Plodding Toward a Recovery

Through the summer doldrums we trudge. Plodding forward gradually to the ever elusive, second-half semiconductor recovery. This is becoming a ritual. The industry waffles on the cusp. Everyone is expecting the last half of this year and the early part of next year to be better. Will it happen this time?

What I have described is the pervasive sentiment of the day. SEMICON West, as expected, was not a barn burner. June, July and August have been tough months for equipment companies. Customers are still kicking tires — yet to break down and place orders.

In my last column, I talked about the bullish action in semiconductor-related issues. I also mentioned that sometime this summer, probably right before or during SEMICON West, stocks would peak until more positive news came in to view. Well, the rally peaked a little later than I expected, but it did peak. Most of the issues I follow have seen 15-20% lopped off their share values. This is not surprising. August has always been a rough month for stocks. Wall Street traders typically take extended vacations this time of year so the action has gone quiet. When they get back, the interest levels should rise. I am expecting to see some fireworks this fall. If the second-half recovery is real, share prices should move higher. If we continue to muddle along at the current pace, there is, obviously, more downside risk.

At this moment, I am leaning toward the positive side of the ledger. There are several large fabs that should start to gear up in the fourth quarter. This ramp should carry us well into the second quarter of next year. One should also factor in the seasonal trends. Averaging the last 10 years of capital equipment orders, they typically start to build momentum in late October and early November. If the averages hold true this year, orders will continue to build strength toward the end of the first quarter and the early part of the second quarter. From there, around May, orders should weaken as we head to the seasonally weak period, like the one we are in today. The weakness typically ends in mid- to late September.

If all holds to plan, we should start to see a recovery late this year. Valuation is still a concern for the stocks. During the past few weeks I have been taking a hard look at the earnings potential for several capital equipment companies. This was a major discussion topic at SEMICON West. How do we balance the need to keep up with Moore's Law and still make money running our business? Efforts to do this, at least during the past five years, have been disheartening. Assuming we do have a year-end recovery, peak earnings for 2004 and 2005 will not hold a candle to the peak earnings of the last cycle. That implies, rather unfortunately, that share prices will not move nearly as much as they have in the past. Of course, I am also assuming that investors will value these companies a little more rationally. Here I could be wrong, given that investors still seem to retain some of those bad habits from the last bull market rally. Many of the Wall Street reports I have read are basing future price appreciation on earnings expectations for 2005. Sadly, extrapolation to "infinity and beyond" still seems prevalent.

I'd really love to pound the table right here and tell everyone to get fully invested. I just can't do that with the evidence at hand. Barring some extreme event, my strategy for the next few months remains unchanged. Play close to the vest. Pick spots. Be nimble. I realize I have been saying that for a while, but there is no reason to go out too far on a limb. We have plenty of time to play the game.