Is it Real?

Today's question: "Should we take some profits off the table, or should we ride with the rally until the recovery really builds a head of steam?"

Better yet: "Is this recovery for real?" Lately, I have been answering this way: "Don't fight the tape. The market knows what is happening." After that exercise, I usually end up asking, "Is the market purposely ignoring all the bad news?"

I think the bottom is real, but a strong turn to the upside is going to take time to materialize. Yes, orders and shipments for both semiconductors and semiconductor equipment have stabilized. Inventories in the chip world have been burned down and businesses have been right-sized. These are good things, but I am not sure if that is enough to support current valuations.

The investment world, evidenced by the performance in semiconductor and semiconductor equipment stocks, is betting that this is the real McCoy and that growth in earnings and revenues is just around the corner. I think this crowd is going to be a little disappointed by the time we get into the quarterly reporting season.

The stocks have been performing marvelously in the face of the awful business conditions. It almost feels as though the relationship between stock valuations and business conditions are at opposite ends of the spectrum. The last time the stocks bucked business trends like this was during March 2000. If you look at a few charts you will see that all-time highs were reached that month and from there it was down, down, down. Share prices went down right in the face of the biggest year ever. The markets were smart anticipating that fall. Maybe they are smart by anticipating a stronger than expected recovery?

Then again, this could be just a good-sized bounce off the bottom. It could be a rally that tricks everyone into believing that business is actually better than it really is. That's my bet — I have been saying this would happen since the middle months of last year. In our newsletter, I tried to convey that we would see a rally starting in the third quarter of 2001. That rally would be based on an extrapolation of seasonal strength and evidence that the bottom is in place. Sure enough, the stocks are following the script. Whether they follow the rest of the story line remains to be seen.

To keep the rally moving to the upside we really need to see some solid evidence that points to end-market strength. Everyone knows that strength in final demand would propel the stocks higher from current levels. Unfortunately, end-market strength is hard to find.

Well, an elongated bottoming process is not the end of the world. In fact, it gives us time to re-position some of our assets into those companies that will win the battle. I believe the winners will be those who provide the most value-added for the least amount of money. Right now I am thinking about software, design and anything that addresses improved capital efficiency on existing assets.

Last, but certainly not least, allow me to answer my first question. We are going to take some profits off the table. Valuations are bound to come in as investors start to realize that the next upcycle will take a while to materialize. It's been a great rally and the profits are welcome. I don't want to get too greedy here. Greed is a terrible thing.