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Based on my research and a knowledge of how inept and utterly horrible this
adminstration is, I wouldn't bet on it. I do not chase rockets, especially
ones that are fueled with hot air and hype.
Read this:
THE HIGH-TECH STRATEGIST
Published Monthly Since 1987
Editor: Fred Hickey
September 3, 1999
DJIA 11078.45'
Running Full Tilt Into Nuclear Winter
A year ago, several market research firms covering the
computer industry issued forecasts that called for a
serious downturn in the computer industry beginning in
mid-to-late 1999. Their surveys found that
corporations had accelerated computer buying over the
past couple of years to prepare for the Year-2000
(Y2K) transition. One of the research houses, the
Gartner Group, coined the term "nuclear winter" to
describe the expected fall-off in computer sales in
late-1999 and 2000.
Forrester Research predicted that U.S. PC revenues
would plunge 14% in 2000 from 1999 levels, and then
remain stagnant through 2002. Forrester's director of
computing strategies told Electronic Business
magazine that the PC boom will "abruptly turn into a
bust at the end of 1999," and the bust will come at a
time when PC production lines may be running full-tilt,
and the resulting oversupply could cause a major
price war.
These forecasts received a lot of attention in the
September/October tech stock massacre last year, and
likely contributed to the tech stocks' troubles. At the
time, there were almost 500 days to go until the
millennium. As of today, there are just 119 days left.
If all these surveys of corporate MIS directors'
intentions were accurate, we should be feeling the
effects of nuclear winter now. In theory, tech stocks
should be under great pressure, discounting the end of
the computer buying upgrade cycle.
Yet, tech stocks today have never been more in favor
with investors. The tech-heavy Nasdaq 100 Index at
2506.69 is 136% higher than its low point last fall.
Semiconductors, as measured by the Philadelphia
Semiconductor index (SOX), have more than tripled from
last fall's low of 183 to 561. While the average
stock is stagnating, or worse this year (the broad
Russell 2000 index is up 2.9%), the big cap
"nifty-techies" continue to grow faster than crabgrass
in August. This year's Nasdaq 100 index gain of 37%
comes on top of last year's enormous 85% surge. In
contrast, the Russell 2000 index's tiny increase
follows last years' 3.5% decline. For almost two years,
investors have lost money in small stocks
The "Big 6"
The stock market's gains continue to be concentrated in
just a few stocks, and the best performers are the
mega-cap tech favorites. The six biggest capitalization
tech stocks (Microsoft, Intel, IBM, Cisco, Lucent
and Dell) are now valued at $1.65 trillion, up $460
billion this year to date. Since the beginning of 1998, the
total valuation of these six has more than tripled.
Just the increase in the valuation of these six tech
stocks over the past 20 months ($1.1 trillion) is more
than what all U.S. stocks were worth in 1982. It's safe
to say that no one is fretting about nuclear winter.
Going back to the beginning of 1995, when it is thought
that this long bull market turned into a mania at
Dow 3834, the big six tech stocks were valued at $133
billion. They're up by a factor of 12.4 times in the
last 4 2/3 years. Combined annual sales ($198 billion)
for these six have less than doubled since the
beginning of 1995. Moreover, growth rates for all of
these companies have slowed in recent years, just as
overall industry growth rates have moderated.
In 1995, semiconductor sales were $150 billion
worldwide. They're forecast to be less than that in 1999.
There's been no revenue growth in the worldwide PC
industry in 2 1/2 years, with ASP declines more than
offsetting mid-teens unit growth, despite the favorable
impact of the Y2K upgrade cycle.
These numbers are more than mind-boggling. Just today,
on September 3, 1999 the melt-up caused by the
"favorable" unemployment report added $63 billion to
the market valuations of the "Big 6." One day's gain.
At their lows in late 1990, all of the stocks in my
top-ten "nifty-techie" list (that I've kept for some years)
consisting of IBM, Hewlett-Packard, Intel, Microsoft,
Motorola, Cisco, Sun Microsystems, Texas
Instruments, Oracle and Micron Tech could have been
purchased for a grand total of $52 billion.
Essentially, most of the technology industry in 1990 is
an even swap for one day's gain of 6 stocks today.
This is insane!!
The stock performance of these mega-cap techs has
created a virtuous cycle. Since they're where most of
the market's gains occur, performance driven investors
(a.k.a "momentum" investors) keep pouring money
into these same names. While mutual fund inflows are
down year-over-year, they're not down in those
funds that have a high concentration of mega-cap techs
in their portfolios. The Vanguard 500 Index fund is
seeing record inflows
A Crowded Trade
The stock market's leadership is getting narrower and
narrower. The market's "breadth" numbers are
horrible. With interest rates soaring, financial stocks
have come under pressure. Investors' response is to
move more money into the big-cap techs and
semiconductors. Drug stocks have weakened, so even more
money moves into the techs. Even the Internet group has
come under pressure, after peaking last April.
The momentum money that used to chase America Online is
now pursuing Texas Instruments (up an
incredible 105% year-to-date).
The massive concentration in large cap tech stocks is a
classic "crowded trade." When we talk about the
stock market bubble, we're talking about these stocks.
When Fed chairman Greenspan uses the words
"irrational exuberance (1996) or "extraordinary" and
"inexplicable" (August, 1999) to describe the stock
market's run-up, he's talking about the action in
Microsoft, Intel and IBM, and not so much the vast
majority of stagnating small stocks. When everyone
thinks about the insanity of this market, they think of
Internet stocks, with no earnings and (sometimes) no
revenues, soaring into the stratosphere. Yet
Microsoft's gain in market valuation since the
beginning of 1998 ($350 billion) almost equals the combined
valuations of every Internet stock in existence today.
Amazon's idiotic $20 billion valuation is a symptom of
the disease. Microsoft's and Intel's combined $830
billion valuations are the disease.
The market is narrowing and becoming ever more
unbalanced. Foreign investors are losing confidence and
have begun to sell the assets of what Japanese
financial leaders call "Bubble.com" (the U.S. stock
market). The loss of confidence and the enormous trade
deficit is driving the dollar down and pressuring
longer-term interest rates higher. Debt levels keep
expanding to feed Americans' outrageous consumption
of goods and their insatiable demand for stocks. The
Fed is trying to "jawbone" down the stock euphoria
without success and has resorted to hiking interest rates.
The whole economic environment has become destabilized,
and coupled with the building fears of Y2K, it's
become a tinderbox. Ironically, this uncertainty is
leading investors to crowd even more into the few big
stock names. A money manager described the thinking in
an interview with Investor's Business Daily:
"Big-growth names will do better than other asset
classes in this environment because they're the largest,
strongest and best-managed companies. They're better
equipped to cope with all kinds of economic
scenarios." In other words, buy IBM at 13 times book
value, Cisco at 100 times earnings and Microsoft at
26 times sales for "safety."
At all major market tops, before the onset of bear
markets, investors always crowd into the big-cap names.
In Japan in 1989, the favorite was NTT. In the U.S. in
1973, the favorites were the "Nifty-Fifty." It's fitting
that investors should be piling into a few big-cap tech
names today, because technology is at the core of
all the bulls' "New Paradigm," and "New Era" theories
that dismiss traditional stock market valuation
measurements.
1929 Deja Vu
The similarities to these periods are scary, but this
market is most like 1929. Investors in 1929 also
thought they were in a "New Era." The U.S. had
experienced a period of unparalleled prosperity, with low
interest rates and inflation. While the economic
fundamentals of 1929 are almost a one-for-one match to
today's, it's the psychology of investors in 1929
that's really frightening. The following is a brief excerpt from
the book Wall Street Stock Selector written in 1930 by
William D. Gann, a great market technician of his
time. In a paragraph titled "1929 Wall Street Panic,"
Gann describes the mood of the day and the
outcome.
"The cause of this panic was due to wild gambling not
only by the people in the United States, but by
people in the foreign countries. The whole world was
gambling in the stocks of the United States. People
were buying right and left regardless of price.
Fortunes were made on paper in a short period of time.
Everybody from the chambermaid to the multi-millionaire
was in the stock market. People had ceased to
work and were watching the stock ticker. New
millionaires were being made in a short time. People had
neglected their business because they thought it was
easier to make money in the stock market. Never
was there a time before in history where a speculative
wave was more overdone than this one. Broker's
loans continued to mount until they reached over 8
billion dollars. It has been conservatively estimated that
the total loans on all stocks outstanding in the United
States exceeded 30 billions of dollars. At the top,
when prices were reached, the total value of all stocks
traded in on the New York Stock Exchange
exceeded 100 billion dollars. Bond prices started to
decline in 1928 and money rates started to advance,
which was the first warning that the bull campaign was
nearing its end. Call money rates were as high as
13 per cent in 1928 and went to 20 per cent in 1929.
Warnings issued by the Federal Reserve Bank went
unheeded. The largest number of new securities were
floated in 1929 of any year in the history of the New
York Stock Exchange, all of which required large
amounts of money to finance. The last stage of this great
bull market had been so rapid that a reaction, an
orderly decline, or an orderly wave of liquidation was
impossible. When everybody had bought to capacity and
started to sell, there was no one else who
wanted to buy and a collapse was inevitable. The
decline was the greatest in history and the public
suffered the greatest losses. However, this was a rich
man's panic as well as the poor man's and the
multi-millionaire suffered along with the lamb. Profits
of 5, 10, 25 and 100 million or more were wiped out in
the short period of less than 3 months. The big traders
were just as unable to get out of stocks as the little
fellow, because there was no one to buy the stocks they
had to sell."
In today's market we have instant Internet
billionaires. We have millions of day traders and on-line traders,
some of whom have quit their jobs to speculate in the
market. Instead of a stock ticker, these traders
watch CNBC all day. Stock market margin debt is nearly
$180 billion (a record), up from $30 billion in
1991. Margin loans are only the tip of the leverage
iceberg. As in 1929, today's investors buy regardless of
price. Bond prices started to decline in the fall of
1998 and have suffered through one of the worst years in
history. Warnings issued by the Fed (as well as from
many other leading economists - Paul Volker, Milton
Friedman, Paul Samuelson) have gone unheeded. Paul
Samuelson, the Nobel Prize-winning economist
compares today's massive stock market valuations to
snow building up on the Alps in advance of an
avalanche, according to a recent report in The Wall
Street Journal. The Fed has now raised interest rates
two times this year and mortgage rates and credit card
rates have jumped.
While we know that history never repeats itself
exactly, we also know "that those who ignore history are
doomed to repeat it." Since seventy years have passed
since the crash of 1929, there are few Americans
around that have any memory of it. That's too bad,
because we're in the process of repeating a previous
generation's mistake. History is not repeating exactly,
although we might have been better off it it did.
There are differences in this mania. Stocks are at
least two times more overvalued than in 1929. A far
greater percentage of the population is exposed to the
stock market than in 1929. We have a negative
savings rate, bankruptcies are at record highs and
consumer debt is unprecedented.
There is one other difference. We're heading into a
millennium change, not just the turn of a decade. In
1929, like today, the pressures were building. But even
today, there are great arguments as to what the
trigger was for the collapse. We know that the market
was exhausted and all the buyers were in before
selling began.
Will There Be A Race To Get Out First?
I believe we're well through the stage where all the
buyers are in and the short-sellers have been destroyed.
While there was no visible trigger in 1929 that started
the selling avalanche, in 1999 we know that within
the next 119 days, some number of investors are going
to pull their funds from the market due to fears of
Y2K-related millennium turmoil. Some are already
pulling out, though it is probably only a trickle. Right
now, most people are still enjoying the last days of
summer.
Over the next several weeks, investors will look at
their portfolios, and decide whether the rewards of riding
this market through to next year are worth the risks.
Greed will hold many in, taxes will freeze others from
action. Already, institutional investors have been
taking steps to reduce their exposure. Risk premiums in
the bond market have been rising. Interest rate spreads
between short-term treasuries and riskier
alternatives have been widening. Corporations have been
drowning the bond market with supply due to Y2K
fears. The treasurer of DaimlerChrysler, which recently
issued $4.5 billion told The Wall Street Journal
recently, "My fear is we're ready for Y2K, but will
there be redemptions from mutual funds hurting liquidity
in the market?"
A Gallup Organization poll completed midyear found that
42% of respondents expect ATM machines to
fail, 38% expect checks to bounce, 22% think the whole
banking system will shut down and 47% either
definitely or probably believe that people will panic
and withdraw all of their money from the bank.
Anticipating these fears, the Fed is printing $50
billion in additional currency.
An Associated Press poll found that a quarter of the
population will take money from their banks and a
third plan to stock up on food, water and other
supplies. A poll conducted by DeRemer & Associates and
Prince & Associates of 1,000 mutual fund shareholders
found that 39% were highly concerned about the
impact of Y2K computer issues, while 14% said they will
sell shares by December. A recent worldwide
survey of 14,000 people conducted by the Gartner Group,
found that almost two-thirds said that they plan
to modify their investments. September and October are
historically the worst two months for the stock
market in the year. Will investors hold their ground
through earnings disappointments?
The Y2K Noise Level Is Building
In two weeks, the State Department will issue an
advisory listing countries expected to experience severe
Y2K issues. The State Department's inspector-general
told Congress in recent testimony that about half
the 161 countries examined by the State Department have
a medium to high risk of experiencing failures in
their telecommunications, energy and transportation
sectors. The inspector general said, "In some
countries, these failures could be mere a mere
annoyance, such as a malfunctioning credit card terminal,
while in others there is a clear risk that electricity,
telecommunications and other key systems will fail,
perhaps, creating economic havoc and social unrest."
"As such, the risk of disruption will likely extend to
the international trade arena, where a breakdown in any
part of the supply chain would have a serious
impact on the U.S. and world economies."
While the U.S. may be reasonably prepared, that's not
the case in much of the world. Many doubt China
and Russia's preparedness. The Russian government
recently admitted that only a third of its vital
computers have been corrected for Y2K. A CIA report
suggested that computer glitches could threaten
Russian gas supplies to Europe in the middle of the
winter. Petroleum buyers are concerned about
computer problems in such oil-producing countries as
Nigeria, Russia and China, among others, with
potential failures in embedded chips in pipelines and
crude oil tankers. Even without disruptions, the
International Energy Agency expects oil supplies this
winter to be the tightest in ten years.
These are some of the more serious problems facing the
world. Then, there are all the crackpots that are
going to get attention over the next several weeks.
There are people building bunkers. Many are buying
guns. Some believe that the world will end. A Canadian
man was arrested two weeks ago for plotting to
blow up the trans-Alaska oil pipeline with 14 bombs on
New Year's Day.
A week ago, a major market strategist was asked on a
national television business show what would turn
him bearish on the stock market. He responded that a
build-up in the "fear of fear" would make him
bearish. The chairman of the U.S. President's Council
on Year 2000 Conversion, John Koskinen told a
conference in Singapore that "A growing problem
confronting every country is the risk of overreaction by
the public." "It's also clear in any country if
millions of people change their normal economic activities all at
once, we'll have significant problems, even if all of
the systems work just fine."
Koskinen is trying to play down fears. But the whole
world has to be persuaded that all's fine, since the
U.S. is more dependent on foreign capital than it's
been in its history. Some argue that foreigners, who
already own a third of our Treasury debt, will shift
even more money here due to having more confidence in
the U.S.'s preparations for Y2K, than in their own
countries.
Money may flow into U.S. treasuries, but will it stay
in non-government backed obligations and stocks
given that much of the world believes the U.S.
(Bubble.com) is a disaster waiting to happen? Most foreign
investors do not swallow this new era crap. The
Economist, the Financial Times and other leading
overseas business publications have been especially
urgent in their warnings concerning U.S. equity
markets. They know that this market is all about
confidence. Investors are buying stocks today because
they expect them to go higher, not because they find
any value. If the confidence is broken, for whatever
reason; whether it's fears of Y2K or even concern that
others will get out first, they will sell and the
collapse will be on. There's a lot of uncertainty about
what the rest of 1999 and 2000 will bring. But there is
one certainty. These stock market valuations cannot
hold. If Y2K doesn't finish this mania off, I think I
know what will.
Tech stocks are on a gigantic run based upon the
perception that end-user demand for computer
technology products is strong. They believe that
surging PC demand is behind the pickup in
semiconductor sales. While they do not know it yet,
they are wrong!!!
In fact, the second-half "nuclear winter" slowdown in
computer sales anticipated by market researchers is
hitting with full force. At this moment, investors are
too drunk with greed to notice it. Not that they've ever
noticed a shift in spending in the past.
Dismal Forecasting Record
Almost all analysts and investors in 1995 believed that
widespread semiconductor shortages and surging
prices were a sign of huge Windows 95-related pent-up
demand for computer products and peripherals. We
all know now that the consensus was wrong. Windows 95
was a disappointment and the markets were
flooded with excess PC components. The semiconductor
(SOX) index crashed from its top of 300 in Q3
1995 to half that level in 1996. In 1996, investors and
industry optimists again became excited about the
second half shipment of Windows NT 4.0. The product
didn't restart PC growth as expected, and the result
was another inventory correction. In 1997, there was
another run in semiconductors driving the SOX index
to around 400. Again, second-half PC demand didn't
materialize. Computer vendors such as Compaq, IBM
and Toshiba stuffed the computer distribution channels
with product in order to meet fourth quarter
numbers. Remember my "channel inventory alerts?" The
channel stuffing led to a brutal inventory
correction in the first half of 1998. The Sox index
peaked in Q3 1997 but then plunged 60%. In late 1998,
there was another channel stuff, primarily by Compaq,
which led to the ousting of Compaq's management
this year.
Weaker than expected first-half PC demand this year,
combined with Compaq's stuffing led to a collapse in
PC-related component sales. Sixty-four megabit DRAM
prices plunged from $10 in early 1999 to record
lows below $4 on the spot market by the end of June.
Micron's inventory soared. Micron had so much
inventory that it cut special deals with PC
manufacturers to incent them to add more memory to PCs. Disk
drive prices collapsed at the end of Q2 in the worst
pricing blood bath that long-time industry veterans had
ever seen. Quantum and Western Digital announced
thousands of layoffs in the current quarter. Quantum's
CEO, Mike Brown pleaded with competitors to put an end
to the "crazy" price cutting.
Intel missed revenue estimates in both the first and
second quarters by $400 million. Last quarter's
earnings were short by 2-3 cents per share. AMD
produced 6 million K6 chips in the second quarter, but
couldn't find a home for almost 2.3 million of them.
A Puzzling Development
In July, something very weird happened. Despite no
apparent cause, DRAM prices began to firm. At first
this was due to rumors of Micron production problems,
which the company denied. Spot market DRAM
prices kept running up, however. Recently, spot prices
have exploded back over $9 and there are reports
today that prices have even broached the $10 mark.
Strange happenings were occurring in the disk drive
market too. All of a sudden, there were shortages in
the popular 4 and 6 gig drives, and prices firmed.
There were no production problems, so everyone
assumed that PC demand had picked up. We know that in
June and July, retail PC demand jumped after
the introduction of the subsidized, so-called "free"
PCs. As you know, I was skeptical of the attractiveness
of these deals, and speculated that the initial surge
of demand might peter out, as had occurred after other
significant price drops.
According to our first report on August retail sales, I
may be right. This week, Allison Boswell Consulting, a
San Francisco market researcher specializing in retail
PC sales reported that PC sales surprisingly fell
8.2% from July to August, despite expectations for
strong sales due to the back-to-school buying season.
Prices continued to fall, with 77% of PCs sold under
$1,000, compared with 64% in July. "The trend has
been consistent since the beginning of the year with
unit sales and average price declining in a consistent
pattern. It is apparent that no matter how low prices
go, unit sales continue to decline in the retail
channel," said researcher Allison Boswell.
Office Depot preannounced a significant earnings
shortfall for the current quarter due to inventory
write-downs of slow moving tech-related products. Sales
in their business products group were also lower
than expected. CompUSA announced 1,800 layoffs of
commercial sales reps located in the CompUSA
stores. As the result, CompUSA sees low double-digit
negative same-store sales growth in Q3. Best Buy's
stock yesterday was slaughtered (down 14%) after
reporting lower than expected same-store sales growth
for August. Best Buy also disappointed by not giving a
positive earnings outlook. A PC mail order firm has
seen very weak results in Q3.
It appears the "free" PC retail blip is mostly behind
us. But let's examine the state of the business PC
market, which is twice the size of the retail market.
PC sales in July and August were terrible in the
distribution channels. This is a stunning development,
because the perception on Wall Street is 100%
opposite to this. The largest PC distributors in the
world are all suffering. Not only is there a raging price
war, but demand is down significantly. Today, Ingram
Micro, the world's leading distributor, with $24 billion
in annual sales was downgraded by Robert Anastasi. He's
considered to be the best analyst covering
distributors. Another analyst also downgraded Ingram
and the stock plunged 9%.
Ingram's Q3 business is very weak. The president of
Ingram Americas resigned this week. This should not
be happening. As of August 1, Ingram became one of only
four distributors authorized to sell Compaq
products in North America through its distributor
alliance program. Thirty-five others were cut and will have
to source through Ingram or one of the others. Ingram
Micro told analysts that they expected an additional
$4 billion in Compaq business annually as the result of
the change. Ingram is not losing business to the
Internet. Ingram is handling the warehouse and shipping
for on-line retailers such as Buy.com. Ingram's
CEO told Forbes magazine this month, "In two years,
we're going to be the back room for the entire
(computer web selling) industry."
The number two distributor in the world, Tech Data, saw
its stock crater 20% yesterday due to concerns of
lower margins and price wars. Price wars do not usually
occur when demand is booming. Tech Data's
CEO this week stated, "There is some raucous (pricing)
behavior out there, even in the U.S. Some
companies have been forced to give away product just to
earn back-end rebates. In Europe, what we've
seen (is) an out of control situation." Tech Data
reported results for the quarter ended in July that just met
expectations. Analysts had upgraded Tech Data's stock
anticipating better-than-expected results. In the
prior quarter's conference call in June, Tech Data
pronounced that the quarter had started very strong,
particularly in the U.S. Something happened in the
interim. July must have weakened.
The third largest distributor in the world, CHS
Electronics also held a conference call last month. The
second quarter numbers were shockingly bad. Revenue was
disappointing and the company experienced
heavy pricing pressure, particularly in disk drives,
their specialty. CHS management stated disk drive
supply exceeded demand in Q2, causing the steepest
price declines ever seen in the drive industry. The
pricing was termed "insane" with product sold below
cost. This was an interesting conference call.
Because it was held halfway through the third quarter,
management had a pretty good read on Q3.
Stunningly, CHS reported that they were now
experiencing "extreme" disk drive shortages, leading to
improved pricing and margins. That's the sound byte
that was picked up everywhere. Disk drive stocks
soared, which added to the illusion that PC demand was
also strong.
The Answer To The Puzzle
Yet, I did not see reported the most important data
point that I heard on that call. CHS stated that third
quarter revenues were "disappointing," with particular
weakness in Europe. This specialist in disk drives is
seeing shortages in drives, yet end-user demand for
them is disappointing. The answer comes! The
computer vendors (and others) are building inventories.
A fear-driven Y2K inventory build has caused the sudden
demand for PC components, even as end-user
PC demand slumps. Many companies in different
industries have admitted to building inventories. Ford
Motor and Phillip Morris told a congressional committee
that they were stockpiling raw materials and
manufactured goods in order to serve customers in the
wake of potential Y2K failures. The
interdependency of the entire supply chain represents
the greatest risk to Ford," said an executive. A
report out of England found that 60% of British
corporations are stockpiling in advance of Y2K
The computer industry is completely dependent on parts
from overseas, particularly from lesser-developed
countries that may be at high risk to supply
breakdowns. We've seen the impact of disruptions in the past.
A few years ago, a Japanese factory supplying epoxy
blew up, sending the semiconductor industry into a
tizzy. Last month, there was a massive island-wide
power outage in Taiwan due to an accident. We still
don't know the full impact. Samsung Electronics'
president blamed the DRAM price spike partly on that
electricity disruption. Taiwan supplies 80% of all the
world's PC motherboards and many semiconductor
types. Many of the fabless U.S. semiconductor vendors
rely on a sole foundry located in Taiwan for their
production. If the Y2K fears weren't enough, there's
also the saber-rattling of a threatened Chinese invasion
of Taiwan. Taiwan is a major supplier of computer
cases, keyboards, modems, power supplies, scanners,
monitors, networking cards and hubs.
IBM sources a large percentage of its board and
system-level products from Acer in Taiwan. A source with
a contact in IBM told me that IBM is building
inventories. Many disk drive components are sourced out of
Thailand and Malaysia.
Intel vice-president Pat Gelsinger recently stated that
Intel's desktop product group is planning for some
potential issues at year-end from supply-line issues.
"We are planning a bit more inventory positioned to
deal with that." According to Electronic Engineering
Times, Intel sent out Y2K surveys to its Japanese
suppliers and followed up with on-site audits. In
contrast to the survey feedback, the audits found that
two-thirds of its suppliers faced an "extreme risk" of
damage from the Y2K bug. Intel's general manager of
year-2000 projects told the magazine, "It was worse
than any geographic region of the world." "The single
biggest finding on our suppliers in Japan was that they
were in a terrible state. Most had not started a
program, and if they did it was totally inadequate. It
was almost as if they were looking for reasons to do
nothing."
The inventory building is not just in PCs. AG
Communications has admitted it is storing extra parts in case
of supply problems. A recent InformationWeek survey of
250 information technology (IT) managers found
that 38% are stockpiling critical supplies to make sure
that production continues and customer needs are
met.
In this era of lean, just-in-time inventories, it
doesn't take much incremental demand to create shortages.
There is no doubt that inventory building is occurring.
It has caused a shortage of parts even where end
demand is weak and supplies were abundant. Shortages
always lead to double and triple ordering and to
hoarding. We've seen this time and again in the
semiconductor industry.
Historically, investors would never pay high stock
multiples due to this volatility. But in this historic, out of
control stock mania, investors have tripled
semiconductor company valuations in less than a year, and
most of the insanity has occurred in just the past few
weeks. They've doubled staid, old, Texas
Instruments over the last eight months. They've driven
Intel up 40 points since the beginning of June. That's
an addition of $130 billion of market cap (up 75%) over
three months. Micron Tech. has more than doubled
since the beginning of July. I know why DRAM demand is
up, and it has nothing to do with PC demand. I
know why Intel's Q3 is running better than expected,
and why they have a hole in demand in the fourth
quarter. I also know why disk drives are in shortage.
Strategy
As always, I suggest that individual investors not sell
short. It's too dangerous, particularly in this mania.
This is a tricky moment. Investors are celebrating
every uptick in DRAM prices with wholesale buying of
nearly every big-cap stock that has anything to do with
technology. As time goes on and shortages worsen
due to panic buying and hoarding, the price spikes
could get even worse. We have no idea how long the
inventory build will last, although I suspect from
Intel's fourth quarter "problem" it won't be much longer.
At some point investors will realize, all at the same
time, that they've been duped, again. This time the fall
won't come with the Sox index at 300 or 400, but north
of 560. This time, the disappointment will not be
caused by Q4 demand that did not materialize, but a
nuclear winter scenario, that will see falling end
demand throughout 2000, with comparisons against
quarters that were inflated by last-minute computer
upgrades.
Over the next few weeks, there will be evidence in the
form of preannouncements for Q3 and warnings
about Q4 that computer demand is slowing.
Hewlett-Packard's stock dropped sharply last month after it
reported weaker than expected order growth. Hidden
within Dell's strong earnings report (due to higher
gross margins and strong consumer demand) was the
weakest business sales growth rate we've ever
seen. There's likely to be more trouble from the
computer distributors and resellers including Ingram Micro,
MicroAge, CompuCom and Inacom. Inacom's CEO admitted to
Computer Reseller News that 20%-30% of
his customers say they will lock down computer
expenditures in coming weeks. Forrester Research
predicts that 69% of large companies will lock down
some portion of their computer infrastructures.
Cahners In-Stat Group predicts 1.8% negative Q4 growth
in networking equipment sales due to the
freezing of purchases by Y2K-wary businesses.
Some investors believe that there will be a pickup in
demand after year-end. That's not what the surveys
show. In fact, a survey by InformationWeek of 300 IT
executives found that replacing mainframes and PCs
are very low on their lists of priorities next year. It
only makes sense. If you needed to upgrade your
mainframe, you'd have done it by now. In the PC world,
a perfect example is Outboard Marine, a $1 billion
boat and engine builder, which was highlighted in
VARBusiness magazine. Outboard needed to replace a
"boatload" of 386 and 486-based PCs for Y2K compliance
reasons. CompuCom supplied 1,700 systems to
them. That "boatload" of older PCs were still useful to
the company. Now they're replaced with speedy
Pentiums. When do you think Outboard will replace these
again? When they die.
The upcoming poor industry reports will not just be
from distributors. IBM's mainframe sales are reportedly
weak. Say goodbye to IBM's strong hardware growth this
quarter. I think IBM's service orders will also
soften again. IBM has done a lot of Y2K service upgrade
business. JPM, a large cable assembly and
wireless harness supplier to IBM and Hewlett-Packard
preannounced weak Q3 results due to a slowdown
in orders from computer customers. IBM and HP account
for a quarter of JPM's business. JPM stated,
"Several of our customers are citing Y2K uncertainties
as either dampening demand or clouding forecasts
for future demand. Look for Compaq's business to be
terrible again. Oracle's sales were supposedly soft in
the quarter just ended. We'll see if they have any
tricks left. Last quarter, they dumped a lot of product in
Asia to make numbers, I'm told.
The semiconductor vendors will have great Q3s,
including Intel. But if Intel's fourth quarter comes up short,
they'll have disappointed in three of the four quarters
this year. Yet, look at the stock price. The celebration
of the death of Intel's competitors was premature. For
the first time ever, AMD's chips surpass Intel's in
performance according to labs that have tested the new
Athlon chip. This has forced Intel to respond with
lower price points in their higher-end. Cyrix and IDT
designs and teams have now been picked-up by Via,
part of a giant Taiwanese family of businesses that
intends to stop Intel from controlling the low-end of the
market. Via reportedly has cut an undisclosed deal with
the world's leading semiconductor foundry at
extremely low prices. A Taiwan Semiconductor executive
recently stated that TSMC will likely move
aggressively into the microprocessor manufacturing
business, which generates higher revenue per wafer
than average. Say goodbye to Intel's 60% gross margins.
Via also has ties with the number two foundry,
UMC. Both have excellent .18 processes, certainly
competitive with Intel's. The Chinese can of worms has
been opened.
Micron is the "gift that keeps on giving" if you take
advantage of its many insane, unsustainable price
jumps. The same analysts that told investors to buy at
every other market peak are daily egging-on
investors to jump in at the top again. They'll never
learn. There is no supply shortfall. There's a temporary
demand surge. I've counted 14 major DRAM vendors all
committed to this market. All are increasing
production dramatically. All will be contributing to
the oversupply once the Y2K inventory build has run its
course.
Investors will soon face a deadly combination: nuclear
winter, an inventory oversupply and the highest tech
stock prices in history. It's beginning to look like
Forrester Research was dead-on when they forecast last
year that the PC boom will "abruptly turn into a bust
at the end of 1999," and the bust will come at a time
when PC production lines may be running full-tilt, and
the resulting oversupply could cause a major price
war. With the imbalances built up in this stock market,
I just can't see this mania continuing with such a
disappointment to its beloved tech leaders. I'm playing
the downside through longer-term put options and
LEAPS. Favorites are IBM, HP, Micron, Intel, Dell and
Gateway.
Fred Hickey
603-888-3954
Information presented in this newsletter was obtained
from sources believed to be reliable but accuracy
and completeness and opinions based on this information
is not guaranteed. Under no circumstances is
this an offer to sell or a solicitation to buy
securities suggested herein. The editor may have an interest in
the companies mentioned. All data and information and
opinions expressed, are subject to change without
notice.
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----------
At 09:58 PM 10/7/99 CDT, bo turger wrote:
>Also, too much worry amongst investors (a contrary indicator). Who on this
>forum think the market will keep trending to new highs? My guess is not too
>many. Consequently, me-thinks that until you yourself feel that emotional
>tug: "oh shit, it really is going to the moon; i gotta get on board now"
>then market is not going to
>mega-crash. IMHO, Bo.
>
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