NEW YORK ( TheStreet) -- Any investor following the recent fortunes of stocks in the LED lighting sector hasn't been reading much good news about the industry or seen promising recent stock action in three prominent LED plays -- Veeco Instruments ( VECO), Cree ( CREE) and Aixtron ( AIXG).

Short activity in all three stocks has increased in recent weeks as the news flow turned negative on the sector -- and in the case of Veeco specifically, shorts are owning the stock in Thursday trading, possibly as a result of the latest negative news item, a report from Digitimes that Chinese officials are concerned about overheating in the LED sector.

Veeco shares are down roughly 5% on Thursday afternoon, yet trading volume was average for the LED stock. Analysts covering the stock say the light volume, but significant stock decline, is the classic sign of a stock that has not just come under short pressure, but come under short pressure at a time when the long bets have abandoned the stock.

That's certainly been a problem for LED stocks in general, with few signals of long-term bullish trading and increasing short interest week after week.

The latest short interest data from the Nasdaq details an increase in bearishness on the LED lighting stocks, with Cree bearishness being the most intensified. It's notable that for all three LED stocks, short interest is at its highest level in more than a year. The Nasdaq short interest data is two weeks trailing, so the short interest on Cree, Veeco and Aixtron released by the Nasdaq this week is as of Aug. 31.

Cree short interest jumped from 11.5 million shares to more than 15 million shares in the two weeks ended Aug. 31. The 11.5 million short positions on Cree two weeks ago was the previous high for the past one year period, and so, the four million additional shorts added in the most recent two week Nasdaq period is notable.

Veeco short interest increased by more than 2 million shares as of Aug. 31. The increase in short interest in Veeco shares has been steady, as had been the rise of the LED stocks until the recent crash. There was only short interest on 1.6 million Veeco shares in August 2009, and at the end of August 2010, short interest had climbed to just short of 13 million shares.

Both Cree and Veeco short interest has increased considerably, even as average daily trading volume was significantly lower in both LED stocks in the most recent two week period.

Yet on Thursday, Cree was actually gaining ground in trading after its recent wallop, up more than 1%, while Aixtron was only down by a similar margin in the afternoon.

The reason for the continuing short parade in Veeco on Thursday may be due to a specific read-through from the Digitimes report that does not apply directly to Aixtron or Cree.

Citing anonymous sources, Digitimes reports that current orders for the MOCVD equipment sold by Veeco and used in LED chip production has reached 1,400-1,600 sets, leading to concerns about overheating from officials at China's Ministry of Industry and Information Technology (MIIT). For comparison purposes, in the last quarter the total installed base of such equipment in the LED sector was 720 sets, according to data provided by analyst Mark Miller of Noble Financial Group. Noble Financial's Miller said that of the roughly 400 LED machine sold by Veeco, probably between 100 and 150 were Chinese sales.

Digitimes writes that "Officials from MIIT revealed that the government is indeed concerned that aggressive investments could overheat the LED industry, and is currently designing its twelfth five-year plan for LED industry development. It is scheduled to announce up to ten new standards and policies in 2010."

Government subsidies in China have helped to spur the sale of the equipment made by Veeco, and Veeco has had a much stronger presence in China than Aixtron. Therefore, the read-through from the anonymously sourced report is that the Chinese government could rein in its current level of subsidies for the purchase of LED equipment, leading to slowing sales in China for Veeco. A lower level of subsidies from China for LED equipment buys could also put pressure on Veeco's pricing.

Currently, the Chinese government subsidizes $1 million to $1.5 million of each MOCVD machine installation, a policy that has helped Veeco to become a leader in China.

The Noble Financial analyst was frustrated by the latest short raining on the LED parade, saying that with the lack of long-only interest to fend off the shorts, the bear action in Veeco has become the classic story about short trading destroying value in a growth company, rather than a market balancing mechanism. The Noble Financial analyst argues that the shorts can have their day now, but the longer-term trends don't support the bear case on Veeco. By 2013, Miller projects a global market of roughly 160 billion LEDs, and that requires an equipment base of 3,750 Veeco-like machines.

"I've done great shorts in my life, but this a total misapplication of the short strategy unless it's very short-term," Miller said. The analyst contends that Veeco's market is nowhere near saturation, and that doesn't even take into account the opportunity in the general lighting market expected to heat up once the U.S. moves to LED lighting in 2012. "This shorting is not based on legitimate fundamental analysis, but all technical. Veeco's market is not going to zero," Miller added.

Veeco shares weren't going to zero either, but Thursday was another day on which shorts were trying to push the LED stock that way.

--Written by Eric Rosenbaum in New York.

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