Michael Wallace The "wall of worry" surrounding the November Presidential election has clouded judgment about the stock market and the underlying strength of the U.S. economy. That goes for the bellwether technology sector, too. And in the short term, anxiety about a possible terrorist attack during the Republican Convention in New York Aug. 30-Sept. 2, civil unrest in Iraq, record-high energy prices, and the risk of a rollback in tax cuts have all conspired to undermine investor confidence.
Yet, beneath the anxiety is plenty of good economic news. Corporations remain flush with profits, interest rates are still low, and business investment in productivity-enhancing technology continues to reap dividends. Barring a replay of 2000's drawn-out "hanging chad" election debacle, investors have reason to be optimistic: The strong links between business capital investment, productivity, and a robust tech sector suggest that the outlook for gross domestic product (GDP) growth should only improve after the elections.
A RECORD FOR CHIPS? In particular, tech should lead the way, forging ahead at the sector's most impressive clip since the last millennium. The Semiconductor Industry Assn. (SIA) reported a 40.3% year-over-year gain in chip sales, to $17.8 billion, for June. In the second quarter, they hit $53.45 billion globally, a 9.5% increase from the first quarter. The SIA says sales are on track for a record $214 billion pace for the year, bolstered by strong sales in the second half, though some moderation is expected into 2005.
Sales of dynamic random-access memory (DRAM) chips have increased more than 100% year-over-year in the second quarter, thanks to strong PC demand -- pushing second-quarter capacity use in the industry into the high 90s, as end users have managed to keep inventories lean. Semiconductors International reported that chipmakers operated at a 95.4% capacity in the June quarter -- the highest in more than four years -- implying that additional factory capacity would have to be brought on-line to meet future demand.
Second-quarter sales of wireless chips leaped by 86.5%, and chips for digital cell phones and cameras surged 52.4% compared with last year. Regionally, Asia-Pacific led with a 61% year-over-year growth rate, with 30% for the Americas, Europe at 29%, and Japan at 26%.
POSITIVE SPIN. The semiconductor industry book-to-bill ratio fell to 1.05 in the preliminary July data, from 1.07 in June, which was at odds with the more optimistic big picture in the tech sector. Book-to-bill translates into $105 in orders received for every $100 in billings and tracks three-month moving averages on orders for semiconductor equipment worldwide by North American-headquartered manufacturers, but not the chip sales themselves.
The ratio continued its steady erosion to the lowest level this year from higher marks set earlier in the spring, such as 1.15 in February. Overall, the chip-equipment industry put a positive spin on the data, suggesting that bookings, most recently at $1.61 billion, had increased each month for the last 11 months to the highest level since early 2001. Indeed, the underlying picture for the sector appears even more solid when considering emerging capacity constraints.
The more positive underlying picture of the tech sector, however, and economic health overall, is supported by the latest second-quarter data from the San Francisco Fed's "Western Economic Developments" report. The Fed noted that the nine state economies in the district (plus three island protectorates) that had been lagging behind overall U.S. growth "gained momentum" in early 2004.
GOLDEN STATE GAINS. Job growth has finally spread throughout the nine states, led partly by some migration from California to the job engines of Arizona, Hawaii, and Nevada. Unemployment in the San Francisco Fed's district and California hit a peak in 2002, but has subsequently tumbled more than 1%, to 5.5% -- markedly closing the gap with the rest of the U.S.
The good news is that job gains in California were broad-based, including residential construction, a modest recovery in government payrolls after the budget crunch, information-technology, and also the manufacturing sector. This has helped reinforce the recovery in consumer spending that boosted sales tax revenues 13% compared with last year, a welcome relief for Governor Arnold Schwarzenegger. The district has also benefited from a rebound in travel and tourism, especially to Hawaii and Nevada, while housing strength has been fueled by still historically low mortgage rates.
In addition, Standard & Poor's raised California's general-obligation bond rating on Aug. 24 by three notches to an 'A' and took the state off credit watch. S&P cited the eased liquidity crunch following the recent sale of $11.3 billion in long-term bonds, California's budget agreement, and its "recent economic improvement." Considering the state ranks as the world's fifth-largest economy, this bodes well for its recovery contributing to U.S. and world growth.
DOUR INDEXES. On top of this, the rebound of orders and shipments in chip equipment accelerated into the first half of 2004, while business capital investment in technology, monthly semiconductor sales, PC shipments, and communication-equipment shipments were all solidly in the double-digits. Plus, lagging IT job growth finally reached positive territory.
All this good regional and national news, however, cut across the grain of the dour performance of the tech-sector indexes. The Nasdaq Composite (NASD) is still more than 15% lower than its January highs, while the Philadelphia Semiconductor Index (SOX.X) shed over 200 points to lows of 360.61 this year before rebounding partly to 384.
Anxious investors clearly have lost their appetite for risk, though the success of Google's (GOOG) IPO, which rallied 25% the week of its launch before retreating, could be an indication of nascent optimism. Our own chartists, however, see signs of a retest of Nasdaq's August low of 1,751 perhaps during this fall before a stronger bottom emerges.
HELP FOR THE FED. The negatives, however, are already clearly priced into the markets. We believe that a rash of optimism about the underlying strengths in the tech sector and the national economy will be revealed going into 2005. Moreover, a rebound in investor confidence would go a long way to helping the Fed wean the country from ultra-accommodative monetary policy.
In short, we think the stock market will look a lot better heading into 2005, particularly if oil prices continue to fall and election uncertainties disappear. Wallace is global market strategist for Action Economics