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As I write this it is becoming clear that the coming week will be a pivotal moment for American markets.

Continuing the trend started by Ciena the week before, the communications infrastructure sector we follow so closely had another tough week. While broad markets were flat the Nyquist sector suffered a steep drop (Nyquist Index -5% for the week). This is a new 52 week low, and not far from the lows set in 2005.

Slightly more than a third of last weeks –5% decline was attributable to a single stock, Time Warner Telecom (TWTC –25%), a large wholesale fiber carrier and Enterprise CLEC. They reported weakness in smaller enterprises which they attributed to economic forces. I suspect the story behind investor reactions is more complex, most likely related to concerns about their ability to service a hefty debt load. Level3 Communication, a larger but comparable company, had a good week. We remain very excited about the value of metro fiber assets following the consolidation events of the past years but remain wary of the debt financing some companies used to obtain them. This is why we own Abovenet (ABVT.pk) which has substantial metro fiber but is not leveraged to the degree it’s competitors are.

Beyond Time Warner Telecom, another 30% of the decline came from 4 other names: Atheros (ATHR), PMC-Sierra (PMCS), Nortel (NT), and Tellabs (TLAB).

We have written about the importance of identifying good hedges and rough markets prove the value of such advice. Cavium, Netlogic, Ez-Chip, and most recently PMC-Sierra remain the best options here. They are good companies but have premium valuations that should be tough to sustain. This is opinion, not investing advice.

It is worth re-examining the opinions about debt and capital structures of optical component companies I expressed at OFC this year. We are most certainly entering a time where it will be difficult to obtain credit. As I said in March, we have entered a period of time where liquidity matters more than technology.

According to Darwin it isn’t the strongest species that survives, it is the one most capable of adapting. Debt takes away options. Liquidity provides them. These options can be frittered away (“The Curse of Cash”) or they can be meaningfully exercised. Well run companies with bad balance sheets can be out-maneuvered by mediocre companies with good balance sheets. It’s the law of the jungle.

Therefore, from an investing perspective, realize now that having the best DPQSK 40G modulator today is much less important than having the lowest Debt to Equity ratio. In deflationary times it is much cheaper to buy someone else's invention than it is to spend the money designing it yourself.

Links

How Washington Failed to Rein In Fannie, Freddie - washingtonpost.com

Long article that timelines the ascent and descent of two companies that went from being unknown to household names. Read why.

Verizon Takes FiOS Fight to Buildings With Chips, Goo : Bloomberg.com

Nice update on VZ's efforts in New York City. Bloomberg technology journalism is a surprising treat.

Cisco's Next Big Bet - Forbes.com

… is datacenters (according to Forbes) Chambers: "We are alone in how many markets we dominate … I spend no time worrying about the competition." Forbes has really declined and now is a venue for softball technology journalism.

Light Reading - Broadband - Indian Carriers Commit to GPON

Good news and a potentially good win for Huawei, and Broadlight. Huawei announced that GPON sill no longer sell at a premium to GE-PON, erasing one of its weaknesses.

LinkedIn: Srinivasan Venkatachary

Google continues to hire people with chip design expertise. As first reported here, they already are building their own 10GbE switches. What could be next?

A Veil of Gloom Descends Across Techland - Barrons.com

Everything looks bad, everywhere. Philadelphia Semiconductor Index is at a 5½-year low and is trading where it was in 1997. Finisar sounded positive yesterday but the chorus of bad news is reaching a crescendo.

Light Reading - Report: UK FTTH Would Cost $50B

I call BS. There's no way it can cost this much. 20-25M UK households, aerial connections similar to East Coast USA but with higher density. Exactly why are they projecting costs higher than FiOS? It should be around $30B, and probably less.

EU's Reding to set out return on telco investment | Reuters

The Telecom Witch Queen decrees 8-12% is a sufficient return on risk capital, an ROI that will attract private FTTH investment from precisely no one, particularly when one can get 6% on Phony Mae and Fraudy Mac USA approved mortgage securities.

Tech Trader Daily - Barron’s Online : Stormy Day For Solar Stocks; Too Many Panel Makers?

People are finally figuring out the Solar business isn't different than the DRAM business. Reading this report of a Solar conference brings back jarring memories of the Telecom bubble years.

Nyquist Sector Performance

The Nyquist Index was established to benchmark the performance of a sector that is poorly correlated with the broad market. Last week’s trading was a good example of why it is a useful tool, with the small/mid cap companies getting crunched again while the big didn’t move. Volume returned to normal after the summer hiatus and declines led advances 41:14.

Cisco was up over 5% for the week as was Juniper, and Ericsson but the small/mid cap sector sagged. This is a reversal of prior weeks where the large cap stocks suffered. I suspect this week will reverse again, particularly if money runs for the exits as it appears to be doing at 5AM EST Monday morning.

Finisar traded strongly and reinforced a band of trading resistance. I feel very strongly that this company will attract institutional interest in the coming months and replace JDSU as the sector bellwether.

BigBand had a big boom based on an analyst upgrade.

Emcore is suffering the pain of being a solar stock. They do win the award for making the most brilliant financial move of the year. Earlier this year, at the very peak of it’s stock price, they converted all debt to equity; those bondholders are now sitting on a 60% loss in less than a year if they didn’t sell. Emcore went from having the 2nd worst balance sheet among component companies to having the 2nd best. Smart move.

Cavium broke some technical trading support levels last week. I don’t think the coming week will be kind to this company.

The performance gap between Level3 and Time Warner Telecom is unexplainable, other than LVLT is a big cap stock and TWTC is not. XO and Cogent, peer companies of TWTC, also had a rough week. The performance of Level3 vs. it’s small/mid cap peers should be an interesting proxy for how investors perceive the future performance of small vs. big.

To learn more about the Nyquist Index, including historical performance and what companies are included, please visit the dedicated page for The Nyquist Small/Mid Cap Index. It identifies the companies that make up the Nyquist Index universe and the methodology behind the calculation of this benchmarking tool.

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