By Michael Wallace Written off numerous times since the Internet bubble burst in 2000 by some of the same analysts who previously preached their virtues, technology stocks quietly rebounded in to their highest level in just over four years last week. Overcoming investor antipathy, corporate governance scandals, terrorism fears, war, and record high oil prices, the shares are reaching new highs as the tech industry continues to lubricate the gears of the U.S. economy and helped corporate profitability via seemingly mundane productivity-enhancing advancements.
Notwithstanding a recent hiccup tied to tough interest-rate talk from Federal Reserve chief Alan Greenspan and renewed terrorism fears, the tech-laden Nasdaq composite index has now gained nearly 90% from the lows of 2002, after the Tech wreck of some five years ago.
BEATING EXPECTATIONS. Gordon Moore would be proud. Intel's (INTC) co-founder predicted back in 1965 that the number of components on a silicon chip would double roughly every 18 months. It seemed fitting that on the 40th anniversary of the so-called Moore's law in April, the sector showed signs of roaring back and helping keep the new paradigm of low inflationary growth on track.
True, above-trend productivity gains of 4% to 4.5% seen during 2002-2004 have likely moderated to a range of between 2% and 2.5%. But this reflects a cyclical moderation around a still-solid secular growth path. PC shipments grew at a brisk clip in the second quarter, led by bargain prices and strong laptop demand, according to researchers IDC and Gartner.
The IDC survey concluded that growth reached 11.7% domestically, but surged even more overseas. Gartner reported a global increase of 14.8%, a figure that eclipsed its forecast by 2%.
SUMMERTIME BLUES. Second-quarter results from the tech sector also have revealed upside surprises, despite numerous headwinds, which included rising labor and input costs. Earnings so far have fared strongly, vs. a year ago, with a 16% gain in net income, as of July 20 -- just part way through the quarterly reporting session.
On a subsector basis, earnings rose 4% for computer services, 11% for software, 31% for hardware, and 19% for telecom, and 571% for the Internet sector. Can you say "Google (GOOG) it"? Semiconductor earnings sank 50%, given their usual summer seasonal slump ahead of the school year.
Seasonality in the chip sector showed up in the Semiconductor Equipment & Materials International group (SEMI) data, which recorded $1.07 billion in orders (3-month average) in June, 2005 -- achieving a 0.93 book-to-bill ratio ($93 in orders for every $100 billed). That was a significant jump, from 0.84 in May, and the best ratio result for the year. Unfortunately, the ratio improvement masked a 4.9% drop in billings, to $1.15 billion in June from $1.21 billion in May, and a 33% year-over-year plunge.
INFLATION ANTIDOTE. Yet, the San Francisco Fed's Center for the Study of Innovation & Productivity (CSIP) confirmed that real investment in information technology grew at a white-hot 30% annual rate in the first quarter of 2005. This was the highest recorded rate since late 2003, though such investment may have pulled back from these high levels in the second quarter.
The Semiconductor Industry Assn. (SIA) reported that global chip sales fell by a modest 0.5%, to $18.05 billion in May, though this still represented a gain of 4.1% from a year ago. On balance, it would appear that healthy levels of capital investment in productivity-inducing technology and processes can continue to buy the Fed some time on the inflation front.
Indeed, as Greenspan highlighted in his most recent congressional testimony on the economy, "Business investment in equipment and software seems to be on a solid upward trajectory in response to supportive conditions in financial markets and the ongoing need to replace or upgrade aging high-tech and other equipment."
SLOWER GROWTH? In response to a congressman's question, Greenspan did note that the drain of productive resources due to the war on terror on multiple fronts could alter the allocation of productive resources -- the opposite of the "peace dividend" at the end of the Cold War. Yet, there is some evidence that shifts in government investment toward security-related companies, and wider application of their technology, have also supported the tech sector.
Evidence of how this fits into the broader macroeconomic picture should be seen in the July 29 government report on second-quarter economic growth, which we expect will come in at a 3% annual rate. That will mark a slowing in growth from 3.8% in the previous two quarters, and a 4.4% average in the prior eight quarters, though annual midyear revisions could boost historic comparisons.
This slowdown should prove temporary, given second-quarter strength in final sales, consumption, fixed investment, and net exports, as well as a chunky $40 billion inventory correction in the second quarter that will leave upside risk for growth in the second half of the year.
CHARTING PROBABILITIES. Fixed-investment growth in the first quarter moderated to a 6.6% rate, and likely slowed further to the 4%-5% range in the second quarter, due to restraint in the construction sector as the industry regrouped following robust first-quarter gains. But growth in equipment and software spending should bounce to 8% in the second-quarter from 6.1% in the first quarter, and a solid trajectory for shipments and orders bodes well for the equipment data in the second half of the year.
The technical charts point to room for tech stocks to forge ahead. A decisive close above 2,213 would leave few impediments to prevent a retest of the May 2001 peak at 2,328, with only the 2,250 psychological barrier as an intervening hurdle.
You just can't keep a good tech sector down. Wallace is global market strategist for Action Economics