There is at least one upside to the otherwise terribly high levels of unemployment - many of those who’ve been laid-off are using the time off as an opportunity to go back to school. As a result, many for-profit education/training companies are enrolling new students at their fastest pace in years. And, the stocks of these schools are starting to show it…. particularly stocks of the smaller companies.

Technically speaking, the S&P Small Cap Education Services Index has been flat since early November, and right now is actually right where it was in early September. However, since mid-November we’ve also watched these stocks do something very few stocks have been able to do… make higher lows, and continue to attack a key resistance level, around 63. The chart itself may not ‘read’ that so clearly, but the fact that the MACD lines (middle of chart) have started to rise rather than continue falling verify that the trend is now pointed upward.

If this index can break above 63 and stay there for a while, we won’t be surprised to see a repeat of the move we witnessed between July and September of last year.

By the way, the ’small cap’ stocks that make up this index include Corinthian Colleges (COCO), Learning Tree International (LTRE), The Princeton Review (REVU), Universal Technical Institute (UTI), Lincoln Educational Services Corp. (LINC), Capella Education Company (CPLA), American Public Education (APEI), K12 Inc. (LRN), and Grand Canyon Education (LOPE).

Anybody interested in this size company (small cap) within this niche (education) certainly won’t find an ETF or mutual fund with that kind of focus. So, the only real way to jump on board is with one or more of these stocks. Just be aware that it’s very hit-and-miss from one stock to the next here. However (obviously), the ‘hits’ can be incredibly rewarding.

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Remember everything I said in this morning’s newsletter about how well-paced the bullish volume had been growing for micro cap stock China Energy Recovery (CGYV)? Yeah, well forget it. CGYV is probably going to post it’s highest volume day ever today. That’s good news though… it’s buying volume, and has pushed the stock all the way up to some important ceilings.

In the newsletter, we specifically mentioned key resistance levels at $2.09 (last week’s peak), and $2.25 (November’s peak). Getting past the first one would be encouraging, while getting past the latter one would effectively mean hitting levels that were new highs seen by an audience that wasn’t distracted by the market’s implosion. (We actually saw higher prices in September, but our coverage literally began on the day the market started to unravel…. not exactly an apples-to-apples comparison.)

While we’ll gloat a little about how this chart is shaping up per our prediction, we’ll also counter that by acknowledging that a bigger move higher is hardly a foregone conclusion; there’s still plenty of risk, as always. On the other hand, they say the trend is your friend until it’s not. Well, right now - and until further notice - the trend is being very friendly to CGYV’s previous buyers.

Though prospective owners would be getting on board at a riskier and higher level (we’re not even going to bother preaching the ‘hesitation’ sermon), from a risk/reward perspective an entry here could still be justified. Just keep a short leash on things if you’re not one of those owners with a wide profit cushion.

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You may or may not recall a little pink sheet called Brilliant Technologies (BLLN.PK) that we covered a few months ago. We didn’t get too in-depth with it - we just thought their primary subsidiary’s (Qtrax) business model was a compelling concept… free-yet-legal music file sharing over the web. Revenue would be driven by ads, and much of that revenue would be passed on to the music’s artists and rights-holders.

From that platform, Brilliant Technologies was going to garner licensing deals with major labels like EMI and Universal. And, over the last few months they’ve done just that. (We’re admittedly still not sure what the revenue model for those big-name labels looks like.)

Though we weren’t able to determine the kinds of dollars could be at stake here for Brilliant, we still wanted to present the idea so you could do what you want to with it.

And how have things panned out? The stock has seen plenty of ups and downs since then, though anybody who bought Brilliant Technologies at its low points in the meantime has had a couple of opportunities to lock in 100% gains.

It’s still (net) flat from where we first looked at it in July (about 3 cents), but the same reader who passed along the idea the first time around recently pointed out that January’s 81% rally was not only built on consistently-higher bullish volume, but also inspired by real news. In other words, maybe this company is actually doing what they said they would, and maybe the stock is actually reflecting that. (Crazier things have happened, you know.)

The news behind the recent action was largely inspired by getting the likes of Universal and Sony on board, but there’s one name missing so far…. a big one - Warner. The reader suspects that one is coming soon too (and let’s face it, Warner’s worth waiting on). Once Warner is signed, Brilliant is likely to put the marketing machine into high gear. We’ve seen a few localized soft-launches (in the U.K. and Australia), but we’re still waiting on the big “grand-opening” event. That could drive major traffic to the Qtrax site, and indirectly boost the stock to who-knows-how-high.

It’s still not an official pick, though we can see how the interest is growing.

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This is a story we’ve been following at arms length for a while now… the relationship between the price of oil and the price of airline stocks. In it’s most basic form, the premise says rising oil costs translate into rising jet fuel costs, which sends airline stocks lower - passengers just can’t afford to pay the higher ticket costs. And, over the last few decades the relationship has actually held up most of the time.

With that in mind, take a look at the chart below; it’s a comparison of crude oil and the airline stocks in the S&P 500. For good measure, we’ve also added a chart of the Dow Jones Airline Index. You tell us what’s wrong with it.

Airline stocks sank when oil was boiling. And, they somewhat popped when oil peaked in mid-July. When oil fell back to multi-year lows though, airline stocks didn’t sustain the recovery. In fact, they fell even further.

So much for the theoretical relationship… or was it something else? It’s worth noting that Delta (DAL), American (AMR), United (UAUA), Continental (CAL), US Airways (LCC) and JetBlue (JBLU) were all net losers in Q4, and net losers for 2008. The yearly loss is understandable, but oil was cheap in Q4.

Since this site is all about finding worthy investments in micro caps (or at least something besides large caps), we suggest taking a look at the next chart. It compares crude oil to airlines again. Only this time, we’re comparing oil prices to the S&P Mid-Cap and the S&P Small-Cap Airline indices. See if anything looks different.

Conclusion? Just this - maybe the problems the big carriers are facing right now have nothing to do with oil prices, since the little brothers in the group seem to be doing ok now that oil prices have been reeled in.

Admittedly that’s a simplified explanation, though still true at its core. The message to investors, however, is the obvious one described by the chart… major airline stocks are still suffering, perhaps because their sheer size makes it tough for them to navigate a turbulent market (no pun intended). In the meantime, the smaller names seem to be doing reasonably well - or their stocks do anyway.

That said, there’s still a big risk even to the small and mid cap carriers here - an explosion in oil prices is likely to send all airline stocks lower, whether they deserve it or not. However…

While it’s certainly possible for that to happen, we believe any rally in crude oil prices would be a gradual incline. That lack of volatility should somewhat shield these rallying airline stocks; the fact that crude’s just not in strong demand during a recession will further allow these stocks to advance.

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We’d be the first to acknowledge that a distant target is tough to hit. When it’s a moving target, it’s almost impossible to expect perfect precision. However, to not even pretend the target has moved is just a tad crazy…. yet Standard & Poor’s analysts still don’t seem to have adjusted 2009’s earnings prediction. (That, or they’re living on Fantasy Island.)

If we had seen these kinds of projections six months ago, it would have been understandable. Heck, we may have even agreed with them. And just to be fair, we still expect 2009 to be a modestly positive year despite how nasty 2008 was, and despite how tough the environment should be over the next twelve months. The S&P forecast, however, well, let’s just say it’s still strangely optimistic.

We’ll just put all of the forecasted P/E’s in a table below so you can see for yourself just how wild they are. As an example though, consider the consumer discretionary sector. Standard and Poor’s thinks the average consumer discretionary stock is going to sport a twelve-month P/E of 14.76 (based on current prices) by the end of 2009. Technology stocks’ projected P/E is only 12.2 for 2009, based on current prices.

We’re not saying either of these groups - or any sector for that matter - can’t or won’t make gains in 2009, but geez… get real.

Part of the optimistic expectation may well be that the company simply hasn’t updated their outlooks yet. However, they generally do so in a timely manner, and it’s not like the economy started to fall apart yesterday. Things turned sour in mid-2007, and stocks really started to verify they were in trouble about two quarters ago… enough time to make an appropriate adjustment.

Take a look at 2007’s P/Es, 2008’s P/E’s (which are technically ‘estimated’, but based on three quarters of ‘actual’ results), and 2009’s projected P/E’s. Then keep reading for our final thoughts.

In S&P’s defense, it’s easier said than done. On the other hand, considering investors at least partially rely on reasonable and timely forecasts, this is slightly frustrating. Or, if the research company really does think things will be this healthy in 2009, we’d certainly like to know more about the rationale.

That being said, there’s another point you absolutely must understand - even if the forecasts are twice as optimistic as they should be, there are still undervalued companies that will post big gains in 2009. You just have to go out there and find them; we’ll certainly do our part to help.

On a sector-by sector basis, though tech, discretionary, and financials may not do as well as Standard & Poor’s thinks they will in 2009, we’re not in total disagreement with their outlooks for healthcare and industrials; both sectors really are a little too undervalued.

Consumer staples stocks are priced fairly based on reasonable growth projections, as are utility stocks. Even some - though not all - telecom stocks are bargains when making the mental adjustment to reel in S&P’s overly-enthusiastic projections.

We’re going to add more layers of detail to this analysis in the near future; we just wanted to plant the seeds now.

Also, if Standard & Poor’s adjusts these numbers (and we hope they do), we’ll update this table accordingly.

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This doesn’t exactly have anything to do with trading micro cap stocks; we just thought it was interesting (and possibly helpful) information about the market in general. In a nutshell, some mid-cap stocks - components of the S&P 400 index - from certain sectors are really turning the heat up. A handful of them have been on a roll for quite some time now, quietly making gains while most of the market didn’t even realize it. There may well be even more potential, however, in these so-far unsung groups.

We were only going to list the top three, but we’re adding #4 since there’s some overlap with this week’s third and fourth-best mid-cap industry. We’re also adding a chart of each.

Take it or leave it; use it or not. We’re not going to drill down any further right now, but we’ve found these outlier trends tend to translate into some pretty good individual stock picks for those inclined to dig deeper.

You may want to pay particular attention to the long-term trend… looking for recent strength from the groups that have poor long-term results. That may highlight an undervalued situation that’s started to turn the corner.

Forest products, which is not necessarily the same group as paper producers (though there is some overlap).

Managed Health Care…. never a bad choice in a recession (though this index seems like it took a good hit in the middle of last year).

Computer storage and peripherals is a bit of a surprise, considering Intel, Micron, Texas Instruments, and other makers of chips and memory were recently blasted for weak earnings and lowered forecasts….too much inventory, and not enough demand. However, there’s clearly at least one mid-cap somewhere that’s not experiencing the same problem.

Though computer hardware is fourth on the list, this chart is actually the most attractive of the bunch.

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We got our first round of feedback to this weekend’s 2009 outlook. Thanks for all of it (even if you disagreed). We’ll post the best-of-the-best discussions about 2009 here in the blog, so we can all best determine what’s likely to be in store for the stock market in the coming year. Here’s the first e-mail…..

Hi,

I read your January 3 issue. I have a couple of questions and am very interested in your thoughts.

First, you said the P/E might drop even further with the next round of earnings releases, but that it wasn’t a cause of alarm right now. Are you saying that it may well be a cause of alarm about a week before the next round of earnings releases begin but meanwhile it’s not much of a consideration in what the market will do in the immediate future? (1)

On that general topic, I was amazed that everybody was sure the earnings reports would be terrible this last time, and they knew it well ahead of time, but still the prices dropped a lot with each big negative earnings report that came out. Everybody knew it would be bad ahead of time, but it didn’t get fully priced into the market until it actually occurred, as though it was some kind of surprise. The difference between that and next time is that maybe these upcoming earnings reports will be worse, but the outlook will be a lot brighter, with words like “but we expect more positive results next quarter” instead of the negative outlooks we saw this time. Do you think that should make a difference that allows the market to hold its own as those earnings reports come out? (2)

I’ve also heard people warn that the reports will be far worse than people expect, in which case I suppose they would still significantly drop. If many people expect even worse earnings next quarter, what I imagine sounds likely is, the market does OK coming through the inauguration and maybe into February, but then people get the willies and start to see bad earnings coming. The market goes down a fair amount. Then they wait and see what happens. If the earnings start out really bad, worse than expected, all of a sudden the market drops a lot further down, even lower than last November 20, and stays down a fair while until a fair number of people are confident the housing market problem is really solved. If they are only as bad as expected, it starts to go up then (end of March) with the idea that the worst truly is over. (3)

Does this make sense to you? If so, it seems like getting out at the end of any January rally would be a good idea and wait to see what happens at the start of the next earnings season. If things tank in the first few days, wait through the earnings season before going back in, but if they seem OK at the start of the next earnings season, the market doesn’t tank, and earnings outlooks are generally positive, buy back in, probably at a level similar to the end of the possible January rally, perhaps lower depending on how fast the market would react. Your comments? (4)

My other question. I have heard some people say that people are not prepared for the number of banks that are going to fail. Many say the housing prices are likely to drop another 20%. The big banks will not fail because the government is committed to them not failing, but there isn’t enough money to keep hundreds of small banks from also failing due to the mortgage crisis. That will happen in 2009 (they say). That will perpetuate the credit crisis much longer than is currently hoped for. I suppose it entirely depends on what Congress does to resolve the issue, to keep people in their homes at prices they can afford but which also don’t break the banks. I have no clue what is likely to happen – I don’t see a way out that sounds workable, but I’m not an economist. Your article seemed to ignore the possibility of a really high number of bank failures spiking this year. If the next round of earnings is worse than expected and also small banks begin to fail in large numbers, I bet the market has very serious problems and will go down maybe another 30% because people are pretty skittish these days. (5)

That’s a negative scenario and I have no idea what will actually happen. But your outlook for 2009 was fairly positive. In your positive outlook are you actually allowing for another 30% drop but figuring it will still end on a much more positive note by the very end of the year, or are you figuring this scenario is simply not going to happen, so if January begins to look good, just go ahead and buy, with sell stops or some such in case things go bad? (6)

Thanks a lot for your thoughts, if you have time to respond. Those are mine, anyway.

Our response: Thanks for the e-mail. You raise some questions I think are worth discussing publicly for everyone to see and think about. So, I’m removing your name and e-mail, but posting your note - and our responses - here.

To make tracking your questions and our answers easier, I’ve numbered everything as best I could.

1. Sorry for any confusion. No, we’re just saying that even if earnings are terrible, so what? The bar is set very low, so even meeting those low expectations would be a relative victory…. or at least uneventful (and thus not a reason for a market bailout).
2. Basically, yes.
3. You’re hitting the nail on the head… it’s all about expectations - not decent or poor results.
4. We’re more in the camp of “companies have prepped us for the worst, and aren’t likely to fall short of those low expectations”. We’re certainly not going to suggest your scenario can’t happen though. Keep a close eye (and short leash) on everything in 2009.
5. While banks will continue to struggle, the pervasive ‘the sky is falling’ mentality - we believe - overstated just how many banks would implode. Again, that’s not a guarantee - just an opinion. Even so, many small bank failures pale in comparison to one large bank failure. We doubt Washington is going to allow more failures from anyone though.
6. Sell stops are always a good idea. Regardless, yeah, we’re more optimistic than pessimistic for 2009, but not because of economic health. We really do see it as a rebuilding year for the economy, but stocks tend to lead an economic recovery, which should begin no later than the latter part of 2009. It’ll still be ugly, but at least positive. A 30% drop before a recovery? I don’t think it will be that drastic….maybe 15% at worst. However, I think most likely it will be a very slow grind, with no big moves in either direction. Things won’t be ‘good’ until 2010, but there’s still money to be made in the meantime.

Thanks for your note. If anybody else has thoughts or responses, feel free to leave them below.

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For the majority of last week’s shortened trading, owners of bulletin board stock China Energy Recovery (CGYV) had plenty of reason to be excited - shares rallied from a close of $1.50 before Christmas to a peak of $2.09 by January 2nd. That’s a pretty big move (+39%), particularly when the holidays are inspiring vacation time. By the end of last Friday though, the air had been let out of the bubble… CGYV was back to $1.70, giving up most of the gain.

Nevertheless, the last several days have actually been pivotal - in a bullish way - for China Energy Recovery shareholders.

Despite the late selloff on Friday, the buying volume up until then had been growing quite a bit (by bulletin board stock standards anyway). And, CGYV did manage to hit its second-highest high in months with that peak of $2.09. While it would have been preferable to see CGYV just blast-off and hit $6.00, we have to give the stock a little wiggle room.

As we can see already today, the buyers are coming back to the table for more after Friday’s close at $1.70. China Energy shares are currently priced at $1.75, but traded as high as $1.80 in the earliest part of today’s trading session.

Bottom Line: Slowly but methodically, CGYV appears to be picking up steam. It may not be a bad time to add your first position, or add more to your current position. If this small cap pick blows through the previous high of $2.25 (made on November 17th), we may not see another retest like the one we saw on Friday.

Also, don’t forget we’re looking for revenues somewhere between $22 million and $24 million for their fiscal 2008. Plan on earnings around $1 million. For 2009, sales should be in the $40 million area, and earnings could fall in between $3 million and $4 million. By comparison, the current market cap of roughly $40 million underestimates 2009’s likely results.

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