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Beware of Groundhog Year
Commentary: Awful tech cycle may be set to repeat itself

By Mike Tarsala, CBS.MarketWatch.com
Last Update: 9:15 AM ET Dec. 4, 2002

SAN FRANCISCO (CBS.MW) - This year's fourth-quarter rally reminds stock strategist Arnie Berman of the one we had last year -- which could be a bad sign for tech investors.

"I feel like we're living the same year over again," says Berman, strategist at SoundView Technology Group, an investment bank with about $160 million in cash, securities and investments. "And 2001 is not the year I want to go through again."

Just like in early 2001 and 2002, we could be in for sub-par fourth-quarter earnings reports in January. Tech executives also could backpedal on their business forecasts. The result would be yet another wave of tech stock selling.

It recalls the movie "Groundhog Day," in which Bill Murray plays a TV weatherman stuck living the same wretched day over and over.

In this case the Groundhog Year of 2001 has already repeated itself. In both 2001 and 2002, the first quarter began with high expectations, yet weak tech earnings crushed the Nasdaq by March.

Rallies in both second quarters eventually failed before markets bottomed out in the third quarter amid fears of business weakness.

And in both years, Berman points out that U.S. markets followed up third-quarter weakness with strong year-end gains, due to normal seasonal sales strength and hope that business would improve once January rolled around.

And then, the cycle started all over -- with a rotten first quarter.


The hype builds

Froth has been building in recent weeks over next year's tech industry prospects. Shareholders seem to be jumping on the few positive comments made by executives -- and choosing to overlook some negative ones.

The flow of news from tech companies hardly seems to provide enough fuel for a 31-percent rise for the Nasdaq Composite since Oct. 10, and a 57-percent rise for the benchmark Philadelphia Semiconductor Index over the same time period.

Siebel Systems (SEBL: news, chart, profile) shares rose 6 percent Tuesday after the software company's CEO said customers appear to be spending more than they did in the third quarter. Investors seemed to temporarily forget that the fourth quarter is normally stronger than the third for most tech companies, due to seasonal spending. Yet Siebel's stock is up 64 percent since its trough in early October.

Sun Microsystems (SUNW: news, chart, profile) shares gained almost 7 percent Wednesday of last week, after CFO Steve McGowan said the computer maker is on track to meet fiscal sales targets for its December quarter. Shareholders seemed to overlook that the company's gross margin will be lower than it was in the September period, and that the company made no specific mention of earnings targets. Sun shares are up 52 percent since early October.

There have been only a few signs of tech business improving. Texas Instruments (TXN: news, chart, profile) this week said that fourth-quarter earnings would beat previous targets, due to increased demand for its computer chips. But the company also said it expected to earn only a penny a share, "plus or minus a few cents", and maintained that its semiconductor sales will still decline from the third quarter. Its shares are up 45 percent from their October trough.

Hewlett-Packard (HPQ: news, chart, profile) is by far the most surprising success story in recent weeks, after the company beat earnings expectations by two cents a share. This week, management added that it has signed more than $900 million in services business, and that it'll achieve $3 billion in merger cost cuts a year ahead of schedule.

But even with H-P's vastly improved numbers and a better outlook for its January quarter, it's hard to overlook that the company's October quarter sales declined in nearly every business category, with the notable exception of printing and imaging products. The company's shares are up 76 percent from their early October low.

"The hard part is increasing the revenue," said Amy Wohl, with Wohl Associates in Narberth, Pa. "This is going to be a very tough market. ... The growth rate is still very, very low."


Overlooking the obvious

Many analysts are focusing only on tech industry positives. Too many completely failed to mention that TechData, the world's second-largest wholesaler of computer products, said last week that the U.S. tech business spending got weaker in November, and that the company was prepared for weak fourth quarter. It's hard to take TechData lightly, when the company distributes products for nearly every major computer manufacturer.

Few if any large service or manufacturing companies have said they plan to spend more on information technology in 2003 than this year. As a result, Fred Hickey, editor of The High-Tech Strategist newsletter, says that most major chip companies, including Intel (INTC: news, chart, profile), will likely cut their capital spending.

Orders are down at chip-equipment maker Applied Materials (AMAT: news, chart, profile), Hickey adds, and the company recently cut 10 percent of its work force. Yet the company's stock trades at more than 90 times current estimates, and about 45 times earnings estimates for 2003.

"Nothing has changed," Hickey says. "It's the same mania that drove Internet company CMGI to its insane level. I couldn't explain a few years ago why Cisco was worth $500 billion. Now, I can't explain why Applied Materials is worth almost 100 times earnings, when they are laying off people."

Shareholders who are still hoping for a rally may point out that retailers are off to a good start with December sales. It's true that a good chunk of the record sales at retailers such as Wal-Mart (WMT: news, chart, profile) and Office Max (OMX: news, chart, profile) is due to sales of consumer electronics products.

"But it's premature to say we're going to have a great holiday because stores had a great Thanksgiving weekend," said Steve Baker, market analyst with NPD Intellect."

We may have already seen the last big stock advance this year. With only a few weeks left in 2002, it's likely that most of the gains since the end of the third quarter are locked in -- just like they were at this time last year, Berman says.


Hope deferred

Looking to 2003, there's a chance that we can eventually break the cycle. Some anecdotal signs show that business could be slowly building. Berman says PC manufacturers are doing fairly well right now. There's better sales feedback from cell phone manufacturers than the same time last year, he adds.

And the networking and telecom sector, which continues to be a drag for all of tech, has shown some progress. The sector will probably post bigger sales in the fourth quarter than the previous three months - an improvement from last year.

But tech sales still aren't great, and the stock values are high. He says it will take constant confirmation that things are improving for the Nasdaq to continue its climb.

For at least the early part of 2003, there's a good chance we'll continue to live through Groundhog Year.