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Thursday, July 03, 2003 10:42:17 PM
RobBlack.com MarketWrap:
http://www.robblack.com/rb_marketwrap.shtml
Stocks fell on the last day of the holiday-shortened week. With an estimated 39-million people planning to travel this weekend, the market had to contend with investors leaving early during a pre-holiday session, but not before we got early fireworks from a heavy dose of negative employment data. Investors know that unemployment is a lagging indicator. The S&P 500 fell 8 points (-0.81%) to 985. The DJIA lost 72 points (-0.79%) to 9070 and the Nasdaq sank 15 points points (-0.91%) to 1663. Stocks pared losses after a report showed service industries expanded in June for the third straight month but eventually the lack of volume pulled them to new lows.
Strong Sectors: oil & gas services
Weak Sectors: electronic manufacturing, homebuilding, oil & gas services, airlines, utilities
Top Stories . . . The U.S. economy lost jobs in June for a fifth month and the unemployment rate rose to a nine-year high of 6.4 percent as slow growth forced companies to fire workers.
U.S. Treasury notes erased their losses and rose in New York trading after government figures showed the unemployment rate rose and the economy lost jobs in June, casting doubt on the strength of the economy.
California may have its credit rating cut by Moody's Investors Service, the second such action by a ratings company in as many days, because the state hasn't agreed on how to close a $38 billion deficit and stop future shortfalls.
Boston Scientific, a medical- device maker whose shares have doubled in a year, said it will hire 1,200 people and spend more to market a new heart stent that helped boost sales in the second quarter.
Siebel Systems, the world's largest maker of customer-service software, said fiscal second- quarter sales were less than forecast because customers delayed purchases.
GDP Predictions . . . The second-half rebound camp is full of economists. A Wall Street Journal survey of 54 economists predicts GDP will grow at a 3.5% annual rate in the third-quarter, and rise at a 3.8% clip in the fourth, helped by tax cuts, and improving corporate profits.
Of Note . . . For the week, the S&P 500 rose 1.3 percent, the Dow climbed 1.1 percent and the Nasdaq jumped 2.7 percent, putting it on a pace for its biggest rise in a month. Stocks have rallied since March as some investors bet that the lowest interest rates in 45 years and a $350 billion package of federal tax cuts will help drive economic growth. The S&P 500 surged 15 percent in the second quarter, reaching its highest in about a year on June 17.
Quotes of Note . . . ``There is still weakness in the employment situation,'' said Michelle Clayman, chief investment officer at New Amsterdam Partners, which manages $1.8 billion in New York. ``We need to see more of the underlying economic numbers turning around for the market to have legs.''
Turning “Positive” Japan . . . Merrill Lynch Chief Global Investment Strategist David Bowers said the brokerage giant is upgrading Japanese equities in its global portfolio to "neutral" from "underweight." Although the global macro environment is not as robust as it would like, Merrill said it's "hard to ignore" falling prices in the Japanese bond market as money shifts into stocks. Bond yields have more than doubled from a low of 0.43 percent to 0.89 percent in recent weeks and prices have fallen 4 percent, not including a big move downward on Thursday. The Nikkei is up 7 percent since June 13. The latest Bank of Japan Tankan business survey released on July 1 was "stronger than expected," including signs of an improved outlook for capital spending, Bowers said.
Eco Speak . . . The Institute for Supply Management's non-manufacturing index surged to 60.6 in June from 54.5 in May, the group said Thursday. Readings above 50 denote service-sector expansion.
The U.S. unemployment rate rose to a nine-year-high 6.4 percent in June, while the domestic economy shed a greater-than-expected 30,000 jobs last month, the U.S. Labor Department reported Thursday. Economists looked for a decline of 3,000 non-farm payrolls and a jobless rate at 6.2 percent vs. 6.1 percent in May. May's payrolls loss was revised to 70,000 from the 17,000 first reported. Factory, retail and business services all reported job losses, while construction, education, health and leisure expanded their payrolls. Government jobs increased modestly. A string of consecutive monthly payrolls declines since February now totals 394,000 lost jobs. The average workweek was unchanged in June, as were factory and overtime hours. Wages increased an expected 0.2 percent last month.
Seasonal factors such as auto plant model changes likely contributed to the unexpected jump in weekly jobless benefits requests, while the less-volatile four-week average fell in the latest period, the U.S. Labor Department said Thursday. The four-week average, promoted by Labor statisticians as a more accurate gauge particularly during this time of the year, fell 4,500 to 425,000 in the latest week. That's the lowest level since the week ended April 5. For just the week ended June 28, jobless claims jumped 21,000 to 430,000. Economists were expecting a decline. Still, the number of Americans who remain on benefits rolls jumped 34,000 to 3.751 million in the latest week. The less-volatile four-week average rose 17,750 to more than 3.736 million Americans collecting benefits. The average stands at its highest since April 1983.
Job Comments . . . The unemployment rate rose to 6.4% in June from 6.1% in May. However, the rise in the unemployment rate was due to an increase in labor force participation. The civilian labor force rose 611,000 as the participation rate rose 0.2 percentage point to 66.6% in June (since March, participation has risen 0.4 percentage point, boosting the labor force by 1.3 million). Household employment actually rose 251,000 in June and, over the last three months, household employment has risen by 130,000 per month compared to the payroll data’s average decline of 41,000. Greenspan’s wider augmented unemployment rate (which includes those who would like a job but aren’t
looking for one) rose to 9.2% from 9.1%. Manufacturing payrolls were again the weakest area of the report with factory jobs falling 56,000 in June, which resulted in factory hours worked falling 0.4%. Private sector hours worked were flat in June and fell at a 1.6% annualized rate for the quarter as a whole.
While this is a disappointing jobs report, the unemployment rate is not necessarily a signal of weakness since its increase resulted from more people looking for jobs. Indeed, over the last three months, household employment has risen by 390,000 while nonfarm payrolls have declined by 122,000. There is a gap, therefore, of over half a million jobs between these two surveys. The decline in layoff announcements in May and June signal stronger net job creation in the third quarter. Although the picture of continued job declines during the second quarter opens the door a little bit wider to a further rate cut at the August or September meeting, the Fed will be well aware of the factors pushing up the unemployment rate and believe the 30% probability of a quarter-point rate cut in August or September is about right.
Financials . . . SoundView Technology Group announced a tender offer for its shares held by persons owning fewer than 100 shares to reduce administrative expenses. It said it plans to pay $11 for each share tendered by an odd-lot stockholder, an 8 percent premium to the June 30 close, the day SoundView announced a one for five reverse stock split of its common stock.
E*Trade said it's begun a search for a new advertising agency for its national TV advertising account. "We've been very successful at building our brand and our customer base. Now it's about connecting with consumers in a more targeted way," E-Trade said. Goodby, Silverstein & Partners, San Francisco, a unit of ad giant Omnicom, has been E-Trade's creative agency of record since 1999 but has chosen not to participate in the review process, E-Trade said.
Knight Trading expects earnings per share in the range 10-15 cents for the June quarter, higher than expected. Knight said the second quarter showed "a marked improvement in the trading environment, characterized by increased volume and momentum." That, and cost-management, it said, lifted the bottom line. It was more guarded in its outlook. It said: "While we are encouraged by the market rally, we view the coming months with cautious optimism. Economic indicators in general are mixed, corporate outlooks remain hazy, and we are entering the traditionally slower third quarter."
CIT Group estimates cut below consensus at Morgan Stanley to $2.47 from $2.93 (consensus $2.56) to reflect lower yields and slower portfolio growth. The firm cuts their 2004 estimate to $2.46 from $2.49 versus consensus $2.83. The firm maintains Underweight rating and $22 target.
Oil & Gas . . . Banc of America remains cautious on Dow Chemical at 16.7x normalized EPS and 8.0x normalized EBITDA. While many investors seem most interested in peak earnings potential, firm is more concerned with weak cash flow and its implications for the dividend and a strained balance sheet; also, $1.63 billion in off-balance-sheet variable interest entities could come onto DOW's balance sheet in 3rd quarter, and on a combined basis DOW's debt could swell more than $2 billion, inflating net debt to 79% of capitalization as adjusted for underfunded pension, OPEB, and net asbestos liabilities. Maintains Neutral rating and $28 target.
Transports . . . JetBlue announced a plan to raise $128.6 million through the sale of 2.6 million newly issued shares. Morgan Stanley has been tapped to lead the stock offering, with Raymond James and Blaylock also partcipating. The stock has nearly doubled since its spring 2002 debut in the mid-$20s.
Delta Air Lines said that traffic in June slowed 5.3 percent vs. last year, mostly because the carrier took 9.1 percent capacity out of its system. As a result, each plane transported more passengers, with a system load factor of 80.5 percent, up 3.2 points over the same period a year ago. Most of the declines came from international traffic, which was down 15 percent year over year on a 16 percent capacity decrease. Flying in the U.S. fell 2.1 percent on a 7 percent capacity decrease
Alaska Air Group reported traffic for its Alaska Airlines operations rose 11.7 percent to 1.356 billion revenue passenger miles in June. Load factor for Alaska Air jumped to 73 percent during the month from 71.3 percent in the same period a year earlier. For the company's Horizon Air operations, traffic leapt 5.8 percent to 145.9 million revenue passenger miles. Load factor for Horizon Air totaled 66 percent in June, a drop from 67 percent in last year's equivalent period.
JetBlue is adding 2 inches of leg room for most passengers. Its rate structure, the airline said, would not be adjusted. The leg-room increase is to be accomplished through the removal of one row of seats per plane. JetBlue's A320s will have 156 seats, down from 162, the airline said, adding that the reconfigurations would be complete by Nov. 19.
Defense & Aerospace . . . Boeing delivered 145 commercial jets in the first six months of 2003. Of the total, 85 were for the 737 Next Generation, one of the most popular jets among the low-cost airlines. The next largest delivery total was for 19 of the 777.
Consumer Products . . . Janney reiterated a Buy on Stanley Works. While the company is far from being out of the woods, the company is working toward restoring credibility with investors; firm also cites the stock's current dividend yield of 3.7%, which exceeds the 10-year Treasury note, as well as the stock's attractive valuation. The firm raises the price target to $32 from $30.
Retail . . . Tweeter Home Entertainment warned that it will miss on its fiscal third-quarter loss forecast, with comparable-store sales down 10 percent for the three months ended June 30. This will put the quarter's total at $170 million, down 3 percent from last year. As revised, Tweeter now sees its third-quarter loss at 17 cents, wider than the consensus of 13 cents among analysts. The company will formally report results on July 24.
Electronics Boutique remains comfortable with 2nd quarter comp guidance. Yesterday confirmed ELBO comps are
running on plan in the negative 5-9% range even though ELBO faces a 20% comp over last year. Strength coming from international operations and the Matrix title. Optimistic about 2nd quarter but cautious about 3rd quarter outlook as the company faces 37.7% comps in that Quarter. Expect guidance for 3rd quarter could be in the high negative single digits for comps. That may lead to NT weakness in the stock. However, we remain optimistic about Q4 as title releases improve and comps ease.
Restaurants . . . Panera Bread cut to Hold from Buy at BB&T based on valuation.
Landry's Restaurants forecast revenue of roughly $300 million for the second quarter, an increase of 29 percent from the same period a year earlier, and $5 million ahead of the average estimate. But the company explained that revenue for June missed its expectations by about $3 million, and June's results provide "a significant portion" of its earnings, meaning it anticipates overall second-quarter results will fall 'a few cents short' of Wall Street's consensus estimate for a profit of 66 cents per share. Landry's, however, still expects to meet its forecast for a profit of about $1.75 per share in fiscal 2003.
Medical Devices . . . Boston Scientific set out earnings and sales expectations for the year. Preliminary net sales for the second quarter rose 20 percent to $852 million, it said, adding it expects earnings per share for the second quarter of 2003 to rise 26-30 percent over the year-ago period to 29-30 cents. It sees third quarter sales declining from the second to between $810 million-840 million and earnings per share between 24-28 cents, excluding net special charges. It sees net sales in the fourth quarter between $860 million-920 million and earnings per share between 28-25 cents, excluding net special charges.
Boston Scientific plans to add 1,200 employees this year to work on its coronary stent system Taxus, most in manufacturing. It estimates Taxus has achieved a 51 percent drug-eluting stent unit market share in Europe, and a 67 percent share in other international markets. BSC also said Taxus has received regulatory approval in Australia and Korea, and that it plans to launch the product immediately in those countries. "We are investing what is required to be prepared for U.S. leadership," the company said.
Drugs . . . Thomas Weisel says that the new FDA list of Paragraph IV Patent Certifications shows an ANDA filing for Merck's Cox-2 arthritis drug Vioxx. The firm says the Vioxx ANDA challenge is new, but expects MRK to defend the Vioxx patent and receive an automatic 30-month stay, and says the legal process may well drag out even longer.
Prudential says that a key upcoming event for both Astra Zeneca and other manufacturers of cholesterol-reducing drugs is the FDA Advisory Committee panel on July 9 that will evaluate AZN's Crestor. While market expectations appear to be that Crestor will move through the panel without facing any serious obstacles, some of firm's industry contacts suggest the FDA may have concerns about the highest dose of Crestor (40mg) currently being pursued; if Crestor emerges with a clean profile at final FDA approval in mid-Aug, significant new competition will be introduced into the marketplace which would adversely impact Pfizer, Merck, Bristol Meyers, Novartis, and Schering-Plough.
Biotech . . . VaxGen plans to complete a Phase III trial in Thailand "including the final analysis and announcing the preliminary results, as planned, in the fourth quarter of 2003." The company said it was responding to reports this week "that inaccurately stated that the company was planning to withdraw from its Phase III trial in Thailand.
Xenova Group and Millennium Pharma initiated Phase I cancer trial (of MLN944, a novel DNA targeting agent under investigation for the treatment of advanced cancers.
Cellegy Pharma PDUFA date for Fortigel is today. Fortigel (previously known as Tostrex) is a topical testosterone replacement gel for male hypogonadism. Peak sales are expected to be around $75 million making it the most important drug in co's pipeline. PDII will be the reseller in the US. The market in general is expecting a full approval.
Gilead Sciences target raised to $66 at Legg Mason.
Media . . . Comcast target raised to $37 at Morgan Stanley from $35. The firm now incorporates lower set-top box prices in their forecasts since the co is rolling out $140 boxes as the primary box, and firm lowers their forecast for rebuild and scalable infrastructure spending in 2005.
Vivendi Universal upgraded at Morgan Stanley to Equal-Weight from Underweight, citing their higher estimate for the value of Vivendi Universal Entertainment assets.
Finding Nemo has generated $259 million in domestic box office receipts through July 1st and has already surpassed Monsters, Inc. to become Pixar's biggest domestic release in history. Expect int’l box office results to approach the level of the domestic box office. Expect the Finding Nemo DVD/home video sales could exceed those of Monsters, Inc. Analysts are raising 2003E revenue from $188 million to $217 million and EPS estimate from $1.45 to $1.70 to reflect the potential impact of Finding Nemo's performance. With the stock near the top of our valuation range of $60, we recommend that investors take advantage of any dips in the stock to add to positions.
Hotel & Leisure . . . Penn National Gaming adds 723 slots at its West Virginia facility.
Telecom . . . Standard & Poor's lowered AT&T's long-term corporate credit debt ratings to "BBB" from "BBB+." S&P said the rating reflects its "negative long-term assessment of AT&T's business risk profile," which it feels continues to be challenged by technology substitution, competitive pricing pressures, and the slow economic recovery.
Bear Stearns reits Underperform on Level 3 due to valuation, risk of further dilution, a high-risk business model, and an overleveraged balance sheet.
IT Services . . . The tenets of a positive stance on IBM are the expanding market share with revenue trends > peers plus structural margin improvement -- remain in place. Believe there is little reason to fear an EPS shortfall in 2nd quarter. Expect 2nd quarter EPS of $1.00. Project revenue growth of 12% to $22.0 billion, all of which will derive from currency and acquisitions. IGS's backlog should rise; Expect accelerating services growth. Services contract signings in 2nd quarter may well approximate $15 billion, boosting the backlog. Still peg 2003E EPS at $4.50. The key 2003 drivers -- restructuring (+$0.35) plus a turn in MicroElectronics (+$0.20) -- more than offset lower pension income (-$0.20). Analysts are counting on just a 3.5-4% Year/Year EPS gain from the core operations (+$0.15). For 2004, the combo of a likely $0.20 of acquisition accretion, another $0.20 per share profit gain from MicroElectronics, and, hopefully, a pickup to 6-7% organic growth in the core operations could lead to a 20% EPS gain next year. Do not view the SEC probe as a precursor of major troubles. IBM's strong cash flow indicates that the business is on sound footings.
Storage . . . Adaptec said its expectation for a strong business upturn in June 'failed to materialize' due to ongoing economic uncertainty. As a result, the company now sees revenue of about $107 million for the first quarter, below its prior projection for revenue ranging from $115 million to $120 million. Adaptec believes, however, that its bottom-line results for the first quarter will land in the middle of its previously disclosed range for earnings before items of 2 to 4 cents per share.
Network Equipment . . . MOT announced it is the first supplier to sign a contract with China Unicom for the Phase III expansion of the operator's CDMA 20001X network. The contract, worth more than $80MM, will bring advanced mobile communications services to customers in the cities of Nanjing, Suzhou, WuXi, Changzhou, Nantong and Zhenjiang in Jiangsu province, one of the most developed districts of China. This is confirmation that Phase III is on plan to begin this summer as expected and confirms view that the CDMA wireless infrastructure market remains a growing one, while the GSM outlook is decidedly more cautious. Expect to hear similar announcements from Lucent, Nortel and Ericsson.
Terayon Communication is saying it now expects a second-quarter loss of 18 to 20 cents per share on revenue of between $30 million and $31 million, better than its previous outlook for a loss of 20 to 24 cents per share on revenue ranging from $24 million to $28 million. Three analysts were looking for a loss of 22 cents per share in the period, on average. The Santa Clara, Calif., communications equipment firm attributed the better than expected performance to higher unit shipments of its Docsis 2.0 cable modem termination system in Asia and North America, a larger than anticipated order for its Multigate cable telephony system from a European customer and higher sales of its legacy S-CDMA product lines.
Semiconductor Equipment . . . KLA-Tencor has confirmed it will introduce its metal metrology product at Semicon West next week; this is seen as a negative for Rudolph Tech, since INTC has been the largest customer for RTEC on its similar system, but has been one of the primary beta testers for KLAC.
Software . . . Parametric Technology forecast a weaker than previously anticipated performance in the third quarter. The company now sees revenue of about $165 million for the quarter, below its prior projection of $170 million. It sees a loss of 12 to 14 cents per share for the period, including a restructuring charge of $8 million, and a charge of $6 million related to liabilities for excess leased facilities due to a slump in the commercial real estate market in the Northeast U.S. Nine analysts are currently looking for a loss of 4 cents per share in the period, on average.
Siebel Systems now expects second quarter total revenue in the range of $330 million-334 million and license revenues at $110 million, which it said is below management's range of guidance for the quarter. Earnings per share are expected at 2 cents, in line with management projections. "The company faced unexpected delays in purchasing decisions by prospects and customers due to the uncertain economic climate and turbulent enterprise software industry landscape," it said.
WebMethods warned revenue for its June quarter will miss expectations, and is expected in the range of $42 million to $43 million, which is below guidance given by the company on April 29 of $45 million to $50 million. It said its per-share results will also come in below the expectations; it now sees a net loss per share for the fiscal first quarter of 13-15 cents a share. On a pro forma basis, WebMethods had guided for a loss per share of 2-6 cents; it now sees a pro forma net loss per share of 11-13 cents. "We were cautious about our fiscal first quarter and the IT spending environment remained tough. We are disappointed by our financial performance and the unexpected weakness in our North American commercial operations."
CIBC upgraded Siebel to Sector Perform from Sector Underperform based on the company's announcement during its conference call that it will restructure and is set to meaningfully reduce costs, as well as valuation.
BMC Software signed a contract with Qwest worth approximately $30 million at end of quarter.
The Wall Street Journal's "Heard on the Street" column discusses Peoplesoft's recent announcement of new software sales exceeding both the analysts and corporate expectations. Despite this development, the stock did not have a dramatic reaction to the news. The article suggests investors are "handicapping" the stock in light of its merger fight for J.D. Edwards and fending off ORCL. A fund manager interviewed from an arbitrage firm states, "I'm more and more comfortable that even if Oracle goes away, the downside is much less scary." The company's new software-licensing deals totaled $105-$115 million for the three months ended Monday. These figures were significantly higher than the $65 million analysts predicted after the ORCL bid early last month.
Symantec NPD reported retail sales at $3.3 million which were down 10% Week/Week following a surge of 21% Week/Week last week. NPD reported retail sales are down 27% Quarter To Date Quarter/Quarter, which is flat with last week. Assuming sales remain flat through the next two weeks, NPD data suggests Symantec's consumer revenue should be down 9% or less, or roughly in line with our forecast of -5% Quarter/Quarter and company guidance of - 6%. Analysts reiterated a Buy rating and $51 price target on Symantec.
Tech Investing Comments . . . Despite the Tech Wreck in the stock market over the past three years, investors remain addicted to technology stocks. Old-timers warn that new bull markets are rarely led by the stocks that led the previous bull market, and that declined the most during the subsequent bear market.
The speculative bubble of the late 1990s was mostly dominated by grossly inflated tech stock prices. Nevertheless, while the S&P 500 Information Technology (IT) Index and the Philadelphia Stock Exchange Semiconductor Index (SOX) fell 83% and 84%, respectively, from their March 2000 record highs to their October 2002 lows, there were several huge rallies in these indexes along the way. And the latest stock market rally, whether measured from last year’s low or this year’s in March, was led by technology stocks.
I would love to join the Tech Cheerleaders’ Club. However, I am not convinced that the outlook is as rosy for tech investors as suggested by the high valuation multiples they seem so willing to pay to join the club. I do believe that the worst of the Tech Wreck is over. I was an early proponent of overweighting tech stocks back in the mid-1990s. I forgot to say “sell” at the top, but I was consistently bearish during 2001 and 2002. Now I am a tech opportunist. I do see some opportunities for profitable investments in the tech sector, especially in the computer hardware, computer software, storage systems, and wireless telecommunications industries. The outlook for the Internet survivors also looks to be very good, but those stocks are among the most expensive in the market.
During the past three years, there have been five significant rallies in the S&P 500 IT Index; the gains ranged between 28.0% and 52.9%, with an average of 40%. The losses during the
subsequent five sell-offs averaged -43%, ranging between -19.0% and -55.2%. The swings in the SOX were even greater. This year, the S&P 500 IT Index and the SOX are up 23% and 29%, respectively, from their March lows. The previous rallies in the bear market were not supported by the underlying business and earnings fundamentals. The latest tech rally has more going for it. New orders for technology are no longer falling, and may be starting to recover. Industry analysts are no longer slashing their earnings forecasts for the current and coming years. In some cases, they are starting to nudge their numbers higher, if ever so slightly. However, the latest rally in tech stock prices once again places very high valuation multiples on these stocks. This is reasonable if earnings rebound sharply. I am not convinced that this is likely to happen across-the-board for the great majority of tech stocks that have participated in the latest rally. I think investors need to focus on groups within the tech sector, rather than the entire sector, selecting those with compelling growth stories.
The S&P 500 includes 82 technology companies. These companies are divided among 13 tech industry groups. The list includes many companies with sales around the world. Nevertheless, most of their business is in the United States. This explains why analysts’ forward earnings estimates for the S&P 500 tech stocks are so highly correlated with new orders for high tech. The orders data are compiled monthly by the U.S. Commerce Department and cover only “computers and electronic products.” Software, IT services, and internal company outlays are not included. The Commerce Department aggregate for IT orders includes “computers and related products,” communications equipment, and an “other” category. Semiconductor orders were dropped about a year ago because some of the major manufacturers refused to participate in the monthly survey. For the overall S&P Technology sector, both new orders and forward earnings rose sharply during the second half of the 1990s. Then both plunged together during 2000 and 2001. Both have subsequently stabilized and show tentative signs of recovering in recent months. Here are some highlights of recent developments in four major S&P 500 tech industries:
* The recovery signs are a bit stronger for the Computer Hardware industry group, where forward earnings are trending higher again and new orders are up 13% over the past year through May, though this time series is especially volatile.
* The new orders for nondefense Communications Equipment are also quite volatile from
month to month. However, they seem to have bottomed out since mid-2001 after declining by roughly two thirds from the peak of 2000. Forward earnings were negative during 2001 and 2002, but have recently turned back up just above zero (Figure 5).
* The forward earnings of the Semiconductor Capital Equipment group tend to be correlated with the industry’s book-to-bill ratio. Earnings estimates for the next 12 months have been rising since the start of the year despite downward revisions for this year because 2004 is expected to be well above 2003. Nevertheless, the book-to-bill ratio has weakened slightly in recent months.
* In the Semiconductor industry, forward earnings for the 16 S&P 500 components have been range-bound since the second half of 2001 following a major sinking spell during 2000 and the first half of 2001. This industry is among the most global of the tech sector. Forward
earnings are highly correlated with worldwide sales data compiled monthly by the Semiconductor Industry Association. These sales have been trending higher since January 2002, and are up 25% through May of this year. Still, May’s annual rate was $150 billion, well below the October 2000 record rate of $224 billion. Sales in both the Americas and Europe have been virtually flat for the past two years at the lowest levels since the first half of the 1990s. On the other hand, sales in Japan and Asia Pacific are recovering. Indeed, they are back at record highs in Asia Pacific.
During 2001 and 2002, industry analysts were forced to slash their earnings estimates for 2001, 2002, and 2003 almost every month, according to my “Earnings Squiggles” analysis. This year, the estimates for 2003 and 2004 have been very stable. Forward earnings are converging toward 2004 estimates, which were up 30% from 2003 estimates as of June. That’s a big increase, but that would raise next year’s S&P 500 Tech sector earnings back only to the 1997 level. Yet the forward P/E in June was 28.1 versus 20.1 during 1997, on average. P/Es of the 82 tech stocks in the S&P 500 using 2004 consensus earnings estimates are trading at multiples of 30 or higher. The S&P Tech sector’s P/E has been 50%-100% higher than the market’s valuation multiple since 1999. Before then, it tended to be about the same as the market’s P/E. Another way to see the same divergence is to compare the market-cap share of the S&P Technology sector, which was 16.3% in June, with the sector’s earnings share, which was 10.3% during the month. My hunch is that the two will converge again—though it may take a few more years to detox all the tech addicts out there. Certainly, industry analysts are still going through withdrawal as they continue to lower their expectations for long-term earnings growth. Perhaps the best indicator of irrational exuberance during the tech-stock bubble was the hallucination of industry analysts that technology earnings could grow by 28.7% per year. That was the consensus when the market peaked during March 2000. Now during June of this year, the estimate is down to “only” 14.6% per year.
http://www.robblack.com/rb_marketwrap.shtml
Stocks fell on the last day of the holiday-shortened week. With an estimated 39-million people planning to travel this weekend, the market had to contend with investors leaving early during a pre-holiday session, but not before we got early fireworks from a heavy dose of negative employment data. Investors know that unemployment is a lagging indicator. The S&P 500 fell 8 points (-0.81%) to 985. The DJIA lost 72 points (-0.79%) to 9070 and the Nasdaq sank 15 points points (-0.91%) to 1663. Stocks pared losses after a report showed service industries expanded in June for the third straight month but eventually the lack of volume pulled them to new lows.
Strong Sectors: oil & gas services
Weak Sectors: electronic manufacturing, homebuilding, oil & gas services, airlines, utilities
Top Stories . . . The U.S. economy lost jobs in June for a fifth month and the unemployment rate rose to a nine-year high of 6.4 percent as slow growth forced companies to fire workers.
U.S. Treasury notes erased their losses and rose in New York trading after government figures showed the unemployment rate rose and the economy lost jobs in June, casting doubt on the strength of the economy.
California may have its credit rating cut by Moody's Investors Service, the second such action by a ratings company in as many days, because the state hasn't agreed on how to close a $38 billion deficit and stop future shortfalls.
Boston Scientific, a medical- device maker whose shares have doubled in a year, said it will hire 1,200 people and spend more to market a new heart stent that helped boost sales in the second quarter.
Siebel Systems, the world's largest maker of customer-service software, said fiscal second- quarter sales were less than forecast because customers delayed purchases.
GDP Predictions . . . The second-half rebound camp is full of economists. A Wall Street Journal survey of 54 economists predicts GDP will grow at a 3.5% annual rate in the third-quarter, and rise at a 3.8% clip in the fourth, helped by tax cuts, and improving corporate profits.
Of Note . . . For the week, the S&P 500 rose 1.3 percent, the Dow climbed 1.1 percent and the Nasdaq jumped 2.7 percent, putting it on a pace for its biggest rise in a month. Stocks have rallied since March as some investors bet that the lowest interest rates in 45 years and a $350 billion package of federal tax cuts will help drive economic growth. The S&P 500 surged 15 percent in the second quarter, reaching its highest in about a year on June 17.
Quotes of Note . . . ``There is still weakness in the employment situation,'' said Michelle Clayman, chief investment officer at New Amsterdam Partners, which manages $1.8 billion in New York. ``We need to see more of the underlying economic numbers turning around for the market to have legs.''
Turning “Positive” Japan . . . Merrill Lynch Chief Global Investment Strategist David Bowers said the brokerage giant is upgrading Japanese equities in its global portfolio to "neutral" from "underweight." Although the global macro environment is not as robust as it would like, Merrill said it's "hard to ignore" falling prices in the Japanese bond market as money shifts into stocks. Bond yields have more than doubled from a low of 0.43 percent to 0.89 percent in recent weeks and prices have fallen 4 percent, not including a big move downward on Thursday. The Nikkei is up 7 percent since June 13. The latest Bank of Japan Tankan business survey released on July 1 was "stronger than expected," including signs of an improved outlook for capital spending, Bowers said.
Eco Speak . . . The Institute for Supply Management's non-manufacturing index surged to 60.6 in June from 54.5 in May, the group said Thursday. Readings above 50 denote service-sector expansion.
The U.S. unemployment rate rose to a nine-year-high 6.4 percent in June, while the domestic economy shed a greater-than-expected 30,000 jobs last month, the U.S. Labor Department reported Thursday. Economists looked for a decline of 3,000 non-farm payrolls and a jobless rate at 6.2 percent vs. 6.1 percent in May. May's payrolls loss was revised to 70,000 from the 17,000 first reported. Factory, retail and business services all reported job losses, while construction, education, health and leisure expanded their payrolls. Government jobs increased modestly. A string of consecutive monthly payrolls declines since February now totals 394,000 lost jobs. The average workweek was unchanged in June, as were factory and overtime hours. Wages increased an expected 0.2 percent last month.
Seasonal factors such as auto plant model changes likely contributed to the unexpected jump in weekly jobless benefits requests, while the less-volatile four-week average fell in the latest period, the U.S. Labor Department said Thursday. The four-week average, promoted by Labor statisticians as a more accurate gauge particularly during this time of the year, fell 4,500 to 425,000 in the latest week. That's the lowest level since the week ended April 5. For just the week ended June 28, jobless claims jumped 21,000 to 430,000. Economists were expecting a decline. Still, the number of Americans who remain on benefits rolls jumped 34,000 to 3.751 million in the latest week. The less-volatile four-week average rose 17,750 to more than 3.736 million Americans collecting benefits. The average stands at its highest since April 1983.
Job Comments . . . The unemployment rate rose to 6.4% in June from 6.1% in May. However, the rise in the unemployment rate was due to an increase in labor force participation. The civilian labor force rose 611,000 as the participation rate rose 0.2 percentage point to 66.6% in June (since March, participation has risen 0.4 percentage point, boosting the labor force by 1.3 million). Household employment actually rose 251,000 in June and, over the last three months, household employment has risen by 130,000 per month compared to the payroll data’s average decline of 41,000. Greenspan’s wider augmented unemployment rate (which includes those who would like a job but aren’t
looking for one) rose to 9.2% from 9.1%. Manufacturing payrolls were again the weakest area of the report with factory jobs falling 56,000 in June, which resulted in factory hours worked falling 0.4%. Private sector hours worked were flat in June and fell at a 1.6% annualized rate for the quarter as a whole.
While this is a disappointing jobs report, the unemployment rate is not necessarily a signal of weakness since its increase resulted from more people looking for jobs. Indeed, over the last three months, household employment has risen by 390,000 while nonfarm payrolls have declined by 122,000. There is a gap, therefore, of over half a million jobs between these two surveys. The decline in layoff announcements in May and June signal stronger net job creation in the third quarter. Although the picture of continued job declines during the second quarter opens the door a little bit wider to a further rate cut at the August or September meeting, the Fed will be well aware of the factors pushing up the unemployment rate and believe the 30% probability of a quarter-point rate cut in August or September is about right.
Financials . . . SoundView Technology Group announced a tender offer for its shares held by persons owning fewer than 100 shares to reduce administrative expenses. It said it plans to pay $11 for each share tendered by an odd-lot stockholder, an 8 percent premium to the June 30 close, the day SoundView announced a one for five reverse stock split of its common stock.
E*Trade said it's begun a search for a new advertising agency for its national TV advertising account. "We've been very successful at building our brand and our customer base. Now it's about connecting with consumers in a more targeted way," E-Trade said. Goodby, Silverstein & Partners, San Francisco, a unit of ad giant Omnicom, has been E-Trade's creative agency of record since 1999 but has chosen not to participate in the review process, E-Trade said.
Knight Trading expects earnings per share in the range 10-15 cents for the June quarter, higher than expected. Knight said the second quarter showed "a marked improvement in the trading environment, characterized by increased volume and momentum." That, and cost-management, it said, lifted the bottom line. It was more guarded in its outlook. It said: "While we are encouraged by the market rally, we view the coming months with cautious optimism. Economic indicators in general are mixed, corporate outlooks remain hazy, and we are entering the traditionally slower third quarter."
CIT Group estimates cut below consensus at Morgan Stanley to $2.47 from $2.93 (consensus $2.56) to reflect lower yields and slower portfolio growth. The firm cuts their 2004 estimate to $2.46 from $2.49 versus consensus $2.83. The firm maintains Underweight rating and $22 target.
Oil & Gas . . . Banc of America remains cautious on Dow Chemical at 16.7x normalized EPS and 8.0x normalized EBITDA. While many investors seem most interested in peak earnings potential, firm is more concerned with weak cash flow and its implications for the dividend and a strained balance sheet; also, $1.63 billion in off-balance-sheet variable interest entities could come onto DOW's balance sheet in 3rd quarter, and on a combined basis DOW's debt could swell more than $2 billion, inflating net debt to 79% of capitalization as adjusted for underfunded pension, OPEB, and net asbestos liabilities. Maintains Neutral rating and $28 target.
Transports . . . JetBlue announced a plan to raise $128.6 million through the sale of 2.6 million newly issued shares. Morgan Stanley has been tapped to lead the stock offering, with Raymond James and Blaylock also partcipating. The stock has nearly doubled since its spring 2002 debut in the mid-$20s.
Delta Air Lines said that traffic in June slowed 5.3 percent vs. last year, mostly because the carrier took 9.1 percent capacity out of its system. As a result, each plane transported more passengers, with a system load factor of 80.5 percent, up 3.2 points over the same period a year ago. Most of the declines came from international traffic, which was down 15 percent year over year on a 16 percent capacity decrease. Flying in the U.S. fell 2.1 percent on a 7 percent capacity decrease
Alaska Air Group reported traffic for its Alaska Airlines operations rose 11.7 percent to 1.356 billion revenue passenger miles in June. Load factor for Alaska Air jumped to 73 percent during the month from 71.3 percent in the same period a year earlier. For the company's Horizon Air operations, traffic leapt 5.8 percent to 145.9 million revenue passenger miles. Load factor for Horizon Air totaled 66 percent in June, a drop from 67 percent in last year's equivalent period.
JetBlue is adding 2 inches of leg room for most passengers. Its rate structure, the airline said, would not be adjusted. The leg-room increase is to be accomplished through the removal of one row of seats per plane. JetBlue's A320s will have 156 seats, down from 162, the airline said, adding that the reconfigurations would be complete by Nov. 19.
Defense & Aerospace . . . Boeing delivered 145 commercial jets in the first six months of 2003. Of the total, 85 were for the 737 Next Generation, one of the most popular jets among the low-cost airlines. The next largest delivery total was for 19 of the 777.
Consumer Products . . . Janney reiterated a Buy on Stanley Works. While the company is far from being out of the woods, the company is working toward restoring credibility with investors; firm also cites the stock's current dividend yield of 3.7%, which exceeds the 10-year Treasury note, as well as the stock's attractive valuation. The firm raises the price target to $32 from $30.
Retail . . . Tweeter Home Entertainment warned that it will miss on its fiscal third-quarter loss forecast, with comparable-store sales down 10 percent for the three months ended June 30. This will put the quarter's total at $170 million, down 3 percent from last year. As revised, Tweeter now sees its third-quarter loss at 17 cents, wider than the consensus of 13 cents among analysts. The company will formally report results on July 24.
Electronics Boutique remains comfortable with 2nd quarter comp guidance. Yesterday confirmed ELBO comps are
running on plan in the negative 5-9% range even though ELBO faces a 20% comp over last year. Strength coming from international operations and the Matrix title. Optimistic about 2nd quarter but cautious about 3rd quarter outlook as the company faces 37.7% comps in that Quarter. Expect guidance for 3rd quarter could be in the high negative single digits for comps. That may lead to NT weakness in the stock. However, we remain optimistic about Q4 as title releases improve and comps ease.
Restaurants . . . Panera Bread cut to Hold from Buy at BB&T based on valuation.
Landry's Restaurants forecast revenue of roughly $300 million for the second quarter, an increase of 29 percent from the same period a year earlier, and $5 million ahead of the average estimate. But the company explained that revenue for June missed its expectations by about $3 million, and June's results provide "a significant portion" of its earnings, meaning it anticipates overall second-quarter results will fall 'a few cents short' of Wall Street's consensus estimate for a profit of 66 cents per share. Landry's, however, still expects to meet its forecast for a profit of about $1.75 per share in fiscal 2003.
Medical Devices . . . Boston Scientific set out earnings and sales expectations for the year. Preliminary net sales for the second quarter rose 20 percent to $852 million, it said, adding it expects earnings per share for the second quarter of 2003 to rise 26-30 percent over the year-ago period to 29-30 cents. It sees third quarter sales declining from the second to between $810 million-840 million and earnings per share between 24-28 cents, excluding net special charges. It sees net sales in the fourth quarter between $860 million-920 million and earnings per share between 28-25 cents, excluding net special charges.
Boston Scientific plans to add 1,200 employees this year to work on its coronary stent system Taxus, most in manufacturing. It estimates Taxus has achieved a 51 percent drug-eluting stent unit market share in Europe, and a 67 percent share in other international markets. BSC also said Taxus has received regulatory approval in Australia and Korea, and that it plans to launch the product immediately in those countries. "We are investing what is required to be prepared for U.S. leadership," the company said.
Drugs . . . Thomas Weisel says that the new FDA list of Paragraph IV Patent Certifications shows an ANDA filing for Merck's Cox-2 arthritis drug Vioxx. The firm says the Vioxx ANDA challenge is new, but expects MRK to defend the Vioxx patent and receive an automatic 30-month stay, and says the legal process may well drag out even longer.
Prudential says that a key upcoming event for both Astra Zeneca and other manufacturers of cholesterol-reducing drugs is the FDA Advisory Committee panel on July 9 that will evaluate AZN's Crestor. While market expectations appear to be that Crestor will move through the panel without facing any serious obstacles, some of firm's industry contacts suggest the FDA may have concerns about the highest dose of Crestor (40mg) currently being pursued; if Crestor emerges with a clean profile at final FDA approval in mid-Aug, significant new competition will be introduced into the marketplace which would adversely impact Pfizer, Merck, Bristol Meyers, Novartis, and Schering-Plough.
Biotech . . . VaxGen plans to complete a Phase III trial in Thailand "including the final analysis and announcing the preliminary results, as planned, in the fourth quarter of 2003." The company said it was responding to reports this week "that inaccurately stated that the company was planning to withdraw from its Phase III trial in Thailand.
Xenova Group and Millennium Pharma initiated Phase I cancer trial (of MLN944, a novel DNA targeting agent under investigation for the treatment of advanced cancers.
Cellegy Pharma PDUFA date for Fortigel is today. Fortigel (previously known as Tostrex) is a topical testosterone replacement gel for male hypogonadism. Peak sales are expected to be around $75 million making it the most important drug in co's pipeline. PDII will be the reseller in the US. The market in general is expecting a full approval.
Gilead Sciences target raised to $66 at Legg Mason.
Media . . . Comcast target raised to $37 at Morgan Stanley from $35. The firm now incorporates lower set-top box prices in their forecasts since the co is rolling out $140 boxes as the primary box, and firm lowers their forecast for rebuild and scalable infrastructure spending in 2005.
Vivendi Universal upgraded at Morgan Stanley to Equal-Weight from Underweight, citing their higher estimate for the value of Vivendi Universal Entertainment assets.
Finding Nemo has generated $259 million in domestic box office receipts through July 1st and has already surpassed Monsters, Inc. to become Pixar's biggest domestic release in history. Expect int’l box office results to approach the level of the domestic box office. Expect the Finding Nemo DVD/home video sales could exceed those of Monsters, Inc. Analysts are raising 2003E revenue from $188 million to $217 million and EPS estimate from $1.45 to $1.70 to reflect the potential impact of Finding Nemo's performance. With the stock near the top of our valuation range of $60, we recommend that investors take advantage of any dips in the stock to add to positions.
Hotel & Leisure . . . Penn National Gaming adds 723 slots at its West Virginia facility.
Telecom . . . Standard & Poor's lowered AT&T's long-term corporate credit debt ratings to "BBB" from "BBB+." S&P said the rating reflects its "negative long-term assessment of AT&T's business risk profile," which it feels continues to be challenged by technology substitution, competitive pricing pressures, and the slow economic recovery.
Bear Stearns reits Underperform on Level 3 due to valuation, risk of further dilution, a high-risk business model, and an overleveraged balance sheet.
IT Services . . . The tenets of a positive stance on IBM are the expanding market share with revenue trends > peers plus structural margin improvement -- remain in place. Believe there is little reason to fear an EPS shortfall in 2nd quarter. Expect 2nd quarter EPS of $1.00. Project revenue growth of 12% to $22.0 billion, all of which will derive from currency and acquisitions. IGS's backlog should rise; Expect accelerating services growth. Services contract signings in 2nd quarter may well approximate $15 billion, boosting the backlog. Still peg 2003E EPS at $4.50. The key 2003 drivers -- restructuring (+$0.35) plus a turn in MicroElectronics (+$0.20) -- more than offset lower pension income (-$0.20). Analysts are counting on just a 3.5-4% Year/Year EPS gain from the core operations (+$0.15). For 2004, the combo of a likely $0.20 of acquisition accretion, another $0.20 per share profit gain from MicroElectronics, and, hopefully, a pickup to 6-7% organic growth in the core operations could lead to a 20% EPS gain next year. Do not view the SEC probe as a precursor of major troubles. IBM's strong cash flow indicates that the business is on sound footings.
Storage . . . Adaptec said its expectation for a strong business upturn in June 'failed to materialize' due to ongoing economic uncertainty. As a result, the company now sees revenue of about $107 million for the first quarter, below its prior projection for revenue ranging from $115 million to $120 million. Adaptec believes, however, that its bottom-line results for the first quarter will land in the middle of its previously disclosed range for earnings before items of 2 to 4 cents per share.
Network Equipment . . . MOT announced it is the first supplier to sign a contract with China Unicom for the Phase III expansion of the operator's CDMA 20001X network. The contract, worth more than $80MM, will bring advanced mobile communications services to customers in the cities of Nanjing, Suzhou, WuXi, Changzhou, Nantong and Zhenjiang in Jiangsu province, one of the most developed districts of China. This is confirmation that Phase III is on plan to begin this summer as expected and confirms view that the CDMA wireless infrastructure market remains a growing one, while the GSM outlook is decidedly more cautious. Expect to hear similar announcements from Lucent, Nortel and Ericsson.
Terayon Communication is saying it now expects a second-quarter loss of 18 to 20 cents per share on revenue of between $30 million and $31 million, better than its previous outlook for a loss of 20 to 24 cents per share on revenue ranging from $24 million to $28 million. Three analysts were looking for a loss of 22 cents per share in the period, on average. The Santa Clara, Calif., communications equipment firm attributed the better than expected performance to higher unit shipments of its Docsis 2.0 cable modem termination system in Asia and North America, a larger than anticipated order for its Multigate cable telephony system from a European customer and higher sales of its legacy S-CDMA product lines.
Semiconductor Equipment . . . KLA-Tencor has confirmed it will introduce its metal metrology product at Semicon West next week; this is seen as a negative for Rudolph Tech, since INTC has been the largest customer for RTEC on its similar system, but has been one of the primary beta testers for KLAC.
Software . . . Parametric Technology forecast a weaker than previously anticipated performance in the third quarter. The company now sees revenue of about $165 million for the quarter, below its prior projection of $170 million. It sees a loss of 12 to 14 cents per share for the period, including a restructuring charge of $8 million, and a charge of $6 million related to liabilities for excess leased facilities due to a slump in the commercial real estate market in the Northeast U.S. Nine analysts are currently looking for a loss of 4 cents per share in the period, on average.
Siebel Systems now expects second quarter total revenue in the range of $330 million-334 million and license revenues at $110 million, which it said is below management's range of guidance for the quarter. Earnings per share are expected at 2 cents, in line with management projections. "The company faced unexpected delays in purchasing decisions by prospects and customers due to the uncertain economic climate and turbulent enterprise software industry landscape," it said.
WebMethods warned revenue for its June quarter will miss expectations, and is expected in the range of $42 million to $43 million, which is below guidance given by the company on April 29 of $45 million to $50 million. It said its per-share results will also come in below the expectations; it now sees a net loss per share for the fiscal first quarter of 13-15 cents a share. On a pro forma basis, WebMethods had guided for a loss per share of 2-6 cents; it now sees a pro forma net loss per share of 11-13 cents. "We were cautious about our fiscal first quarter and the IT spending environment remained tough. We are disappointed by our financial performance and the unexpected weakness in our North American commercial operations."
CIBC upgraded Siebel to Sector Perform from Sector Underperform based on the company's announcement during its conference call that it will restructure and is set to meaningfully reduce costs, as well as valuation.
BMC Software signed a contract with Qwest worth approximately $30 million at end of quarter.
The Wall Street Journal's "Heard on the Street" column discusses Peoplesoft's recent announcement of new software sales exceeding both the analysts and corporate expectations. Despite this development, the stock did not have a dramatic reaction to the news. The article suggests investors are "handicapping" the stock in light of its merger fight for J.D. Edwards and fending off ORCL. A fund manager interviewed from an arbitrage firm states, "I'm more and more comfortable that even if Oracle goes away, the downside is much less scary." The company's new software-licensing deals totaled $105-$115 million for the three months ended Monday. These figures were significantly higher than the $65 million analysts predicted after the ORCL bid early last month.
Symantec NPD reported retail sales at $3.3 million which were down 10% Week/Week following a surge of 21% Week/Week last week. NPD reported retail sales are down 27% Quarter To Date Quarter/Quarter, which is flat with last week. Assuming sales remain flat through the next two weeks, NPD data suggests Symantec's consumer revenue should be down 9% or less, or roughly in line with our forecast of -5% Quarter/Quarter and company guidance of - 6%. Analysts reiterated a Buy rating and $51 price target on Symantec.
Tech Investing Comments . . . Despite the Tech Wreck in the stock market over the past three years, investors remain addicted to technology stocks. Old-timers warn that new bull markets are rarely led by the stocks that led the previous bull market, and that declined the most during the subsequent bear market.
The speculative bubble of the late 1990s was mostly dominated by grossly inflated tech stock prices. Nevertheless, while the S&P 500 Information Technology (IT) Index and the Philadelphia Stock Exchange Semiconductor Index (SOX) fell 83% and 84%, respectively, from their March 2000 record highs to their October 2002 lows, there were several huge rallies in these indexes along the way. And the latest stock market rally, whether measured from last year’s low or this year’s in March, was led by technology stocks.
I would love to join the Tech Cheerleaders’ Club. However, I am not convinced that the outlook is as rosy for tech investors as suggested by the high valuation multiples they seem so willing to pay to join the club. I do believe that the worst of the Tech Wreck is over. I was an early proponent of overweighting tech stocks back in the mid-1990s. I forgot to say “sell” at the top, but I was consistently bearish during 2001 and 2002. Now I am a tech opportunist. I do see some opportunities for profitable investments in the tech sector, especially in the computer hardware, computer software, storage systems, and wireless telecommunications industries. The outlook for the Internet survivors also looks to be very good, but those stocks are among the most expensive in the market.
During the past three years, there have been five significant rallies in the S&P 500 IT Index; the gains ranged between 28.0% and 52.9%, with an average of 40%. The losses during the
subsequent five sell-offs averaged -43%, ranging between -19.0% and -55.2%. The swings in the SOX were even greater. This year, the S&P 500 IT Index and the SOX are up 23% and 29%, respectively, from their March lows. The previous rallies in the bear market were not supported by the underlying business and earnings fundamentals. The latest tech rally has more going for it. New orders for technology are no longer falling, and may be starting to recover. Industry analysts are no longer slashing their earnings forecasts for the current and coming years. In some cases, they are starting to nudge their numbers higher, if ever so slightly. However, the latest rally in tech stock prices once again places very high valuation multiples on these stocks. This is reasonable if earnings rebound sharply. I am not convinced that this is likely to happen across-the-board for the great majority of tech stocks that have participated in the latest rally. I think investors need to focus on groups within the tech sector, rather than the entire sector, selecting those with compelling growth stories.
The S&P 500 includes 82 technology companies. These companies are divided among 13 tech industry groups. The list includes many companies with sales around the world. Nevertheless, most of their business is in the United States. This explains why analysts’ forward earnings estimates for the S&P 500 tech stocks are so highly correlated with new orders for high tech. The orders data are compiled monthly by the U.S. Commerce Department and cover only “computers and electronic products.” Software, IT services, and internal company outlays are not included. The Commerce Department aggregate for IT orders includes “computers and related products,” communications equipment, and an “other” category. Semiconductor orders were dropped about a year ago because some of the major manufacturers refused to participate in the monthly survey. For the overall S&P Technology sector, both new orders and forward earnings rose sharply during the second half of the 1990s. Then both plunged together during 2000 and 2001. Both have subsequently stabilized and show tentative signs of recovering in recent months. Here are some highlights of recent developments in four major S&P 500 tech industries:
* The recovery signs are a bit stronger for the Computer Hardware industry group, where forward earnings are trending higher again and new orders are up 13% over the past year through May, though this time series is especially volatile.
* The new orders for nondefense Communications Equipment are also quite volatile from
month to month. However, they seem to have bottomed out since mid-2001 after declining by roughly two thirds from the peak of 2000. Forward earnings were negative during 2001 and 2002, but have recently turned back up just above zero (Figure 5).
* The forward earnings of the Semiconductor Capital Equipment group tend to be correlated with the industry’s book-to-bill ratio. Earnings estimates for the next 12 months have been rising since the start of the year despite downward revisions for this year because 2004 is expected to be well above 2003. Nevertheless, the book-to-bill ratio has weakened slightly in recent months.
* In the Semiconductor industry, forward earnings for the 16 S&P 500 components have been range-bound since the second half of 2001 following a major sinking spell during 2000 and the first half of 2001. This industry is among the most global of the tech sector. Forward
earnings are highly correlated with worldwide sales data compiled monthly by the Semiconductor Industry Association. These sales have been trending higher since January 2002, and are up 25% through May of this year. Still, May’s annual rate was $150 billion, well below the October 2000 record rate of $224 billion. Sales in both the Americas and Europe have been virtually flat for the past two years at the lowest levels since the first half of the 1990s. On the other hand, sales in Japan and Asia Pacific are recovering. Indeed, they are back at record highs in Asia Pacific.
During 2001 and 2002, industry analysts were forced to slash their earnings estimates for 2001, 2002, and 2003 almost every month, according to my “Earnings Squiggles” analysis. This year, the estimates for 2003 and 2004 have been very stable. Forward earnings are converging toward 2004 estimates, which were up 30% from 2003 estimates as of June. That’s a big increase, but that would raise next year’s S&P 500 Tech sector earnings back only to the 1997 level. Yet the forward P/E in June was 28.1 versus 20.1 during 1997, on average. P/Es of the 82 tech stocks in the S&P 500 using 2004 consensus earnings estimates are trading at multiples of 30 or higher. The S&P Tech sector’s P/E has been 50%-100% higher than the market’s valuation multiple since 1999. Before then, it tended to be about the same as the market’s P/E. Another way to see the same divergence is to compare the market-cap share of the S&P Technology sector, which was 16.3% in June, with the sector’s earnings share, which was 10.3% during the month. My hunch is that the two will converge again—though it may take a few more years to detox all the tech addicts out there. Certainly, industry analysts are still going through withdrawal as they continue to lower their expectations for long-term earnings growth. Perhaps the best indicator of irrational exuberance during the tech-stock bubble was the hallucination of industry analysts that technology earnings could grow by 28.7% per year. That was the consensus when the market peaked during March 2000. Now during June of this year, the estimate is down to “only” 14.6% per year.
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