MARKET ACTIVITY/TRADING NOTES FOR DAY ENDING WEDNESDAY, DECEMBER 31, 1997 (3)
NYSE RINGS OUT RECORD YEAR, TRADERS EAT CAKE
Balloons rained down and noise-makers squealed on the floor of the New York Stock Exchange on Wednesday as dealers celebrated a record breaking year in terms of both market capitalization and trading
volume.
Among the revelers, NYSE Chairman Richard Grasso closed the market session with a wide swing of the gavel and then enthusiastically blew a kiss to the exchange floor.
"Everybody seemed very happy," said Ed Polcer, a cornet player with the Banjo Rascals, coming off the floor. "We played 'Four-Leaf Clover,' which is probably very appropriate for the New York Stock Exchange."
Despite Asian woes that sent market jitters blustering through Wall Street late in the year, 1997 saw several records crushed.
Global market capitalization rose to a record $11.2 trillion, and average daily trading volume was 526.9 million shares for 1997, an increase of almost 28 percent over 1996's record 412.0 million. A hefty 3,046 companies are now listed on the exchange, which added a record 279 new issues during the year, the exchange said.
The exchange also had eight of its busiest trading days in 1997, led by Oct. 28 when 1.2 billion shares changed hands.
For Lynn Newman, the NYSE's new director for media relations, that translated into a hectic entry.
"I think the only three words I like hearing better than, 'no warm wash' are 'no new messages,"' Newman quipped, as she watched traders cutting hungrily into one of eight sheet cakes, with "What a Year!" written in frosting across the top.
Mariachis, bagpipe players and a barbershop quartet roamed among traders during the day's festivities, capped by a shower of 3,000 balloons at the 4 p.m. market close, and a flury of pink and white order slipsthrown into the air.
"We make our own grafitti," Newman said.
WALL STREET DEFIED HISTORY IN ROLLER COASTER RIDE OF 1997
Wall Street Defied History In Roller-Coaster 1997
Wall Street defied history in 1997, set a slew of records and took investors on a roller-coaster ride along the way.
In a year for which most market analysts predicted at best modest gains, the benchmark Dow Jones industrial average roared past two millennium marks for the first time ever in a single year.
But pullbacks in the spring and fall, including two days in October that saw the Dow suffer its biggest single-day point loss ever, followed by its biggest single-day point gain, tested investors' will.
"It was a pretty tumultuous year," said Bruce Bittles, market strategist at J.C. Bradford. "But it turned out pretty positive for the average investor."
Following a 33 percent gain in 1995 and a 26 percent rise in 1996, history was against Wall Street's bulls. Never before in its 101-year history had the widely watched gauge posted three consecutive gains of over 20 percent.
But on Wednesday the Dow industrials, which entered 1997 standing at 6,448.27, ended with a 7.72-point loss to close the year at 7,908.25, a 22.6 percent rise.
The Standard & Poor's 500, an index tracked by many mutual funds, rose 31.0 percent in the year.
The Nasdaq composite, heavily influenced by big high-technology companies, including Microsoft Corp. and Intel Corp. rose 21.6 percent.
Stocks began the year with a steady climb, with the Dow crossing the 7,000 mark on Feb. 13, taking just four months to add 1,000 points.
But stocks stumbled in the spring after the Federal Reserve moved to raise short-term interest rates by a quarter percentage point on March 25. By mid-April, the Dow had fallen 9.8 percent.
After the stumble, investor optimism about strong corporate earnings took over and and a steady flow of investor cash powered the market forward.
On July 16, the Dow topped 8,000.
It hit its closing peak of 8,259.31 on Aug. 6.
But since then, stocks struggled as investors reassessed lofty share prices amid the currency and market turmoil in Asia and signs that U.S. corporate profit growth could be slowing.
The concerns came to a head in late October, just over a week after Wall Street marked the 10th anniversary of the 1987 stock market crash.
On Oct. 27, the unraveling of financial markets in Hong Kong and other Asia centers sparked a global selloff. The Dow fell 554 points, or 7.2 percent, to 7,161, its biggest single-day point setback.
On that day, for the first time, curbs instituted after the 1987 crash halted trading for 30 minutes after the Dow fell 350 points. After the Dow fell over 550 points, trading was halted again for the final 30 minutes of trading.
The sell-off drew comparisons to the 1987 crash, but in percentage terms the decline was less than a third of the 22.6 percent the market fell on 1987's "Black Monday."
In what some took to be a sign of the U.S. market's resilience, on Oct. 28 Wall Street led a global stock rebound.
The Dow finished that day up 337 points, or 4.7 percent, at 7,498, its biggest single-day point gain. New York Stock Exchange volume topped 1 billion shares for the first time, ending the day at 1.2 billion.
Looking ahead, analysts said they expect further volatility in 1998, forcing investors to pick out individual stocks that are strong enough to survive a topsy-turvy market.
"The key to '97 for the really successful investor was selectivity," said Arnie Owen, managing director of capital markets at Cruttenden Roth. "I think selectivity is going to be the key for '98 also."
PULL SURVIVORS FROM THE TECH WRECKAGE
Dust off the damage done to oversold stocks like Level One and Analog Devices, and you'll find bargains in the rough.
If you get a call from a broker pushing technology stocks this month, you might want to ask if a dose of Dramamine is included.
Wall Street has sharply lowered its expectations for the growth of technology companies, given questionable demand from bombed-out Asian economies over the coming 12 months. But even if the discounting of late 1997 proves sufficient to mark a short-term bottom for their stock prices, much bad news yet lies ahead. In short, the roller coaster isn't over.
This environment is opportune for traders who thrive on volatility. But what's a bargain-hunting long-term investor to do? The answer boils down to risk tolerance. Technology will certainly remain one of the highest-growth segments of the U.S. economy over the next decade. Even a recession will not change this. And eventually, Asian economies will recover.
So as we enter 1998, the key for investors will be to navigate with an understanding of the risks of each tech industry segment and each company. Here are a few concepts to consider as you assess valuations. We'll pay special attention to semiconductor companies, as they have suffered the most damage recently.
Some companies stand to gain from the "Asian Contagion."
Compaq Computer (CPQ) derives only 11% of its revenues from all nations in the developing world, and if the sluggish Japanese economy is included, Compaq's exposure to Asia runs at about 15% of revenues. Not a week passes without news of continued pressure in the disk-drive and memory-chip market. These lower costs translate into higher gross margin dollars for Compaq.
Declining Southeast Asian currencies also translate into cheaper labor and other resources, boosting margins on re-exported products. Compaq, Dell Computer (DELL), Hewlett - Packard (HWP) and many other hardware manufacturers will successfully find leverage in this trade-off.
But as many analysts are quick to point out, weakening demand in the PC industry overall puts downward pressures on pricing. The booming low-priced PC market will also pressure profit margins. Some companies will better counter this trend by balancing build-to-order inventory models or increasing their focus on the mid-level or high-end PC and server markets.
The jury is still out on which companies will benefit most from this complex equation of lowered expenses and lowered prices. But at least on a relative basis, most analysts expect Compaq and other leading hardware manufacturers to weather the storm far better than manufacturers of PC peripherals.
Companies offering technology-related productivity solutions and software will continue to weather the Asian storm better than the hardware companies.
Debacles at Oracle Corp. (ORCL) and Electronics For Imaging (EFII) aside, in comparison to the Philadelphia Exchange Semiconductor Index (SOX), the CBOE Computer Software Index (CWX) looks like a champ. When considering new investments, look for companies with low Asian revenue exposure and companies delivering tools to boost corporate productivity. Many stocks in these areas have higher valuations, but tech-sector volatility may lead to discounts in the near future. These companies could include systems-consulting and software-development firms like Cambridge Technology Partners (CATP) and design-automation companies like Cadence Design Systems (CDN). Or you could try mining the billing-outsourcing trend, embodied by Saville Systems (SAVLY).
Tech-industry segments will continue to suffer commensurate with their Asian exposure.
Nowhere is the damage more clear than with semiconductor capital equipment companies. Shares of these manufacturers rocketed higher for much of this year. No more. Pick a company -- any company. They are all down, with the vast majority off 50% or more from their 52-week highs.
When the Chips Are Down
How bad is it for semiconductor and semiconductor-manufacturing equipment makers?
Arguably, the semiconductor industry proved to be the leading indicator for the entire crisis. And if you believe Merrill Lynch's semiconductor research department, it's time to put your semiconductor stocks out to pasture until the second half of 1998 at the earliest. Said prominent Merrill Lynch chip analyst Tom Kurlak in a Dec. 2 conference call with money managers: "I think this is the real down cycle for this particular era."
A bit of history is in order:
The period between 1989 and 1992 saw relatively low semiconductor capital spending for fabrication plants (known in the trade as "fabs"). Expenditures ranged from 14% to 16% of semiconductor manufacturers' revenues.
This set up the "shortage era" of 1992-1996, when a confluence of factors set in -- including a strong PC demand cycle, Intel's aggressive microprocessor upgrade ramp and a boom in networking demand at the advent of the commercial Internet. Semiconductor manufacturers rushed to boost fab capacity. Capital investment ballooned to 20%-25%.
By late 1997, we were left with the legacy of massive overcapacity. The vast number of plants churning billions of chips put downward pricing pressure on an industry that is simultaneously seeing softening demand from end users in both the PC and networking industries. Not a pretty picture.
This month, researchers at Dataquest reported that the 16-megabit DRAM, the chip generation most commonly used for personal computers today, crashed to $2.10. Earlier this year, the chips were priced north of $5. At the same time, the next-generation 64 megabit DRAM that South Korean and Japanese firms are clamoring to build (and for which they must buy equipment to retool production lines) plummeted as low as $14.69 from prices above $50 last December.
Memory prices have been falling at two to three times the normal 30% annual rate. Something has to give. In Kurlak's view, that something is capacity -- full 40% to 50% cuts in capital spending, and eventually, inventory write-offs and lay-offs. This is a process "we think will take the bulk of 1998 to unfold," he said.
Capital cuts do not occur in a vacuum, however. They are contingent on semiconductor manufacturers' views of end-market strength. The communications and PC industries account for more than 75% of semiconductor demand, and Kurlak and other analysts have been reacting to smoke signals in those end markets:
The industry research firm IDC cut its 1998 worldwide PC-unit forecast to 13.5% growth; the research firm has been modeling about 17% average annual growth for some time.
There have been signs that wireless subscriber growth will slow in Asian countries, with cellular-phone makers Ericsson (ERICY) and Nokia (NOK/A) both noting a slowdown in Indonesia already.
The networking and disk-drive industries, most notably Cabletron (CS) and Seagate Technologies (SEG), have been rife with profit warnings as well.
Picking Stocks in the Wreckage
So what's ahead for 1998 -- a wide-ranging continuation of the recent downturn, as Kurlak expects, or opportunities for savvy long-term investors?
Probably the latter.
"If one were to look at semiconductor industry profitability," says Carl Johnson, president of the semiconductor-market research firm INFRASTRUCTURE, "it would be hard to argue against a stance saying this is a continuation of the '96 downturn." But unit growth rates clearly indicate that the semiconductor industry is witnessing reasonably strong demand despite a difficult pricing environment, Johnson says.
Johnson is concerned about the prospects for capital-equipment companies in 1998. "The fallout from Southeast Asian debacles is not over by a long shot," he says. Analysts likely will be paying closer attention to Japan in the months ahead as well. "I really fear the second quarter of next year. That's when the Japanese will balance the books and decide how much money they will spend during their fiscal year," Johnson adds.
Investors in semiconductor capital-equipment companies have argely priced in the bleak 1998 picture, however, so it's possible that increasingly little downside risk remains. Although the shares could still sink 20% or more during periods when bleak news hits the tape, Johnson believes that "Wall Street has been pricing the stocks as if companies will go out of business."
He's most fond of equipment companies serving the testing segment, such as Teradyne (TER); the assembly segment, such as Kulicke & Soffa (KLIC); the chemical-mechanical planarization segment, such as SpeedFam (SFAM); and the automation segment, such as PRI Automation (PRIA), Asyst Technologies (ASYT) and Brooks Automation (BRKS).
Semiconductor-equipment shares will very likely experience the widest trading range of all technology segments -- and any given stock could plunge worse than the average if orders are pushed out by Korean or Japanese customers. But values will present themselves throughout the year. Investors have time to bone up on fundamentals -- and especially time to build a shopping list for use later in the year.
On the semiconductor side of the technology ledger, there are already compelling investment opportunities. Some analysts recommend highly selective accumulation, underscoring the traditional volatility of technology stocks. Cowen & Co.'s head semiconductor analyst, Drew Peck, falls into this camp, favoring National Semiconductor (NSM), Analog Devices (ADI) and other companies in the analog segment of the semiconductor industry, where the industry's overcapcity is less of an issue.
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