The technology sector gets a big surprise with Microsoft (MSFT) announcing that it will cease to pursue the acquisition of Yahoo! (YHOO). Most analysts and market pundits expected Jerry Yang & Company would ultimately accept a deal, albeit at a higher price than Microsoft’s initial offer. Expect Yahoo! stock to take a precipitous plunge at the market open and the announcement of class action lawsuits from its larger shareholders. While this saga of two tech giants unwinds, plenty of news in the rest of the tech sector deserves attention.

The Nasdaq Composite continues to roar back from the recent market slide with a strong 2.2% gain last week. This makes my tech market bifurcation thesis look increasingly faulty. The bellwether technology issues have performed well as predicted, but so has the middle tier and even the bottom tier. International growth accounts for much of the resilience and strong performance. Technology companies reporting satisfactory or better results included Affiliated Computer Services (ACS), a business processing outsourcing and information technology services firm, Ansys (ANSS), a provider of engineering simulation software, Expedia (EXPE), the online travel e-commerce company, TeleCommunication Systems (TSYS), a provider of carrier-class wireless technology, Concur Technologies (CNQR), a maker of expense management software, LoopNet (LOOP), a website for commercial real estate listings, and Symantec (SYMC), the security software giant.

What about the rest of the market? Hallelujah! The Oracle of Omaha, Warren Buffett, has openly stated that the worst of the recent credit crisis has passed. Many value lemmings and growth copycats will take this as reason to dive back into the market with enthusiasm. Indeed, we are an eager shareholder society and investing is both pastime and profession. Investing might very well be religion. It is so for the pilgrims that never miss the Berkshire Hathaway (BRK-A) annual pow-wow to join in the proceedings presided over by high priests Buffett and Munger. The event occurred just this past week and, as usual, Buffett warned shareholders of smaller future returns for Berkshire. This warning is coming from the greatest investor alive, the prophet of profit, and the diminishing returns doctrine is probably the one part of the gospel the congregation finds hard to believe. We’ve all grown accustomed to his ability to outperform and deliver us from the evil of poor returns.

Macro

American taxpayers should be receiving their economic stimulus checks in the coming weeks. Will this provide the country with a sudden explosion of consumer spending? The bureaucrats in Washington believe that the increased spending will pull us out of the recent economic slump. But what will we probably do with our returned tax dollars? For the legions of homeowners who have seen the value of their most significant asset plummet in price, will they put the check towards a mortgage payment? Robert Shiller, the economist and father of the Standard & Poor’s/Case Shiller housing price index, predicts that housing declines have not come to an end and further declines could exceed the damage suffered during the Great Depression. In that scenario, homeowners on the brink of mortgage default would just walk away and spend their stimulus checks elsewhere instead of holding onto homes with values underwater.

Micro

Interactive Intelligence profit drops, sales rise – Confirmation bias, the cognitive error whereby investors search only for evidence that confirms their beliefs, is a very common mistake. With the second paragraph of this post, I run the risk of committing the more surreal non-confirmation bias, whereby I cite only evidence that refutes my tech market bifurcation thesis. So I best avoid this masochistic foible by pointing to Interactive Intelligence’s (ININ) somewhat disappointing earnings report. The company’s call center management software generated record sales but profits actually declined from the year ago quarter. There has been much debate about where corporations cut back expenditures in recessionary or slowing economic environments. The consensus is that advertising is the first thing cut. I don’t think so; I believe that short-sighted corporations tend to cut customer service functions and budgets. If true, ININ remains in trouble. Full Disclosure: I currently have a long or short position in ININ in one or more of my private investment partnerships.

MicroStrategy 1Q profit declines as operating expenses rise – Here is another case of a technology company that was able to grow sales while seeing profits decline. Are second-tier technology companies losing pricing and negotiation power? Are large corporate customers taking advantage of the slowing economy as an opportunity to demand better terms from technology suppliers? I remember when MicroStrategy (MSTR) generated as much hype as Salesforce.com (CRM); the promise of business intelligence software was as big as sales management software. Michael Saylor’s company took investors on an 18.6% dip last Friday.

Sohu 1Q profit soars with rising brand ad, online game sales – Last week, I profiled Sohu.com (SOHU), a Chinese Internet portal and online gaming company. Since then, the company reported record results and the stock rose an astonishing 25.6% in the space of five trading days. Sohu.com’s TianLong Babu massive multiplayer online game has become a best seller. The long term prospects for this company should be extremely bright and so are the long term prospects for the gaming industry in Asia. However, buyers of the stock now would be paying premium prices.

Perfect World Collaborates with Intel and Haier – Perfect World (PWRD) is another online gaming company based in China. The new alliances with Intel (INTC) and Haier give it some serious marketing muscle to push its massive multiplayer online games (MMOGs). They’re usually called “massively multiplayer online role playing games” (MMORPGs) but I’m going to keep it short and sweet. I’m also going to assume that future large scale games will not all be role playing game formats. Someone is going to produce a smash hit with a massive scale first person shooter like Halo.

Dolby posts higher Q2 profit; raises 2008 view – I used to take the public bus to high school in the ghetto and pass by the red brick building that houses Dolby Laboratories (DLB). San Francisco was an interesting place to grow up. One minute I’m riding the bus through the South of Market neighborhood and checking out the shingles of creative technology companies and the next minute I’m riding through the ghetto looking at beat up cars and pit bulls loosely chained behind chain link fences. Unlike in the digital video space, where scores of competing codecs vie for dominance, the digital audio space is in fact dominated by Dolby technology.

AgFeed Industries Completes Previously Announced Acquisition – China’s economy is bound to slow down just a bit as global macro factors diminish the competitive advantage of its low cost labor force. Nevertheless, population growth is unlikely to slow much and all those billions of hungry mouths to feed bode well for food companies. AgFeed Industries (FEED) produces hog feed and chicken feed. The company is aggressively expanding into hog raising and turning itself into a vertically integrated food producer.

A couple weeks ago, I wrote about my pessimism regarding the technology sector. The market had seemed to interpret the surprisingly good results reported by Big Blue (IBM), Google (GOOG), and even Yahoo! (YHOO) as reasons for unleashing optimism and a bargain hunting shopping spree for stocks of publicly traded technology companies. Maybe the recessionary environment and the woes faced by banks and the American consumer would not negatively impact corporate budgets for technology. My skepticism rests on the ability of secondary technology companies to weather the economic slowdown. In other words, I think there is going to be a bifurcation of the technology sector, with blue chips performing in line with expectations and second tier players getting hit hard by purchasing slowdowns.

How has my skepticism aligned with reality? As usual, I’m wrong more often than I’m right. Over the past week, Apple (AAPL), Amazon.com (AMZN), and Microsoft (MSFT) all reported earnings greater than expectations. These blue chips however warned of weaker results in the foreseeable future. For the week, Apple stock rose 5%, Amazon ticked up 1%, Microsoft ticked down 1%, and Yahoo! fell a whopping 6%. Yahoo’s weak showing had a lot to do with Microsoft reiterating its reluctance to increase its bid for Jerry Yang & Company. These mixed results mask a surprisingly strong showing by the Nasdaq Composite Index which rose 0.8% for the week. This implies that a lot of the secondary technology issues performed better than other sectors of the economy. Industrials in the Dow Jones Industrial Average rose only 0.3% and the blue chips in the S&P 500 did slightly better with a 0.5% rise. We’ll get an even better reading on the technology sector as bellwethers like Blackberry maker Research In Motion (RIMM), Cisco Systems (CSCO), Hewlett-Packard (HPQ), and Dell (DELL) report their earnings in the upcoming weeks. In the meantime, I’ll be looking for a lot of smaller technology companies to run into a brick wall.

Macro

The media just started latching onto the rising cost of food story. All throughout Ben Bernanke’s easing of credit and interest rates, which in the short run looks like a success, I worried about his staying power because of inflation. The Federal Reserve is stuck between a rock and a hard place because of the conflicting forces of inflation and the slowing economy. Everyone knew about oil’s incessant march to record prices, but few worried about food prices. Recently, The Economist ran a cover story on the food crisis. Much of the blame rests with increased planting of corn for biofuels instead of wheat for food. The unintended consequences of government initiatives and regulations bolstering or subsidizing the use of ethanol are now materializing in record food prices. The head of the United Nations warned that the dearness of food could cause political and social instability. Asian countries are in a mini-panic because of the skyrocketing price of rice, the staple input of Asia. Riots have erupted in Egypt and even the prime minister of Haiti was forced to resign over food shortages. Crises bring opportunities, so rumors of American food conglomerates craving foreign food companies abound as executives weigh their next move in response to the food crisis. Will we want to drive more or eat more? That is a very basic question.

Micro

Interactive Intelligence to Announce First Quarter Operating Results – Interactive Intelligence (ININ) provides software applications used by contact centers or call centers. ININ has some award-winning products. One of the most interesting to me is their Interaction EasyScripter, which is software that allows for management of “scripts” for call center agents. Companies that rely on call center agents to sell products or perform customer service should find EasyScripter very useful. I’m considering using EasyScripter or something similar in the sales efforts of the startup I’m involved in. The company reports earnings after market close on Monday and analysts expect 8 cents of earnings per share for Q1 this year. ININ is one of the second tier technology companies that will test my thesis, that blue chip technology companies will do fine through the economic downturn while the smaller technology companies suffer from budget cuts. Full Disclosure: I currently have a long or short position in ININ in one or more of my private investment partnerships.

Decker surges on higher outlook – We can’t always focus just on technology and food. Let’s take a look at fashion for a bit, albeit low fashion. Decker Outdoor Corporation (DECK), the maker of those annoying UGG boots took short sellers on a 21.55% ride after reporting earnings growth of 18% for Q1 2008. DECK has other product lines, but the primary driver of growth is the UGG boots line. Always be skeptical about fashion fads. Take a look at the stock charts of CROCS (CROX) and Heelys (HLYS) for an illustrative warning.

Focused Strategy Helps Chipmaker Rise Above Sector’s Slump – Back to technology, I just had the power brick on my Hewlett-Packard Pavilion laptop fail on me. Replacement power bricks are unbelievably expensive. Why can’t laptop manufacturers standardize on power bricks and power cords so we can all buy a one-model-fits-all commoditized power unit? The Universal Serial Bus (USB) port has worked so well for consumers. Power Integrations (POWI) makes a tidy business supplying the chips that control power bricks.

Citi upgrades Sohu.com – I pay great attention to the China tech sector and, recently, the Chinese passed the United States for the most Internet users. Sohu.com (SOHU) is China’s version of Yahoo!, an Internet portal company. Sohu.com, unlike Yahoo!, is growing by leaps and bounds. Also unlike Yahoo!, Sohu.com has figured out online gaming. Going forward, its online game, TianLong Babu, will be a strong contributor to the bottom line. If you think World of Warcraft and online gaming has had a big impact on the American gamer, just keep your eye on what massive multiplayer online games (MMOGs) will do in China and the rest of Asia.

Netgear shares tumble after profit drops on US, UK woes – I love Netgear (NTGR) products. Netgear powers my home network. However, it seems that Cisco System’s Linksys division is taking market share by sparking an industry-wide price war. Wireless networking, once the next big thing, has become a commodity. Aside from a few gifted companies like Apple and Cisco, hardware makers often fall prey to the commoditization trap. It happens sooner rather than later. Netgear reported Q1 earnings dropped 20% and promptly saw its stock take a 16.74% dive.

Shares of Synaptics drop after fiscal 3Q profit slides – Synaptics (SYNA) specializes in touchscreen technology. It used to do a lot of business with Apple supplying technology for iPod user interfaces. The long term growth of electronic equipment with touch interfaces like the iPod, iPhone, and the flood of iPhone competitors soon to come bodes well for this company. Cell phones and smart phones will have increasingly intelligent touch interfaces. Even automobile dashboards will become flattened digital touch interfaces rather than today’s analog dials and switches.