A long but very interesting interview with Fred Hickey, who is bearish on tech stocks, from The Street.com
http://www.thestreet.com/p/comment/streetsidechat/1289155.html
Fred Hickey tends to enrage today's generation of tech investors.
As editor of the High-Tech Strategist, Hickey has been a snarling bear on tech stocks since 1998. After the historic
rally in tech in 1998 and 1999, however, he looked a bit foolish.
But after last year, he was looking a lot smarter. And so far in 2001, he has made money for his readers. He told
people to go long tech at the beginning of this year. The January rally tech proved him right as rain. And now, what
is he forecasting for tech? When does he see the tech inventory correction clearing? Has he chucked the bear suit?
To find out, read this conversation between Hickey and TSC chief markets writer Brett D. Fromson.
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Brett D. Fromson: Fred, the Fed is clearly now dedicated to doing whatever it thinks it takes to get this economy
from slumping into a recession. We have a new administration that's going to be cutting taxes in some manner. Why
shouldn't we be buying technology stocks, which theoretically should do well in this kind of environment?
Fred Hickey: Well, there are a few reasons. The first one is that tech stocks haven't corrected enough. They're far
too expensive relative to where they've been historically.
Brett D. Fromson: Explain your thinking there.
Fred Hickey: Well, we have a Nasdaq composite P/E ratio that's 100 or over, which is unprecedented, except for
last year. And you can even look at individual numbers and you'll see many tech stocks still selling for P/Es well
over 100, even though we're seeing across-the-board growth rates decline. You're seeing companies like Intel
(INTC:Nasdaq - news - boards), which looks like it might be cheap because it's dropped in half, selling now at
almost 40 times estimated earnings -- 40 times!
I've tracked Intel for years, almost the better part of two decades now, and for the largest part of that time, their
P/E ratio was in the 10 to 15 range. But that was when they were growing rapidly. Here the forecast is for sharply
declining earnings in 2001. Does that justify 40 P/E for a company in a mature PC market when growth rates are
declining? I don't think so.
But it does symbolize the excessive optimism out there regarding tech stocks. The great performance in the past
couple of years hasn't been erased in people's minds yet. There's no fear, only greed, and that's what we see
represented in the stock prices today.
Brett D. Fromson: Let me ask a question following up on Intel. Is there some expectation in that 40 multiple that
the company will return to some higher growth path soon?
Fred Hickey: Obviously there is. But, I don't see the justification for it. It's completely irrational. You know that
their growth rate has been in decline now, along with the PC market, for three years. As the PC market has
matured and become saturated, there aren't any technology drivers to speak of. Why anyone thinks that there'll be
a big pickup in the second half with Intel is beyond me, or even next year, 2002. Now, there's this general
enthusiasm, general expectation that we'll have a second-half rebound. Everywhere. The whole economy will pick
up in the second half.
Brett D. Fromson: Yes, let's talk about that a little bit.
Fred Hickey: We don't have any evidence of that. The only evidence we have right now is of a deeply slumping
economy. Layoffs on layoffs on layoffs, whether it's DaimlerChrysler (DCX:NYSE - news - boards) or Sara Lee
(SLE:NYSE - news - boards), you name it. And when 26,000 Chrysler employees or 7,000 Sara Lee employees
get laid off, I guarantee you they're not going to be buying new notebooks or personal computers for them. So the
expectation is that this is going to turn around magically in a matter of months. The only reason people believe this is
that they believe that the Fed has a magic wand and whenever it lowers rates, it can turn the economy around all by
itself.
Brett D. Fromson: On Jan. 1 in your newsletter, you recommended 20 stocks to play for a bounce. Review that for
us, please.
Fred Hickey: Yes. Over the 20-plus years that I've been investing, I've seen many, many, many tax-effect bounces.
Brett D. Fromson: And by tax effect you mean ...
Fred Hickey: Meaning what happened was that you had a number of technology stocks that were badly beaten in
the year 2000. And because they were badly beaten, and because there had also been a lot of gains early in the
year, people used tax losses in the stocks that were down to offset their gains. And because we hadn't seen that in
recent history, because we'd only had up years, we hadn't had the tax effect like we'd seen through most of the
time I've been investing.
I also looked at the stock prices and the valuation level of these companies that were, I thought, unfairly smashed at
year-end, just because of the tax-loss element. All of them have some problems. They may have lost position, they
may have stumbled in a quarter or two, but I knew all the products. I've known the companies for years, I knew
where they were positioned. I knew they weren't going to go away, and, more importantly, in some cases they
were trading near cash value or book value per share. And so if you were just going to play a bounce, I knew that
these issues were so cheap that they were likely to bounce in a "January effect" bounce.
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"Tech stocks haven't corrected enough. They're far too expensive relative to where they've been historically."
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Brett D. Fromson: Give us a few examples, if you would.
Fred Hickey: BMC Software (BMCS:Nasdaq - news - boards) was one, Inprise, which then changed its name to
Borland (BORL:Nasdaq - news - boards), was another. 3Com (COMS:Nasdaq - news - boards) was another
one. Electronics For Imaging (EFII:Nasdaq - news - boards). They all had great balance sheets, and all have been
companies that are not fly-by-night. All have been established for years and all have strong positions in their market
niches.
Brett D. Fromson: Now update us. What happened in January to the stocks that you mentioned as being worthy
for a bounce?
Fred Hickey: Well, BMC Software more than doubled. They also reported better-than-expected earnings. Down
year to year, but still better than expected. Inprise/Borland did the same on better-than-expected earnings.
Electronics For Imaging also reported better-than-expected earnings. It had a significant bounce.
Brett D. Fromson: Typically, you're talking about gains within what range?
Fred Hickey: Oh, anywhere from 50% to 100%.
Brett D. Fromson: All right.
Fred Hickey: And these weren't the only ones that bounced in January. There were many, many other stocks,
many of which I think did not justify their bounce, OK? [Laughs] My forecast was aided by a Fed that came in on
Jan. 3 and accelerated the bounce. There were many things that bounced. These were very good picks, because
risk was limited even if the Fed didn't lower rates and even if the market turned down.
Brett D. Fromson: Now what are you telling your readers?
Fred Hickey: There were 20 names, and about the majority I will say, "Sell those stocks."
Brett D. Fromson: Because?
Fred Hickey: Because they have bounced so much. They're no longer near book and cash value if they've doubled.
You've now put quite a distance between that book and cash value, in many cases. And the problems still exist that
caused the market to decline in 2000.
And those risks are magnified right now, because of the rapidly declining economy. So the likelihood of continuing
problems for these companies -- several of them, anyway -- is high.
Brett D. Fromson: How much, then, is your negative view on technology dependent upon the expectation of
macroeconomic recession?
Fred Hickey: I would say, very much. I think the most serious mistake an investor can make is not to consider all of
the variables. If you just think about what one particular company is doing and use its recent history -- last quarter
or last year's or the last two years -- without considering macroenvironment conditions, then you're going to miss all
of these earnings messages, you're not going to be able to forecast properly. As an investor, you have to forecast
the future. And you better not be using only the past as your guide.
Brett D. Fromson: On Wall Street, pretty much every economist is predicting no recession. Even the most bearish
ones at the moment are handicapping the probability of a recession as one in three. Why are you so much more
gloomy?
Fred Hickey: I think that my forecast for technology is dependent first and foremost upon valuations. When you
have these kinds of valuations, which are unprecedented, it is a dangerous moment to be investing in tech stocks.
These are not valuations you would see at the end of a bear market, and the beginning of an upturn. Go back 500
years, and you'll never see anything like that.
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"As an investor, you have to forecast the future. And you better not be using only the past as your guide."
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Brett D. Fromson: Do you have any prior periods that we could benchmark?
Fred Hickey: Sure. You go back into 1990, our last recession, and you will see that we would have a P/E ratio of
around 10 overall for the market. We had Dell (DELL:Nasdaq - news - boards) billing at 10 times earnings for
years. Intel was selling at 10 times earnings. Microsoft (MSFT:Nasdaq - news - boards) was at 20 times earnings.
And these were the great growers, the great leaders with unlimited futures. I don't know what the Nasdaq was, but
I believe it wasn't anywhere near 100, I know that. It was somewhere south of 30.
Brett D. Fromson: Let's talk a little bit about the expansion of P/E multiples. Undoubtedly, it has been driven
significantly by investors' sheer optimism. But does part of it not also reflect a fundamental improvement in the
American technology sector?
Fred Hickey: Absolutely not. In 1990, the argument was made that tech stocks deserved below-market multiples.
Brett D. Fromson: Why was that?
Fred Hickey: Because investors thought that tech was a mature industry at the time. They thought that the market
was saturated. Growth rates had slowed.
Now, the growth rate had slowed in the PC market to levels that were higher than they are today. All right, the
growth rates in the PC market were higher than they were last year when we had an economy that was booming.
That was a bottom in a recession, 1990-91. My point is that at major market turns, the consensus always has it
wrong. They had it wrong in 1990. It was an almost unlimited upside through the 1990s, as we saw in tech stocks,
and in prospects for tech stocks. But, as I look forward in 2001 and I look at the major drivers of technology, I
don't see that. I see saturation.
Brett D. Fromson: Explain what are the major drivers in technology.
Fred Hickey: Well, the personal computer is number one. By far, it's the largest consumer of semiconductors.
Number two, cell phones. Because you talk about size of markets here and the consumption of, say,
semiconductors, you're looking at a $150 billion to $200 billion market. The largest drivers are PCs and cell
phones, and PCs and cell phones have boomed throughout the 1990s.
Brett D. Fromson: What kind of growth are you forecasting for PCs and cell phones over the next year?
Fred Hickey: Well, it's hard to see out five years. But what you're going to have is cyclical periods. It's now a
cyclical industry. When you're at levels of saturation that we have in corporations, where virtually everyone in a
corporation that requires a PC has one, you'll have periods of time, as you do with automobiles, within a three- to
five-year period, where, after periods of growth and demand [have] been sated and the replacement market has
ended, you'll have no growth or negative growth. That's what we're going to see in the PC market. Right now, we
have no growth in revenue. And this year I think we're going to be negative.
Now, will that last five years? I don't think so.
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"I think there's no chance, zilch, of a pickup in technology in the second half of this year."
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Brett D. Fromson: Right, but you also know yourself that the stock market is known to discount the future in
current stock prices.
Fred Hickey: Agreed. But what technology drivers were there? In 1990-91, we had a technology driver in
computers. First of all, we had a very small penetration in the consumer market. We now have 60% of households
with PCs. We weren't completely saturated in business markets; now we are.
Brett D. Fromson: Let's talk about another key driver -- cell phones.
Fred Hickey: We've gone from, let's see, just a couple of years ago, 100 million units sold, to an estimated 400
million units this year. Think about how many people there are on the planet. There's 6 billion people on the planet?
Half of whom make about $3 a day? Enough to survive, not enough to be paying wireless fees. What we're seeing
is 100% (or near 100%) penetration in places like Finland and Italy. Penetration among those who can afford it will
use them. In the U.S., it's becoming very high.
The growth rates have started to fall off, and what are we seeing now? We're seeing a fairly dramatic decline in
pricing in order to try to keep growth rates up, and they still can't do it. We're seeing price wars out there, and so
the forecasts for cell phones, recession or boom notwithstanding, are going to go down from here, because of the
level of maturity in that market. We're talking about significant changes in these markets, huge changes.
Brett D. Fromson: You're talking about a secular slowdown, not cyclical?
Fred Hickey: That's right.
Brett D. Fromson: All right, what about the whole question of the inventory buildup that we're seeing all along the
supply chain in technology? How do you see that, and how will that affect recovery in the technology area?
Fred Hickey: Well, I mean, that's the other thing. We never had such a looming inventory correction in 1996 and
1998.
Brett D. Fromson: Could you describe those briefly?
Fred Hickey: Sure. The industry became enthusiastic about the prospects of Windows 95 for PCs. Because of
that, they overbuilt PCs; they overbought for components and when Windows 95 didn't take off as expected -- it
was still a very strong product, obviously, but didn't take off as expected -- companies were left with excess
inventory. The economy was still strong. We weren't looking at a recession. We had an inventory correction. The
inventory correction lasted six to nine months before they cleared the inventory, meaning they had to mark down
prices into a strong economy, and they were able to clear the excess.
The same thing occurred in 1998. In this case, it was more than just PCs. It was also communications products.
Brett D. Fromson: What happened in 1998?
Fred Hickey: Well, you had the crisis in Asia, where economies sunk. People had expected Asia would be the
fastest-growing consumer of semiconductors and other electronic components, and when Asia fell off, you were
left with an inventory overhang, which then had to be cleared. And again, it took six to nine months to clear the
inventory into a relatively strong world economy. And, of course, we had the Fed pumping money like mad in
order to offset the perceived world weakness. So there was always lots of money. There was always a strong
economy behind a period when they were clearing the inventory excess.
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"There's 6 billion people on the planet? Half of whom make about $3 a day? Enough to survive, not enough to be
paying wireless fees."
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Brett D. Fromson: Why won't we see that kind of six-month inventory correction this time?
Fred Hickey: We've not even begun the clearance. We're here in January and inventories are building. And why?
People have known that these inventories were building since early last year. Cell-phone inventories were building
then. There was concern at many of the contract manufacturers about the rapidly building inventory. There's been
concern. There's been talk of cutting back inventory. They have tried to cut back inventory, and what has
happened? They have built through it. Why have they built through it? Because the economy has stunk.
Now, is the economy going to pick up? What's going to happen to these inventories in the next month as more
people get laid off? This is a different environment. This is a recession. There was no recession in 1998, when they
were clearing inventories. There was no recession in 1996. There was one in 1998 in Asia, but it wasn't
worldwide.
Brett D. Fromson: How long do you think this is going to take?
Fred Hickey: This will not clear, because the economy is not picking up. Right now, we know that as a fact. We
can disagree on what's going to happen in the second half.
Fact: Every company that has reported in the last few weeks, including Nokia (NOK:NYSE ADR - news -
boards), has forecast lower-than-expected numbers, each time. Every time, whether it's Ericsson (ERICY:Nasdaq
ADR - news - boards), Motorola (MOT:NYSE - news - boards), whether it's Sun Microsystems
(SUNW:Nasdaq - news - boards) or whatever, each of those companies has been surprised by this severe decline
in demand. And with a severe decline, they have not properly adjusted inventory, and inventories have built up.
Their forecasts were for much higher growth. The only way you clear inventory is if somehow you can stimulate
higher growth, or you can shut off your production, and no one's shutting off production yet. No one shuts off
production, because they all believe in the Fed. They all believe in the second half.
Brett D. Fromson: When you say they shut off production, what do you mean?
Fred Hickey: You'd have to shut down a manufacturing plant. There are only two ways to clear inventory: You
either cut prices enough to stimulate great demand and/or you cut back on production.
Brett D. Fromson: We've seen the discounting.
Fred Hickey: We've seen the discounting, and we've also seen its effect so far. Nothing. [Laughs] We've not
cleared any inventories. We've seen them continue to build, which is also what tells me this is a real secular problem
here.
Why is that? Well, because the markets are saturated. This is the longest-running expansion in history. The Fed has
continued to come in at every point where you think the situation would normally correct, and it pumps money
madly.
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"Add a recession or a slowdown to this massive oversupply of capacity and are you going to get a pickup in those
industries? No way. No chance."
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Brett D. Fromson: Let's assume that we don't have a recession, but we simply have a period of slow growth. How
would this change your forecast for technology companies and technology stock prices?
Fred Hickey: Well, if it was 0% to 2% growth, none of these technology companies are geared for that kind of
growth. No one is expecting 0% to 2% growth. We will continue to overproduce at that level. Do you know why?
Because the Fed, and I'm going to keep coming back to this, continues to pump money at the most egregious rate
ever seen in history. And this created a bubble and too much capacity.
Too many cell-phone plants, too many PC companies, too many automobile factories, too much steel capacity, too
much paper capacity, too much of everything. We have a tremendous amount in capacity. We have had capital
spending in technology near 40% to 50% growth rates, year on year. And that's not what the growth rate of the
end markets is. We've been building up to this huge capacity, and that's why prices have plunged. Even before the
recession or slowdown occurred, prices were plunging in PCs and DRAMs and cell phones and everything,
because we had too much capacity. Now, add to that a slowdown. I say it's going to be a recession, but whatever
it is, add a recession or a slowdown to this massive oversupply of capacity and are you going to get a pickup in
those industries? No way. No chance.
Brett D. Fromson: You're about to put your February issue to bed. Give us a bit of a preview of your thinking right
now.
Fred Hickey: What I'm going to show in this newsletter is the massive inventory levels that have built up. There's no
one, not one company that I can think of, except for maybe IBM (IBM:NYSE - news - boards), that didn't lower
its forecast for the first quarter. These are hopeless optimists.
Brett D. Fromson: Which is one of the reasons, of course, they've been able to achieve what they have in the past.
Optimism is often associated with success.
Fred Hickey: Yes, but it's also what caused every inventory correction in every downturn we've had. And
particularly here, because we've had this longest-running expansion in history and we've had the greatest stock
market mania in U.S. history. The greatest bubble in history. There are all kinds of imbalances out here.
Brett D. Fromson: Are you equally bearish on stocks in general, or just technology stocks?
Fred Hickey: The excesses have been in technology. You look at capital expenditures. The excesses have all been
in cap ex. What happened was that investors poured all of their money into IPOs and bonds and convertibles in an
orgy in the last couple years. That's where all the performance was.
So we ended up with 40% to 50% growth in cap ex in tech, and virtually nothing in other areas. I believe we still
have a lot of excesses in this economy. We created all these Internet companies that had no reason to exist, in my
book.
Brett D. Fromson: Now let me ask you, speaking of the Internet companies, some of them have been absolutely
crushed, and some of them are really selling at a discount to cash. Is there anything to like in this beaten-up sector?
Fred Hickey: One of the companies that I had on my January bounce list was a company called Allaire
(ALLR:Nasdaq - news - boards). The price was $5. It's a software company for the Internet, a pure Internet
company. They had $4.58 in cash. So you were paying $5, and they had $4.58 in cash. They didn't have any debt.
Brett D. Fromson: Positive cash flow?
Fred Hickey: The cash flow was not positive, but it wasn't significantly negative, and that's the difference. Meaning
that if you bought that, you were paying almost nothing for the company, and I knew their products were very
good. You were basically buying the products for nothing at that level. The cash burn was slight. They couldn't burn
through that cash hoard. It would take them years to do so. So this company was not at risk of going away, in a
month or two, or a week, which is all I wanted to hold it for. And so what happened was that they got bought out
in January. It was so cheap they got bought out by Macromedia (MACR:Nasdaq - news - boards), and the stock
prices doubled.
Now, that was a reasonable investment for an Internet company. I looked at a lot of Internet companies with cash.
I did not consider these companies that were burning cash like mad even if they still had a lot of cash on the
balance sheet from IPO proceeds.
Brett D. Fromson: Did you look at DoubleClick (DCLK:Nasdaq - news - boards)?
Fred Hickey: I looked at DoubleClick.
Brett D. Fromson: What was your evaluation at that time?
Fred Hickey: It wasn't anywhere near as attractive as the other 20 companies I have on this list.
Brett D. Fromson: Because?
Fred Hickey: Because their cash burn was a lot greater, and I don't think DoubleClick was 1-to-1 cash-to-market
valuation, or anywhere near close to that. And with DoubleClick, I knew that Internet advertising was not being
very successful, I saw a lot of risk about how successful Internet advertising is going to be anytime soon. That was
not the case with Allaire. I knew they had good products that people buy.
Brett D. Fromson: Most investors feel that they need some exposure to technology.
Fred Hickey: Sure.
Brett D. Fromson: What do you say to them, given your very bearish outlook?
Fred Hickey: I would say a few things. One, you can't just buy and hold technology companies because the risk of
obsolescence is very high. This is not like buying Gillette (G:NYSE - news - boards) or Procter & Gamble
(PG:NYSE - news - boards), and you can stick it in a drawer, and feel safe about it.
Brett D. Fromson: Although some people who own Procter & Gamble would say you can't stick that in a drawer,
either.
Fred Hickey: Well, the prospect of Procter & Gamble going away in a very short period of time, as we've seen in
technology, is unlikely.
Brett D. Fromson: What would you say to the investor who wants to own tech long term?
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" You put a 30 P/E on the Nasdaq, which would not be the growth rate of these tech names. You would have a
Nasdaq under 1000."
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Fred Hickey: I would say, don't. What's wrong with 6% cash when I know your return is going to be negative for
sure? Why not try another area? There are times when you can make a lot of money in tech, and that's when
they're cheap. And there are times when you can lose an incredible amount of money in tech, and that's when they
are dear.
Today they are dearer than ever before, except for last year, and we saw what happened last year. We've not
corrected excesses when I see surveys that show that most online investors expect the Nasdaq to increase 74% in
2001. When I see expectations of double-digit gains everywhere.
That is not a time to buy tech stocks. You buy them in 1990 when no one wants them, when they're hated. You
can make tremendous amounts of money. You buy them in 1993. You buy them in 1987. You buy them in 1982.
You can buy them at all of those times, when I bought them, by the way. I have been bullish for three quarters of
the time that I've been investing in tech stocks. And I've been invested in tech stocks in some fashion or other 90%
of the time. But there are certain times when you don't want to be invested.
Brett D. Fromson: Bottom line, you're saying that at the end of 2001 the typical stock index and the indices that are
loaded with tech will be down considerably?
Fred Hickey: You put a 30 P/E on the Nasdaq, which would not be the growth rate of these tech names. You
would have a Nasdaq under 1000.
Brett D. Fromson: This year?
Fred Hickey: We could.
Brett D. Fromson: But this year?
Fred Hickey: I said we could. There's no way that I can tell the timing. I can tell you at any point in time whether
there's high risk or low risk. This is high risk. I'll go on record as saying that I think there's no chance, zilch, of a
pickup in technology in the second half of this year. Even if I'm 100% wrong on the macroeconomy, it will not save
technology because of the overcapacity and overinvestment that has occurred in these last few years. |
