A new WatchList called "FWS Favorites" was sent to you on July 15, 2005. The performance of the top stocks in this WatchList has been nothing short of spectacular. Quick Test shows that the top 10 stocks ranked by VST gained an average of 32.21% in 13 days for a 904.27% annualized rate of return! Was this plain luck or have we got something here?

The background and origin of this WatchList was described in my three essays of 07/01/05, 07/08/05 and 07/15/05. The whole idea with Firework stocks, as you may recall, is to find low-priced stocks that are skyrocketing in price. As explained in my essays, these stocks can be found in a number of ways. But most of them fizzle out and crash back to earth in short order. So the trick is to find the stocks which are most likely to continue going up.

I do this in two steps. First, I test for a second or confirming explosive price increase and put them into a WatchList called "FWS Weekly Matches." Then I look at the graph of every stock the FWS Weekly Matches WatchList to select the ones I want to put into the "FWS Favorites WatchList." Cherry-picking is a very important part of this process because you usually get what you see. If a stock's price has been going up and down in an erratic, chaotic pattern, that's what you should expect from it in the future. If a stock's price has been going up in a smooth, distinguishable pattern, you can have a reasonable expectation it will continue to behave that way.

To be truthful, I haven't used the FWS Favorites WatchList long enough to know whether or not we have just been lucky with it. I do know this, however, I've made a lot of money with these stocks so far and I don't think it was all luck. I took some profits today because I believe the market is seriously overbought. If the market does go into a downturn, I'm going to ride with the FWS Favorites that keep going up and cash in those that begin heading down. Meanwhile, this is My Favorite WatchList.

SPECIAL NOTE ON VECTORVEST WATCHLISTS.
The control on the following VectorVest WatchLists: "Best New Highs, Worst New Lows, W-O-W, FWS Favorites, FWS Weekly Matches and FWS 2005 Cumulative" has been adjusted so that they cannot be backtested prior to the date on which they were created. Last week we illustrated a backtest on FWS Favorites that began on January 7, 2005. This should not have been possible because the WatchList was created on July 15, 2005. The backtest is illustrated again this week from the appropriate starting date, July 15, 2005.

The Investment Climate section of today's Views shows that earnings are rising, inflation is falling and interest rates are rising. According to our Truth Chart, (See VectorVest Views of 03/21/03 and 03/28/03), this combination of circumstances is called a Case (3) Bull Market Scenario. It is quite unusual and normally doesn't last very long. Why is it called a Bull market scenario and why won't it last long?

The key to every Bull market is visible evidence of rising corporate earnings. VectorVest uses the stocks in the S&P 500 to analyze earnings performance. We simply open the S&P 500 WatchList, make a graph of the summary line and examine the 50-day MA of EPS. The data is shown weekly in the Investment Climate section of this report. When the Trend Indicator is above 1.00, earnings are rising. The indicator currently stands at 1.11. You may see a graph of this data by clicking on Graphs in the Main Tool bar, clicking on Market Climate Graphs; then clicking on S&P Earnings and S&P Earnings VV. Yes, earnings have been rising, but note that the trending indicator is not as high as it was last year.

So far this year, second quarter earnings have been shown to be rising nicely and stock prices have been responding to the good news. In fact, most of the major indexes have been hitting four-year highs. Since rising earnings drive stock valuations higher, it is logical that they drive prices higher. But everything on Wall Street is not logical. For example, falling inflation rates should lead to lower interest rates, but interest rates are rising right now. What is going on?

Dr. Alan Greenspan, Chairman of the Federal Reserve Board, is responsible for maintaining monetary stability here in the United States. To do this, he along with his Board of Governors manipulate the supply and the cost of money depending upon their analysis of the economy, inflation and other factors. They decrease the supply of money and raise interest rates when they believe the economy is overheated and inflation is moving higher. They do the opposite when the economy is weak and needs to be revived. More often than not, they overplay their hand and cause boom and bust cycles.

They raised interest rates too much in 1999 and 2000, bursting the stock market bubble and causing an economic recession. Then they desperately lowered rates to 45-year lows in 2002 and 2003 to resuscitate the stock market and the economy. If we are to believe Dr. Greenspan, the economy is fine now and inflation is not a problem. But he will continue to raise interest rates anyway. He wants to return the Federal Funds rate from a historically low level of 1.00% two years ago, back to its normal level of about 1.5% higher than the inflation rate. If one uses the 2.50% inflation rate shown by the Consumer Price Index, his target Fed Funds rate would be 4.00%. Since the current Fed Funds rate is 3.25%, and he has been raising interest rates in 0.25% increments, one would expect that there are three more 0.25% increases to go. Will this mark the end of the Bull market?

The only way to know is to refer to the VectorVest Investment Climate wherein the basic trends of earnings, inflation and interest rates are analyzed each week. As long as earnings continue to rise, we will be in a Bull Market Scenario.

P.S. Make sure to read next week's Strategy of the Week.

The concept of "Firework Stocks" was introduced two weeks ago. You may recall that this moniker was inspired by the Fourth of July holiday. So a "Firework Stock" is a low-priced stock whose price flat-lined for a substantial period of time, then broke-out on high volume to double, triple or quadruple in a matter of weeks or months. In that essay I described how to identify these stocks and in last week's essay I wrote about how to find them.

Unfortunately, there is some work involved in going through this process. But you don't have to worry about it. VectorVest has done the work for you. We have provided you with a new WatchList Group called, "Firework Stocks - 2005," which contains the following WatchLists: FWS 2005 Cumulative, FWS Weekly Matches and FWS Favorites.

FWS 2005 Cumulative is made up of the top 50 stocks found each week by using a search called, "Finding Firework Stocks," located in the Delta Searches-Stocks Group in UniSearch. Thanks to the programming wizardry of our Product Development geniuses, this WatchList shows only the stocks that were in the WatchList as of the date you select. For example, on January 7, there were 50 stocks in the WatchList. On January 14, 75 stocks were in the WatchList. This means that 25 stocks were found by the search on both 01/07 and 01/14. The matching stocks were excluded from the Cumulative WatchList but they were put into a new WatchList each week called, "FWS Weekly Matches."

This arrangement allows us to see which stocks broke-out each week, and to keep a running log of the stocks that broke-out during the year. I look at graphs of the FWS Weekly Matches WatchList as my primary source of new stock selections. It contains the lower-priced up-and-comers and offers more upside potential. However, I also look at stocks in the Cumulative WatchList to find good candidates for purchase that didn't make it into the Weekly Matches WatchList. The selection process is simple, but takes some training.

Let's look at the stocks in the 01/14/05 FWS Weekly WatchList, for example. Open the WatchList and set the Date to 01/14/05. You should see Innovo Group at the top of the list. Now highlight all the stocks and click on Graph in the Local Toolbar. Customize the graph to show only the data from 01/14/04 to 01/14/05. This step is necessary to avoid being influenced by the stock's performance since 01/14/05. Make sure to show Volume in the lower portion of your screen. Now you're ready to judge these stocks.

Here's what to look for:
1. Has the stock's historical price pattern been relatively smooth?
2. Has the stock's price been flat or rising for the past several months?
3. Has Price broken-out on high volume, i.e., well above average, over the past
week or so?
4. Is AvgVol greater than 10,000?
5. Has the stock been hitting higher price highs?

Given these guidelines, I would have bet my money on the following stocks: ISAC, RICK, NWMV, ASTM, CEIW. Note that I picked only five of the 25 stocks in the WatchList. When I close the graphs and re-open them, I see that I could have made money on INNO, QMRK, SHOE, and SPSC, but didn't because I didn't pick them for one reason or another. QMRK and SHOE had nice price patterns, but AvgVol was too low. Of the five I did pick, three would have been winners. In hindsight, I shouldn't have picked RICK and ASTM because they were pulling back after a big rise in price. I'll try not to do that anymore.

Of course, you also could go through the same exercise each week with the Cumulative WatchList and find some good winners. But that is even more work. So, we created a third WatchList to save you time and help you make better choices. This WatchList contains the stocks that comply with the five criteria shown above and contains the Firework stocks that we would buy right now. All you need to do with this WatchList is open it, look at the graphs and make your choices. I call it my FWS Favorites.

Given the Fourth of July holiday spirit last week, I wrote about finding "Firework Stocks." A Firework Stock is one that shoots upward in price and goes on to do a double, triple or quadruple in a matter of weeks. In that essay, I said that these stocks could be found by using the "Price-Volume Winners" and/or the "Teeny Boppers" searches, which are both located in the Strategies - Price-Volume Group of UniSearch. Although both of these searches are quite good, I am going to present another search technique today that I like to use.

The whole idea, here, is to spot these guys at the lowest possible price. This is not an easy thing to do because a lot of low-priced stocks go up 50 to 100% in a day, only to crash back to earth.

The best way to overcome this problem is to find the guys that keep hitting new highs. So the key to this technique is to find low-priced stocks which have had successive price break-outs. I do this by using a combination of the Delta function, WatchLists and graphs. Here's the procedure:

1. Run Price Deltas on all stocks greater than $1.00 and less than $10.00, sorted in descending order of percent price gain.

2. Put the top 50 stocks into a WatchList. (The cumulative WatchList.)

3. Repeat step (1) the following week.

4. Create a new WatchList made up from the top 50 stocks from step (3) that match the stocks in the WatchList from step (2). (A new WatchList of matching stocks is created every week.)

5. Add the top 50 stocks from step (3) to the cumulative WatchList from step (2).

6. Sort the stocks in the weekly WatchList created in step (4) by VST and look at their graphs.

7. Select the stocks that show a chart pattern in which Price flat-lined, or was in an up-trend, for several months; then broke-out to a new high on above average volume.

As if you hadn't noticed, this technique is rather complicated. But do not fear, VectorVest will do the work for you. As of tonight, you will find a new search in the Delta Stocks Group of UniSearch called "Finding Firework Stocks." You will also find a new WatchList Group, called "Firework Stocks - 2005," which will contain two WatchLists: The cumulative list, called "FWS 2005 Cumulative," as of 01/14/05 and the weekly list, called "FWS 01/14 Matches," as of 01/14/05. You will receive the up-to-date cumulative WatchList and the complete set of weekly WatchLists next Friday. For now, I suggest that you examine the graphs of the stocks in the "FWS 01/14 Matches" WatchList. Remember, you're looking for nice, smooth price patterns of a stock that has been flat-lining or rising; then explodes higher on above average volume. See how many of those stocks you wish you had purchased.

This technique nailed FORD, which, peaked at $23.00, at $4.11; DSTI, which peaked at $16.13, at $2.72 and NTRI, now at $14.71, at $3.25. If you're willing to raise the current price in the Finding Fireworks search we have sent to you, you will find many More Big Winners.