It seems that you shorted BRCM & now you scared because the logic of this article. Think for a minute, without
technologies, what the heck this country got left to trade with the world.
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Nothing to Fear but Fear Itself
By Rebecca Thomas
March 5, 2001
Grossly Slower
Source: Department of Commerce
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REMEMBER the Old Economy-New Economy debate? It reached its apotheosis almost exactly a year ago.
On March 7, 2000, Procter & Gamble (PG) plunged 31% in a single session after it warned that earnings growth would weaken in the coming quarter due to soaring oil prices and the rising cost of paper pulp. The shocker inflamed the long-simmering inflation debate and drove the Dow Jones Industrial Average down 374 points that day.
As traders fretted that rising interest rates would undo the remarkable 10-year economic expansion, everything from Philip Morris (MO) to Boeing (BA) took it on the chin. Everything, that is, but technology stocks. Over the next few days, money flowing out of the so-called Old Economy found its way into tech darlings like Cisco Systems (CSCO) and JDS Uniphase (JDSU). Amid renewed patter about technology's immunity to rising interest rates, the Nasdaq Composite surged to an all-time high of 5048.62 on March 10.
So much for the wisdom of Wall Street.
What's become abundantly clear over the past 12 months is that technology stocks are, indeed, vulnerable to all manner of economic cycles. Overpriced technology stocks, especially so. As the economy slowed dramatically in the fourth and first quarters, creating stockpiles of everything from communications chips to routers, technology earnings unraveled faster than just about anybody anticipated. That shocked the Street and has left individual investors gasping. It's telling that since that Nasdaq peak, Philip Morris and Boeing are up 152% and 80%, respectively, while Cisco and JDS Uniphase have both plunged roughly 70% each. Seems like we've got one economy after all.
A good question to ask at this point, however, is whether the markets are any smarter today than they were a year ago. There's no debate that a deep gloom has descended upon both Wall Street and the economy at large. But is the negative sentiment any more valid than the wild euphoria that attended the Nasdaq's pinnacle last March?
Probably not. As we'll discuss in a moment, the economy has hit a deep pothole. But it's also worth noting that it's also holding up fairly well at this point, all things considered. Inflation is tame, unemployment remains low, budget surpluses keep growing and big tax cuts are on the way. As the old saying goes, if there's anything to fear, it's probably fear itself: With consumer and business confidence at an all-time low, the real danger is that the pervasive gloom will become a self-fulfilling prophesy. But even then, the Federal Reserve has plenty of room to maneuver.
It's our view that investors would be wise to focus their sights on the end of the year and avoid getting caught up in the short-term pessimism. There's little doubt it will probably get a little worse before it gets better. But it will get better. The economy will merely take time to recover, as it always has.
Short-Term Pain
For the moment, Wall Street has simply lost confidence in policy makers' ability to engineer a speedy recovery. Since the Greenspan Fed took the unprecedented step of lowering interest rates by a full percentage point over a single month, stocks have careened lower. Economists, too, are nervous: "I don't see that we're off to the races anytime soon," says Mark Zandi, chief economist at West Chester, Pa.-based research firm Economy.com. "The risks are very high that [the economy] isn't going to keep its head above water." Concurs Lehman Brothers senior economist Ethan Harris: "It's a little early to be looking for a turnaround.... We're still in the collecting-negative-signals stage."
The roots of the current turmoil stretch all the way back to last spring, when consumer spending started to slow noticeably after a red-hot winter shopping season. While some moderation was to be expected, rising gas and heating bills intensified the retrenchment, as did the Fed's aggressive anti-inflation campaign. It didn't help when the dot-com bubble burst, taking down technology stocks of all stripes. The wealth effect that had ballooned during the bull market of the mid-to-late 1990s quickly deflated.
But as consumers hunkered down, businesses did just the opposite. They kept rolling out new products and services to satisfy what was widely believed to be an inexhaustible appetite for the wired and wireless. What resulted was a broad imbalance between supply and demand. In the fourth quarter of last year, gross domestic product rose at a scanty 1.1% rate — its weakest pace since 1995 and miles below its second-quarter growth pace of 5.6%. Ironically, the same just-in-time business technologies that have helped boost the U.S. economy's productivity may have contributed to the speed of the decline. Those technologies alerted managers to excess inventories much more quickly than in the past. And once alerted, they dialed back new production with breakneck speed.
The result: a rapid slowdown in corporate earnings. Intel (INTC), Cisco, Nortel Networks (NT), Microsoft (MSFT), Dell Computer (DELL) — the warnings have been like a tolling bell. A consensus of analysts tracked by First Call/Thomson Financial predicts that S&P 500 profits will decline in the first two quarters of this year. "We are clearly in a profits recession," says First Call's research director, Chuck Hill.
Whether it will all add up to recession is open to debate. Although most economists believe the broader economy isn't yet contracting, a growing minority of Wall Street firms (including influential Morgan Stanley Dean Witter) thinks we're already in the midst of a recession — as characterized by two consecutive quarters of negative growth.
Consumers Hold the Bag
The determining factor: consumer confidence. If the pervasive gloom causes enough households to postpone buying decisions, the economy could be in for a summer of pain. If sentiment firms up, a so-called soft landing is likely. The near-term health of the U.S. economy rests on the U.S. consumer's "animal spirits," says Lehman's Harris. Ominously, those spirits are running low.
Consumer sentiment has dropped 25% below its peak of last spring — a decline typically associated with periods preceding a recession. While households remain fairly sanguine about current conditions, their expectations for the near future fell to an eight-year low in February. Economists say high-profile corporate layoff announcements, big-time portfolio losses, and a persistent recession-buzz emanating from the media and the Bush administration have all played a role.
What to Look for
OK, so now for the good news. Although consumers say they feel less optimistic about the economy, they're still shopping (albeit not at last year's red-hot rates). Retail sales may have slowed from January to February, but they're still running above November and December levels. Sales of automobiles came in well above plan last month. Layoffs are indisputably on the rise, but workers are still finding new jobs relatively quickly. That helps explain why the unemployment rate has ticked up only slightly, to 4.2% in January from 4% in December. In his testimony last week before the House Financial Services Committee, Fed Chairman Alan Greenspan noted that the exceptional economic weakness late last year "seemed less evident in January and February."
Moreover, consumers (and investors) tend to forget that monetary policy takes time to work. Since the Fed only began cutting rates in January, it's too soon to look for signs of a full-fledged recovery. What people should focus on is policy makers' commitment to continued rate reductions. Since inflation remains fairly low, it's reasonable to presume that the Fed will make another move later this month — and perhaps in May.
Merrill Lynch chief economist Bruce Steinberg would like to believe that the productivity-driven economy is characterized by both "speed of descent and speed of recovery." If he's right, the same new technologies that have enabled businesses to immediately discover inventory imbalances and quickly cut production should engender a swift recovery. That said, betting on whether we get a quick, V-shaped recovery or a slower U-shaped upturn has become Wall Street's favorite parlor game. Says David Orr, chief economist of First Union Capital Markets: "My sense is that the glut of new technology that has been built up over the past two or three years is going to take longer to work off" than some think.
"Calling the turning point is the hardest part of economic forecasting," says Jim Angel, an associate professor of finance at Georgetown University's McDonough School of Business. "Exactly when and how it's going to turn around is really the wild card here." While we aren't in the business of predicting, we can offer a few clues as to what to look for as evidence that the economy is, indeed, turning around.
First and foremost, it's important to keep track of how quickly companies shed excess supply and resume production. The best place to monitor inventory progression is through the new-orders component of the National Association of Purchasing Managers' monthly survey of manufacturing activity. "When orders get back above 50 (they're now at just 40.8), that means there's enough buying going on that retailers won't have enough product to meet demand," says Orr.
Economists also recommend following hard spending data, not just consumer-sentiment figures. After all, it doesn't much matter how people are feeling, so long as they're spending. "I would tell consumers to go to the mall, and if they detect a pickup in spending, then perhaps there's reason to believe that the latest series of downward earnings revisions will soon come to an end," says John Lonsky, chief economist at Moody's Investors Service. If anecdotal evidence isn't enough, you can always monitor the Commerce Department's monthly retail-sales figures, as well as the big auto manufacturers' monthly sales reports.
And let's not forget the important role the stock market plays as a conveyer of investor sentiment. While the equity market often gives false signals (consider that the market took off in January only to collapse again last month), a sustained rally often represents renewed confidence in the economic outlook. To be sure that the next upswing is for real, Economy.com's Zandi recommends waiting until the Wilshire 5000 index — the broadest measure of stocks — reaches a market capitalization of at least $12 trillion. Its current valuation: around $11.4 trillion.
Most economists we spoke with think it will take until the end of the year at least for the recovery to really take hold. But it's possible the market will anticipate a turnaround by several months. After all, lower interest rates may start paying off sometime this summer just as tax refunds start burning a hole in consumers' pockets. There's also the prospect of a substantial (and probably retroactive) tax cut. Add it up, and there may be plenty to warm up the animal spirits after this winter of discontent. Time heals all things — especially the economy. |
