The 805 support level was tested six times before the bulls finally took control. Yesterday we saw the long-awaited breakout over the 850-860 range on the S&P 500, and today it proved to be another false breakout. A move over 850-860 that sticks for a few days should mark the beginning of a bigger move to at least 905-915. The December advance stopped at 915, and both the January 2008 and September 2008 rallies were stopped at their respective 60-day moving averages. Today’s 60-day moving average is 905. If 905 and 915 can be taken out, the 1015 to 1065 range comes into view. But today the S&P came back down to 850 to test it as a support level. It failed to hold, and unless this reverses immediately tomorrow or Monday without any further damage (making today a false breakdown as a bookend to Wednesday’s false breakout), yet another trip to test 805 is underway.

Investors are very confused these days by several big issues:

• Are we headed for more deflation or increasing inflation?
• With all the money the Fed is pouring into the economy, why is inflation so low?
• What will happen to stocks under deflation? Inflation?

Deflation or Inflation?

There have been a spate of books recently talking about deflation, and the drop in real estate prices, oil and other commodities and stocks makes it look like those authors could be right. Yes, the demographics of retiring baby boomers is a strong deflationary force that will be with us for many years. Yes, the credit collapse is not being dealt with effectively, and President Obama’s new stimulus package now winding its way through Congress is just more of the same failed top-down programs doomed to fail. Yes, the technology underlying the New Economy forces prices down every year — the very definition of inflation, if you don’t do any quality adjustments.

It’s obvious that the Fed is extremely concerned about deflation — and that’s why those authors who now seem right will turn out to be wrong. I saw a comment the other day that “the Fed can’t print money fast enough to prevent the collapse.”

Nonsense. The Fed doesn’t have to “print” any money, they can create it at the stroke of a pen, in any amounts necessary to stop deflation. And they will, because their fear of deflation has blinded them to any more sensible policy. The numbers are huge, and the outcome is inevitable.

In 1919 we had the World War I banking crisis, when $2.8 billion was borrowed from the Fed. It was almost completely paid back by 1923. Then, in the Crash of ’29, Fed borrowings ran up again to $1 billion. That was almost completely paid back by 1933, and there were zero borrowings from the Fed until World War II. During WWII, Fed borrowings ran up to $0.5 billion, then back to zero, and then up to $1.5 billion in 1951, during the Korean War. That was the peak until 1969.

During the Vietnam War, borrowings went over $1.5 billion in 1969 and peaked at $3.3 billion in 1974. Once again, the money was quickly repaid and borrowings were back to zero by the end of 1975.

But then came the savings and loan crisis, and borrowings hit $8 billion in 1986-1987. Most of this was repaid, but $1.5 billion remained on the Fed’s books. The pre-1969 peak was the floor for a while, but all the borrowings were repaid by 1990.

Alan Greenspan flooded the economy with money in the second half of 1999 in order to counterbalance any economic disruption from Y2K, and ran borrowings back up to $3.5 billion. When January 1, 2000 turned out to be a non-event, he quickly ran borrowings back down to zero. So, from 1919 to 2007, the maximum borrowing from the Fed during a war, crash or crisis was $8 billion during the savings and loan debacle, and the tie for second place was $3.5 billion during the Vietnam War and $3.5 billion for a once-in-a-century event, Y2K.

Then came Ben Bernanke. In December 2007, Bernanke took Fed borrowings up to an unprecedented $15.4 billion. In January 2008, he approximately tripled that to $45.7 billion. Here’s how the rest of the sad story plays out:

February 2008	$60.2 billion
March 2008	$94.5 billion
April 2008	$135.4 billion
May 2008	$155.8 billion
June 2008	$171.3 billion
July 2008	$165.7 billion
August 2008	$168.1 billion
September 2008	$290.1 billion
October 2008	$648.3 billion
November 2008	$698.7 billion
December 2008(e)	$800.0 billion
January 2009(e)	$900.0 billion
February 2009(e)	$1,200.0 billion
March 2009(e)	$1,500.0 billion

We are headed for a huge inflation. Here is the St. Louis Fed graph of the Adjusted Monetary Base:

So Where’s The Inflation?

There are two components to the impact of money on the economy: Growth in the money supply (above) and velocity of money, or how fast it moves through the economy (below):

Money is flowing from the Fed to the banks, and then it is not moving. Banks are hoarding it as excess reserves and not making loans. Instead, they are shoring up their balance sheets. Bernanke will continue to pump money into the banks, with the next wad being the “bad bank” concept that was rejected as an inferior idea a few months ago when then-Treasury Secretary Paulson decided TARP was a better idea.

The Fed will flood the banks with cash without requiring them to lend it out, because if they all started lending at once, inflation would take off like a rocket. Instead, the banks are borrowing money from the government at very low rates and from their depositors at somewhat higher rates, and not covering their costs. Traditionally, banks shoot for a two percentage point (200 basis point) spread over their cost of funds and lend out every penny they can. Now, because they are not lending, they can’t cover their overhead and quarterly expenses, and are running losses. Bernanke is betting the pressure will get to them one-by-one, and so they will start expanding their loan portfolios one-by-one, and velocity will pick up slowly enough to keep inflation at an acceptable level (4% to 6%).

I think he loses that bet. Bankers are herd animals, and if one starts lending and reporting growing profits, the others will be doing the same thing within weeks, if not days. The monetary base has doubled, so if the banks start lending, prices will double. That’s why I see hyperinflation coming, not continued deflation — at least until after the dollar collapses.

Speaking of which, newly-confirmed Treasury Secretary Timothy “Taxes are Voluntary” Geithner didn’t pick a fight with China in his recent Congressional testimony, as so many pundits claimed. China has been picking a fight with us, signaling that they don’t want to keep buying U.S. Treasury debt and may sell some to finance their domestic stimulus package. Geithner was just signaling back that if they start selling significant Treasury debt, we will muscle them into increasing the value of the yuan and blow up their attempt to stop the decline in their GDP.

(Yes, I know they said they are still growing at 6.8%, much slower than their previous double-digit growth. So if I believed them, I should have said “stop the slowdown in their rate of GDP growth.” But if I believed them, then I would have to believe in other things with more credibility, like the tooth fairy.)

What Will Happen To Stocks?

Stocks are assets — real assets, just like commodities or real estate. They are shares of corporations that have property, plant and equipment, products, patents, trained people, sales forces, distribution channels. In a deflation, assets go down in value. The dollar strengthens. It’s great for creditors that don’t own too many assets.

But in an inflation environment, assets go up in value. In a hyperinflation, they soar. I expect stocks to do just what they did in Germany after World War I, or in Argentina in the late 1980s and 1990s: Go up. In nominal terms, they will go up a lot. Even in real terms, adjusted for inflation, they should go up a little. Companies will keep paying dividends if their business is healthy, and their business will be healthy if they take advantage of the MegaShifts in demographics, the credit crunch and technology.

Which brings us to some more of our companies reporting earnings, and other generally good news.

Biotech MegaShift

Amgen (AMGN) reported a good quarter, although their guidance for 2009 revenues was a little light. The company did $3.75 billion in the quarter and grew pro forma earnings by 6% to $1.06 a share, both in line with consensus estimates. Aranesp sales fell 15% year-over-year to $706 million, below my $750 million estimate. But their anti-inflammatory Enbrel, which is partnered with Wyeth, booked a 7% increase to $913 million, above expectations for $894 million. Assuming Pfizer succeeds in taking over Wyeth, Amgen will have a much bigger marketing partner for Enbrel in 2010.

Epogen, the first-generation version of Aranesp that is mostly used in kidney dialysis, was up 1% to $646 million, where Wall Street was expecting a 1% decline. The white blood cell boosters Neupogen and Neulasta were up 6% to $1.12 billion.

Amgen’s 2009 guidance was for sales between $14.8 billion and $15.2 billion, below the consensus for $15.4 billion. But their earnings guidance of $4.55 to $4.75 per share bracketed the consensus for $4.68 a share, even though they will spend heavily to prepare for and launch their osteoporosis drug, denosumab. In truth, as was obvious from the questions on the conference call, it isn’t sales or earnings that will move this stock this year, it is the approval of denosumab in October and Phase III data on denosumab in cancer, due in the June quarter. Management said they are well along in partnering discussions for European sales for osteoporosis, and they are seeking priority review at the FDA for treatment of bone loss in men receiving hormone therapy for prostate cancer. That could get the drug on the market before October. Continue to hold the Amgen January 2010 $40 LEAP call (WAM AH) for my $35 target.

Geron (GERN) jumped over 60% in a couple of days on huge volume after the FDA finally approved the company’s Investigational New Drug application for treating spinal cord injuries with human embryonic stem cells. Last Friday’s approval followed the inauguration by less than 72 hours; President Obama had pledged to get rid of the Bush Administration’s regulations on using embryonic stem cells. Geron is not subject to the regulations because they don’t take Federal funding for stem cell research, but the FDA was lying low anyway. They might not have gotten away with it if Christopher Reeve was still alive.

Although the stock will give back some in the near term after hitting its highest price in almost two years, GERN is an obvious winner in the Obama era. The company has more patents, R&D spending and preclinical programs in stem cell research than anyone. This Phase I safety trial scheduled to start this summer is small — eight to 10 people — and will go quickly, so we should get results before year-end. The goal is to restore movement to paralyzed people by a single injection of nerve cells made from embryonic cells at the site of injury. Most spinal cord injuries don’t sever the cord, they bruise it, damaging the long fibers of nerve cells called axons. This damage stops the flow of electrical signals from the brain that control movement, resulting in paralysis. Geron has shown in 24 studies involving 1,977 rats and mice that stem cells help reconstitute myelin, a layer of insulating material that protects the axons. I am expecting the treatment to be safe, and the company to say they saw signs of efficacy.

GERN has over three years of cash on its balance sheet, which should be enough to get them through a Phase II trial of a couple of hundred patients. With more than 12,000 new spinal cord injury cases each year in the U.S. alone, accruing patients should not be a problem. CEO Tom Okarma said: “We are treating a desperate patient population that has no hope of any recovery whatsoever. If we see efficacy in these early studies, the excitement will be hard to overestimate. This will be fast- tracked, and I don’t think we’ll be needing thousands of patients.” Buy GERN up to $9 for my $18 first target.

Content on Demand MegaShift

EMC (EMC) reported an on-consensus fourth quarter, but said the outlook is so murky they could give no guidance for the March quarter or the 2009 year. While other tech companies have been saying the outlook is flattish and uncertain, EMC seemed to be forecasting something worse for the industry as a whole. The company said they expected to do better than the rest of the industry, and they expect the second half of the year to be better than the first half. Everyone is saying that, based on hope.

For the quarter, revenue rose 5% to a record $4.0 billion, a much slower rate of growth than earlier in the year. Annual sales rose 12% to $14.9 billion, just under EMC’s $15 billion target. They did 32 cents a share pro forma and before a restructuring charge, compared to their guidance for 30 cents to 31 cents.

On the conference call, management said that in the last downturn in 2001, when EMC got killed, they were pricing their hardware 50% to 100% higher than competitors. This time they are “very competitively priced” and don’t expect pressure for drastic price cuts. But they said IT managers are doing “just in time” spending, sitting on their budgets until they absolutely can’t wait any longer to buy more computing power, networking or storage.

The big near-term driver for the stock will come at an Analyst Day to be held between mid-February and mid-March, where management will disclose whether it intends to maintain its majority stake in VMware (VMW). We took a position in EMC in the belief they would spin off or sell their VMware stake, and I am convinced that the two companies are worth more as separate businesses than combined. The global recession has forced a decision, and I think it will be a tax-free spinoff to shareholders. VMW also reported earnings and forecast March quarter revenues below Wall Street’s estimate, and the stock is down about 20% from its January 8 high. It would be easier and just as effective for EMC to spin off their shares rather than sell them to a single buyer and pay out the proceeds in a special dividend. I think the two separate positions will total to $20 to $25 by next January, so continue to hold the EMC Jan 2010 $15 LEAP calls (WUE AC) for my $11 target. They are now under $1, but if we wait for the Analyst Day announcement we can take a lot of the risk out of buying additional calls.

Harmonic (HLIT) announced earnings after the close today, and I’ll be on the conference call shortly. They did $96.9 million, in sales, up 11% from last year and 20 cents a share pro forma, up from 19 cents last year. The consensus was looking for $93.2 million and 17 cents, so they beat on both metrics. In the press release they said revenues for the normally slow March quarter will be in a range of $72 to $78 million. The consensus was looking for $88.7 million, so the stock is down about 22 cents a share in aftermarket trading. Given that the March quarter is always slow and that HLIT management gives very conservative guidance, I don’t think this is all that important. If I hear anything different on the conference call I’ll send you a Flash Alert tomorrow. For now, HLIT remains a Top Buy up to $10 for my $18 target.

Infinera (INFN) also reported after the close, with non-GAAP revenues of $86.2 million and a pro forma loss of 10 cents a share. The consensus numbers were $75.5 million and a 10 cent loss, so there was no disappointment there. I’ll hear whatever guidance they give on their conference call later today, but I don’t expect anything radically different from the consensus for $75 million in sales and a nine cent per share loss. Again, you’ll get a Flash Alert if there’s any significant news. Buy INFN while it is under $10 for my $30 target.

Zhone Technologies (ZHNE) reported another poor quarter. They did $31.0 million in sales, down $1 million from the September quarter and down more than 33% from last year’s $46.6 million. Their GAAP loss was $4.7 million or three cents a share, better than the September results of a $6.5 million loss or four cents a share, but worse than last year’s $1.2 million loss or one cent a share.

Pro-forma EBITDA, the measure by which management chose to be measured, was a $4.5 million loss in the quarter, about the same as the $4.6 million loss in the September period. In the December 2007 quarter they produced breakeven pro forma EBITDA, a long-time goal. Unfortunately, it was a transient victory.

On the conference call, management said that until the economic environment improves, Zhone will continue to focus on the growth segments in access like integrated DSL, voice and video, while continuing to cut operating expenses and trying to improve gross profit margins by cutting manufacturing costs. Well, duh. That’s what everyone is trying to do, and what Zhone has been doing for the last several quarters. It isn’t working.

NASDAQ has given everyone a pass on being delisted if their stock trades persistently under $1, so Zhone has not had to implement their shareholder-approved reverse split. I really think the Board of Directors needs to take this company private or sell it. Continue to hold ZHNE for some sort of transaction.

New Energy Technology MegaShift

Cree (CREE) mat benefit from several provisions in the $819 billion Obama stimulus plan that just passed the House of Representatives. I expect some of the funding to be taken up by two House Appropriations Committee proposals, one for $31 billion “to modernize federal and other infrastructure with investments that lead to long-term energy cost savings,” and another for $16 billion “to repair public housing and make key energy efficiency retrofits.”

Cree is another Obama stock, and CREE remains a Top Buy while it is under $22 for my $50 target.

Suntech Power (STP) preannounced much better than expected revenues for the December quarter of $405 million to $420 million, far above the consensus for $358 million. The company pegged full-year 2008 sales at $1.91 billion to $1.93 billion, 4% better than their November reduced guidance and about 2% above the consensus.

Due to sharp drop in polysilicon prices, they are taking a $46 million to $58 million inventory wrtieoff, which will reduce their GAAP earnings to breakeven, plus or minus a penny. It is smart to take the hit in one quarter, rather than letting it pressure profit margins for the next couple of quarters. The company has eliminated 800 jobs and continues to reduce costs.

Not to be repetitious, but this is yet another Obama stock. It is pretty obvious that solar and windpower are going to be big winners in energy infrastructure spending. We’ll get more detials on the quarter when they report final results on February 18. I want you to buy STP up to $16 for my $40 target.

WiMAX MegaShift

Towerstream (TWER) has been trading up on some 10,000 and 20,000 share blocks, totaling over 150,000 shares on a couple of days this month. I think some small institution noticed that in spite of the recession, or maybe because of it, TWER announced they are making good progress towards their goal of being EBITDA positive in their existing markets this quarter. Managements that hit their marks in this environment get extra credit. There also may be an Obama effect, thinking that the new broadband initiatives in the stimulus package will benefit TWER. That remains to be seen, but eventually I expect the new administration to tackle rural broadband access for both individuals and businesses. I’ve used both Direcway and WildBlue to manage newsletters from rural areas, and I would be first in line for a Towerstream T-1 alternative. TWER is a Top Buy all the way up to $6 for my $16 target — a heck of a long way from $1, I know, but they will get there.

Orlando Money Show Schedule

I’ll be making two presentations at the Orlando Money Show next week:

• Friday, February 6: 1:40 PM to 2:25 PM “Tech Stocks: 12 to Buy, 2700 to Sell”
• Saturday, February 7 10:40 AM to 11:25 AM “Surviving The Great Inflation”

Website Changes

I’ll be overhauling and upgrading the NewWorldInvestor.com website starting this weekend, and there may be glitches or minor outages in the process, so I apologize in advance. I think you’ll like the result, which will let me communicate with you more frequently and answer questions of general interest during the week instead of waiting for the Radar Report. You’ll also be able to comment on things I write and discuss issues with other subscribers and me. Starting next week, I will be both publishing and editing New World Investor, and there won’t be any changes to your username, password, number of issues left on your subscription, access to archived issues, etc. There will be a lot more content and more frequent updates as we evolve towards a Web 2.0 model to continue this journey together.

Tuesday’s Inauguration Day meltdown in the S&P 500 looked like the end of the road for the bullish-consolidation-around-850 case, with the only chance of redemption being a strong rally on Wednesday right out of the box. And, of course, that’s exactly what we got. So Tuesday and Wednesday turned out to be just two more consolidation days in this volatile process. Today’s dip tested both Tuesday’s low and yesterday’s high, and while that does not support an immediately bullish case, it also is not enough to take the rally possibility off the table. I expect this consolidation to continue for a few more days, but with less and less volatility. Then we should either get the decisive breakout over 860, which would mark the beginning of a significant rally, or the decisive breakdown under 800 and a test of the 775 low that easily could fail.

Longer term, the weekly S&P chart is showing that all the sturm und drang since the October low has been nothing but a long consolidation. The good news is that I cannot find a single prior case where a drop of the July-October magnitude was followed by another weekly downtrend.

But it does sometimes take quite a while for the weekly chart to get any upside traction, and double or even triple bottoms are common. After the October 1987 Crash, it took a whole year before the weekly chart showed a meaningful uptrend. I don’t think it will take anywhere near that long this time, due to the $8+ trillion in cash on the sidelines, ready to come into the market. The S&P has absorbed so much bad news over the last three months that I believe a long, deep recession is already discounted. But investors want a sign that a recovery is beginning before they come back into the market, and we haven’t seen that yet.

I continue to see 2009 as a sector-picker’s market. Financials, durable goods like autos, retail and defense will not do well. Areas that benefit directly from Obama’s recovery initiatives, like infrastructure and alternative energy, will be fine. Technology companies that sell cost-saving or New Economy equipment and services will be fine.

Technology Leads

Which brings us back to yesterday’s rally. IBM set it off by delivering surprisingly strong earnings and guidance, due to growth in their services business. Hewlett-Packard probably will do the same, thanks to their acquisition of Electronic Data Systems. The money this year and for the foreseeable future is in helping companies lower costs and compete better in the New Economy.

I wrote last week about the three great deflationary forces loose in the world: The demographics of aging, retiring baby boomers in the U.S., the worldwide credit collapse, and the impact of technology in “flattening” the business world and bringing down costs and prices. A lot of the established companies are being blindsided by the New Economy, just as I and others predicted in the late 1990s. If an IBM, H-P or Omniture (OMTR) can help companies respond effectively, the corporate funding will be there to use their products and services. If an Akamai (AKAM) can dramatically improve the customer’s experience on a company’s website, or a Harmonic (HLIT) can provide the equipment to deliver voice, data and high-definition video to a cocooning consumer, or a QuickLogic (QUIK) can enable a manufacturer to introduce a new line of products with customer-specified features while providing a cell phone video experience that’s head-and-shoulders above the competition, their revenues will grow sharply in 2009. If a Towerstream (TWER) or Telkonet (TKO) can show a customer immediate cost savings with a fast payback and high ROI, they will win business away from established, slower-moving suppliers.

But aside from storage, where we own EMC (EMC) via a LEAP call, most technology hardware companies will have a tough time in 2009. Microsoft’s poor results announced after the close yesterday, following Intel’s poor results reported Tuesday, clearly show the personal computer sector is very weak. I don’t think cell phones will have a very good year, either, including the smart phone niche. PCs and cell phones account for about 45% of all semiconductor usage, so the chip companies also are in for a tough year.

My list of tech sectors that will do well doesn’t even get to the Avian Flu and Biotech MegaShifts, where the Obama Administration will be looking for better, cheaper and more effective health care for many more people as we move towards universal coverage. Or the New Energy Technology MegaShift, which President Obama has made a priority both for creating good new jobs and reducing emissions, while also reducing our dependence on foreign oil. It’s going to be a heck of a good year for many of our buy recommendations, and after the big rally I still see coming, we will sell those that are not going to do so well.

Biotech MegaShift

Rochester Medical (ROCM) settled their anti-competitive practices lawsuit with Covidien for a disappointing $3.5 million, of which $2.5 million will go to their lawyers. Earlier, they had settled with CR Bard for $49 million and with Premier Purchasing for $8.8 million. I was expecting more. However, Wall Street rarely pays up for one-time legal settlements, and the real driver for this stock is the dramatic change in Medicare reimbursement for intermittent catheters and to stop reimbursing hospitals for hospital-caused infections. ROCM remains a Top Buy up to $20 for my $40 target.

China MegaShift

Speaking of sectors not doing well, China is really falling apart. Exports fell in November and December for the first time in seven years — so much for the holiday season. Their December quarter GDP rose only 6.8%, down from steady double-digit growth rates over the last several years. The contagion is spreading across Asia, with Japanese exports down at a record 35% clip in December, South Korea saying they had a 3.4% GDP decline in the December quarter as exports collapsed, and Singapore warning their GDP could fall as much as 5% in 2009.

The myth that Asia can do OK even when the rest of the world slumps, or that Asian domestic demand and regional trade will sustain growth even without U.S. demand has been put to rest, just as I predicted. The Chinese government plan to spend $586 billion to increase GDP will have an impact eventually, but like so much of this downturn, by the time the solution has an impact, the problem will be much bigger than expected. Going from double-digit growth to low single-digit growth or even a GDP decline has a very leveraged, negative effect on any economy. Domestic demand will collapse even faster than exports, because inventories have to be dramatically reduced throughout the system, expansion plans put on hold, and employees laid off. Thousands of factories already have closed along China’s export-driven southeast coast, and upwards of two million workers laid off.

Our only direct exposure in the area is UTStarcom (UTSI), which we are holding for a potential buyout. If we don’t get a bid by late spring, we’ll take our loss and move on. For now, hold UTSI.

Content on Demand MegaShift

Akamai (AKAM) delivered streaming Internet video of the inauguration for many of the major news portals. The event set a record for them, with 7.7 million people watching video streams at the same time. On a normal day, there are rarely more than two million simultaneous viewers. The major news portals like Yahoo, CNN, MSNBC, AOL, the New York Times, ABC, CBS, Fox and the Washington Post all streamed the event, some with video embedded right on their home page for the first time. All went well and AKAM remains a Top Buy up to $20 for my $60 target.

Intel (INTC) reported last Thursday after the close, as your Radar Report was being posted to the web. I got the basic numbers into that issue: $8.2 billion in sales, down almost 20% sequentially from the September quarter, and four cents a share, both meeting guidance that had been lowered twice. On the conference call they said this was only the second time in 20 years that fourth-quarter revenues were below the third quarter, the last being in 2000 when revenues declined less than 1%.

They also said they are on track to introduce 32-nanometer process technology in the second half of 2009, and they will not slow down the introduction just because the economy is weak. That was music to my ears, as it means they will come out of this with tremendous cost and performance advantages over competitors like Advanced Micro Devices. I think AMD could be headed for bankruptcy.

But this week, in an internal Webcast for employees, management said Intel could report a loss for the March quarter, which would be the first quarterly loss in 22 years. Reportedly, in answer to a question, they said profitability is “too close to call.” They will lay off up to 6,000 workers as they consolidate and close five fabrication facilities, including their last Silicon Valley chip foundry — how’s that for marking the end of an era? I essentially learned how semiconductors are made by visiting Intel factories in the early 1970s (and also which semiconductor equipment stocks to buy or avoid).

In order to clear some inventory, this week the company cut processor prices. The popular Core 2 Quad Q9650 chip, used in desktop computers, went from $530 in December to $316, a 40% reduction. Other Core 2 Quad chips had 16% to 20% reductions. The Celeron 570 processor for laptops dropped 48% to $70. Intel will offset some of these price cuts with manufacturing cost reductions, as happens every year in the semiconductor industry. Still, it’s clear why the March quarter profitability is too close to call.

Our Intel 2009 $22.50 LEAP call (NQAX) expired worthless last Saturday, and I don’t think we should establish a new position in the stocks or the LEAPs until the PC market stabilizes.

New Energy Technology MegaShift

Since the dramatic two-week drop in solar stocks right after the election, Canadian Solar (CSIQ) is up 60% from its low and Suntech Power Holdings (STP) has gained over 75%. Money is flowing into the sector because it is an obvious beneficiary of whatever energy programs the Obama Administration proposes. Another direct beneficiary is going to be Cree (CREE), which reported a stellar quarter this week. During the Presidential campaign, Obama visited Cree’s facility for a meet-and-greet. I expect him to order a wholesale replacement of government incandescent and florescent lights by LED lights, beginning with the obvious parking garage and loading dock applications. He may even single out Cree by name — wouldn’t that be nice for the stock’s price?

Cree reported $147.6 million in sales for their December second quarter, up 24% from last year. However, that included a one-time licensing fee from Mitsubishi Chemical of $5.6 million, so on an apples-to-apples basis, the gain was more like 19.4% to $142.0 million. They earned 14 cents a share pro forma, not counting the five cents attributed to the licensing fee. On the same basis, the consensus was looking for only nine cents. On a GAAP basis, they earned seven cents excluding the fee.

Management forecast March quarter revenues in a range of $128 million to $135 million, with pro forma earnings of 10 cents to 13 cents a share. They expect the quarter to be sequentially lower due to weakening demand in consumer, mobile and automotive markets, which will be partially offset by growth in commercial lighting. Lighting is the reason we own Cree. During the quarter, they announced volume production of the LR24, which replaces the common fluorescent fixtures in suspended ceilings. That is the largest commercial lighting market in the world, and they have completed a showcase installation at the Federal Reserve Building in Washington, DC. During this quarter, the Pentagon will begin installing 4,200 LR24 fixtures as part of a major renovation. An Obama announcement of a government change to LED lighting might come with the first Pentagon installations.

Cree also announced high volume availability of the XLamp XP-E with 122 lumens per watt, the highest output in the industry. It is targeted at general outdoor and indoor lighting, as well as for retail displays. In their R&D lab, they hit an industry-best 161 lumens per watt. Cree has a history of moving ever-advancing technology quickly from the lab to production to high-volume availability.

On the conference call, several of the analysts seemed surprised that Cree is doing so well. I expect to see them increase their June 2009 fiscal year estimates from the current 42 cents and, especially, their June 2010 estimates from the preannouncement consensus of 52 cents. They are way low on 2010; I believe Cree will earn 75 cents or more next fiscal year regardless of the recession. That’s the kind of stock we’ll want to keep after the next rally plays out. With $360 million in cash and no debt, they are in excellent financial shape.

Light-emitting diodes (LEDs) have pretty much taken over the mobile phone display business, especially at the higher end. Laptop computers will be next, with LED displays replacing liquid crystal displays (LCDs) beginning in the second half of this year. Even though laptops will show little or no growth in 2009, the LED share of displays will be increasing from 0% and show good growth. At the same time, the LR24-type fluorescent fixture replacement market will start to grow in earnest in the second half of the year, if only from Obama’s Federal government initiative. The fourth driver of LED demand will be the conversion of LCD TVs to LED TVs. Look for the first, expensive products to be widely available for Christmas 2009, with explosive growth beginning in 2010.

Cree is not dirt-cheap, at around 25X my June 2010 estimate and about 19X my 2010 calendar year estimate of $1.00. But it will grow 20% to 25% a year each of the next five years, well above the 16% growth Wall Street expects, and is in an “Obama sector” that should be recession-proof. When money comes off the sidelines into the market, this is an easy story for the brokers to sell to the money managers. CREE remains a very timely Top Buy in spite of the recent price jump, all the way up to my $22 limit for a $50 target.

FuelCell Energy (FCEL) said the Connecticut Department of Public Utility Control has issued its draft decision approving 6.6 megawatts of projects based on FCEL’s Direct FuelCellpower plants. A final decision is scheduled for the end of January, and I expect it to be confirmed. FCEL remains a Top Buy up to $12 for my $22 target.

Connacher Oil & Gas (CLL.TO) said it resumed full output at Pod One of its Alberta oil sands project after six weeks of curtailment due to low prices. Connacher was the first major Canadian oil sands producer to reduce production when oil prices tumbled below $40 a barrel. They cut production in half to 5,000 barrels a day, and said they will reach full production again by the end of February. Returns on their extra-heavy crude have improved as the discount narrowed for oil sands-derived bitumen versus benchmark light oil, and the futures market for oil improved dramatically even though the spot market remains depressed. Connacher also suspended construction of Pod Two, and that remains on hold until they get more clarity on future oil prices.

The stock is below $1 only because investors think the recession will keep oil prices depressed for a long time. I strongly disagree. CLL.TO remains a buy all the way up to $4 for my $9 target.

Security MegaShift

American Science & Engineering (ASEI) announced a $67.1 million order from the U.S. government for ZBV Military Trailers, a ruggedized version of the Z Backscatter Van. It will be deployed for counterterrorism applications in harsh environments like Iraq and Afghanistan. ASEI is a buy only on dips back under $59 for my $93 target. Remember that they are about to announce earnings, and their quarter-to-quarter results are erratic. You may get one more chance to pick it up under the buy limit.

WiMAX MegaShift

Airspan (AIRN) said a preliminary review showed they shipped about $19 million in the December quarter, of which $17 million was WiMAX gear. That’s right between the two published estimates on the quarter of $18.0 million and $23.4 million, and below last year’s $23.8 million. It’s a disappointment. They did announce a $12.5 million expansion project win with Costa Rica’s main telecommunications operator, I.C.E., so at least they are still getting business.

However, the company also said they have $2.7 million in accounts receivable due from Nortel, which filed for bankruptcy on January 14. They will be lucky to collect 10 cents on the dollar. This could mark the end for AIRN, as they have been running the company on fumes with the financial markets so tight. With the stock down to 16 cents, we may as well continue to hold AIRN to see what happens. I am eliminating the target price.

LEAP Call Update

Two of our tech blue chip LEAP calls expired worthless last Saturday, showing that buying long-term call options into a generational bear market was a bad idea. We’ll take the following off the New World Investor website: Amgen January 2009 $70 LEAP call (YAA AN), and Intel 2009 $22.50 LEAP call (NQAX). We previously sold the Motorola January 2010 $10 LEAP call (WMA AB). I’m changing the recommendation on all the other 2010 LEAP calls to “Hold” for now, and we will sell them in the spring at higher prices than we are seeing today.

Yesterday’s market drop, based mostly on weak holiday retail sales (wow, what a surprise) and weak results at the banks (gee, Surprise #2) left the S&P 500 and Dow Jones Industrial Average down more than 9% in the last six trading days. In the first nine trading days of the year, the Dow fell 6.6%, the second worst start to any year ever. The worst start was 1978, when it fell 6.7% in the first nine days and finished down 3.2% for the year — less than half the opening salvo decline.

Also as of yesterday’s close, the S&P 500 had given up half of its gain since the 11-year closing low on November 20. I guess that’s Surprise #3 — a 50% retracement of an upswing. How often does that happen? (Answer: All the time.)

Although the talking heads are trying to put a negative spin on everything these days, because their job is to follow the trend and confirm what the viewer already believes, the truth is we are still consolidating the upturn, and we are still stuck in the broad 850 to 910 range on the S&P. However, we may finally be about to resolve this bull/bear impasse one way or another.

The current decline looks like just another fake-out to scare the bulls and embolden the bears, just as the Santa Claus rally turned out to be a fake-out in the other direction. Just as that rally briefly went over the 910 top of the range, this decline undercut 850, touched 810 this morning and then came right back up to 850, before selling off a bit. But my read is the downturn has exhausted itself in the near-term, and the S&P should not have much trouble getting back over 850.

It’s what happens after that that counts. If we see the recent drop consolidated by another trip up to the 910 area, the case for a multi-month rally to a Spring high remains intact. But if we see a sideways pattern in the 850 to 860 range, where the drop is consolidated by the passage of time instead of an increase in price, that will reveal a very weak market that is likely to break down well below 850. It’s still possible we’ll retest the November lows one more time before a meaningful rally can get underway, but that is the low-probability scenario, in my opinion.

Meanwhile, the latest Fed bubble continues unabated, with the yield on the 10-year Treasury note falling back to 2.2% and on the 30-year bond to 2.9%. There’s still no fear of inflation among bond buyers, in spite of the Fed’s unprecedented creation of money and credit. Due to the relative size of the markets, the Bond Bubble is bigger than the Dot Com Bubble and the Real Estate Bubble combined. The Fed has not only done it again, they’re still doing it and they are setting up the U.S. economy for the biggest destruction of real wealth in history. It won’t just be the professionals and pension funds that take the hit, either. The Treasury is counting on newly-conservative individual households to take up much of the new debt required to fund the trillion-dollar Federal deficits. Foreign holders of Treasurys have signaled they’ve had enough, with their interest income from already-pitifully low rates wiped out by the weakening dollar. So, sadly, our government is going to load down the taxpayer with huge amounts of new debt, sell the paper to individuals, and then let inflation destroy the value of their “conservative” investment portfolio.

I just drove across about a third of the country, from California to Boulder, Colorado. From Reno, there are only two major intermediate stops: Salt Lake City and Cheyenne. I had a good weather window, except for the 200 miles approaching Cheyenne, where three semis were flipped on their sides by blowing wind and snow, and one guy managed to roll both his car and his U-Haul trailer upside down in three feet of snow. It’s an amazingly empty part of the country, with most of the few radio stations being 50,000-watt monsters featuring syndicated programs. The financial advice programs were appalling. Almost all had some variation of “30% to 40% in bonds” as their base recommendation — this at the peak of a monster Bond Bubble! It sounds so conservative that I fear millions of investors will be sucked in to Treasurys at 2% to 3% yields, and lose their shirts over the next five years.

We shouldn’t enter our pending position in the Proshares UltraShort Lehman 20+ Year Treasury (TBT) quite yet, although it may have begun the bottoming process. Recall from the December 31 Radar Report that this exchange-traded fund moves twice as much as the iShares Barclays 20+ Year Treasury Bond (TLT) exchange-traded fund, but in the opposite direction. It will be an ideal way to profit from the popping of the Bond Bubble. I am hoping to pull the trigger soon.

After the close today, as this issue of your Radar Report goes up on the website, Intel will be holding their earnings conference call. They preannounced most of the numbers last week, and in today’s press release they confirmed $8.2 billion in sales for the December quarter, down 23% from last year, and said they earned only four cents per share. Whether or not this is considered a “good” conference call depends entirely on their tone and guidance. For the record, I am expecting a “bad” conference call and I think it is thoroughly discounted by the current stock price. In the press release, they said their new technologies and new products will help them ignite market growth and thrive when the economy recovers [emphasis added] . They gave no indication when they might see a recovery, and said that they would not give March quarter revenue guidance, while adding that internally they are using a further decline to $7 billion for planning purposes. This guidance-that-is-not-guidance is lower than the consensus expectations.

It’s reasonable to expect most of the upcoming conference calls to be just as bad, although we have many companies like Harmonic (HLIT) and QuickLogic (QUIK) that should buck the trend. Watch the reaction to the calls over two or three trading days. A stock that drops on bad news that everyone should already know often snaps back quickly over the subsequent trading day or two. That’s a “tell” for an oversold or sold-out stock.

Also remember that even during earnings season, there is other fundamental news on how our companies are progressing in this obviously tough environment. It’s important to keep an eye on real-world developments even when the stock market action seems to overwhelm them.

Biotech MegaShift

QLT (QLTI) lost their appeal in the Massachusetts Eye and Ear Infirmary patent case, related to prior art on Visudyne. The District Court had ordered a 3.01% royalty on all past and future sales. QLT estimates that will cost them $113.2 million plus interest and legal fees. Although the company says they are considering an appeal, I believe their best course of action is to accept the verdict and pay the relatively low royalty.

Visudyne sales are still falling. The company announced global sales in the December quarter fell 32.7% from last year. As usual, non-U.S. sales fell the most, down 36.3%, but even U.S. sales fell 20.0%. We won’t get more color on the quarter until the February 19 conference call. I want to know if the U.S. decline was a distributor stocking issue, or if there is some new factor in the mix. We are waiting for the Visudyne-Lucentis combination trial results to turn Visudyne sales back up. QLTI is a buy up to $4 for my $12 target after the combination macular degeneration trial results are published.

Content on Demand MegaShift

Motorola (MOT) said yesterday after the close that they had a terrible holiday season, selling only 19 million phones in the December quarter, down more than 50% from last year’s fourth quarter and well below the 25.4 million they sold in the September period. As a result, they will miss the consensus estimate for December quarter revenues of $7.5 billion, coming in at $7.0 billion to $7.2 billion.

Instead of accelerating R&D to fix their obvious product line problems as fast as possible, they announced another 4,000 job cuts, of which 3,000 are from the mobile division. Their new smartphones should have been out by now, but the company has cut employment so much that I don’t see how they can continue to be a full-line phone provider. At the Consumer Electronics Show in Las Vegas, Palm introduced a dramatically better smartphone, lifting themselves back into the ranks of front-line suppliers, with Apple and Research in Motion. Motorola’s schedule has slipped, they’ve postponed the spin-off I wanted to see to unlock the value in this situation, and now they are cutting muscle to save money just when they need to increase research productivity. I’ve been very disappointed with the direction the new CEO has taken the mobile division, and it is time to take our losses and sell the Motorola January 2010 $10 LEAP Call (WMAAB) . With the contract selling for less than 20 cents a share, you may be tempted to just tuck it away and see what happens a year from now. I don’t think it is worth the effort to keep up-to-date on the company, given the direction they’ve chosen, so I would just go ahead and take the loss.

New Energy Technology MegaShift

FuelCell Energy (FCEL) won a $30.2 million contract for the second phase of a Department of Energy research program to develop clean coal-based power plant technology. The company has until September 2010 to build a 25-kilowatt solid oxide fuel cell stack. The eventual goal is to develop megawatt-class power plants that operate on coal-based syngas. In the first phase of the program, FuelCell and their partner, Versa Power Systems, developed a solid oxide fuel cell prototype that met all the DOE specs. FCEL remains a Top Buy up to $12 for my $22 target.

Gasco Energy (GSX) said they had record quarterly and annual natural gas production from their Unita Basin wells, in spite of deliberately curtailing production for several weeks in order to stockpile gas for higher prices in the winter heating season. The current cold weather along the East Coast has lifted gas prices, and the company is back to full production.

Gasco management said they will revise their 2009 capital spending budget down to the point where they can fund it from internal resources. With all energy prices down, they think it is prudent to trim their expansion plans. I agree, although I expect oil prices to be climbing in the second half of the year. Buy GSX up to $3 for my $9 target as energy prices recover. At less than 50 cents a share today, the stock is a gift.

WMAX MegaShift

Towerstream (TWER) announced that the San Francisco market has achieved positive EBITDA (earnings before interest, taxes, depreciation and amortization — essentially, cash flow). That makes SF, Chicago, New York, Boston and Providence all positive, or five of their nine current markets. Management’s decision last year to curb expansion in favor of driving to positive cash flow is proving prescient, as the financial markets are closed to new, small companies. There won’t be any massive shareholder dilution here; the company will fund their future growth from cash flow. TWER remains a Top Buy up to $6 for my $16 target. At its current price under $1, it is one of the cheapest tech stocks I have ever seen.

Last Friday’s sharp S&P 500 rally to 934 set a new top for the short-term outlook, and the subsequent consolidation around that level followed by yesterday’s quick test back down to 905 was just as expected. We should see a sharp jump from the 905 energy level, with a close over 934 marking the next leg up to 1065 or so. This is all part of a larger pattern that can still get us to new highs this spring, although that has become a stretch goal. Wherever this rally tops out, I still expect the following move to be a very big downleg, probably bigger than the one we just went through.

Earnings season starts next week, and it is going to be bad. Intel (INTC) has been one of the last “things are not that bad” companies, so their negative preannouncement yesterday had more implications than for their own company. Intel said their December quarter came in around $8.2 billion in sales, well short of their prior guidance for $8.7 billion to $9.3 billion. That guidance was a reduction in November from their original $10.1 billion to $10.9 billion, so the quarter became progressively worse. At $8.2 billion, it will be down 20% from the September quarter and down 23% from the 2006 December quarter.

The company also said their gross profit margin will be at the low end of the 55% to 59% guidance range. That’s mostly due to the effect of lower volumes on overall manufacturing profitability, but some of may have come from price cutting to move out old inventory.

Intel remains the premier semiconductor company, but our January 2009 $22 50 LEAP Calls (NQAX) are going to expire worthless, and I don’t think we should replace them with the 2010 contract given the outlook for personal computer spending this year.

The immediate question is what Intel’s announcement might mean for other companies in the Content on Demand MegaShift. EMC (EMC) also pre-announced, but they said it was a good quarter: $4 billion in sales, up 4% from last year and meeting the consensus expectation for $3.96 billion. They’ll earn 23 to 24 cents a share pro forma, matching expectations.

In spite of being on target, the company is cutting their 33,000 person workforce by 2,400 in order to save about $350 million in 2009 and $500 million in 2010. The CEO and senior staff will also take pay cuts. These moves are being made even though they are driven by capital spending, not consumer spending, and capex will recover with a bang as soon as the economy recovers.

Due to the same tilt towards capital spending, there should be little or no impact of the weakness at Intel on Akamai (AKAM), QuickLogic (QUIK) or any other of my recommendations. The drivers for their businesses are not personal-computer based, and some such as Harmonic (HLIT) are likely to surprise to the upside. In general, I expect our companies to do substantially better than average during the January earnings season.

Avian Flu Megashift

Crucell (CRXL) is in talks with Wyeth to sell itself for about double the pre-announcement market value. At about $1.5 billion, CRXL would go for around $23 a share. Because they just turned profitable, that would be a disappointing valuation. Even though the stock jumped $4.43 yesterday, we would be better off in the long run if CRXL’s Board of Directors turns this deal down. It just does not fully reflect the real value of the company. I will keep you up to date on how the negotiations go, and give you a heads up and analysis on how to vote on any actual deal. With CRXL already up from its lows, I’m moving the stock to a hold while we watch this play out.

China MegaShift

The transformation of American and European banking has been remarkable and obvious. On the surface, little has changed in China. But instead of mergers and bank failures, Chinese banks are engaged in a “Great Leap Backward,” making uncollateralized loans to financially stressed borrowers at the direction of the government.

Even though most banks are state-owned, China had made substantial progress in cleaning up the bad loans made in the ’80s and ’90s. At some banks, 50% of the loans went bad. But then regulators began surprise inspections every so often. Bankers stopped making uncollateralized loans to any firm except for the largest corporations.

But now the global recession has slammed demand for Chinese manufactured products, and the commercial real estate market in and around Chinese cities has started to collapse. In November the central government announced a $586 billion, two-year stimulus package. At the same time, they ordered banks to approve loans for $14.7 billion in fixed asset investment before the end of 2008. There wasn’t even time to do proper due diligence, or in some cases even get the documentation done, but all the loans have been made. When you got your job from the Party and your alternative is being shot, you make the loan. In addition, the banks are expected to finance 75% of the stimulus package over the next two years.

But here’s the biggie. Local governments, which historically got the banks in trouble by ordering loans be made to their buddies, have announced another $2.9 trillion in stimulus projects, all to be financed by the banks. That is the Great Leap Backward. I think the depression in China will be deep enough and long enough to insure that all the money gets spent, with most of it wasted. The China Implosion is going to be long-lasting.

I continue to believe the new management team at UTStartcom (UTSI) is prettying up the balance sheet for a sale, and you should continue to hold UTSI for my $10 target.

Biotech MegaShift

SXC Health Solutions (SXCI) will be a major beneficiary of the Obama Administration’s work to fix the health care system. Pharmacy benefit managers are key players in lowering costs while increasing coverage and quality, the two difficult-to-reconcile goals of health care overhaul. The profit margin on generic drugs tends to be higher than on branded drugs, and pharmacy benefit managers will benefit as some of the most-prescribed drugs come off patent over the next few years. Lipitor (cholesterol), Plavix (heart attack), and Zyprexa (bipolar disorder) all come off patent in the next three years. Buy SXCI on any dips under $15 for my $30 target — the company is unaffected by the recession.

* * * * *

There’s been very little other news as companies hunker down during their “quiet periods” and get ready to report their December quarters (hard) and give March quarter guidance (harder). Even the annual Consumer Electronics Show in Las Vegas seems quieter this year. I expect next week’s Radar Report to be back up to full length as earnings season starts in earnest, and I continue to talk with you about expanding New World Investor to cover all the vital changes and opportunities that are coming over the next few years.