Tech Trends II (Analysis): What're the Drivers and Outlooks
Consider this a direct continuation of the prior post on Technology since there was too much ground to cover in one post, even one of mine. :). Which also provides a great opportunity to debunk the received wisdom for today - obviously the markets took off and the only possible explanation was, of course, the surprise jump in durable goods orders. Let's parse that out a little because it sets the table for so much else that we need to dissect. First off on the markets - judging from sector ETFs the real news was Finance (XLF +1.9%), Homebuilders (XHB +3.7% !!) and Energy (XLE, 1.6%). Now if capital spending were the thing that'd be some different sectors. In reverse order you've got a hurricane - likely temporary, fantasies about a surge in mortgage applications and the fact that Fannie fired three top execs today. Sometime likely in the middle of the day when the markets surged "for no observable catalyst" before falling back at the end of the day. And bear in mind Finance is still 21% of the SPX and Energy about 10%. There you have it folks - unsinn as usual.
So moving away from nonsense what we'd like to do is trace thru the outlook for Technology spending by asking what's the outlook for capital spending, under which it falls. Bear in mind the prior discussion about the severe earnings jeapordy we see coming from the disappearnce of currency conversions on foreign revenues as well as falling international demand. And the fact that the markets seem to be getting nervous, i.e. aware of, that little fly in the ointment. So that boils the question down to what's investment going to look like ? And in parallel how's that going to impact demand in each of the major Tech sub-industries, in line with our "Dumbbell Ecology" discussion about who plays at what level of the layers and in which markets (yes, I'm afraid this may mean reviewing the prior post:Tech Trends I (Readings): Big Picture to Key Players).
Durable Goods and the Tech Outlook
So what did the DG numbers tell us this time ? Well take a gander at the accompanying chart. YoY% changes in new orders for durables, capital goods ex-aircraft and industrial production, montly to Jan04 and quarterly to Jan99. Which should clearly establish it's a business cycle related data series, that they three of them move together with the cycle and, recently, some interesting things have happened. IndProd is headed down - so much for domestic industrial activity and therefore future domestic cap spending. Reflected in a flattish Durable orders curve. Notice that capital goods have jumped short-term, though not noticeably in the longer timeframe. Can you spell exports and oil equipment ? We thought so and think that pretty well explains things. If you'd like a more detailed breakdown a superb one is on EconomicPic Data:Durable Goods - July.Well worth your time.
IBM as Earnings Exemplar
After the break we continue this line of inquiry by diving deeper into investment in the business cycle big picture, looking specifically at Software & Equipment and then look at stock price performance for some bellweather tech companies. But we want to conclude with a dissection of IBM's last earning report just to close the loop on the currency conversion and foreign revenue issues. You've got to give IBM enormous credit for the clarity and honesty of their materials - this lays things out so explicitly we can analyze and comment on it. And that's not true in many cases. Since we can, we did. And take a look at the major comments. And then think about the fact that almost every other Tech company is exposed to the same pressures and risks. In other words what we have to seay about IBM applies to everybody else as well !!
Investment and the Business Cycle
The three major components of Investment in the national accounts are Residential, Structures and Equipment/Software. The latter two are business spending and our primary concern. Typically RI precedes a downturn while the latter two lag it. Let's look at how we're doing now. No real big surprises - RI is in the tank and headed for worse (still can't believe the Homebuilders...). Anyway, guess what Structures aren't doing badly but Equipment and Software spending has turned down pretty sharply. In fact it looks to us as if Eqp/SW (Capex) turned down almost as sharply Q106 as it did at the beginning of the Tech Bust.
We might also want to ask so what ? Part of the explanation is that Structures really got hurt badly in the last downturn - nobody was building new plants or warehouses. And part of the uptick this time around is that Oil Field facilities gets rolled up there as well - e.g. offshore drilling platforms.
There's another interesting little factoid one needs to consider - Structural investment isn't relatively a big deal. In fact the whole Tech Bubble was concentrated in the Eqp/SW category. For all practical purposes Structural spending is nice, it's cute but it's not a swing factor. Just so you get a sense of perspective remember that terrible market crash - well ask yourself how significant that little dipsy doodle was in late '01 and thru '02 in tech spending ?
Equipment/Software Detail
Courtesy of our friends at Northern Trust here's Eqp/SW spending back to '00 quarterly showing the QtQ% change at a seasonally adjusted annual rate. Take a real good look and ask yourself how healthy you think capex is anyway ? And bear in mind that QtQ data is "jumpy", i.e. volatile. You need to run an average thru the middle of those bars. By and large that looks to us as if capex was pretty poor from Q207 forward and is really beginning to get worse, fast. In other words domestic demand for Tech Spending is beginning its' own private little downturn though you may not hear John Chambers tell you that for a couple of quarters. Now would be a good time to start preparing though.
Stock Performance: Bellweathers and Sectors
The chart below is a tracking portfolio of what we think are representative bellweather stocks in the US technology industry. It's worthwhile to look at the key stats and compare the day's change (from Tu. 8/26) to the 50da moving average differences to the distance form the one year High/Low numbers. Notice that some pretty sound companies are running above their 50Da averages still, e.g. HPQ, Dell, and others. Now our opinion of Dell's turn around is a matter of record since we devoted an entire long post to dissecting the details of that strategy. And judging by the readership stats many people find it interesting every day. One could/should perform a similar analysis on the others and see what their invidual cases are. We'll leave you with one big observation and two questions. First off notice that only three companies are slightly below their one-year highs: ORCL, SAP and IBM. The first two because the thesis is that companies will keep spending on application software because it saves money in a downturn. If you believe that you may have a buying opportunity. If you believe this logic chain you might have a shorting opportunity. The other "high-performer" is IBM which is managing the company for EPS numbers. Later we'll get into the strategic consequences. But with the currency impacts and slowing international revenue growth, well what do you think ? And don't take IBM as an isolated case - take it as representative of just about every company on this chart. And with all that in mind notice there's another bunch who're down for the year in line with the index (~ 15%), including Dell, HPQ, and APPL. Now ask yourself is that likely to remain the same or not ?
