Pushing Out

The recovery in the chip business has yet to appear. Prior to September's events I was anticipating some seasonal strength to develop. So far, most indicators have not turned the corner (sigh).

After making new cycle lows late in September, stocks in the chip equipment business have made a bit of a rebound. Investors are still betting that business will turn in the early quarters of next year, but there is not a good argument supporting that. I have a feeling we will see another down-leg in the stocks later this year. The reason I believe this is that many stocks in both the semiconductor and semiconductor equipment world are still one or two standard deviations from trough valuations.

Of course, I could be wrong on this point. There is a lot of liquidity being pumped into the economy and some of it is bound to find its way into the stock market. The market is rallying as I write — despite all the bad news. We might not see the stocks get as low as they have during previous down cycles. Even today investors are clinging to the hope that a recovery will finally appear in the first quarter of next year. Don't bet the farm on it.

We have heard from some companies in the chip equipment arena that customers are investing far less than they should be at this time. On a recent Novellus Systems earnings conference call, management mentioned this point. This is a tough issue because many device makers are in rough financial shape. Many will not survive this downturn. To me, the fact that chipmakers are investing less is not surprising. They invested way too much in the last cycle. Couple this with the very stagnant state of end demand and it becomes quite obvious why there's not a lot of investment taking place.

What is it going to take to turn the industry around? No doubt, sentiment in the corporate and consumer worlds needs to take a turn for the better. That's not going to happen overnight. Most companies are still cutting IT budgets and consumers have battened down the hatches. In both cases, tech buyers are finding little reason to spend money, partly because what they have in place serves their needs. Killer apps are difficult to find. Another part is simply because of the weak condition of the economy.

Later next year I suspect that corporate and consumer pocketbooks will begin to loosen up, and the end markets for IC-laden products will begin to rise. In the interim, companies in the chip and chip equipment businesses must stay focused on cash-conserving initiatives and new design wins. Getting the financial house in order is important, but new design wins are essential to the long-term viability of the company. To participate in the next cycle companies have to get their new products into the market today.

So there's the mission. Find the companies that have their financial houses in shape. Financial strength is important, but with it comes the need to know if the new designs are being embraced by customers. Once we find a company that satisfies these two criteria it is a matter of building a solid investment position at reasonable price points. I am not good at timing markets, so I choose to buy in one-third of a position at a time. That way I can average my investment cost if the stock price deteriorates.

Be patient. There is plenty of time to get positioned in the right investments. From the looks of business today, things are not going to turn on a dime.