Tech sector taking the brunt of the US slowdown
24 July 2001
It has now become quite clear that the slowdown in the United States is being led by the manufacturing and high tech sectors. Industrial production shrank by 0.7 percent in June, the ninth straight month of decline. That makes this the longest period of contraction since 1982. Industrial production has shrunk over 4 percent since its peak in September 2000. Capacity utilisation fell to 77 percent in June, the lowest since August 1983.
The impact on technology firms has been dramatic. Estimated 2001 earnings for technology stocks in the S&P 500 have dropped by more than half over the past year. And estimates continue to be revised downward.
Of course, the impact of the US tech slowdown is not restricted to the US alone. If anything, in a globalised economy, the tech slowdown is quickly exported to the rest of the world. In fact, US imports fell by 2.4 percent in May, bringing the decline to an 11.6 percent annual rate in the past six months. The decline in imports helped to cushion domestic production. Business equipment output fell at an 8.6 percent annual rate in the November-May period, but real capital goods imports collapsed at a 31.4 percent annual rate, and imports of advanced technology products plunged at a 44 percent annual rate.
Such declines are clearly being felt in Asia, where a large proportion of exports consists of high tech capital goods to the US. Asian exports fell 2 percent year-on-year in April and 12 percent in May. In June, exports declined year-on-year by 13.4 percent in South Korea, 16.6 percent in Taiwan, and 2.3 percent in China.
Singapore appears to have been hit especially hard. Non-oil domestic exports fell 16.9 percent year-on-year in June. Export of electronics products tumbled 21.2 percent. Singapore's Chartered Semiconductor Manufacturing, the world's number three maker of custom-made chips, reported a loss of $107.6m for the April-to-June period, more than three times the first quarter's loss of $30.9 million. The company's capacity utilisation rate plunged to a dismal 31 percent, compared to 61 percent in the first quarter, while its average selling price (ASP) shrank 7.6 percent to $1,147 per wafer.
So is the bottom in sight for the technology sector? Nobody knows for sure. Some of the latest indicators show that the slowdown may be decelerating. The new orders index, part of the US National Association of Purchasing Management's monthly manufacturing gauge, has been improving since the January low of 37.8 and hit 48.6 in June, just below the dividing line between expansion and contraction (50). The inventory-to-sales ratio for non-tech manufacturing was 1.35 in May, down from a peak of 1.40 earlier in the year. But for technology manufacturing, the inventory-to-sales ratio has been increasing steadily from 1.25 in December 2000 to 1.54 in May.
Apart from concerns over the near-term outlook for the sector, there are also concerns over the medium-term outlook. Many economists have suggested that the extreme over-investment over the last few years means that the recovery, when it comes, is likely to be weak. Andy Xie of Morgan Stanley, for example, sees a bottom in capital expenditure in the US in the fourth quarter of this year or the first quarter of 2002. However, he sees flat growth in capital expenditure after that. His colleague, Daniel Lian, does not see a full recovery in information technology demand until 2003.
However, investing in the technology sector does not require certainty in the near-term outlook for that sector. If stock prices fall low enough, the patient investor might still make money over the long term. Therefore, the question is whether technology stock prices have fallen low enough to warrant a closer look at technology stocks.
In the US, the average prospective P/E ratio of technology stocks in the S&P is over 30, or about 50 percent higher than the S&P 500 average. This reflects the superior projected long-term growth rates for technology stocks. Incidentally a similar premium exists in the Singapore stock market, where the average historical P/E ratio of electronics manufacturing stocks is about 17 compared to around 12 for the Straits Times Index. The P/Es of Singapore electronics manufacturing stocks have halved since a year ago, when they averaged around 34. However, with earnings expected to decline between 30-50 percent this year, prospective P/E ratios are almost as high as in the US and do not look so attractive.
Furthermore, tech stocks are vulnerable to downward adjustments in both earnings projections as well as P/E ratios. If the anticipated recovery is delayed or weaker than expected, investors might downgrade the valuation premium that tech stocks currently enjoy over the rest of the market. Such a double whammy would definitely hurt returns from these stocks.
In conclusion, the technology sector remains highly risky for investors. Investors who can stomach high risks may consider nibbling in tech stocks now -- after all, high risks often come with high gains. But more conservative investors should probably look elsewhere in a stock market that already has ample bargains.
Disclaimer: The commentaries posted here represent the opinions of the author at the time of posting and should not be taken as investment advice. Readers who wish to take any investment action based on information obtained from this site should seek appropriate advice from a qualified financial adviser.