Don't Get Too Optimistic about a Tech Recovery
By Rick MacDonald
Despite an earnings warning by networking giant Cisco Systems (CSCO ) after the close of trading Apr. 16, the tech sector seems to have held up pretty well. Why? One reason might be that Cisco management was still optimistic about the company's long-term outlook. They indicated that despite its current difficulties, Cisco's growth rates are expected to once again recover to the robust 30%-50% annual growth pace that has been the company's hallmark.
In a sense, the comments gave the market some confidence that, while the inventory correction in the tech sector will remain a drag over the next few months, the trajectory for growth coming out of this correction will retain the vigor seen in the late 1990's. Given the important consequences of such as outlook for financial markets, the economy, and the Fed, we at S&P MMS thought it was worth taking a closer look at recent developments in this crucial sector.
One of our favorite proxies for overall tech demand is the "selected high-technology industries" aggregate from the industrial production report issued by the Federal Reserve. With the Apr. 17 update for March, first quarter growth is now pegged at only a 5% seasonally-adjusted annual rate (SAAR), which marks a breathtaking slowdown from the 72% SAAR that was in place in the first half of 2000 and well off the 40%-plus average gain seen in the second half of the 1990's. (Worth noting: These figures are surprisingly similar to Cisco's.)
In fact, this quarter's figure is hovering at a level of growth normally seen only during recessions, as the current rate marks the slowest pace of quarterly growth since the second quarter of 1991. This figure may still prove to be optimistic, given the recent tendency for sizable downward revisions in subsequent data. Moreover, this is a "real" measure, which implies that nominal measures are taking an even bigger hit with the hefty price declines announced as of late.
What is particularly interesting is the degree to which those supposedly "in the know" continue to see little change in the long-term outlook despite the drastic change that has occurred over the short-term. Instead, we fear that the sharp slowdown seen over the last few months may be a more ominous sign of a return to a more "normal" long-term growth rate in the tech sector than many in the market want to believe. Looking at growth in the tech sector from a much longer perspective (over the past 30-plus years) rather than just the past few years, it becomes clear just how much of an anomaly the last few years were for the sector.
A SMALLER PIE.
Overall, we would not be surprised if longer-term growth for tech production is settling more in line with the pre-boom, but still relatively healthy, longer-term historical range of 0%-30%, rather than the 20%-50%range that characterized the second half of the 1990's.
While the popping of the dot.com bubble by itself argues for a return to more normal growth rates, we think many are overlooking the risk posed by over-capacity -- especially given that the tech sector is one of its own biggest customers. It's more than a bit concerning that high-tech capacity was still growing at a hefty 43% SAAR in the first quarter despite production screeching nearly to a halt. Note that this divergence marks the widest "over-capacity" gap in the history of the series -- dating back to 1967.
Our fear is that too many of the established players are operating under the quixotic assumption that all will grab market share from a pie that could prove to be much smaller than most would care to believe.
MacDonald is a Senior Economist for Standard & Poor's