Bullish on Tech Jude Wanniski December 22, 2000

[Mike Churchill, who heads our global team, wrote me this internal memo last night and I found it so persuasive that I'm sending it out to you as is... He is of course correct that the adjustment to the monetary deflation is relatively small compared to the potential for the New Economy tech sector -- and that most of the world is not deflating with the U.S., having either floated away from the dollar or adjusted their currencies to offset the dollar/gold decline.] Here is Mike:

I keep seeing signs of value in tech. There has been wholesale abandonment of all the cutting-edge new technologies that people were paying up for nine months ago. Do those technologies not work anymore? Of course they do. The market may be making a valuation error on the downside. You now can use normal Graham & Dodd valuation methods for companies like Gateway, Applied Materials, Siliconix, and even Broadvision and Yahoo, and come out with normal or close-to-normal results -- they basically sell for the multiples of retailers and consumer cyclicals (Yahoo being the equivalent of a really hot young retail chain, and Siliconix selling cheaper than Sears). Tech is still going to be the fastest-growing segment of the global economy for the foreseeable future, so why shouldn't it command a premium to the rest of the market? I think it should, and that it certainly will in the near-to-medium-term future. The earnings estimates will need to bottom first for a sustained rally, and that might take 3-12 months. But how long is that for serious investors?

The thing that never ceases to amaze me about tech investing is the incredible time-inefficiency of tech valuations. When Yahoo was $250 a share, it would have needed to grow about 100% annually for 10 years to bring the shareholder a reasonable return. Today, Yahoo is down about 87% from that level. What were people thinking at $250? And what are they thinking today at $26? Is a growth recession enough to warrant a 87% stock decline? When they were paying $250, did they think the world would never see another recession??? Today, Yahoo looks reasonable, if not cheap. Certainly it can grow 50% a year -- and it trades at only 50x 2001 estimated earnings. That means you can buy THE premier stock in THE premier new economy industry for about 35x 2002 earnings and 20x 2003 earnings. I'm as value-minded as they come, but to me that rates as cheap considering the stock has no debt and intellectual capital worth untold billions. Garbage stocks are ceasing to exist and all outlandish valuations are being retraced. This market reminds me of Mexico in 1995-97. Everything gets taken down, the garbage never comes back at all, and the good companies come back stronger. Today there are vast swaths of the established tech industry where you KNOW the companies are here to stay and the valuations are cheap. Two basic examples are computers (GTW, DELL, CPQ) and semiconductor equipment makers. Regarding the latter, you can be sure that new generations of semiconductors will be needed. So you know there will always be a need for companies that can make the equipment to make them.

AMAT, COHU and KLIC are some top names. The chart of KLIC offers a textbook example of the time-inefficiency of tech invesetors. Its price has swung up and down like clockwork the past five years: up 400%, down 80%, up 350%, down 75%, etc...

Regarding computers, I was in Circuit City last night and had an epiphanita (small ephiphany). They are selling 600 mhz laptops for $1,000. Just two years ago I paid $1,000 for a 100 MHz machine. I would LOVE to have a 600 mhz machine, and just haven't gotten annoyed enough with the one I have now to go buy another one. I will, though. Everyone will. This idea that upgrading is a thing of the past, and that the computer market will be a perpetual backwater going forward, makes no sense to me. Applications are getting more complex and more interesting, and these will require more and more firepower. Video streaming will become the standard in the near term, and you certainly need at least 300 mhz to use that properly -- probably 500. In 90% of the world, of course, they don't have computers at all. In the developing world, the computers all tend to be kind of ratty. The tech industry retains the ability to exhibit surprise strength in a deflation, with the 1998 rally being a key example.

The tech market is global and the U.S. dominates it, and most of the rest of the world is not suffering a deflation anyway. Meanwhile, rate cuts and tax cuts will help revive the deflation-ravaged old-economy companies that were the first to get hit three years ago. These are the customers of the tech firms.

By coincidence, the November book-to-bill ratio came out yesterday for semiconductors, and it was 1.12. That means there were 12% more semiconductor bookings than shipments for the month. Here's an excerpt from Al Frank's The Prudent Speculator on that:

"While the North American-based manufacturers of semiconductor equipment posted $2.74 billion in orders in November 2000, a decline from $3.0 billion in October, worldwide shipments in November were 60% above the level posted in November 1999. 'A decline in orders and shipments has been widely anticipated given the record-breaking activity over the past year and the industry momentum that has been sustained since September 1998,' said Stanley Myers, president and CEO of SEMI. 'While many industry analysts have been revising their 2001 forecasts downward, capital spending announcements point to a ramp-up in 300 mm wafer production in 2002, suggesting 300 mm technology remains a factor in 2001.'" While we may need some time to get to the absolute bottom, the positives mentioned above should be enough to spark an explosive tax-selling-relief rally beginning any day now. In other words, the smart money should be jumping at these opportunities and overwhelming what remains of the year-end tax sales. The monetary deflation will continue to drag the overall U.S. economy, but the best of the tech sector should be able to overcome that drag as well.