MARKET EARNINGS
Don’t blame the Fed. It’s the earnings – technology earnings!
The key thing to watch as we go forward is what the technology companies are saying about the outlook for their sector. The Fed actions are still important, but we believe the tech sector is the key to how deep and how long the economic downturn will be.
The Fed would probably have successfully engineered a soft landing, but for two factors not foreseen at the time. First was the sustained higher energy prices. Second was the cyclical slowdown within the technology sector. Neither energy or technology analysts foresaw what was coming in these two sectors. If the highly paid Wall Street analyst were not able to foresee these two problems, how can the investment community expect the Fed to have anticipated them?
The bigger of the two problems is turning out to be technology. Clearly, when earnings growth for the S&P500 technology sector drops from a 42% gain in 3Q00, to only a 3% gain in 4Q00, to current expectations of a 31% decline in 1Q01, it indicates that tech has more problems than just a slowing economy.
Probably the major factor causing the tech slowdown is the excessive spending for tech capital equipment that has left too many industries with excess capacity.
Time is the only solution to digest all this added capacity and get demand in line with capacity. The Fed can do little about that. When managements say they have no visibility for the second half of the year, translate that to it’s going to be some time before their business rights itself. The solution is not just working off inventories, but digesting the excess purchases of technology products. There has been too much duplication of capacity in technology based industries.
Among the other factors contributing to the cyclical downturn in tech are a maturing of the personal computer market, the collapse of the internet companies, and the transition to a new generation of Windows software.
The real danger is that the downturn in the tech sector contributes to a deeper downturn in the other economic sensitive sectors. It could be the additional factor to nudge the overall economy into recession. The direct impact of the tech downturn is the economy will suffer from the lower contribution to GDP from the tech sector. The indirect effect will be the negative impact on consumer confidence from the tech layoff announcements and the depressed tech stock prices.
The pre-announcement situation is growing more ominous. As a result, we believe it is worth repeating and updating parts of our comments from last week. The parade of negative pre-announcements continues. Even worse, the pace has quickened at a time when it should have slowed. The pace of tech warnings has accelerated to a full gallop. For those who say there are no more major tech companies left to warn, sit tight; they can all warn again, and again. Some already have.
Normally, there are a number of pre-announcements associated with the reporting of the prior quarter earnings that comes the last three weeks of the first month of the quarter. The pace is fairly subdued in the second month and the first week or two of the third month. Then the pre-announcements accelerate to a frenzy during the last week of the quarter and the first two weeks that follow.
This quarter, the pace actually showed an increase in February and the first two weeks of March over the January pace. Negative pre-announcements are running 47% ahead of the record setting pace of 4Q00. The 554 warnings already match the pre-4Q00 record that was set in 3Q98, and the peak weeks are yet to come. Warnings from the tech sector are 113% ahead of the 4Q00 pace. Furthermore, the percentage of all pre-announcements that are negative (69%) is much higher than in 4Q00 (48% at the equivalent time in 4Q00 and 54% at the end of the 4Q00 pre-announcement season), since both positive and on-target pre-announcements are coming in at a much slower pace than in 4Q00.
Since 1 Jan, expectations for the problem tech sector’s earnings growth have dropped from a 4% gain to a 31% decline for 1Q01, from a 2% gain to a 29% decline for 2Q01, from an 11% gain to an 17% decline for 3Q01, from a 22% gain to an 8% gain for 4Q01. Full year has dropped from an 11% gain to a 17% decline.
With tech warnings coming out at such a fervent pace, it seems likely that tech earnings revisions will continue in free fall, and the slashing of estimates will move further out. In the last week, analysts have begun to slash 4Q01 estimates for tech. A month ago expectation for 4Q01 tech earnings growth was a 21% gain. Two weeks ago it was 17% and one week ago it was 15%. It now stands at only 8%, and that is comparing to a very weak 4Q00. Down earnings in 4Q01 for tech now look like a real possibility.
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