Techs plumb the market's depths
Commentary: If you think the recent sell-off has made technology stocks cheap -- think again. They may not have hit bottom yet.
Market dictates a reassessment of Autonomy
By Om Malik
Red Herring
March 15
If you are like that kid in the annoying McDonald's commercial who keeps asking, 'Are we there yet?', the answer is no. Despite recent triple-digit declines in the Dow and the Nasdaq, I think technology stocks are still far from hitting a bottom.
Looking beyond the sensationalist headlines, I believe that the market is still overvalued and at this point carries a downside risk. Of course, you can choose to believe the technical pundits and the so-called fundamentalists, but do so at your own peril. Fred Hickey, editor of The High Tech Strategist newsletter and a stock-market sage, is one of the few people who believes that the market remains expensive.
Mr. Hickey is quite adamant in saying that this market is headed south -- fast. Of course, the Wall Street pundits feel otherwise and are calling for a rebound. Now take Mr. Hickey's advice -- he has been calling for a sell-off since March 2000 -- and he has proved to be right. Or you could listen to the din on the bubblevision, known as CNBC, and take the word of people who were touting the market as being oversold in early January 2001. Had you taken their advice then, you'd probably be looking at some sizable paper losses about now.
Let me run down some numbers for you that, if nothing else, should make you want to embrace the safe cocoon of the U.S. Treasuries.
CHEERLESS CHIPS
The Philadelphia Stock Exchange's Semiconductor Stock Index is up slightly for the year -- despite the fact that the chip down-cycle has just begun. Why you should not be in the chip stocks at all is quite simple: Intel (Nasdaq: INTC), Texas Instruments (NYSE: TXN), PMC Sierra (Nasdaq: PMCS), Xilinx (Nasdaq: XLNX), Broadcom (Nasdaq: BRCM), RF Micro Devices (Nasdaq: RFMD), Teradyne (NYSE: TER), and every major chip company have pre-announced, and they are expecting tougher times ahead. Intel is in fact letting go of more than 5,000 people and will not be able to meet even its reduced numbers.
'The current economic environment has dramatically reduced demand for our customers' products. Our visibility is very limited at this point, and we don't know how long the current downturn might last,' George Chamillard, chairman and CEO of chip equipment maker Teradyne noted in a statement. Because Teradyne's customers are chip makers, it is quite obvious that the worst is yet to come.
Take Intel as an example, and you can figure out why everything seems to be so expensive. In 1990, Intel sold at about two times trailing sales, at a time when sales were growing at 30 percent a year. In 1995, it was trading at three times trailing sales, with sales growing 40 percent a year. Now the stock is trading at six times sales, even though revenue is expected to decline this year.
Intel is not the only company that appears overvalued. According to research firm Birinyi Associates, the Nasdaq is trading at around 150 times trailing 12-month earnings. In the pre-bubble era, i.e., before Netscape's IPO in 1996, the Nasdaq's trailing price-to-earnings ratio was about 51.
WARNINGS BONANZA
Chuck Hill, research director for First Call, has estimated that tech sector earnings will fall 29 percent in the first quarter of 2001, show another 27 percent decline in the second quarter, and skid a further 14 percent in the third quarter, compared with last year's numbers. Mr. Hill notes that the 'rapidity and depth of the downturn in tech earnings suggest that tech has problems beyond the slowing economy. It has all the appearances of the downturns in 1969-1970, 1973-1974, and 1979-1980, when internal problems in technology coincided with a recession.'
The personal computer market, overspending for telecom equipment, and over-saturated wireless handset markets are to blame for this downturn, and, if inventory levels are to be believed, then things are not looking that rosy either. Take the PC market as an example -- PC unit sales have been falling (year-over-year) for the past six months, according to PC Data, with the sharpest decline coming in January this year.
What highlights the longer-term problems of the PC market is the fact that the box makers were giving hefty discounts to move inventory. With PC penetration running at 63 percent of U.S. households, the 30 percent-plus growth rates for this industry are over, contends Mr. Hickey, who believes that the PC majors will be clawing each other's eyes out to gain market share, at the expense of profits.
Things are no different in the wireless world. Despite the widespread saturation (running at over 50 percent in Europe), the number of handset makers are going up in this business. In 2000, Nokia (NYSE: NOK) continued to extend its market share lead. But earnings estimates for the company have been slashed by several analysts this year, and, according to First Call, Nokia is now expected to post an earnings increase of just 10.6 percent in 2001. When the largest wireless phone maker in the world is having trouble posting earnings growth, then what chance do smaller rivals have?
Ericsson (Nasdaq: ERICY) and Motorola (NYSE: MOT) are battling with Siemens (NYSE: SI), Samsung, Mitsubishi, and Alcatel (NYSE: ALA ) for market share. At the same time, a large number of Asian phone makers, including several Chinese companies, are entering the market. Economics 101 says that when too many players are competing for a finite number of customers (450 million in 2001), there is going to be a severe price war, and margins are going to evaporate.
The networking industry is facing its own Waterloo. Cisco Systems (Nasdaq: CSCO) and Nortel Networks (NYSE: NT) scaled their operations based on perceived demand from the competitive local exchange carriers, application service providers, and the dot coms that were funded by the ill-directed venture dollars. By doing so, Cisco and others of its ilk raised the expectations of component makers like PMC Sierra, Applied Micro Circuits (Nasdaq: AMCC), and JDS Uniphase (Nasdaq: JDSU), companies that are supplying the very guts of the gear.
We cannot blame the venture capitalists alone for the bursting of the bubble. Federal Reserve chairman Alan Greenspan has to share some of the blame, as the Fed's aggressive rate cuts in 1999 have appeared to help cause the economic slowdown that is currently affecting technology companies. I don't think another rate cut, or even President Bush's proposed tax cut, will save technology in the foreseeable future. And if that means putting all your money into bonds, then do it.
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