VECO

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Piper Jaffray analyst Ahmar Zaman took over coverage of VECO on July 15th, reducing the firm's rating on the stock and slashing both its price target and EPS estimates. He cited "uncertainties around order momentum" as the reason behind his actions. On the 15th and 16th of July, VECO shares lost $5, or approx 11% following Piper's downgrade.

With VECO's report yesterday, we see that the company is doing far better than Zaman expected, and its guidance negates any of Zaman's fears.

But were they really fears at all, or is something else going on?

Ask yourself the following questions...

Is Zaman completely and utterly inept after years of expensive education and office experience?

Can Zaman do the third grade math required to make the right call on the LED sector?

We happen to think that Piper Jaffray (and all other Wall Street firms) know the deal.

They want lower prices.

So is Zaman incapable of conquering third grade math, or did Piper want to pick up shares of VECO as cheaply as possible ahead of its earnings report?

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To answer this question, we need only to look into Piper Jaffray's recent past.

In 2005, Piper agreed to settle with the SEC, NASD, NYSE, NASAA and the New York Attorney General in a landmark securities fraud case in which Piper had released "biased research designed to benefit its own business."

If you google "piper jaffray fraud", you will be astonished at the sheer number of these incidents.

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So what should we believe happened this time? Should we believe analyst ratings? Should we follow financial "news"? Is it designed to help the retail investor? Are they just being good samaritans, pitying the little guy and lending him a helping hand?

Part of the purpose of this blog is to expose how Wall Street really works, and leave you to draw your own conclusions.

CREE

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CREE broke out from its multi-month consolidation, which bodes well for the LED sector, as well as for the broader market. This is not a guarantee that the market will begin a new leg up from here, but it is yet another sign that the bulls are coming on very strong in the tug-of-war for control of the market. Even though CREE is not near 52 week highs and is not posting the largest percentage gains of the stocks in the LED space, it still is the leader of the sector. What the leader does, the rest of the stocks in a sector will do.

Now that we're quickly closing in on LED earnings, (RBCN on Aug 5 & CREE on Aug 10), we're hoping to be blessed with some upside that allows us to exit all or part of our positions before the earnings are released. Lightening up on shares that rally ahead of earnings is a win-win situation. You make your profit and avoid the risk of an earnings miss. Only in rare occasions will you miss significant further upside. Over the course of an investing career, it is better to miss these rare upside moves than to repeatedly participate in 50% gaps to the downside.

APKT

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Acme Packet is a company that provides border control solutions. It was started in 1866 by Wassily Wassilyevich Kandinsky. They currently own and operate over 14,000 lookouts along the US-Mexico border and an additional 12 along the US-Canadian border.

Actually, none of this is true, but it really doesn't matter. All we see is a stock that is above an uptrending moving average, holding its own despite a weak broader market, trading within a trend channel, at all-time highs. Both its quarterly and annual earnings show steady growth.

On a pullback to the bottom of the channel (below 29), which could happen tomorrow morning, it may make for a good short term trade on the long side.

We don't have the same confidence in APKT for the intermediate term as we have with the LED sector, but for a quick trade it makes little difference.

RBCN's Channel

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Above we've posted a chart of RBCN now that its channel is becoming more clearly defined. We're using a 55 day moving average, because it best fits the chart. The fact that the average parallels the computer-generated linear regression line (shown in yellow) confirms the angle of the chart's ascent. It is at this point in a company's growth cycle (4 to 5 months in) where we start scaling into and out of our position based on the stock's position in its channel. With the stock at its neutral centerline, there is no reason to buy nor sell. If the stock drops to the green line, we add. If it rallies to the red line, we take some profits. In theory, when the stock is at the green line, you should have 100% of your intended position. This does not mean you should have no available cash. When the stock is at the yellow line, you should have half of your position. When it is at the red line, you should have no position. There are lines at the 25% and 75% marks as well, which we have not drawn. By scaling into and out of the position within the channel, one can increase profits and limit risk. We do not follow these rules verbatim. We like to maintain a 20% to 25% position in a strong stock even when it reaches the red line. Conversely, we only hold a 75% to 80% position when it corrects to the green line, allowing for intraday spikes below the line caused by the action of the broader market. However you choose to trade a stock, you should know that in most cases, it serves a trader well to coordinate their exposure with the stock's relative position in its channel, at least to some extent. We've many times sold entire positions in stocks blowing through the top of their channel, figuring we'll always be able to buy it back cheaper at some point in the near future. In over 90% of cases, this holds true. The top of RBCN's channel is at approx $37 right now. If it surged to $38 or $39 in the next few sessions, we would sell. Our money could be put to better use elsewhere while waiting for RBCN to come back to the yellow line, which it most likely soon would.

Crime Pays

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The chart above is that of Goldman Sachs, which is rallying in response to a settlement on its recent fraud case. Goldman Sachs was accused of defrauding investors out of $1B, although many sources believe the figures are a lot higher. In true SEC fashion, Goldman is being fined half that amount. It is yet another shining example of how crime pays, as long as it's white collar crime. Throughout its history, the SEC has allowed companies to profit from their crimes. An incentive for fraudulent practice? Only on Wall Street.

RBCN

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Ever wonder what would happen to the stock chart of a company whose top brass all liquidate their positions in unison, followed by a nearly 10% correction in the indexes in just 9 sessions?

The chart above is just that. RBCN is the perfect example of why you should listen to the chart and not the headlines.

We updated our performance on the left side of the blog today, and while we basically have the same amount of capital we had in mid June, the market has fallen approx 5% since then. We consider this a substantial gain for us, as all performance is judged relative to the indexes.

RBCN remains the relative strength leader in the LED space. There may be other companies with lower P/E's, higher EPS's, higher PS ratios, etc, but compared to the importance of relative strength, none of that matters. If you make your approach to investing as simple as Nick Darvas did, you will find that all of the information you need about a company is in its chart. Fundamentalists completely reject this thinking, preferring to live in an ivory tower of complex formulae and psychological theorem. Most of the strict fundamentalists that we know are no longer investing in the market. They just couldn't beat it on a consistent basis. Instead, they publish books on how to beat the stock market... go figure.

CREE

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Has there ever been a more perfect descending triangle than this one? CREE has held its $60 support level in a textbook way, while putting in lower highs over the past 3 months. Triple and quadruple bottoms never hold, so we have to bet on the odds and say that it's only a matter of time before CREE breaks support. We happen to own it, but are holding onto it anyway. We're looking to buy more CREE, as we feel it's quickly approaching fair value. The confluence of events (falling share price and rising EPS) are shortly going to meet head on.

If the broad market (Mr. Market) continues to fall, it may even give us a below value price on CREE! We'd be backing up the truck if that happened, in keeping with our theory that the LED's haven't seen their highs yet.

The quick math on CREE...

CREE's EPS is somewhere around $1.68, soon to be $1.93.

A fair P/E for CREE is approx 25, in line with its 20% annual growth rate

25 x $1.93 = $48.25

So if CREE drops another 12 points, we could quickly see a rush of buying that brings it back into the 60's in just one or two sessions. Whether you're a day trader, an intermediate term trader, or a long term investor, you should keep your eye on CREE because it may soon offer the trifecta...

1.) Growth

2.) Value

3.) Popularity

Company Growth Cycle

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The chart above is a random chart of a typical company's growth cycle. Unless you find the next AAPL or GOOG, you'll find that this cycle typically only takes about 2 to 3 years to run its course. The numbers on the chart do not correspond to the Stages (1,2,3 and 4) that we often mention when talking about what part of the growth cycle a chart is in. We just put them there to divide the chart into 3 phases to help explain what happens to the valuation of the stock as it makes its way through the cycle. All of the figures below are just a ballpark, and may vary widely from one specific stock to the next.

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In phase 1, a company hardly has a positive EPS. It may just be coming off of several negative quarters. Its market cap is low, and its volume may even be low. It's P/E, however, may be very high. This is the period when investors know that the company will be a huge success, but they aren't quite able to figure out just how large its potential really is. The stock may have an EPS of .17, but analysts are predicting that the company's EPS a year later will be anywhere from $1.10 to $1.45. Confident that the company will earn at least $1.10 during the next fiscal year, investors apply a P/E of 30 to this hypothetical future EPS, giving it a price tag of $40 or so. Of course a stock in this early stage with an EPS of .17 and a price of $40 appears to all of us to have a P/E of 235. This keeps all but the most daring of investors away, but it's actually a great time to discover the stock.

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In phase 2, enough time has passed that investors are better able to understand the size of the company's market, its competition, the potential for its technology, etc. At this point, the stock trades at a more reasonable valuation, as the future of the company begins to come into focus. Future earnings become more predictable. The company may be earning $1.50 a year, with prospects of earning $1.85 the following year. Its P/E may now be around 40, and it'll have a price tag of about $60. All of the math will now make sense, luring investors that seek a combination of growth and reasonable value.

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At the end of phase 2, when the stock hits about $75, something happens that makes investors realize that the earnings growth of the company is not sustainable. There are many reasons this may happen. The stock will start selling off strongly as investors start recalculating its valuation. During this phase, the stock is not only being valued with lower EPS forecasts, but a lower P/E as well. The company, currently posting an annual EPS of $1.80 may be forecast to make $1.95 the following year. Even though it is still growing, it will not be making the $2.20 investors had previously counted on. To make matters worse, its P/E now drops to 12 because it's expected that the company's annual growth rate will drop from 30% to about 10%. Consequently, the stock's price drops quickly to $23. From there, the company just becomes forgotten, and the stock slowly makes its way to 40 cents.

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This is what we can learn from the chart above...

-You should know that all of these realizations that investors have about a company come about 9 months before any of it is evidenced in the earnings reports or news reports.

-Ideally, you want to discover a stock when it's in the first phase. The P/E will seem outrageous during this phase, but the earnings will quickly catch up if investors are right about the company's prospects.

-If you find out about a stock during phase 2, you can still profit, but it's a more dangerous game. You must sell if the stock makes a simultaneous and decisive break of its trendline and moving average. This kind of explosive breakdown more often than not marks the start of phase 3.

-You should never fall in love with a stock. If you're one of the investors buying the stock after it enters phase 3 (thinking you're getting a great deal), you're in for a big suprise. When people say "buy low", they don't mean to buy a stock locked in a downtrend during a strong broader market. They mean buy a strong, uptrending stock during a selloff in the broader market.

-The time it takes for a stock to make its way through this entire cycle gets shorter and shorter with each generation. People do not have the attention span they had decades ago. Our guess is that all of the Ritalin-addicted kids today will soon control a market that completes this entire cycle in under a year's time.

-"Buy and hold" does not work. Unless you're lucky enough to find the next AAPL, holding a stock for the long term will destroy your portfolio, which leads us to a Snotism...

-All stocks eventually go to zero.

Relative Strength

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There are a myriad of ways to calculate relative strength. Many software packages have their own formulas for scanning through charts and assigning relative strength values to them. Investor's Business Daily (IBD, also short for inflammatory bowel disease) includes a figure for relative strength in its listings.

But you really are better off without all of the fancy formulas and calculations. Because we're honing in on just one or two hot sectors at a time, we find it far more reliable to just watch the top 5 stocks in the sector/s on a daily basis. This gives you a feel for the stocks, which you don't get by relying on relative strength figures.

Relative strength, in its purest form, is simply a comparison of a stock's performance relative to a baseline. The baseline should be diversified, so the indexes are used. A quick glance at a group of stock charts is all you need to pick the relative strength leader. Times of broad market weakness are not only the best times to compare relative strength, they're also the times when you'll do your buying. So while you may not like market corrections, they are an essential part of your success, and you should eagerly await them.

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We've posted 4 charts above. The first is our baseline, the Nasdaq. You could use any index for this, but we chose the Nasdaq because its moves have been textbook, from its nearly perfect S-curve to its nearly identical double bottom.

The S-curve started off this whole "Big Fat Greek and then some BP worst environmental disaster in U.S. history" correction. Once we were in it, we had no choice but to use it as a way to ferret out the highest relative strength LED issue.

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In chart #2, the chart of CREE, you'll see that CREE's bottoms roughly align with the bottoms of the Nasdaq. That is, they are all kind of in the same area. CREE's relative strength is flat. In other words, it is just mirroring the moves of the market, nothing less & nothing more. Of course it will move at a higher percentage than the index, but relative strength does not factor in percentages, it merely distinguishes between which stocks have buyers and which don't.

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The chart of VECO shows a stock with weak relative strength. Each low was lower than the last, despite the broader market being able to hold its bottom. Once our top holding, we sold VECO when its relative strength came into question. With Friday's performance, VECO is redeeming itself. We will only know in hindsight if VECO's severe correction was just a panic, or company-specific problems. Its fundamentals still appear strong, but we feel that we're better safe than sorry... where there's smoke there's fire. We may repurchase VECO at some point, but are still concerned that its weakness during the correction may be a window into some "behind the scenes" issues.

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The last chart is a chart of RBCN, which swept us off our feet during the correction. Each low was higher than the last. Charts that exhibit this kind of strength during periods of market weakness are the first to make new highs when the market turns around. They also most often do tremendously well during the subsequent bull run. The mechanics of it are simple... there are few sell orders during the months of the correction. For whatever reason, people want to hold this stock. So when buyers return to the market, the buy orders overwhelm what few sell orders exist, and the stock rallies strongly. The reason people don't want to sell this stock (or any other stock with high relative strength) is typically not known to the retail investor for several quarters. We are not privvy to the boardroom discussions, factory visits, wildly complex formulae, and other shenanigans that go into determining which companies are poised for explosive growth. Despite being left out of all of this, they do inadvertently give us a very valuable treasure map... the chart.

"Professional" Performance

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We feel like Andy Kaufman on the set of Saturday Night Live... "Do Latka, Do Latka!"

So here's your token chart of RBCN's breakout, complete with volume. Our guess is that as long as the market doesn't tank, RBCN will retrace a bit and then take off again.

But this post isn't about RBCN... it's about actual "professional" stock market performance.

The market has been flat over the past 10 years, trading at or about 10,450 in June 2000 and in June 2010. This makes it the perfect time frame to compare mutual fund performance, against an unchanged index. So here's what the "pros" have done with your money over the past decade...

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Vanguard Life Strategy Growth Fund

+ 1.48%

Vanguard Life Strategy Moderate Growth Fund

+2.75%

T. Rowe Price Growth Stock Fund

+.77%

T. Rowe Price Midcap Growth Fund

+5.94%

Fidelity Blue Chip Growth Fund

-1.84%

Goldman Sachs Capital Growth Fund

-2.20%

Goldman Sachs Strategic Growth Fund

-2.67%

Goldman Sachs Structured Large Cap Growth Fund

-5.29%

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So there you have it, a random sampling of growth fund performance over the past 10 years. Those burdened with the inclination of trusting the "professionals" to manage their money over the past 10 years have done exactly what the market has done, on average. These are the lucky ones. Others burdened with the same inclination found themselves invested with Bernie Madoff and similar cretins.

We don't have 10 year figures for our own performance, but using what we do have thusfar, we're up 17.9% over the past 2 years, for an average of approx 9% annually. If you believe it's not fair for us to compare our 2 year performance with their 10 year performance, you only need to look at what the market has done over the past two years. It's not flat as it was for their period. It's down about 17.5%.

So there you have it... the "pros" that haven't been caught are serving up flat returns and making huge fees for their "services". Those that have been caught are serving life.

Can anyone give us any good reason why someone would invest with the "pros"?

RBCN Breaks Out

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All of the relative strength (resistance to decline) that RBCN has been displaying over the past several months has proven to be an overwhelming force, exposing itself in an incredible breakout to new highs today. To say the least, these highs are coming long before the market posts its own new highs. The theory we have that relative strength is the most important indicator of a stock's intermediate term success has been shown to have real predictive value with RBCN's breakout.

We bought more RBCN this morning at just under 29, putting our portfolio at a point where we're just about 50% invested. There's no guarantee that the broader market has seen its lows yet, hence the other 50% we hold in cash.

For those of you thinking you've "missed" RBCN... think again! Today's action is a very strong signal of the health of the stock (and the company), and bodes very well for its near term (3-4 month) performance. If we did not already own RBCN, we would buy 25% of our intended position here on the breakout and wait for a pullback (approx 50% of the breakout's magnitude) to buy another 50%. The last 25% would be bought if the broader market corrects to new lows, pulling RBCN back below resistance.

We may still buy more on the pullback ourselves. Conversely, there is a point at which we'd sell some of our shares if the stock continues to rally strongly over the next 2 to 3 sessions. This is unlikely, but it does happen.

In almost every case we've seen where a stock breaks out to new highs strongly while the market is just beginning a turnaround from a correction, it has been just the beginning of a very impressive bull run for the stock. It should be noted, though, that the breakout is almost always met by a retracement which can be substantial, as momo traders buy and sell the breakout without any intention of holding for several months, or quarters, the way intermediate term investors do. This retracement of the breakout is often reversed very quickly, as would-be buyers see it as a second chance to get on a train they thought they had missed.

As long as the broader market doesn't sell off significantly, it's our guess that RBCN will rise steadily for the forseeable future.

RBCN

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RBCN looks as if it's inside an ascending triangle, perhaps at the top of a high-flying flag. We don't put much emphasis on recongnizing all of the several thousand various chart formations because people that do so lose credibility very quickly. There are really only a small handful of formations a chartist should be aware of, and the triangles are one of them. Even if you want to shy away from putting a fancy name on them, you should note when a chart is bound by resistance and support levels, particularly when either of the two are ascending or descending. These patterns are merely a map of current investor psychology (sentiment), which is why certain formations appear time and time again.

Right now, the chart of RBCN is telling us that each time the stock sells off, traders are hell bent on not missing the next bottom. So much so, that each bottom is higher than the last. In other words, they'd rather pay up for the shares than miss the train. Most ascending triangle patterns break to the upside. Not always, but most of the time this is the case. If RBCN shows signs of an imminent breakout, we may be buying more of it despite having to average up. This is because during this current period of great instability in the broader market, RBCN's performance has thusfar been unwavering. If everything we preach on this blog about relative strength is true, stocks like RBCN that resist the decline make the best investments when the market turns around.

Relative Strength

Any questions?

Tony Hayward

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BP CEO Tony Hayward:

"The overall environmental impact will be very, very modest."

"We will mount, as part of the aftermath, a very detailed environmental assessment."

_________________

Facts:

-The Exxon Valdez spilled 11M gallons of oil, contaminating 1,300 miles of Alaska's coastline.

-The BP Gulf of Mexico oil leak is estimated to have spilled anywhere from 20M to 175M gallons of oil thusfar.

-The coasts of Texas, Louisiana, Mississippi, Alabama and Florida are expected to be impacted by the disaster. This includes the Everglades, along with 7 other national parks.

-The BP Gulf of Mexico oil leak is already being called the worst in U.S. history.

Relative Strength

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The graph at the top shows the relative year-to-date (YTD) performance of the indexes and the LED stocks we've been following. The chart at the bottom shows how far off each stock is from its recent highs. While the indexes are basically flat for the year, the LED stocks are still way ahead of the game. This may be little consolation to those who bought in more recently.

Another thing can be deferred from these charts, and it happens to be the most important thing going ahead. One stock stands out as the clear leader in relative strength... RBCN.

RBCN has not only outperformed the others on a YTD basis, it has also fallen less than any of the others from recent highs. This is spectacular when you consider how contradictory this is. The stocks that do very well (have the highest momentum) usually correct the most. RBCN has managed to post impressive gains AND resist giving them back. This leads us to believe that the stock is in strong demand, and will emerge from this correction with explosive strength, posting tremendous gains over the next several quarters. It is our belief that smart money is flowing into RBCN, giving it its incredible resistance to decline. In an ideal world, we would now be blessed with a few sessions of capitulative selling which brings RBCN into the low 20's or high teens, at which point we could back up the truck. Opportunities like this are rare, but in a nutshell, they are what the other 70% of our portfolio is for.

This all takes great patience, but in time it will all make perfect sense.

VECO

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VECO & AIXG fell today, supposedly on "news" that Applied Materials and Samsung are going to enter the MOCVD market. We frankly don't care what the "news" is, or what it means to the company. All that matters to us is the chart and the earnings. The chart has been showing increasing signs of waning strength versus the other LED issues. We traded in almost 2/3rds of our VECO holdings for shares of CREE and RBCN yesterday based on this relative strength issue. We did not have advanced knowledge of today's impending "news". Approx 12% of our portfolio is still invested in VECO. So where do we go from here?

First we look at the chart. The chart is at a very critical point, resting on a fairly long term trend channel. This trend channel was reiterated by its moving average until its recent rally took it well above its normal trading range. So we don't have a moving average to rely on, but we do still have the channel. Either VECO will rally strongly from here, solidifying the support its channel has created, or it will break down hard. One of these outcomes could happen as early as tomorrow, or it may happen after the stock trades around this support area for some time.

Either way, our discipline is certain... we let go of stocks that break down hard and close at their lows (intraday spikes don't count, especially if brought on by a spike in the broader market). Regardless of what they do after decisively breaking down, we sell and never look back. We try to always look to the future rather than dwell on the past. Right now, until/unless they follow suit, CREE and RBCN look very strong relative to the market, and we will continue to buy them on dips instead of buying back into VECO.

The psychological aspect of this is as follows... stay focused on the goal. The goal is not to have made a good trade on an LED stock, namely VECO. The goal is to double the money you've invested in the LED sector during the craze before it's over... then find the next craze and do it again. Finding the stock that will make that happen is never easy. Nor is the discipline required to trade in a way that will make that goal a reality. Keeping your capital invested in the highest relative strength stocks in a strong sector is a sure way to beat the market. But you have to be flexible, and remain focused on what your bottom line will be in December, not what it will be next week.

We will continue to closely watch CREE and RBCN for signs of high relative strength, or waning strength, whatever the case may be. As for now, neither stock is disappointing on that level. Although both are off their highs, they are both higher than they were on April 1st, which cannot be said about VECO, MRVL, AIXG, or the indexes.

Relative Strength

Periods of market weakness are the best times to judge a stock's strength, especially relative to others in its sector. Yesterday, VECO was the relative strength winner in the group. Today, CREE and RBCN are coming on strong. One day does not make a trend, so we'll have to keep an eye on this race. We feel that relative strength is the single most important characteristic a stock can have, and that it is therefore the greatest predictor of future performance.

If CREE & RBCN continue to outpace VECO (not in gains but in strength relative to the market), we may just shift our position from VECO to a combination of the two. It's too early yet, but there's no doubt at this point that CREE, RBCN and VECO are far outpacing their weaker counterparts, AIXG and MRVL. Now with only three stocks in the running for "highest relative strength LED issue", it shouldn't be too hard to choose which will be the top dog during the market's next leg up.

VXX

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Some time ago, we predicted that the market would trade in a wide range for the next several years (something like 7,000 - 10,000). We still believe this, and given recent events, we believe that the market just put in the top of this range. Now to find out where the bottom will be!

We ran into two of our well-respected Wall Street hedgies this weekend and asked them both where they thought the market was headed. One is a long term thinker and his reply was, "over the next 4 to 5 years... much higher". He did not seem in the least bit concerned with what happens over the next few months. The other told us that he sees the market going much lower. He admitted, though, that he was on the wrong side of the trade during the market's recent upside. He said he's been a bear on the market for a long time, and continues to be. He suggested not choosing sides and instead trading the VIX.

Given that our chats were inconclusive (one bull and one bear), we have to rely on our own spidey sense. Our guess is that given everything the market is facing right now, it'll drop to about 8,000 or so (lows of last summer), to mark the low for its new trading range. But that's just another two days of trading, so why fret?

We probably should not be 33% invested at the moment, and we may trim that percentage a bit if the market rallies. Otherwise, we're just going to remain focused on the intermediate term (end of year), and use this time to increase our exposure in companies with great promise. We still stand firm on our belief that the LED stocks will double by year end from whatever lows they make during this correction. Perhaps CREE from 55 to 110, or VECO from 35 to 70, whichever it may be, that's too large a gain to miss out on. We still strongly believe that these stocks have not put in their tops just yet, and that belief is rooted in our theory that they will not top out until a few quarters (or a year) before their earnings growth tops out. Given the size of their market, we don't think they've reached that point yet.

That said, we're still not willing to pay up for these names. We want them cheap. If the market drops 800 points one of these days, we'll be buying, not selling.

Along with our focus on buying low, we're also going to take hedgie #2's advice and play with the VIX. For those unfamiliar with trading the VIX, you should know that you cannot but the VIX directly. Instead, there is an ETF called VXX which tracks it. The chart above is a chart of VXX.

After the market calms down for a few sessions, this index will drop. During market corrections, the VXX goes sideways in a broad range, making very rapid swings from its lows to its highs. This makes it a great trading vehicle. Buying VXX anywhere in the low 20's looks to us to be a sure winner over the next couple months, as we agree that market volatility is here to stay until at least the next quarter. Buying VXX in the low 20's (if possible), is perhaps the best insurance policy against a market crash. There is little downside, because for it to drop significantly, traders would have to reach a point of complacency. Given the events overseas, our own struggling economy, and the market's recent large gains, we just don't think traders are going on vacation anytime soon.

For better or worse, here's our prescription...

-Cash is King. (have at least 2/3rds of your portfolio in cash).

-Use this correction to get bargains on strong growth stocks that you plan to hold until year end.

-Hedge your portfolio with a bet on continued volatility by buying VXX on dips.

S&P & VECO

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The chart at the top is of the S&P index. The market has gone from one of "buy the dips" to one of "sell the rallies". If this is another healthy correction, then the S&P could retrace to approximately 1100. We believe this is just another healthy consolidation period for the market as opposed to anything more substantial. It's perfectly reasonable for the U.S. market to tread water for some time, given the uncertainty overseas. While we may see some dramatic 200 - 300 point one-day losses for the Dow, in our mind it's just treading water given the huge upside it's experienced lately. No doubt the next few weeks will offer some excellent buying opportunites. One thing we always remind ourselves during market corrections is that they are the best time to see relative strength, and that the strongest stocks will hit bottom long before the market itself. A strong stock could hit bottom next week, even though the market won't hit its lows for another month. This is often how investors miss the bottom, expecting that both the stocks on their wishlists and the market indexes will bottom out together. This isn't how it works. If you've chosen strong stocks, you should be starting to buy in very soon.

The lower chart is a chart of VECO. We're staying put with our position, although we know there may be more pain ahead. We're looking to buy more LED stocks in the days/weeks ahead. We'd like to get back into CREE, which we sold some time ago at around $76. We still feel it's overvalued, and will remain stubborn about not paying up for these shares. Stocks with low EPS's (high P/E's), such as RBCN and MRVL, are getting hit particularly hard because during corrections, stocks revert to fair valuations based not on forward earnings, but on current earnings. In this regard, we feel VECO is a bit of a safe haven, and any undue selling pressure will present a buying opportunity. We may be wrong on VECO, but we don't have enough reason to turn against it at the moment. With a P/E of 15, there's no reason for us to sell into weakness.
The only other trade we're considering is one in the Ultrashort indexes, like SDS, QID, or DXD. We are not looking to start this position at the market's current level, but if the market rallies strongly, we'll have to assume that it's a bear trap and buy into one of these. The current market downturn is not likely to end quickly, as macro-economic uncertainty such as what's happening overseas takes many quarters to work its way through. There is no reason, however, for the U.S. market to trade in sync with the overseas markets. The U.S. will likely pull out of the downturn quicker, with our strongest sectors eventually rallying so quickly that anyone not invested will have a very tough time getting in. It is our belief that the LED stocks will roughly double by year end from their Spring lows. These lows, whatever they may turn out to be, will be put in sooner than most traders expect.

Our Take On VECO

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It always amazes us how little patience some investors have. If you read the message boards, you'd think VECO is going out of business. What's wrong with a stock, or an entire sector for that matter, correcting after months of phenomenal gains? In our view, absolutely nothing. Volatility goes hand-in-hand with growth stocks. As long as a chart stays above its uptrending moving average and hasn't broken down below the bottom of its trend channel, then we really don't care what it does above those lines.

We see VECO as a company poised to experience significant growth through some time in 2012. If we didn't already own it, we would have bought some today. We fully accept that at some point these LED stocks will reach a plateau where their future growth is calculable, and that will end their 15 minutes of fame. But until you personally buy your first LED bulb, don't worry about the LED craze being over. It's already a foregone conclusion (not to mention a government mandate) that every lightbulb in the world will be changing over the next 4 years. It isn't until you're in some random deli overhearing people talk about LED stocks that you should fear their run being over.

The big-picture thinkers, like Peter Lynch, suggest that you should never look at charts with intervals of less than 5 days. That is, charts where each bar represents a week of trading. The logic behind this is that it keeps you focused on the longer term picture, where blips like this are hardly visible.

Buffett would tell you that if you liked the stock yesterday at $54, then you should love it today at $47. How true that is.

Let's stay focused on the big picture and not let the short-term thinkers and window dressers distract us.

VECO

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(This post has been updated to reflect VECO's latest guidance)

Time to re-evaluate VECO. The chart shows that it is either well above the top of its channel, or it has simply started a new channel. This is an arithmetic chart, so "going parabolic" is not unusual for the strongest growth stocks. It's when a stock goes parabolic on a logarithmic chart that you need to run for the hills. Going solely by the channel and moving average, VECO is overbought and ripe for a correction. It is only an immediate cause for concern if its fundamentals tell us the same thing, so let's take a fresh look at them...

Over the past four quarters, VECO has posted earnings of

-.15, .16, .41 & .49, for a current EPS of 91 cents. Next quarter, VECO projects to report earnings of 78 to 90 cents per share, well above the 59 cents previously expected by analysts. For the purpose of our calculations, we're going to assume VECO will report 85 cents per share next quarter.

No one really knows how well the LED companies will do, as the number of lightbulbs in the world is an incalculable figure. History has proven, though, that during their most aggressive growth phase, companies grow by approximately 20% to 30% annually for about 5 years at a time. Beyond that, growth at that rate is unsustainable. We therefore typically use 25% as our estimate for a company's EPS growth, so as not to get caught up in a Dutch Tulip bubble.

This number should be scaled up or down depending on the size of the company. For a company VECO's size, an estimate of 25% to 30% is acceptable. As an example, we might use 20% to 25% for a company the size of CREE, and 15% to 20% for a company the size of AAPL.

This estimate yields a P/E for VECO of 30 to 36, using a PEG ratio of 1.2. As we've said before, Buffett supports the use of a PEG ratio of 1.2, so who are we to play with that number?

Using VECO's current EPS, it should be trading anywhere between $27 and $33. If we had a broad market correction right now, this may be where VECO would retrace to. And it would be a steal at that. But who goes by current EPS figures?

Looking out 3 months, VECO's projected EPS ($1.91) suggests it will be worth anywhere from $57 to $69. Even if we go with a more conservative growth rate like 20%, we'd be looking for VECO to be priced at around $48. So we don't feel that there is a lot of downside in holding VECO here, despite how "nosebleed" the chart appears.

Looking out two quarters, the 15 cent quarter will be replaced perhaps by another 85 cent quarter, giving VECO an EPS of $2.61. At that time, VECO could be trading at around $80 per share.... maybe even higher if the market is surging at that time.

Our approach going forward is going to be to hold VECO and add on dips. Of course there is a number at which we would sell, but as long as it stays below $60 or so, we won't even be considering it.

In another note, we continue to believe that the market is blowing off and about to retrace significantly enough to give us good entry points on just about every issue.

CREE

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CREE is taking a small hit today after beating expectations. How many think it's going down because people expected better results? How many think it's going down because it was at the top of the channel? Of course we believe the latter, but it's just a difference in philosophy with no change to the actual outcome (the bottom line). We believe that if CREE had dropped to the bottom of the channel in the days or weeks heading up to the earnings report, it would have soared upon its release. So then is it good news or bad? Like all stock market news, it's neither. It just depends on where the market is when it's released. But we digress.

The point of this post is that we sold CREE a short time ago at 76 something, saying that there's little risk in selling near the top of a channel. Although we didn't catch the very top (you rarely will), we didn't exactly get locked out of the stock either. While it's tempting to buy back into CREE based on it having a bit more strength than we had anticipated, we still feel it's richly valued. We're no stranger to paying up for growth, but we'd rather wait for a really bad day in the broader market and steal the shares from someone standing on their window ledge. You're not getting a bargain buying CREE 6 points off its high.

Blowoff

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The chart above is a chart of the Nasdaq, although the S&P and Dow look similar. We're not sure if we've ever posted about the S-curve blowoff in the past, but it should become a familiar pattern for readers of this blog. We've seen this pattern many times, and it always marks a top (at least a short term one). The trouble is finding the exact top, because the last few days of upside on this pattern can be explosive, leading to excellent gains. The general rule of thumb is that an S-curve has a centerpoint, and its lower half roughly equals its upper half. Using this concept, the market has a bit further to climb before it rapidly returns to earth. When it returns, it will typically go to the 3/4 mark, or halfway mark of the S-curve.

We sold CREE a bit early, and are suprised by its continued strength. We cannot, however, justify its valuation, and therefore feel safer invested in VECO at the moment. If the market is experiencing the kind of blowoff rally we believe it's in right now, we'll be picking up more shares of VECO when it retraces. Although a quick buck may be able to be made by buying into the current hype, it's a dangerous game and will typically end in a loss when the dust settles. Euphoria has set in to the market, but will only last a short time. We feel that now is a time to be cautious. Not fearful, but cautious. Others are getting greedy, and markets that run on greed are always short-lived.

LED Valuations

We've had a great run in the LED stocks recently, and that calls for a fresh look at the numbers to see how they're currently valued, and where they may be headed. Let's put aside the events of the past couple months and focus on the only question that matters now... "Would we buy these stocks if we just discovered them today?"
First, we have to estimate their growth potential and earnings growth timeline. From this standpoint, the LED stocks are still attractive. People have not yet even started to buy these products, and government regulations are soon going to force people to do so... worldwide. This suggests that the LED stocks still have a way to go. But what do the numbers tell us?
Going on the assumption that the actual earnings growth peak for these companies will occur when people first start buying these items in quantity, it suggests that these companies may not hit the top of their growth cycle for another 2 years or so. This means the stocks will hit their peaks in about 15 to 18 months (6 to 9 months before the earnings growth tops out).
Being conservative, the LED companies can be expected to grow approximately 20% to 25% a year over the next 3 to 5 years. This gives them fair P/E's of somewhere between 25 to 30.

VECO
Current EPS= -.22 -.15 + .16 + .41 = .20
Current P/E= 47/.20= 235
EPS in 3 mos= .16 + .41 + .46 + .54 = 1.57
P/E in 3 mos= 47/1.57= 30

CREE
Current EPS= .13 + .18 + .30 + .38 = .99
Current P/E= 77/.99= 78
EPS in 3 mos= .30 + .38 + .43 + .46 = 1.57
P/E in 3 mos= 77/1.57= 49

The above numbers show that while their current EPS's suggest that these stocks are way overvalued, a very different picture will emerge just a few months out. These numbers also suggest that CREE is about 65% more expensive than VECO. This makes sense, seeing as how the 800lb gorilla always attracts the most investors, and therefore carries the highest valuation.
It is our opinion that CREE is overpriced at $77 considering that if it stayed at its current price, it's P/E would be 30 in approx 9 months. That means that it will go sideways for the next 6 months or so before it has room to move higher. Don't believe it? Watch. It may go higher and then drop, or lower and then rally, or just go sideways. Either way, you'll be able to buy CREE at $77 again later this summer or in the Fall. There's no rush to jump in at its current price.
VECO, on the other hand, will have a P/E of 30 in just 3 months if it stays at its current price of $47. We would buy VECO here if we were just discovering it today. Even better if it corrects into the low 40's. The closer we can buy it near a P/E of 30, the better off we'll be in the long run. We're currently looking for an entry point for VECO, and to a lesser extent a re-entry point into CREE.
So where will these stocks top out? There are too many variables involved to give an answer to this question. And truth be told, nobody knows. But from where we stand now, the numbers suggest that at their peak, CREE and VECO could both be trading at approximately $100.
(assuming a P/E of 40 and an EPS of $2.50) It won't be long after their EPS's reach about $2.50 that widespread talk of lower margins, cheaper LED's, expiring patents, newer products, etc, will cause these stocks to put in a top.
If you want to really prepare for the LED craze, we suggest that you get yourselves margin accounts. When these stocks top out, they are going to fall very hard. Any company making products that can easily be duplicated cheaper in Singapore will crash in the end. This isn't a Google where the brand is irreplaceable. This is cut-throat competition for cheaper prices.
When these stocks begin their fall from grace, we will immediately discontinue our love affair with them and reverse course. The LED stocks will be headed to zero like all other stocks. But until then, let's enjoy the ride to $100 by setting up sniper posts and picking off a few shares here and there on those days when people just sell with passion for no reason whatsoever.

Chart of CREE

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Snot sells CREE

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We sold all of our shares of CREE this morning, after a UBS upgrade put the stock up 7 points. We have nothing against CREE, and will likely repurchase it at some point in the near future. We just feel overexposed at the moment to stocks that are trading at or above the tops of their channels, well above their moving averages. The chart of VECO above illustrates this.

We chose to sell CREE rather than VECO today because VECO offers better value at the moment. Both companies are expected to report approximately $2.00 or better by the end of 2010. With similar EPS forecasts, we'll take VECO in the 40's over CREE in the 70's.

VECO announced that it will be releasing earnings on Monday, April 26th. If the stock surges prior to earnings, we may be selling it as well.

We feel that the broader market is not ready to run out of steam just yet. One of two scenarios will likely happen. In the first scenario, the market will continue its climb to about 11,600 or so. Then it will correct about 10% sometime this summer. In the second scenario, the market will continue to climb to about 12,500 or so, then experience a 15% to 20% correction sometime in the Fall (perhaps October). In either scenario, these LED stocks could easily remain bouyant for the next several months, possibly putting in some very impressive highs (CREE at $100 and VECO at $80?). We plan on being on board for the ride, but are also very well aware that at some point between now and October, people are going to remember that the reality of the current economy is in no way suggestive of anything more than Dow 12,000. The upside is limited from here for the broader market, and any fluff will quickly evaporate. Although we aren't looking to get back to 100% cash just yet, we are going to be more conservative going forward considering these stocks have already posted some very impressive gains. Our sale of CREE today marks a transition in our investing mindset from one of "everything's peachy, buy and hold" to "sell into strength, don't be caught overexposed".

Account 16

This is the current allocation in account #16. It is owned by Jane Stewart, but for reasons of anonymity, we'll call her Ms. Smith.
Ms. Smith doesn't know that her account is the most aggressive of the ones we trade. All she knows is that she makes about 25% a year. There isn't a lot of capital in this account, so we trade it more aggressively than any other. Our other accounts have shares of CREE and MRVL, for reasons of diversification.

VECO

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What a tough call. VECO is at the top of its channel, and thereby triggers a short term sell in our book. On the other hand, the fundamentals make VECO look cheap, even at $43!

Here's the math...

If VECO grows at a conservative 20% a year, then we should expect its P/E to be approx 25, assuming a PEG ratio of about 1.2.

VECO's current EPS is 88 cents. This would make a fair price for VECO of .88(25) = $22.

Using its current EPS, VECO looks expensive. But if you look ahead a quarter or two, you'll see a whole different picture. In June, the 88 cents becomes $1.57. By December, it becomes $2.34.

Using the June estimate, a fair price for a share of VECO would be 1.57(25) = $39. So it's not overvalued at all. Looking out to December, we calculate a fair price of 2.34(25) = $59.

If VECO were to go from its current price of $43 to a price of $59 by December, that would be a 33% increase in just 9 months. We fully expect that VECO will reach $59, and perhaps even trade in the 80's by the end of the year.

So do you sell now because the technicals tell you to lighten up on the shares? Or do you hold because the fundamentals are telling you to buy more? We cannot answer this, as it's up to an individual's investing style (tolerance for risk). As for us, we're not heavily invested to begin with, so there's no impetus to run for the exits. If anything, we're looking to add to our LED positions. If we get a huge rally to impossible heights well above the top of the channel, we'll lighten up on the shares. In the meantime, though, we're going to let the fundamentals be our guide. If we were very heavily invested in VECO, we would lighten up here.

It should be noted that CREE and AIXG have higher P/E's than VECO, and a surge to the upside would therefore be more of a reason to sell those names. We're willing to hold a stock that is valued for the next quarter's EPS, but not one that is valued 9 to 12 months out. We continue to see value in MRVL, as well as strong technicals.

Diversification

Diversification is preached by most "professional" money managers. For the record, it is not right to use the term "professional" in conjunction with the term "money manager" unless the word "professional" is in quotes. Although our dealings with Wall Street have unwillingly forced us to accept that crime pays as long as it's white collar crime, we have a hard time accepting that any criminal deserves to be called a "professional". The crazy part of it all is that if they name their firm "Bradstreet Wharton Wellington Financial, LLC", somehow it makes them feel as if what they're doing is "professional". Some of the more brainwashed among them have even been able to convince themselves that what they do is legal. But we digress.
Here at "Snotwheel Financial", our advice is different. If you look into studies about diversification, you'll find that owning just 3 or 4 stocks removes such a large component of the risk of not being diversified, that there's really no need to own more than that. We don't believe in diversifying amongst sectors at all. We like to buy 3 or 4 stocks in the hot sector and that's it. The reason we diversify within the sector is to remove company specific risk, which is always present. These risks vary from uncontrollable events such as natural disasters to creative accounting. The reason most "professional" money managers own dozens of stocks is because they have little choice. They have billions of dollars to invest, and do not want to own more than 10% of any given company. If you're a small investor, you're not bound by these requirements, and can therefore beat the "professionals" at their own game.

VECO

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VECO has been trading sideways for the past several months. This may be discouraging to investors who meanwhile watched CREE rocket to new highs. But we're not in the least bit discouraged by VECO's recent performance. We see a perfectly healthy chart that needed to rest after a long run from early Nov to early Jan. VECO is wedging itself into an ascending triangle, an extremely bullish formation marked by higher lows and horizontal resistance. (see lines drawn on chart above).

All of this is happening within the trend channel, above an uptrending moving average, and with the backdrop of a relatively bullish broader market. This all points to an impending breakout for VECO to new all-time highs. We're early to point this out, as the stock is likely to struggle for a few days at resistance (+/-38) before making its move. Not all breakouts from ascending triangles are the same. A lot of its power is derived from the action of the broader market. If VECO can climb to 38, then have the market drop for a few sessions while VECO manages to tread water, then the rebound in the broader market will translate into a powerful breakout for VECO. Conversely, if VECO begins to break out and the market then decides to sell off for a few sessions, VECO's breakout may be thwarted. Regardless, it's important to note that with each passing day, this chart is bottling up more and more potential energy. We feel that it's only a matter of time before it reaches 40, which is more than 10% higher than its current price. With this one trade alone, an investor could statistically outpace the yearly performance of 87.9% of mutual fund managers.

Cree's Channel

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With all of these growth stocks, there comes a time when it gets hard to even draw a channel on them because their charts start to look parabolic. If you switch from an arithmetic chart to a logarithmic chart, you can straighten the chart out and see it more clearly. The strongest stocks look parabolic even on a log chart. Any stock that looks parabolic on a log chart is a strong sell in our opinion. No company can sustain that kind of growth. The numbers just get too big.

CREE has not gone parabolic on a log chart yet, but has definitely done it on an arithmetic chart. We can only draw a trend channel going back about 5 months on an arithmetic chart of CREE, as pictured above. Regardless of how you draw the channel, you have to admit that CREE is a tempting sell. If we were heavily invested, we'd be lightening up a bit on these shares. Considering we're only partially invested, we're going to ride it out. Based on the trend channel, CREE could reach 75 before needing any kind of a pullback. At 75, we'd be very tempted to take some off the table in an attempt to repurchase those shares at a lower price within a week or so. There's only so far a stock can go before people start taking some profits, and CREE is definitely in the nosebleed section at the moment. We'd feel more comfortable with it if it were just running parallel along the yellow line. It's a double-edged sword because we like to see the relative strength, but at the same time we don't want the stock to overheat out of fear that a sharp drop could rattle investor confidence. The best thing CREE could do is go sideways for a month while the market goes lower. That would take a lot of the risk out of the picture.

New Highs

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VECO is trading at new highs today, long before the indexes to say the least. It looks like VECO can make it to approx $42 before hitting the top of the trend channel and needing a breather. It's unlikely it will continue at this trajectory and get there within a week. It's more likely that the speed at which these stocks are climbing will taper off and give way to charts that cling to the yellow line in the center of the channel, moving slowly upwards until a new catalyst comes along.

That catalyst may be another leg down for the broader market, but that remains unknown. The broader market, for the record, is not out of the woods just yet. It remains below its downtrending 50dma, and neither the S&P nor the Dow have taken out their early Feb highs.

What the market does over the next several sessions is critical to helping us determine whether we just completed a healthy 10% correction, or whether we're in the early stages of a larger selloff.

CREE

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The chart of CREE above exemplifies why relative strength is the single most important attribute for a stock to have. When the market was correcting, CREE managed to stay above the moving average. Now that the market is hinting at a possible technical recovery, CREE is off to the races. No doubt it will make new highs LONG before the market itself.

If the market is just gearing up for another leg down, CREE will be able to absorb that plunge most likely without breaking through its moving average or trend channel once again.

VECO shows similar strength, but AIXG has become a weak stock. If AIXG does not begin to show signs of renewed strength, we may have to let it go.

We bought some MRVL today after researching it more thoroughly. The company is posied to experience explosive earnings growth over the next year or two. Having the support of fellow "aggressive growth" investor, Ken Heebner, doesn't hurt either. We like the prospects for the stock, and will more than likely be adding to it so long as it continues to gain popularity among investors. Popularity is the one element that is hardest to quantify, as there is no fancy formula to plug it into. Yet, it has more influence over a stock's future than any other variable.

CREE has certainly caught the attention of the investing public, and we hope to see that interest last for another few quarters, provided it doesn't overheat beforehand. Stocks with this kind of "popularity" run the danger of getting way ahead of themselves, hence our use of trend channels to help us scale into and out of positions in companies based on how close they are to the reality of their earnings potential.

We are now 36% invested, holding CREE, VECO, AIXG and MRVL. Cramer, are we diversified?

Financials

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What better reason to believe that the market is headed lower than charts that look like this? The chart above of Citigroup (C) demonstrates just how fragile the financial sector is at the moment. The odds that Citi breaks support and heads lower are very high. We continue to believe that we'll see a full 10% correction in the market, and perhaps even 15%. This is one of the reasons we sold all of our Ultralong index positions at the end of December. We don't have any reason to believe that the market will continue to drop after completing this modest, healthy correction. We believe that Dow 9,500 (S&P500's 1020) is in line with the reality of the current health of our economy. In an ideal scenario, the market would capitulate in two or three days of massive selling, then have a strong intraday rebound after a panic selloff one morning.

If it unfolds this way, there will be value to be had across the board. We will be backing up the truck on the LED stocks, particulary CREE, which is demonstrating excellent relative strength considering what the broader market is doing. If the market does begin to peel off a few hundred points a day for a few days in a row, it will look like we're headed to Dow 6,500 again. You'll be forced to decide for yourself whether or not this is a healthy correction or another leg down in a very tiring bear market. We're sticking with the "correction" theory, but encourage everyone to do draw their own conclusions.

Please participate in our poll at the left hand side of the page. Thanks, Snot

AIXG

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Charts don't get much more ominous looking than this. AIXG has spent the past several weeks forming a descending triangle. The odds strongly favor that this chart will break down into a new, lower trading range. We believe the market is not all that far away from doing the very same thing. This does not deter us from our plan, but rather has us excited that better prices may be just around the corner. The lack of buying interest in the broader market is becoming more evident with each trading session. Hopefully all stocks will capitulate in a fast and extraordinary selloff that marks the bottom of this correction.

Rubicon

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We promised we'd ferret out the material suppliers of the LED market, so here's one stock for you to look into. Rubicon Technology (RBCN) makes innovative crystalline products for LED applications. Unfortunately, it's not easy to put a price on the stock, as the company is in the red. It is expected to become profitable sometime this year. We'll file this one as the most speculative one of our "4 horsemen of LED". We don't normally buy large positions in stocks of companies that aren't generating profits, but we wouldn't mind gambling on this one with a small percentage of our portfolio given the potential of the entire sector.

RBCN is currently trading near the bottom of its channel, making it attractive on a technical level. VECO is supposed to be reporting earnings on Feb 8th, with RBCN reporting on Feb 9th.

We'd like to have about 1/3rd of our portfolio in the LED stocks before these earnings release dates. It would not be suprising if these stocks sold off just prior to their respective earnings releases. When an uptrending high-momentum stock sells off strongly just prior to earnings, we see it as a rare opportunity to sneak on board the train.

Broader Market

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The chart above is a chart of the Dow from 11:41am today. It's too early to say the market is going to have a down day, as it could well close up 200 points. But from its early indications, we may just get that broad market correction we've been looking for. To confirm that a correction is taking place, we'd need to see a simultaneous and decisive break of both the bottom of the trend channel and the moving average. If the market closed here (down approx 190), we would have neither just yet. Still, it would be a good sign that bargain prices may be in the near future. The financial news will tell you that the market fell this morning because Obama plans on further tightening banking regulations. This actually has nothing to do with why the market is selling off this morning. The financial news folks are the most frustrated individuals in the world. Every day, they have a stack of positive news stories in one pile, and a stack of negative news stories in another pile. Depending on which way the market goes each day, they blame it on stories from either the positive or negative pile. The real reason for the majority of the market's moves is just human nature. If the market goes in one direction long enough, people get bored. It's been going up for 10 months now, and is due for a correction. The "news" is irrelevant.