street still does not “get” Intel. The gross profit margin was a little disappointing, simply because Intel saw strong sales of entry-level computers, primarily laptops, in Asia and other less-developed areas. As the incomes in these areas rise, and the cost of fully-featured computers falls, it is inevitable that more and more people will buy their first computer. Yes, the first one does tend to be pretty basic, low-priced and carry lower profit margins. But these are brand-new users, and just as cell phones always start in a new country with the cheapest model and then benefit from steady upgrades, computers will follow the same path. The only place it can be “bad” to find new, entry-level global customers during a U.S. recession is on Wall Street.

Intel pointed out that sales were strong worldwide, in spite of the obvious weakness in the financial sector, which historically is a big consumer of computers. CEO Paul Otellini said he is seeing “tremendous” demand for microprocessors, and “no fallout” from the U.S. credit crisis.

I suspect the earnings drag from Intel’s flash memory operations has as big an impact on profit margins as the product mix impact. Intel can overcome that through a combination of even more advanced processing technology to lower costs, and the rise of solid-state storage to replace disk drives in laptops. The latter trend should be well underway in 2009. In the meantime, their new Atom processor for the Mobile Internet Device (MID) market is winning designs that will be in production as early as this quarter. The MID market fits between Smart Phones and laptops, and after a couple of false starts like tablet computers, looks ready to take off.

Intel is a company with a renewed sense of healthy paranoia, better chip designs and still the best production processes in the business–even better than IBM, Taiwan Semiconductor and Samsung. Their push into MID devices and integrated WiMAX chips and functions show how aggressive they are.

Intel’s MegaShifts

There will be a lot written this weekend about the last 40 years at Intel, and even though I was lucky enough to be involved in some of it, I’m more interested in the next 40 years. Pat Gelsinger, a very smart guy who has held the Chief Technology Officer position at Intel, recently talked about four major megashifts that Intel is riding. The first is a dramatic increase in the number of actual processors on each chip. Today we get excited about dual (two processor) and quad (four processor) chips. Gelsinger says to get ready for tens to hundreds of processors per chip in the “many core” area.

You won’t need those chips to write a letter or update a spreadsheet, but think about medical imaging, where the computer has to grind away for a few minutes before the images are processed. With the instant, real-time images from “many core” processors, interactive medical devices become a reality. Speech recognition will completely replace the keyboard. (I use Dragon Naturally Speaking 9 now, and it is good but not great. It will be great on a “many core” processor.) I developed Murphy’s Dictum many years ago when I was running a project management software company: Give programmers and system designers more power, and they will write software to use it.

Pat’s second prediction is that the ubiquitous X86 architecture will wind up everywhere, in cellphones, consumer products and small devices. Intel’s Atom is very low-power for the MID market, but the next version will use substantially less power for the cellphone market. Intel knows that one of their biggest competitive advantages is the huge amount of software already written for the X86 architecture, and they want it to be available on a wide range of new devices, especially those consumer products requiring low power usage for long battery life.

His third prediction is one Intel has talked about internally for years, giving me little glimpses from time to time at the Intel Developers Conferences. It is that through a combination of new, low-power devices; always-on, inexpensive broadband access; and smart sensors, virtually everyone on the planet will have 24 hour access to the Internet and therefore their bank account, retail stores, cars and houses.

The fourth prediction is that Moore’s Law will continue, and the semiconductor industry will double chip capacity every 18 months or so. The flip side of that is that the cost to process an instruction or store a bit of data continues to fall 50% every 18 months. Economic progress depends on lowering costs, and never in history have costs been lowered this rapidly. There are two ways costs fall. One is to squeeze the circuit lines closer and closer together, to make the chips smaller and smaller so more will fit on a wafer of silicon. Intel is down to 45 nanometer spacing. The other is to make the silicon wafers bigger. Intel and the rest of the industry are currently making chips on 12″ diameter wafers (actually 300 millimeters, or 11.8″). I’ve been with this industry from 2″ wafers to 4″, 6″, 8″ and now 12″ diameters. Intel is about to raise the bar and move to 18″ wafers (actually 450 millimeters or 17.7″). That will cut production costs 40% just because there is more surface area to pack on more chips, although it will drive the cost of a single semiconductor fabrication facility towards $6 billion to $8 billion. Just like a game of high-stakes Texas Hold ‘Em, each time the ante goes up, fewer players can afford to stay in the game. Intel will be the first company into production. I know it looks like a huge stretch to get the stock from $22 to $35 in the six months remaining to January 16, 2009, but that is still the most likely outcome. Continue to buy or average down the Top Buy-rated Intel January 2009 LEAP calls with a $22.50 strike price (NQAX) under $6. The target price is $12.50 at expiration, about 6X today’s closing price.

Biotech MegaShift

CombinatoRx (CRXX) will hold its 2008 Research & Development Day Event the morning of July 23. We’ll get a detailed update on their product pipeline, which may help the stock. You can listen to the webcast at www.combinatorx.com. CRXX is a buy up to $7 for my $16 target.

eResearch (ERES) sold off a bit after two Wall Street firms downgraded the stock. Rich, a subscriber, recently asked: “ERES is down this morning on news that a couple research firms have cut their ratings on the stock to Underperform with a $12 target. They say they believe increased automation within QT studies may be occurring, which threatens to lead to another leg down in pricing for the entire industry. Should we bail on ERES?”

Rich, it is true there are more pharmaceutical and biotech customers using semiautomated QT studies, which have a lower revenue per study, but the same profit margins as the Thorough studies. ERES is cutting costs by further automating the QT study process, and should be able to maintain profit margins. The key here is the huge number of drugs that have to have cardiac impact testing, as shown by eResearch’s explosive growth in orders and backlogs. Europe and Japan are piling on, too, so I think eResearch is still in the sweet spot and ERES remains a Top Buy when it is under $16 (as now) for my $30 target.

QLT (QLTI) said that global sales of Visudyne hit $40.7 million in the June quarter, up 11.5% from the March quarter and the first sequential quarterly increase since Avastin entered the market. U.S. sales dropped only 1.8% from last year. Sales outside the U.S. fell $37.7% year-over-year because Avastin entered that market later, but those declines will moderate over the next few quarters. We’ll hear more on the conference call, but the stage is set for some good combination therapy results, growing Visudyne sales and a much higher stock price.

ViroPharma (VPHM) finally announced their next big acquisition: Lev Pharmaceuticals (LEVP), an almost unknown Bulletin Board biotech that treats inflammatory diseases. LEVP has a drug, Cinryze, before the FDA for approval by October 14. On May 2, the Blood Products Advisory Committee voted unanimously that there is sufficient evidence of the safety and efficacy for the approval of Cinryze for the prophylactic treatment of hereditary angioedema (HAE), a rare genetic disorder that leads to episodes of severe swelling in the face and extremities. It can be fatal if it causes swelling in the larynx, and the current treatment is anabolic steroids first, but if that doesn’t work they punch a hole in the patient’s neck so they can breathe. About 10,000 people in the U.S. have HAE, although only 4,600 have been diagnosed, and Lev holds orphan drug status for Cinryze for both prophylactic (preventing an attack) and acute (treating an attack after it has started) indications.

ViroPharma is paying $442.9 million up front, approximately 82% in cash and 18% in stock. The deal is expected to close before the end of the year. There are two contingent payments of $87.3 million each, one if and when Cinryze is approved later on for acute HAE, and another if it achieves $600 million in sales by 2018.

The HAE market is roughly $250 million to $300 million in sales today, so that $600 million target is very interesting to me. ViroPharma’s management is expert at extracting value from drugs by expanding label indications and producing compelling data to convince physicians to use a drug and payers to reimburse for it.

VPHM stock immediately sold off 15%, supposedly because they have committed their cash to a company no one ever heard of. That’s ridiculous – they’ll still have over $230 million in cash after the deal closes. The only real issue is whether they will extract enough value from the drug to earn a great return on the investment, which brings us back to that $600 million annual sales target. Orphan drug status gives a company exclusive rights to a market for seven years, so even though there are competing drugs in other companies’ pipelines, it certainly looks like Cinryze will be first to market for preventive use. CSL Behring’s Berinert could be approved on September 6 for acute cases, beating Cinryze to market. But it could as easily be sent back for more data, giving ViroPharma a chance to get the Cinryze label expanded to include acute HAE. Both drugs have orphan status, and they might just split the acute market.

ViroPharma expects Cinryze to have a comparable price to other ultra-orphan drugs, in the $200,000 to $400,000 range. If it’s used by 25% of the 4,600 identified HAE patients and is priced at $300,000 annually, then it could bring nearly $350 million in annual sales pretty quickly. The total available market in the U.S. is 10,000 patients times $400,000 or $4 billion. They won’t hit that, of course, but the headroom is there for VPHM management to work their magic.

Cinryze sales will make up for any decline in Vancocin sales due to generic competition in 2009 and 2010. ViroPharma then has another drug, Camvia, coming to market in late 2010 or early 2011. Camvia treats cytomegalovirus in stem cell and liver transplant patients. ViroPharma management estimates peak sales of $400 million to $500 million for Camvia, but I think that is a very conservative estimate. It could easily be a $1 billion drug. Take advantage of the transient weakness in Top Buy-rated VPHM to load up under $12 for my $25 target. You certainly want to own this one before the October 14 FDA approval.

Content on Demand MegaShift

Telkonet (TKO) traded back under 50 cents a share, and subscriber J.R.H. asked: “What in the world is happening to TKO? Are you still looking for it to be at $1 by year’s end? Is it going to tank, go out of business, or be bought out? I appreciate your guidance, thanks!”

The company is doing well while the stock has too small a market capitalization to be doing anything. As for the rest of your questions: Yes, no, no, probably not. They are riding two MegaShifts, broadband access over powerlines, and intrabuilding energy monitoring and control. The wind is at their back in both markets, the company is well managed and they are driving towards positive cash flow. I hope it isn’t bought out, because the opportunity and management is there to build a big, successful company. Buy TKO all the way up to $5 for a $15 target.

New Energy Technology MegaShift

Holly Corp. (HOC) was hurt as oil prices climbed, squeezing the “crack spread” that determines a refinery’s profitability. Now that oil prices are dropping, the stock started to move up yesterday, trading over $30 during the day. If this works the way it was supposed to about 60 days ago, HOC should rally steadily from here as oil prices fall. HOC is a very timely buy up to $48 for my $70 target.

p>Eight years ago, on August 28, 2000, I made a fateful and wrong decision. The dotcom stock market bubble had scared me earlier in the year, and in February I had the model portfolio in my California Technology Stock Letter up to 85% in cash. After the big market break in April and May, I recommended putting some money to work. But in early July I realized Microsoft was going to miss the published estimates, so I wrote that in the newsletter and recommended raising more cash. The Wall Street Journal picked up my prediction, which caused a drop in Microsoft’s stock and resulted in an angry call from Microsoft Investor Relations saying that while my estimate was OK, the consensus range I had given the Journal was not accurate. I pointed out to them that was the consensus on Bloomberg at that very minute. A few hours later, the highest estimates on Bloomberg were suddenly revised lower–a very impressive display of power by the Microsoft IR folks.

When Microsoft reported, they hit the revised range, but then gave soft guidance for the September quarter, so the stock was clobbered anyway. It dragged the tech sector and the whole market back down for a couple of weeks, but then the market posted four straight weekly advances. Most of them were small, but by the end of the run the S&P was back over 1500 and nearly up to the all-time high.

As I sat down to write the last issue in August, to be published August 25, 2000, I added up the pluses and minuses. Tech stocks were not cheap, but business was booming. The fourth quarter is the best of the year for the broad market and for technology. It looked like a great holiday season for consumer technology products. The stocks had absorbed a big hit in April-May, and found strong support and fresh buyers to rally them back to the breakdown point. It was a Presidential election year, which usually meant the market would hold up well through the election into the New Year. I decided I had been too cautious in February, and recommended going fully invested by Labor Day to catch the next leg up.

Wrong.

The next week was up. But the week after Labor Day was down–and so were the five weeks following that. The market stabilized for a few weeks after that, until the election, and then tanked while the world focused on hanging chads and the Supreme Court picking a President. And after that, things really fell apart.

That’s when I started researching a better way to approach the broad market, one based on real statistics, with the goal of understanding the risk and reward at any point in time, rather than trying to predict the outcome. The old shibboleths work about half the time, and this year the “sell in May and go away” crowd may have something to crow about, as the first five weeks after the end of May were all downers. I say “may have” because they also tell you to buy back in during the usual October slaughter, so a big rally from here could take away everything they can claim to date.

So what are the risks and rewards right now, on the edge of another Presidential election cycle, after a sharp drop in the market? The 1265-1275 level on the S&P 500 has been a very powerful attractor/repeller level since the July 15 market turn from 1200. All three bear raids to drive stocks lower than 1265 have failed. Every bull run to break away has failed, most recently at 1302 on August 15. Today’s run puts us back in striking distance of a breakout over 1302, but we’ve been here before and failed.

So the risk is that the 1265-1275 level doesn’t hold up under a fourth bearish assault, and we head back down to 1200–a 7.5% drop. Of course, after a consolidation around 1200 there could be another drop to the next support level at 1100, set in August 2004, but that is an issue to deal with at the time.

The reward is to about 1380 right now. There is an important barrier at 1326 that would take a few days to get through, but 1380 is the reward equivalent of the drop to 1200. That is a 6.4% reward. From there, the attractor/repeller levels are at 1440 and 1555, the all-time high. But, again, that is an issue to be dealt with at the time.

While I still think the market will resolve this long period of consolidation to the upside, what I know is that between 1265 and 1302, the market is not telling us anything useful. It is just consolidating. So no one can tell you which direction the market is going to go next until the market itself tells us by either decisively breaking 1265 to the downside or 1302 to the upside.

That could happen next week, as the portfolio managers come back from the beach. The first few days after Labor Day will show their initial bias, bullish or bearish, and then if the other side cannot turn that tide, we’ll know what the major trend is.

If that trend turns out to be down, I expect the weakness to come from and be focused in the homebuilders, related retailers, the financials and possibly energy. The home mortgage resets will be about five times as bad in 2009 as they are in 2008, so there is good reason to anticipate weakness in these areas. On the other side, we should see strength in technology, exporters, materials, commodities and the like.

If the trend turns out to be up, it almost certainly will be led by technology and exporters, as the financials have a long way to go before they’re back on solid ground. So I think we are in the right sector, whether the next move is up or down, and we should know shortly which direction we’ll be dealing with.

Biotech MegaShift

Amgen (AMGN) finally got FDA approval for Nplate, their blood platelet booster for chronic immune thrombocytopenic purpura (ITP). ITP is an autoimmune disorder that results in low platelet counts, which can lead to serious bleeding events. There are 140,000 treated chronic ITP patients in the U.S. and Europe, and Nplate looks like another blockbuster billion-dollar drug. Nplate is the first drug that directly encourages platelet production by stimulating the patient’s bone marrow. Approval was delayed twice by the FDA, first in April and a second time in July.

In a strange bit of news yesterday, Amgen said they will no longer offer rebates to oncologists for their use of Aranesp. Critics said the rebates were causing overuse of the drug, so Amgen will instead offer up-front discounts to heavy users. But, guess what? The company undoubtedly will price things so their net revenue from Aranesp goes up. Thank you, critics!

And if you think Aranesp is “overused.” now, wait until you see what happens when the stupid new Medicare reimbursement rules run the blood supply down to zero. Doctors have been giving blood transfusions instead of using Aranesp, per Medicare’s instructions, and the blood situation is critical all over the country. In my backyard, the Red Cross Northern California Blood Services Region said just this Monday that several blood types, especially type O, are at extremely low levels. Red Cross currently has less than a one day supply of both O-negative and O-positive blood, and less than a two-day supply of all other types. Donations tend to slow in the summer, and people don’t donate right before a three-day weekend. Nearly half of the population has type O blood, and O negative blood is also the “universal donor” blood often used for emergencies.

Amgen already sells four of the top 10 best-selling biologics in the world, and their osteoporosis drug will make that five out of 10 after it is approved. The stock has been hitting new 52-week highs, but the short sellers are digging in their heels. I think they are about to be run over. The Amgen January 2010 $40 LEAP call (WAM AH) has run up sharply and I am moving it to a hold for my $35 target. The January 2009 $70 LEAP call (YAA AN) that we bought originally has come back to life, but I am also moving it to a hold until expiration. There probably is not enough time to get AMGN up to my original $90 target by mid-January, but it can get substantially higher from here and give us a better exit price for the 2009 LEAP.

Isolagen (ILE) announced another win for the Isolagen Process. This was a 40 person Phase II, open label (no placebo) trial to treat facial wrinkles and creases all over the face. Patients received two treatments approximately five weeks apart. About 83% of the patients and 75% of the independent dermatologists evaluating the results (they did not perform the treatments) found improvement in the appearance of wrinkles. But what was really interesting was that more that more than 90% of both patients and dermatologists saw a six-month improvement in skin quality: softness, suppleness, smoothness, firmness, thickness, moistness, evenness in appearance and refreshed appearance. I think the aging baby boomers will jump on this treatment as soon as it is approved for anything, and dermatologists will use it off-label. In my experience, dermatologists are like surgeons and they do pretty much whatever they want to. ILE remains a Top Buy up to $2 for my $9 target.

QLT (QLTI) continued their promised divestment and downsizing program, as this week they licensed their Atrigel sustained-release drug delivery technology to Reckitt Benckiser Pharmaceuticals for $25 million, plus up to $5 million in milestone payments. Reckitt also took on a facility in Fort Colllins, Colorado, and 18 employees. QLT has sold off $240 million in assets so far, including their acne gel Aczone to Allergan for $150 million. Still to go: QLT USA, and Eligard. That will let them focus on Visudyne.

What, Visudyne? The dead, old-news macular degeneration treatment? Yes, indeedy. In the June quarter, they saw the first significant sequential growth in Visudyne sales in three years, up 12%. Even better, a number of the combination clinical trials are coming to a conclusion, and I think they all will show that the proper way to treat macular degeneration is to use a course of Visudyne first, and then follow up with a round of the anti-VEGF drug of choice. Instead of “losing” to Lucentis, Visudyne+Lucentis is going to be the standard of care.

Obviously, Wall Street does not believe me. But the RADICAL combination Phase II trial of Visudyne followed by an anti-VEGF is on track to release six-month data results in the fourth quarter. Novartis has two ongoing combination studies with data coming in 2009. The MONTBLANC study is fully enrolled and 12-month data is expected in the first half of 2009. The DENALI study is almost fully enrolled, with results expected in the second half of 2009. QLTI can be bought all the way up to $6 for my $12 target.

China MegaShift

UTStarcom (UTSI) was named the #1 broadband infrastructure company in India by Voice & Data for the second year in a row. Voice & Data is the leading telecom publication in India, and they specifically commended UTSI for its direct impact on India’s telecom market growth. Not too shabby. UTSI remains a hold for my $10 target.

Content on Demand MegaShift

Motorola (MOT) is holding its third-place market share in the latest Gartner Group report on worldwide cell phone sales. Motorola had 10% of the market compared to 10.2% last year. Nokia still leads with 39.5% and Samsung kept second place with 15.2%. LG has 8.8%, up from 6.8% last year, and could pass MOT if we don’t see the iPhone competitor soon. Gartner reduced their growth rate forecast for industry sales this year by a couple of percent, but it’s up to MOT and new co-CEO Sanjay Jha to execute well and start growing its share again. Buy the Motorola January 2010 $10 LEAP call (WMA AB) up to $2 for my $7.50 target price, based on MOT stock getting to $17.50. I think we’ll see that price long before expiration.

Zhone Technologies (ZHNE) said the Board of Directors has approved a reverse stock split to keep their shares trading on the NASDAQ. They are recommending something between a 1-for-5 and a 1-for-10 split, and there will be a shareholder vote. I recommend voting no. I’m sure there is a reverse split somewhere that actually increased shareholder value, but I haven’t seen it yet. What usually happens is this: Zhone reverse splits 1-for-10, the stock goes from 35 cents to $3.50, it maybe gets up to $4, then they announce a poor quarter and it goes to $2.50. Happens almost every time.

They also made a confusing statement about repricing options to “the last reported sale price of the stock on the grant date.” Seems to me that’s where they are already, so I’ll wait for the proxy materials to see what they mean. For now, hold ZHNE for my $1 target, most likely in an acquisition.

New Energy Technology MegaShift

Canadian Solar (CSIQ), like all solar stocks, will continue to be volatile until the reimbursement rules are set in Germany and Spain, and it becomes clearer when the polysilicon shortage will end. LDK Solar said they were able to expand their wafer production ahead of schedule, and raised their 2009 revenue guidance to $2.8 billion to $3.0 billion. Analysts were expecting $2.43 billion. LDK also said they will increase capacity from 1.2 gigawatts at the end of 2008 to 2.2 gigawatts by the end of 2009 and 3.2 gigawatts by the end of 2010. There seem to be no issues about demand; it is all about supply of polysilicon and realized prices. Because Canadian Solar recycles their own polysilicon, they are less affected by wafer shortages and profit pressures.

Solarfun, another public Chinese solar stock, said they expect average selling prices to fall 5% to 10% in 2009. That knocked Solarfun’s stock down 8%, which is silly: A 5% to 10% drop would be the lowest annual drop in several years. The company also raised its 2008 revenue guidance and said they expect 50% growth in 2009, even including the price drops. It is vital that prices fall every year, because the industry needs to get from today’s $4 per watt down to around $2.50 or $2.00 per watt in order to drive a wholesale conversion to solar. It’s the old semiconductor story, where in the 1980s Wall Street would knock Intel down every time they cut microprocessor prices, simply because the Street did not understand a business model based on Moore’s Law.

I expect Canadian Solar to grow revenues this year by 220% to $965 million, and then double that in 2009. The stock would be cheap at 24.2X, and it is selling for that multiple on trailing 12 month earnings of $1.28. But they will report $2.70 this year, so it is selling for only 11.5X this year’s earnings. When you can buy such rapid revenue growth at such a low multiple, do it! CISQ remains a buy while it is under $31 for my $65 target next April, or possibly as early as the end of this year.

FuelCell Energy (FCEL) reported results last night and held their conference call this morning. It was a great quarter on the top line: Revenues increased 106% to $27.9 million, driven by a triple in product sales to $23.2 million. The company increased its manufacturing run rate to 30 megawatts a year in order to fulfill the backlog. Although the product cost-to-revenue ratio improved from last year to 1.68, that was worse than the March quarter due to a $2 million charge for a manufacturing defect in fuel cell stacks. However, management said they are on track to hit their 20% cost reduction target this year.

The company lost 39 cents a share, worse than last year’s 24 cents, in part because they are shipping more and still lose money on every box out the door. They burned $17.4 million in cash and have $104.4 million left on the balance sheet.

On August 15th, South Korea announced a plan to increase the country’s energy self-sufficiency to 50% from 5% by focusing on low-carbon green energy technologies like as fuel cells. Posco Power, FCEL’s South Korean partner, has ordered over 38 megawatts since the partnership began in 2007, and will have their 50 megawatt plant open in September. They plan to increase it to 100 megawatts by 2010. FCEL will deliver fuel cell modules to be incorporated into systems by Posco.

Next year should bring the company close to a positive gross margin, which will reduce the quarterly cash drain. FCEL remains a Top Buy up to $12 for my $22 target.

Gasco Energy (GSX) filed for a $250 million shelf offering that could be debt securities, preferred or common stock, or other securities. This does not mean they are going to sell stock now or at these low prices. It is just smart to get through the registration process and have it sitting on the shelf, ready to go if an opportunity or financing window comes along. GSX remains a buy up to $4.50 for my $9 target, probably as natural gas prices soar this winter.

USGeothermal (HTM) held their annual meeting and said the water-cooled Unit I power plant at Raft River is performing well during the hot summer conditions, generating between 9.5 megawatts and 10.5 megawatts with 99.9% operating availability for the past three months. The company has a new reservoir model and will drill in spring 2009 to increase fluid rates and bring the plant up to its 13 megawatt rated capacity.

vIn Nevada, the existing water-cooled San Emidio power plant is generating between 2.5 megawatts and 2.7 megawatts during the summer heat. They’ve started drilling on a well projected to go to 1,800 feet and support a new power plant planned to increase power production by an order of magnitude to 27 megawatts.

In Oregon, they are waiting for permits to drill three more wells at Neal Hot Springs to scope the potential size and production capability of the reservoir. I am pleased to see them making the transition to an operating company, solving the real-world problems that the wannabes don’t even know exist, and growing the company to multiple geothermal fields and power plants. Geothermal made sense at $40 oil; it coins money at $80 oil. HTM is a Top Buy up to $4 for my $6 target, which is nearly a triple from current levels.

Security MegaShift

American Science and Engineering (ASEI) booked the $22.2 million order I told you to expect for 22 Z Backscatter Vans, including operator training, spare parts, service and warranty. This adds to their whopping backlog, and the stock soared over my buy limit. For that reason only, I am taking it off the Top Buy list, but if a sudden market drop knocks it back, don’t hesitate to buy ASEI under $59 for my $93 target.

SiRF Technology (SIRF) dropped sharply Tuesday after a judge at the U.S. International Trade Commission (ITC) recommended that imports of some of SiRF’s GPS chips be banned. The ban would affect both the chips for personal navigation devices and cell phones, and the devices themselves, if they already include SiRF’s chips. All this is because Broadcom won an initial ruling from the ITC that SiRF violated six patents on global positioning systems.

The company immediately filed an appeal and, in a really interesting development, <>the ITC staff also filed a separate appeal. I haven’t seen that happen before. SiRF said they have “multiple ways” of dealing with a ban, even if one is imposed–which seems unlikely. The appeals will be heard in December, and then the final ITC ruling is subject to a sixty-day Presidential review period. After that, it can be appealed to the Federal Circuit Court of Appeals.

SiRF has more than 250 worldwide patents and more than 370 applications pending. The issued 250 patents include some of the early GPS patents that SiRF acquired when it bought Conexant’s GPS business in 2003 and Motorola’s GPS assets in 2005. I think Broadcom wants access to some of these patents and eventually there will be a cross-licensing agreement to settle the matter.

It is far more important for SiRF’s recovery that they introduce a combined processor/GPS chip at a price point that gives them high-volume design wins in the next round of consumer devices. I believe they have the technology to do that, and the acting CEO certainly knows how to manage engineers. But they still need the right permanent CEO and a successful processor/GPS chip to really get back on track. From these levels, there is little risk in giving them some time to execute their plan. I am lowering the buy limit on SIRF to $5 and the first recovery target to $12, which still makes it a very attractive speculation on a successful processor/GPS program.

WiMAX MegaShift

Airspan Networks (AIRN) supplied the equipment to Nth Air, which launched a WiMAX network in Denver in time for 5,000 delegates and 15,000 media people at the Democratic National Convention. The wireless broadband network was sold to Nth Air by an Airspan partner, Fujitsu Network Communications, and eliminated worries about potential bandwidth bottlenecks in existing wireless networks due to the influx of people. AIRN remains a hold for my $5 target.

Yesterday, the Fed said they would loan Fannie Mae (FNM) and Freddie Mac (FRE) as much money as they needed at 2.25%. Meanwhile, the Treasury Department will attach a provision to the current housing bailout bill being marked up by a joint committee of Congress that allows Treasury to buy common or preferred stock in the firms and increases each company’s Treasury credit line from $2.25 billion. The credit lines will probably go up one-hundredfold to $225 billion each.

Both Fannie and Freddie are overleveraged, and on any honest accounting have a negative net worth. But companies with a negative net worth do not have to file for bankruptcy as long as they can get the cash to pay their bills. The Fed loan facility makes it clear there will be no liquidity crisis at Fannie or Freddie. The Treasury equity investment program makes it clear there will be no solvency crisis, either.

Of course, it is in theory a terrible idea to lend even more money to an overleveraged company, because the act makes the balance sheet even worse. But by taking these three steps–a new Fed credit line, a Treasury equity line and an increased Treasury credit line–the government makes it clear that Freddie and Fannie are too big to fail, without having to explicitly guarantee their debt. That’s important, again in theory, because Fannie and Freddie have about $5.3 trillion in debt outstanding, which happens to be about half of all the mortgage debt in the country and is also roughly equal to the entire external debt of the federal government today. A formal guarantee would have doubled the taxpayer-backed debt overnight, with possible bad repercussions on the dollar. After yesterday’s action, it is clear to all that the implicit guarantee is real–no more denials, Secretary Paulson–but it doesn’t have to show on the government’s books.

At the bottom of bear markets, we often see these historic bailouts–Penn Central, Continental Illinois, Chrysler. Now you can add the Bear Stearns bailout, which created the first bottom in March, and the Fannie/Freddie bailout, which will create the second bottom today. This morning, Freddie Mac did a $3 billion short-term debt offering that was “surprisingly” well received. You can bet that over the weekend a lot of arms were twisted to bid in this auction to make sure it was “surprisingly” well received to calm the markets.

Where do we go from here? I expect my bank, Washington Mutual, to be taken over by the FDIC, along with National City and maybe one more. Bank of America, Wells Fargo and Citibank are too big to fail, but not Washington Mutual and National City. They may even let Lehman Brothers go under instead of finding a buyer, but that depends on how big their derivatives exposure is. Yet those will just be ripples on the pond, like IndyMac Bancorp last Friday after Senator Chuck Schumer brought it down almost single-handedly. Western civilization will not go into decline if Washington Mutual goes away.

Intel reports after the close tomorrow, kicking off what should be a series of earnings reports that meet or slightly beat expectations based on cautious guidance, followed by another round of continuing cautious guidance for the September quarter. The financial sector will report terrible earnings, but that is already in the market. So I don’t think earnings reports can derail a rally, and with over $4 trillion in cash on the sidelines, the VIX Fear & Greed Index well over 20 and sentiment indicators about as negative as they get, the market rally should begin. There’s some good news coming on the international front that should lower oil prices, which I will cover in this week’s Radar Report, and help keep the rally going. When the S&P gets up to 1440, we’ll find out if it can break through into a parabolic rally to new highs through next April, which is still my expectation, or if it will fail and spend many more months in the toilet.

Under either scenario, these companies and stocks (all below their buy limits) should do especially well based on their expected news flow and results:

	Friday Close	Target Price
Avian Flu
BioCryst (BCRX)	$2.69	$30
Crucell (CRXL)	$14.99	$35
Biotech
CombinatoRx (CRXX)	$3.41	$16
Dendreon (DNDN)	$4.83	$40
Electro-Optical Sciences (MELA)	$6.61	$12
QLT (QLTI)	$3.55	$12
Rochester Medical (ROCM)	$10.24	$40
ViroPharma (VPHM)	$11.94	$25
Content on Demand
Akamai (AKAM)	$31.18	$60
EMC 2010 LEAP (WUE AC)	$1.98	$11
Harmonic (HLIT)	$9.39	$18
Infinera (INFN)	$8.75	$30
Intel 2009 LEAP (NQAX)	$1.53	$12.50
QuickLogic (QUIK)	$1.58	$8
Silicon Image (SIMG)	$6.00	$16
Telkonet (TKO)	$0.45	$15
Nanotech & Materials
Harris & Harris (TINY)	$5.66	$10
New Energy Technology
Energy Focus (EFOI)	$1.90	$15
U.S. Geothermal (HTM)	$2.33	$6
Rentech (RTK)	$1.52	$8
Robotics
iRobot (IRBT)	$12.72	$30
Security
American Science & Engineering (ASEI)	$51.26	$93
WiMAX
Alvarion (ALVR)	$6.12	$17
TowerStream (TWER)	$1.18	$16

Other stocks either above their buy limits (eResearch, Amgen 2010 $40 LEAP calls) or with less news flow (Affymetrix (AFFX) and SiRF Technology (SIRF)) will do just fine in the rally I am expecting. While I expect a temporary $30 to $40 pullback in oil prices, which kept some of the New Energy Technology MegaShift stocks off this list for now, I think the commitment to alternative energy and oil sources is unstoppable at this point. I’ll have more on that in this week’s Radar Report so stay tuned for Thursday.

The very tough market environment continues, but at the risk of sounding like the boy who cried: “Wolf!” there was a sign of strength today that could be the harbinger of the next upleg. Back on March 17, the S&P 500 low was 1270, although the futures got as low as 1255 before the opening. I didn’t think the S&P would need to revisit that area before starting what is shaping up to be one of the sensational rallies of all time, but it did. On June 27 the Index dropped to 1272 and bounced a bit, indicating that support level might hold. But the continuing bad (and old) news from the financial sector negated that thought, and last Thursday, before the three-day holiday, the Index touched 1252 before rallying into the close. Again, it looked like that could mark a bottom.

Then this week’s rollercoaster ride occurred. Monday saw a stab down to 1240 before bouncing right back to 1252. Tuesday saw early weakness down to 1243 followed by a 31-point rally to a 1274 close. That breakout sucked in all the bulls, including me. Good job, Mr. Market! The bull trap snapped shut yesterday in a waterfall decline back to 1245, and on to this morning’s bottom at 1237 and afternoon retest at 1239. The S&P has now declined 20% from its October high of 1576, finally entering official bear market territory.

However, after Fed Chairman Bernanke and Treasury Secretary Paulson testified this morning, the S&P bounced back in a stair-step pattern. One day does not a rally make, but regaining 1253 by the close means this could be the actual double bottom I’ve been looking for. I want to see the S&P head back down briefly to test 1244 or even 1237, and then rally back over 1270 before I finally believe that we are truly off to the races. The opportunity for the bulls is there, and we will let the market tell us what to do.

Bernanke and Paulson Encourage the Market

What did Bernanke and Paulson say in this morning’s testimony to make the market feel better?

“It is clear that some institutions, if they fail, can have a systemic impact. For market discipline to effectively constrain risk, financial institutions must be allowed to fail.”

Like Bear Stearns, right? If it had been allowed to fail, the traders and top execs would have had to return a billion dollars of bonuses to the bankruptcy court. So much for market discipline.

“We want a strong dollar. A strong dollar is in our nation’s interest. We’re going through a tough period right now.”

Yes, a tough period that’s now lasted–what–10 years? Or do you want to go back to 1971, or even 1946? And if you think this is tough, wait until you announce that the U.S. taxpayer is going to pay for the subprime mortgage mess by guaranteeing agency debt.

You may remember Secretary Paulson last year reminding the markets that the government does not guarantee Fannie and Freddie’s debt, which caused major market drops. But yesterday, Fannie Mae had a terrible debt offering, with investors treating the AAA-rated two-year paper like it was five steps lower amid rumors of insolvency. William Poole, the former head of the Federal Reserve Bank of St. Louis, retired from the Fed in March and is even more outspoken now than he was before. He said yesterday that both Fannie Mae and Freddie Mac are insolvent, and that the government should acknowledge it. Of course, if the government did that, they would have to make their implicit guarantees explicit, putting the taxpayer on the hook for billions of dollars of real estate loans.

Would they do such a stupid thing to us? In a heartbeat! The agency bonds that Fannie and Freddie issue are held by most U.S. banks as a large part of their reserves. In 1998, there were about $3.5 trillion in U.S. Treasuries outstanding, and another $3.5 trillion in mortgage-backed agency debt. Today there are about $4.5 trillion in Treasuries outstanding, but after the real estate bubble, there is $9.5 trillion in agency debt. Many banks hold this paper in similar proportions.

Yesterday, the spread between agencies and Treasuries reached a 22-year high. But the banks can only hold them if they are rated AAA, which has them dependent on the implicit guarantee. (Neither Fannie nor Freddie has filed audited financials for the last few years, yet the SEC lets the stocks trade and the rating agencies maintain their top rating.) With traders now indicating that they have lost confidence in Freddie and Fannie’s balance sheets, the rating agencies will have to downgrade the debt unless the government makes the guarantee explicit. These are the “bond vigilantes” from the 1980s back in the saddle again, administering discipline to a government that in fiscal and monetary matters shows no discipline at all. If the agency debt is downgraded, banks will have to sell it to buy Treasuries that meet the standards for capital reserves. But there’s no one to sell to. Foreigners don’t want to buy dollar-denominated debt because they know in spite of Paulson’s posturing a declining dollar solves many of his and Bernanke’s problems. Plus, a lot of their institutions already hold tons of U.S. agency debt.

The Deutsche Bank analyst, who is also a former Freddie Mac executive, stated on a conference call yesterday that Freddie Mac (FRE) could go below $5. This information was given as the stock was falling 25%. It was down another 22% today to $8.00. As soon as the run starts on agency debt, a formal guarantee could come any day, which would spark an enormous equity rally in spite of a plunge in the dollar. If oil prices start down at the same time…well, you can see why I keep saying we could see a life-changing rally out of this mess.

I said last week that a drop through 1257 on a closing basis is likely to snowball into a fall to 1210 or even 1152. That risk is still on the table, so we need to see a close over 1280 to believe the rally is starting for real. In the meantime, June quarter earnings reports start next week, and most companies should hit their numbers but give cautious guidance due to the state of the domestic economy. Even in this quiet period, we’ve had some news.

Biotech MegaShift

Affymetrix (AFFX) was sued by MIT for patent infringement related to an expansion of the GeneChip technology. The patent regulators ruled in May that MIT was the first inventor on a patent application that Affymetrix filed in September 2004, and I am sure that the two have been talking about royalties ever since. This is just part of the negotiation strategy, and I expect it to be resolved with a licensing agreement that will not damage Affymetrix’ business. Obviously, MIT is more interested in getting royalties than damaging the source of the royalties. MIT and one of its professors own a company that holds the MIT patent, and it is entirely possible that Affymetrix will just buy it. AFFX remains a buy up to $15 for my $35 target by next April.

Amgen (AMGN) sells for 11X the 2008 consensus earnings estimate, and 10X 2009. Genentech sells for 22X the 2008 estimate and 19X 2009. Celgene is valued at 42X 2008 and 27X 2009. Amgen is expected to grow earnings 10% in 2009 and 10.4% longer term (five years). Genentech is expected to grow earnings 13% next year and 21% longer term. For Celgene, the 2009 earnings growth rate is 53%, and 41% long term.

I know of no reason why Amgen should grow at half the rate of Genentech and one-fourth the rate of Celgene over the next five years, when they all have major pipelines of new drugs, the same market and the same regulatory environment. To put it another way, AMGN’s stock discounts a very modest future, where surprises are likely to be to the upside. Celgene, however, discounts a rapid-growth future, where surprises are likely to be on the downside. It made sense to bring Amgen’s stock down once to lower the current earnings base due to lower sales of Epogen and Aranesp. It does not make sense to bring it down twice to reflect a lower growth rate, unless the denosumab osteoporosis data coming soon disappoints (it won’t). Buy the Amgen January 2010 $40 LEAP (WAM AH) under $10 with a $20 target.

ViroPharma (VPHM) has a July 23 date with the FDA Pharmaceutical Science and Clinical Pharmacology Advisory Committee that will review the steps a generic-drug maker would have to go through to get approval for generics of drugs similar to Vancocin. The Committee has emphasized this is not just about Vancocin, and there will be later hearings to cover specific drugs. Although VPHM fell when the FDA floated a rule to allow generics without human testing, it has become obvious that (1) the timetable for a Vancocin generic was not altered in any way, contrary to everything Wall Street was worried about, and (2) the path to a generic version of Vancocin is going to be much tougher than the Street or the generic companies expected. In light of the misperceptions the stock still languishes. In light of this meeting, I am making VPHM a Top Buy while it is under $12 for my $25 target.

Content on Demand

EMC (EMC) was nicked for $2 a share after their 86% holding in VMware (VMW) plunged following the replacement of the founding CEO, Diane Greene. She’s done a great job building the company with her husband, Mendel Rosenblum , the company’s cofounder and Chief Technology Officer. I expect he will bail shortly. EMC replaced her with the former #3 executive at Microsoft, Paul Maritz who retired in 2000 from Microsoft after 14 years at the company and started a small company that EMC bought. He brought Windows 95 and Windows XP to market, and certainly adds the kind of senior management that Wall Street usually likes to see. But the change was so abrupt that it rattled the Street. It doesn’t help that VMware also said their revenue growth this year would be “modestly” below their 50% guidance. VMW was down about 30% after the news.

A different viewpoint on the situation is that VMW is growing almost 50% in an environment where others can’t grow at all, and they’ve now replaced the entrepreneurial management with experienced senior management to take the company to the next level. I think that’s how Wall Street will view it after the dust settles. Microsoft is VMware’s main competitor, and Maritz knows exactly how they think. It’s hard to imagine someone better able to lead the company for the next few years. Continue to buy the EMC January 2010 LEAP call with a $15 strike price (WUE AC) up to $5 for an $11 target.

Intel (INTC) will be one of the first technology companies to report earnings after the close next Tuesday. I am looking for 25 cents a share on $9.2 billion to $9.3 billion in sales, with guidance for 32 cents to 36 cents on revenues of $9.8 billion to $10.3 billion in the September quarter. While the U.S. outlook will be murky, the Asian forecast will be quite strong.

Charles P. wrote that: “The INTC JAN 2009 LEAPS are becoming a worry for those of your subscribers who purchased them. INTC stock is under pressure and the LEAP is falling at an uncomfortable rate in sympathy. On top of this we have the time erosion factor. With all this going on the LEAP continues to stay on your TOP BUYS list. Please Michael; give us some comment on why you see this LEAP surviving.”

Charles, I understand your worry, as we are entering the period where time premium starts to disappear and the stock needs to move up quickly to hit my targets. Wall Street seems to think Intel is a big, inflexible company that can’t adapt quickly. Obviously, I think Wall Street is wrong. Intel’s CEO, Paul Otellini, has done a great job of revitalizing the product line while reducing costs, and I think some amazing things are coming in several areas: Pushing the X86 architecture into very low-power devices, integrating WiMAX and other broadband access protocols into the processor, as well as introducing phase-change memory. But the big driver short-term is when people get comfortable with the economy and stage a major stock market rally. Intel is viewed as a cyclical stock, and even with lingering problems (however well contained) in the financial sector, technology is the likely leader of the next upleg. When the institutions want more technology, Intel is one of the first stocks they buy.

An interesting insight into Intel’s reach: The FDA just passed Intel’s home-health care tools to enter human trials. The Intel Health Guide is a set of tools in a dedicated touchscreen computer.

The computer attaches to typical home healthcare devices like blood pressure monitors, glucose meters and scales. It then collects data and sends it via the Internet to doctors for monitoring. Intel thinks they can save the healthcare system a bundle by providing a system that lets people care for themselves at home in an effective, monitored way. They are targeting the diseases of aging in anticipation of the baby boomers’ age wave. This is just one example of the flexible, innovative company we own, and unless there is no rally, I still think the LEAPs will pay off. The Intel January 2009 LEAP (NQAX) calls with a $22.50 strike price remains a Top Buy under $6 for my target price of $12.50 when the stock hits $35 before expiration.

Telkonet (TKO) said they have installed their 200,000 wired hotel room, providing broadband access over the electrical power line (BPL). While they have an amazing opportunity to sell their energy management systems in this high energy cost environment, the original core BPL business is humming along. They are now in Choice Hotels, Destination Hotels & Resorts, Marcus Hotels & Resorts, AmericInns and Vantage Hospitality, among many others. TKO remains a Top Buy up to $5 (yes, almost 10X the current price) for my $15 target.

New Energy Technology MegaShift

Gasco Energy (GSX) said they had record gas production in the June quarter, hitting 1,300 million cubic feet equivalent, up 15.7% over last year’s June quarter. With gas prices so high thanks to the demand for summer air conditioning–man, it is hot here–they should report a great quarter. Buy GSX up to $4.50 for my $9 target.

Infinity Energy Resources (IFNY) got some great news on the Fourth of July when the Autonomous Region of the Southern Atlantic voted to approve Infinity’s offshore Nicaraguan exploration and development contracts. They will now buy some seismic data, maybe generate some of their own, and keep looking for partners for this potentially blockbuster leasehold. The stock is trading on the pink sheets at 40 cents a share, and remains a buy all the way up to $2 for a $7 first target based on the ultimate value of their Nicaraguan concession.

Robotics MegaShift

iRobot (IRBT) recently filed an 84-page patent for a robot lawnmower. The “Lawnba” filing covers an all-electric or a hybrid gas/electric mower in various configurations, from the Roomba disc shape to a pentagon, with two to five cutting heads. It uses optical and acoustic sensors to stay away from hard surfaces, water or barriers, and can sense uncut grass. The barrier methods include perimeter wires, solar-powered spikes GPS navigation as well as a radio beacon. RFID tags or proximity sensors keep it from running into pets and kids. Very cool! There are others already on the market, such as the perimeter-wire Robomower from Friendly Robotics, an Israeli company:

And the no-wire-needed Lawnbott LB1200:

But iRobot has the distribution channels, and if they can get in on the market for less than $1,000–what are all the teenagers going to do for summer work? The patent covers a recharging station that the Lawnba would return to on its own, an edge trimmer, a clippings bag that could be dumped at your compost bin, and a grass comber to fluff the grass prior to cutting. Maybe they can repurpose the Luge gutter cleaner to go after dandelion roots. IRBT is a buy up to $15 for my $30 target.

Security MegaShift

SiRF Technology (SIRF) has a fully diluted market capitalization around $135 million. The company’s stated book value is $490 million, and after subtracting out goodwill and other non-tangible assets, it is $197 million. They’ll do about $270 million in sales this year. So the stock sells for less than 70% of tangible book and 50% of revenues per share. It’s worth at least $10 per share today in a buyout, and $20 if they stay independent under a new CEO. For you value buyers, SIRF can be bought up to $8 for a $20 target with low risk.

WiMAX MegaShift

John T. asked: “Alvarion has moved down in the last 45 days from a high of about $9 to a trading range of $6.00 to $6.50. Is this a sign of weakness or a buying opportunity?”

Clearly this offers an excellent buying opportunity. Additionally, Alvarion (ALVR) just qualified for the U.S. Department of Agriculture Rural Utilities Service program and was granted “Buy American” status. These are required for operators requesting federal funds from the Rural Broadband Access Loan program to buy and deploying broadband systems in rural areas. Over the last six years, Rural Utilities Service has provided almost $6.5 billion in telecom grants, loans and loan guarantees for rural development. Alvarion’s BreezeMax is the first and only licensed WiMAX system they have accepted. ALVR is a Top Buy up to $11 for my $17 target.

* * * * *

Subscriber Daniel P. wrote: “I would like to get your view on financial stocks. Is it time to buy or sell?”

I spend a lot of time looking at companies and stocks that probably will never become recommendations, partly because they are important customers for technology companies, and partly because they have important implications for the whole market. That’s why I’m concerned that most investors don’t realize that General Motors (GM) and Ford (F) are going to file for bankruptcy. Most don’t know that a crucial portion of the U.S. banking system’s reserves are in agency debt from Fannie Mae and Freddie Mac. These things can blindside one’s portfolio.

I think it is too early to invest in financial stocks, but I do think a relief rally is coming as soon as Bernanke and Paulson bite the bullet and formally guarantee Freddie and Fannie’s debt. So there is a trade, or at least a better opportunity to sell financial stocks, coming up. I would rather own real growth companies in that kind of market, and use the bounce to sell financials and get into other things. I still think a bear market is coming starting around April of next year, and the Fed and Treasury are asking for tools to preside over the orderly liquidation of financial institutions that get in trouble. By this time next year, that will be most of them.

Incidentally, in the bank failures so far this year, the FDIC has paid out on their $100,000 per account insurance. But they have not paid for anything over $100,000, and some people and companies have lost millions. On a side note, when the Fed closes a bank, the ATM stops working and they don’t cash checks for sometimes four to six weeks. If you are not at one of the “too-big-to-fail” banks, be careful.

By the way, do you know the difference between a pigeon and a mortgage lender? The pigeon can still make a deposit on a BMW.

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.

We’ve had some interesting market activity in the past few days and I wanted to get in touch to let you know that we’ve hit a critical point in the market that you need to know about and adjust your portfolio accordingly.

Tuesday was a picture-perfect double bottom in the S&P 500, matching the mid-March low. The market not only undercut the crucial 1270 level early in the day, it rallied and then undercut it again all the way to 1260 around lunchtime on the East Coast. The money energy came flooding in at that level, and ran the index up 26 points to close just over 1286. A further move through 1292 today will set this pattern in concrete, and we ought to march pretty quickly back up to the 1326 breakdown point, and then on to the big resistance at 1440. From there we will either see the rally fail, possibly falling to new lows and a real bear market, or after a bit of consolidation more energy will flood in and the slingshot up to new highs will be on. We could see a 20% upturn in a month as the shorts cover, the put buyers panic and the $4 trillion in sideline cash tries to get into the game.

With all of our current economic problems, what on earth could drive this huge, possibly historic rally? The background is simple: Markets love to get everyone on the wrong side (bears short, bulls in cash) and then make a streaky move in the opposite direction. The nominal driver this time probably will be falling oil prices. The oil price charts have been in a parabolic upmove since September 2007, fulfilling the dictum that parabolic moves can go higher and last longer than anyone expects. But Dictum #2 is that they always end in a sharp drop, a rally back towards the highs, and then a serious drop into a consolidation period. Look at the recent drop in soybeans from $15.70 to $11.05, or in gold from $1,034 to $850. A 20% drop in just a few weeks is no big deal for a parabolic move like this. It happens all the time. Even if oil is going much, much higher over the next several years, as I suspect, it needs a consolidation period similar to what gold is going through now and equities have been going through for about a year. A quick drop back to the last big breakout level of $110 a barrel would put a lot of energy behind a stock market rally.

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. But I don’t think you’ll need it. Remember that this run should last into April 2009, as we proceed through the usual pre-election government spending, the Obama enthusiasm and the 90 day honeymoon period after his election. There will be bad news all along the way, but bears will be pushing the known problems that have not been able to take the S&P below 1270 yet. Right now, that looks like we’ve hit a market bottom for quite a while. Don’t miss the move to come. You should be fully invested, while staying alert for sudden weakness that drops the S&P back under 1270 for real. I’ll be in touch again if there are any further adjustments you need to make to your portfolio.