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Posted 11/24/2003
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Beating expectations is the same old con
Tech companies and analysts still are distorting numbers to make a rough period look like a recovery. It's just more of the kind of rot that almost no one, including the SEC, seems to mind.
By Bill Fleckenstein
Recently, Applied Materials (AMAT, news, msgs) did just what bulls had whispered: It beat the pro forma number by a penny, said orders would be up 20% (more about that in a second), and still forecast earnings of just 7 or 8 cents this quarter. That would mean Applied Materials 11th quarter in a row of sub-10-cent earnings.
Folks might be interested to know that in its best year ever, 2000, the company made $1.21. Enough said. In 1998, which was not a bad year for technology, AMAT made a whopping 28 cents. Yet the day after its Nov. 13 earnings announcement, folks responded as if this "good" news were already discounted. In the last year, the stock has risen 100%, while revenues were just reported to have dropped 15% year-over-year.
Meanwhile, what you won't hear equipment companies advertise is that their much-ballyhooed orders from chip makers can be canceled. As I wrote in my daily column: "If you run a fab, like bull Morris Chang of Taiwan Semiconductor (TSM, news, msgs), you might decide to place a few orders, just in case."
Investors are paying up for expectations
That is how the game is played these days. Folks chasing these stocks don't require the companies to actually make any meaningful cumulative progress. What happened in prior quarters doesn't really matter, as long as expectations are met for this quarter -- even if the stock price has appreciated the entire time, as Applied Materials has done.
It's just like the game that was played in the mania, with Internet eyeball counts and various other "metrics" cooked up to justify hyping stupidly priced ideas masquerading as businesses. So, there really is no "there" there when it comes to Applied Materials or many of these semiconductor-equipment stocks. They are just speculative playthings, which means they can basically trade anywhere, up or down.
Dead fish hears it from horse's mouth
Turning to the dead fish who cheer the game on, a leading analyst whose name rhymes with "denial" must have come away disappointed from Dell's (DELL, news, msgs) recent conference call (though his obtuseness remained intact, as you'll see in a minute). To his question about whether the company could be seeing a "budget flush" and therefore increased demand for IT products in the fourth quarter, Kevin Rollins, Dell's basically straight-shooting COO, responded that he didn't know what a budget flush was. And he added that such a notion was essentially nonsensical.
On to a key comment: Rollins said that third-quarter growth was unusually high, and the company saw a bunch of channel filling. That he took the initiative to share this observation is very important. It's the first corroboration of some pipeline filling/inventory pileup going on in the PC world. I have cited this occurrence in the cell phone business, but here is the first admission of such in the PC world. It was precipitated, to some degree, by Hewlett-Packard's (HPQ, news, msgs) price hikes at the beginning of this quarter (after it had lost so much money last quarter during a price war). The company kept producing PCs that then didn't sell, thereby creating too much inventory. Rollins specifically talked about the intense nature of the price competition, and added that he expects it will continue.
Anyone listening to that call would have been hard-pressed to find a lot to cheer about in PC land.
Anyone, that is, who doesn't swim in the dead (fish) sea. Yes, Mr. Denial himself -- just days after Mr. Rollins made short shrift of his "budget flush" -- trotted out his nonsense ("the potential budget-flush in Q4," is how he referred to it) to upgrade computer hardware and certain semiconductor sectors, in addition to a few specific stocks. (These stocks already have discounted not only a budget flush but a veritable economic boom.)
For those who haven't been paying attention, in the year 2000, semiconductor stocks didn't peak until the fall, as dead fish like him were out talking about how Windows 2000 was going to spur demand. (Microsoft (MSFT, news, msgs), which owns MSN Money, produced Windows 2000.) That did not happen.
Shortly thereafter, the analysts came up with this notion of a PC corporate upgrade cycle, which also has not materialized. PCs are replaced sporadically, but there is no "up-cycle."
Paying the piper for pipeline filling?
That brings me to Intel (INTC, news, msgs), a stock that has attracted no shortage of folks eager to proclaim the PC-upgrade myth. A few weeks ago, after the company reported results for its latest quarter, I specifically noted that there was no business growth to speak of in America. Intel's growth all came from China. If you think that Intel's growth in America also benefited from pipeline filling, and it took that pipeline filling to get the company to mid-single-digit growth, you can only wonder what will happen to Intel if things slow down, as I expect. (Kevin Rollins, I would note, said that because the third quarter was better, the fourth quarter would probably come in at the low end of expectations.)
Since China has been responsible for much of Intel's success, I anticipate an air pocket in that stock between now and the end of the first quarter of 2004.
Of course, the rest of Chip Land, which has benefited from the cell-phone boom and the double- and triple-ordering going on in that area, is also on borrowed time. Lots of companies in the sector will face rough sledding between now and Q1. It's too soon to say this trouble is a certainty, as we still have to assess end demand. But I am expecting that it will be a certainty soon enough. I have a theory about what we will be seeing, but we still need to see how it actually turns out.
Empire statesman vs. Potomac watch-poodle
Turning to a potentially huge story that is still in its early chapters, we are seeing a serious battle developing between the SEC and New York State Attorney General Eliot Spitzer, a scandal-unearthing hero. He recently lambasted the watch-poodle for its partial settlement with Putnam, saying that the settlement was "enormously troubling," that the SEC "went behind my back," "that the SEC was oblivious to fund misconduct," and that "I'm not sure I can work with the SEC."
Then, this past Monday, Spitzer blasted the SEC in an op-ed piece in The New York Times called "Regulation Begins at Home." He certainly seems to have pretty valid arguments about the SEC. He does not strike me as a partisan hack, though I would not be surprised to see the mutual-fund uproar take its place in the upcoming election food fight. Under such circumstances, these things can acquire a life of their own and potentially affect market psychology. The issue bears watching even more when in the nation's paper of record, the New York State attorney general writes:
"Unfortunately, the SEC's deal with Putnam does not provide a satisfactory answer to these questions (about the refund of exorbitant fees and safeguards against future abuses). Instead, it raises new questions. The commission's first failure is one of oversight. The mutual fund investigation began when an informant approached our office with evidence of illegal trading practices. Tipsters also approached the commission, which is supposed to be the nation's primary securities markets regulator, but the commission simply did not act on the information. The commission's second failure was acting in haste to settle with Putnam, even though the investigation is barely 10 weeks old and is yielding new and important information each day."
SEC no evil
It sounds as though Spitzer believes there's more to be uncovered in the Putnam investigation, the nature of which might sully the SEC's credibility. If this turns out to be the case, and if he can argue convincingly that the SEC was trying to hasten closure so as not to roil the markets, then rest assured, investor psychology will be rattled. (That the SEC tried to make things run smoothly and do the bidding of the Investment Company Institute was suggested by a page-one story in the Nov. 16 New York Times titled "SEC's Oversight of Mutual Funds Is Said to Be Lax.")
Certainly, the ongoing Senate probe of the mutual fund industry will prove unsettling, notwithstanding all the other reasons to shake investor psychology.
What a decline will illuminate
Heretofore, the public has been willing to look the other way, to some degree, accepting business as usual on the part of corporate America, dead fish, or the mutual fund industry. The same obscene behavior that defined the mania has been given a wide berth. However, if the pervasive rot continues to build, and the SEC looks like it's not even serious about getting to the bottom of the scandals (much less catch them ahead of time), the perception of the whole industry could change radically. I intend to follow this bouncing ball carefully, because it could turn out to be a key component of a psychological change on the part of the public that will intensify when stock prices finally head down.
My belief continues to be that when the bear market resumes (a process we may now be seeing), folks will launch a witch hunt. All of these stories will be re-examined, and change will take place. Though a witch hunt will ensue, the public should also include itself as one of the targets. As the old expression goes: "Fool me once, shame on you. Fool me twice, shame on me."
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site. At the time of publication, Bill Fleckenstein was short Intel and Applied Materials. His investment 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 MSN Money.
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