Wall Street fantasies give optimism a bad name
Lots of people from Federal Reserve Bank officials to smug analysts to the companies themselves insist the first quarter will show improvement. Sorry, I can’t agree.
By Bill Fleckenstein
If you still have your Champagne flutes lying around after New Year's, join me now in a toast to Robert McTeer. Only this time, fill them with beer. You see, the president of the Dallas Federal Reserve Bank recently opined that even though some of the gains of the "new economy" had all the substance of foam, "there was still much more beer than before." Thankfully, he wasn't invited to Barron's Roundtable, where there was already enough residual "bubbly" to go around.
Barron's annual Roundtable is a worthwhile read, not only for the insights of a couple of gentlemen but for an understanding of the psychological pulse of some rather complacent "pros." (The first of three consecutive installments was published Jan. 12.)
Roundtable stained with smugness
Many who were dead-wrong in last year's picks appear uniformly bullish this year, mostly on the back of nothing more than arm-waving. (The guys with the soundest arguments, Marc Faber of Marc Faber Ltd. in Hong Kong and Swiss money manager Felix Zulauf, had the best records. But just because somebody was right last year doesn't mean they'll be right this year, and vice-versa.) None of the bulls seems much humbler, despite how poor last year was. In fact, I detected a note of smugness among this group. I am not being critical of their mistakes, since everybody in this business makes them. I have made tons myself. But given how badly they fared, a little more contrition may have been in order.
I also detect much bullishness because of the widely held belief that "the government is targeting the stock market and wants it higher." If there were merit in that reason, people would want to be bullish on markets like Japan, where the government has not just targeted the markets but openly bought stocks. Its price-keeping operations (PKOs) work momentarily, but then they fall apart. In the long run, such intervention is bad, because investors are unable to trust the prices, knowing that they've been artificially pushed higher.
In my opinion, governments that fiddle in markets undermine investors' confidence. Further, this only exacerbates the overvaluation problem that’s been weighing on the market since before 2000. And it postpones the inevitable adjustments that people need to make. And yet, given that targeting the stock market has proven not to be bullish in Japan, I am shocked at the number of "pros" who deem it to be a good thing here. It's just a variation on the Greenspan put. People thought they were safe because Fed Chairman Alan Greenspan would never let the stock market go down. I don't even have to waste my words talking about how silly that notion was, though it had its share of believers for a long time.
Less McTeer, more beer
Speaking of the man who we don't talk about anymore, one of his cohorts, Dallas Fed president McTeer -- second in line for Most Incompetent Performance by a Fed official -- recently wrote an op-ed piece in The Wall Street Journal called "Productive America" that is absolutely stunning in its (a) arrogance and (b) cluelessness.
Exhibit A: "The growth and productivity numbers of the New Economy period (the emphasis is mine; note his capital letters for 'n' and 'e') were more impressive before data revisions. Not only is the future not what it used to be, neither is the past. So, productivity growth only doubled in the new economy. I'll take it. There ought to be a law against data revisions, or the statute of limitations. There may have been more foam and less beer in the New Economy numbers (again, capitalized) than we thought, but there was still much more beer than before."
It sounds to me like he was drinking a lot of beer prior to penning this. Can you believe that he made those comments in an era where we are now seeing what corporate charlatans did? So, if he were running a company, would cooking the books have been OK if it cast things in a better light? I mean, how can this man hold a position of responsibility and write an article like this? It's appalling, as is the following fallacy: "Faster growth turned budget deficits into surpluses." No, the market mania and the capital-gains taxes that flowed from the ridiculous prices that the mania spawned were responsible for the surpluses. (I am all for faster growth, though. Don't get me wrong about that.)
The end of the article is truly priceless: "But the recent performance of productivity does augur well for long-term growth once we get beyond the current soft spot. (This is a "soft spot" that he, of course, never saw coming, that has blown holes in most state budgets and corporate pension plans.) The economic imperative that drove productivity growth in the '90s -- increased competition due to a deregulated, free-trade, global economy -- has not disappeared."
If this is a soft spot, what does a "hard spot" look like?
Paleolithic precedent
For those of you who were not math majors, that is a perfect example of arguing logically from a false premise to a false conclusion. Basically, what McTeer says is that the need for productivity actually caused it, and we still need more. Therefore we will have it. This is patently untrue. He is correct to state that there is an economic need for productivity. The increased competition that he cites is also correct. But that's not what drove productivity. Productivity is a byproduct of the technological advances that have been occurring for hundreds of years. Here I would just note his failure to mention that productivity growth in the McTeer era was less than in a couple of eras gone by.
This piece reeks of unbridled arrogance on the part of someone who has done a terrible job at the Fed, who hid behind the same "new era" nonsense, and who when the whole thing started to come unstuck dispensed more bad advice by telling people to go out and buy another SUV. I am nearly speechless at the depths of his bombast.
Forked-tongue-and-cheek gazette
Turning to tech world, where bombast often pinch-hits for fundamentals, I'd like to share some thoughts on Intel's (INTC, news, msgs) first-quarter guidance, and then a bit of perspective, via the guidance from Teradyne (TER, news, msgs) and Linear Technology (LLTC, news, msgs), which were released the same day last week.
Regular readers know my expectation has been for rather horrific Q1 guidance in general. That was really not the case with Intel, at least in terms of revenue guidance. Intel is trying to hold to a range of $6.5 billion to $7 billion, down approximately 6% sequentially. (Fourth-quarter revenue came in at $7.1 billion.) The company formed that target based on "historical seasonal patterns." I think those revenue estimates have almost a zero chance of being met, because this quarter is not going to be "seasonally typical."
When one looks at what Intel has been doing, I think the company doesn't really expect that either, since it slashed 2003 capital-spending plans to approximately $3.7 billion. It's one thing to try to hold your guidance for revenues in an optimistic fashion, and another thing to cut capex and lay off employees (4,700 in 2002). Perhaps that accounts for CFO Andy Bryant's less than spectacular verbiage when he acknowledged "no underlying economic growth," and said he didn't know if PC demand was recovering.
For all the excitement around Intel's beating the number, it's worth noting that the day after the company released its guidance, the stock closed on the low, down 2.5%. At least that day, "the market" voted my point of view. And then Microsoft (MSFT, news, msgs) on Thursday lowered its own revenue guidance for the March quarter and 2003 fiscal year. As for the stock split and dividend news, I'll have more to say about this next week. (Editor's note: Microsoft owns MSN Money.)
Priced for perfection, worthy of defection
It's interesting that two weeks ago, so many in the dead-fish community were looking for Intel to up capex plans. Why anyone would expect Intel to up capex, given the state of the market it sells into, is beyond me. For that matter, why would anyone want to buy semiconductor-equipment stocks at a price-to-sales of over four times that of the "bottom" in 1990, when:
The companies themselves are announcing layoffs.
Big discounting is ubiquitous to their business.
Capacity utilization at many chip fabrication companies is 40%, and fabs are being sold at dimes on the dollar. (For example, just last week, Microchip (MCHP, news, msgs) put another fab up for sale.)
In essence, the securities in this business are almost priced for perfection when in fact, the wheels may be coming off the bus. Let me quickly add that if all the foregoing were happening, and these stocks were statistically cheap, then one might be tempted to bottom-fish. That would assume that the bad news was priced in and the risk had been squeezed out of the price. Now, however, the opposite seems true.
Intel baloney vs. twin testimony
Last week, the sad state in which the industry finds itself was described by Teradyne's CEO, George Chamillard, as follows: "The combination of a weak economy, weak demand for technology products and the uncertain world situation overwhelmed the recovery we had begun to see in the first half of 2002," adding, "Unfortunately, none of those negative factors has changed as we enter 2003."
I think that Chamillard's view, vs. whatever optimistic outlook people are choosing to read in Intel's guidance, is more aligned with the facts. My belief is that things are worsening in the technology sector, as well as in the economy at large. Consumers are paring back because they can see the massive fiscal dislocations occurring at the state and local levels. They note the cuts in services, the rise in taxes and layoffs. Then, there is whatever consternation and postponement of decisions that will be made as the apparent war with Iraq approaches. In any case, I believe that Q1 is liable to be worse than people think, and notwithstanding the companies that try to put on a brave face like Intel, I expect many of them to guide lower.
Linear Technology, another company with an expensive stock, echoed Teradyne's cautionary comments last week when it discussed guidance for this upcoming quarter: "Backlogs are low, and customers continue to order only to near-term demand. Therefore, confidently and currently forecasting short-term future results continues to be difficult." But then Linear Technology speculated about happier times to come, adding "However, the March quarter is customarily (the emphasis is mine) stronger for us, and we expect some improvement in demand." Linear Technology beat the number, though in part because it slashed R&D 10% sequentially.
The company also saw pretty severe pricing pressure as average selling prices for its chips declined from $1.70 to $1.54. This is not supposed to happen to analog companies, because of their proprietary designs, and the level of pricing pressure just demonstrates how tough business is. Trading at 13 times sales, Linear Technology is a very dangerous stock to own. In any event, here is another example of a company trying to put on a brave face as it assumes this quarter will be historically similar, i.e., up 3% to 7% sequentially, when the odds as I see them are that it will not be able to make the number.
'Beat the overvaluation'
However, even to discuss "making the number" indicates that we are still playing the ridiculous game called "beat the number." In all the Wall Street parlance, people lose sight of the real problem with these technology companies, which is that they are so expensive. I think Intel will be lucky to make 50 cents a share this year, so it's trading at 35 times earnings for basically a no-growth, saturated market. The semiconductor-equipment companies likely won't make any money, either, so their price-to-earnings are truly astronomical.
These very generous valuations imply stocks that, to repeat, are almost priced to perfection. But their company fundamentals are deteriorating due to a weak economy and saturation in the business. (The problems that I delineated for tech companies are also true for many other companies, but to a lesser extent.) Currently, despite Robert McTeer’s optimism, there are no new drivers of technology, and yet no shortage of people who keep coming back to this sector. I think that disconnect demonstrates how speculatively oriented the tape in general continues to be.
William Fleckenstein is the president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column for TheStreet.com's RealMoney. At the time of publication, William Fleckenstein held short positions in Intel, Linear Technology and Microchip Technology and was long Microsoft puts. Positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of CNBC on MSN Money. |
