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Posted 8/16/2004
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The great tech recovery is coming undone
Tech stocks are selling off because companies built up inventories for demand that hasnt materialized. But the bad news has just started.
By Bill Fleckenstein
Last week produced compelling evidence that the tech slowdown I have been warning about for some time can no longer be ignored. Companies all along the tech food chain built up inventory in hopes that demand would be waiting at the other end. That "strategy" was never sustainable, and it's now coming undone -- more rapidly than even I would have imagined.
Last Wednesday saw the Nasdaq ($COMPX) and SOXX (aka the Philadelphia Semiconductor Index ($SOX.X)) dispatched to the downside for nearly 1.5% after bad news the night before from networker Cisco Systems (CSCO, news, msgs), chip company National Semiconductor (NSM, news, msgs) and semiconductor equipment maker Kulicke & Soffa (KLIC, news, msgs). And things got worse on Thursday.
Cisco disappointed for several reasons:
- An anticipated decline in its inventories turned out, in fact, to be a rise of $100 million.
- Its accounts receivable were up 16.8% sequentially on a 5.4% gain in revenues, leading me (and perhaps others) to think that maybe Cisco stuffed a few customers to try to make the quarter.
- Then, CEO John Chambers lowered next quarter's guidance a shade, citing less optimism from the CEOs hes spoken with. Given his habitually sunny leanings, things are probably a fair bit worse.
If you're any kind of component supplier to Cisco, your orders are going to be cut back. By extension, Cisco's news is also bad for other networking companies. (Remember, there's already a mountain of inventory around with all the contract manufacturers as well.) Bottom line, as I've been chronicling for some time, there is plenty of tech inventory everywhere. (For an example, see Is Seagate's swoon bad news for Intel?)
National Semiconductor gave us an early look at how poorly this quarter is shaping up. The company said there was a problem with demand for flat panels and cell phones, specifically citing demand issues concerning Chinese cell phones. National Semi itself is a good proxy for parts going into PCs as well.
Semiconductor-equipment supplier Kulicke & Soffa also said its conversations with customers indicated a general slowing in the rate of semiconductor growth." Result: the company said it was lowering revenue expectations for the quarter from $180 million to a range of $135 million to $165 million. Percentage-wise, that's potentially (and obviously) a very sizable drop. Meanwhile, it's only the end of July, and its quarter doesn't end until September.
What that implies, and what similar data points imply, is that market conditions in the chip sector have turned sour rapidly. Kulicke & Soffa made the announcement because its customers, the semiconductor manufacturers, cut back orders. So, the sum of that information last Tuesday night essentially left investors nowhere to hide in chip land the following day.
Hewlett-Packards ugly surprise
Likewise, there was no safe harbor for Hewlett-Packard (HPQ, news, msgs) investors on Thursday; its preannouncement of lowered guidance tagged the stock for more than 13% for the day. One of the morals of this stock is: Be careful buying formerly "great" businesses that look kind of cheap on paper when they're run by people whom you believe to be truth-challenged. (See The nations worst CEOs.)
One thing you learn about tech stocks is that when they look cheap, they're often really not. They have such horrendous problems that the earnings you anticipate melt away before your very eyes. In any case, I never expect to hear the whole truth and nothing but the truth from Carly Fiorina, and so I pay very little attention to what she actually says.
Obviously, Hewlett-Packard has been affected by the vicious price war in the products it sells and by the relative lack of demand for those products. It has been apparent for some time that PC weakness was coming, as I have long opined.
My July 19 column ("Intel's twin woes: excess capacity, slack demand") specifically suggested that either Dell or Hewlett-Packard would be puking in the not-too-distant future. So, if Carly says she didn't get the "normal" acceleration she was expecting, you can decide what you believe it says about her judgment.
Meanwhile, I think the really interesting news from Hewlett-Packard was that business slowed rather dramatically. Carly alluded to this by noting: "It's fair to say in the last month or so of the quarter, we did see a slowing -- the economy did a bit of a stutter step. That is why we did not see the normal acceleration in demand toward the end of quarter."
But I heard more about the slowdown from other sources at the company. In fact, in one e-mail to me, someone noted that the quarter started out OK, then almost stopped completely.
The rapid rate at which the slowdown at tech companies seems to be occurring has surprised even me. What I'm still not clear about is whether this stems just from all the inventory out there or from real end-demand issues, which I believe is the case but can't prove conclusively just yet. (Dell (DELL, news, msgs) managed to make its numbers and waxed poetic on its conference call, but I continue to feel that it, too, is living on borrowed time. There are issues in the balance sheet and with end demand.)
Bottom fishers, beware
Of course, the pain in tech land has spawned countless bottom fishers who think that we must be hitting the low. It was only two weeks ago that folks believed the 400 level on the SOXX made some sort of a difference. To these bottom fishers, I would just caution: The news is only starting to get worse.
Meanwhile, valuations are still too high, as wild expectations drove these stocks to prices that were completely untenable. So even though many of them are down considerably from their highs early in the year, they still have quite a ways to go, as those highs, like the highs in the mania, were a false reference point.
One, two, three hikes you're out?
Don't worry, be happy: That was the gist of the Fed's rate-hike announcement last Tuesday. Our esteemed central bankers tried to pretend they weren't behind the inflation curve and that they weren't raising rates into a slowdown already under way.
So now the stock market faces the prospect of an OK economy and a third rate hike (and the implications of the old saw: three steps and a stumble), or a worsening economy and no rate hike.
That Hobson's choice isn't bullish. To repeat my recent message: The Fed's credibility is on borrowed time, and the market's recognition of such will constitute an inflection point with far-reaching implications.
Disavow a bubble, dig a deeper hole
The Fed's credibility was the subject of "Greenspan Underestimated Bubble and Now Overestimates Expansion," a terrific column by Jesse Eisinger in the Wednesday issue of The Wall Street Journal. Here is Jesse's succinct summation of the problem:But the Fed and its chairman aren't just in that one box. They are in the middle of a Russian doll of their own making. Mr. Greenspan must now raise rates, because, for Mr. Greenspan's legacy, the economy must be on a steady expansion path. It must be so because he has asserted that he dealt with the bubble and its aftermath correctly. For that amount and duration of stimulus -- coupled with the enormous tax cuts from the Bush administration -- not to revive the economy would mean that the Fed's Deal With Bubbles After They Pop policy isn't a successful course. Of course, part of why the Fed chairman is in this predicament (assuming he understands any of it in the first place) is that, as Jesse writes: "It is difficult for Mr. Greenspan to say the bubble is the reason for the current lackluster conditions. To do, Goldman Sachs economist Bill Dudley told Jesse, they have to say the bubble had real consequences, not just financial consequences. It forces them to take responsibility."
This is the discussion folks will have when we experience "the next time down," and it accounts in part for why I think the Fed's loss of credibility will have such widespread ramifications.
Inflection points: evolutionary, not instantaneous
As to the timing, let me state clearly: This juncture of enlightenment will not happen in the space of one hour or one day. It is a gestation-type process that develops over the course of many weeks or many months. What I firmly believe is that, with benefit of hindsight, we will label the early part of the second half of 2004 as an inflection point for the Fed's credibility -- and the belief in its ability to deliver us to the promised land of sustainable economic growth and a rising stock market.
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. 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. At the time of publication, Bill Fleckenstein was long Cisco puts, short Intel and long Intel puts. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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