"Fool Me Twice"

The Daily Reckoning Presents: A Guest Essay. Fred Hickey warns: “Don’t be suckered by the Street’s latest high- tech hype.” The semiconductor industry is still in the midst of the worst downturn in its history – and semiconductor stocks are still grossly overvalued.


The sell-side – brokerage house – analysts are at it again, urging investors to hop on board the tech stock train before it leaves the station.

Merrill Lynch recently warned that the semiconductor train was pulling out and raised ratings on a dozen semiconductor chip stocks and another seven semiconductor equipment companies. Shortly thereafter, in monkey-see, monkey-do fashion, W.R. Hambrecht used the same train-pulling-out phraseology as an excuse to upgrade a different set of semiconductor names that Merrill had somehow overlooked.

Last year, the trains brought the dupes to the slaughterhouse instead of the promised land of plenty. Trillions of dollars of wealth were destroyed and trillions more will be destroyed later on this year, once the train cars are packed full.

[As we mentioned in the Daily Reckoning yesterday], NBC cheerleader extraordinaire, Maria Bartiromo, titled her August 2000 column in her hubby’s Individual Investor magazine: “Ready for a Rebound.” Column subheadings were: “Nasdaq 6000?” and “Soaring Semis.”

All Maria did was parrot what the “experts” of the time were stating. Dan Niles, the hottest semiconductor analyst in August 2000, provided most of the quotes for Maria’s “Soaring Semis” section.

This is what Maria wrote: “One sector showing no signs of a slowdown is that of semiconductors, which has come roaring back from its slump in 1997 and 1998, powered by explosive demand for everything from cell phones to Palm Pilots to the Internet itself. ‘All those things require semiconductors and none of them has seen a slowdown, so it looks as if the gains will continue for at least a year and a half,’ says Lehman Brothers analyst Daniel Niles.” Maria also quoted DLJ analyst Boris Petersik, who predicted higher DRAM prices and a one-year 102 target price for Micron Technology.

Last year, Petersik was Wall Street’s favorite analyst covering DRAM and Micron. But how accurate were these predictions from the leading analysts?

Standard 128-megabit DRAM prices were $18 in the July- August 2000 time frame. They are now less than $1.80. DRAM prices experienced their fastest decline in history, which is saying a lot, because DRAM prices are always falling. Research firm Dataquest predicts that the DRAM market in 2001 will suffer its worst revenue decline in history – down 55% year-over-year – from $31.5 billion in 2000 to $14 billion in 2001.

Micron’s stock never hit the $102 target price, though it did break above 93 in late August before heading into a death plunge that saw it lose 70% of its value (nearly $40 billion) in just eight short weeks.

That’s another example of why over the years I’ve called Micron “The gift that keeps on giving” – for short sellers and especially put and LEAP option buyers. Note that at the peak stock price last year, Micron sold at nearly two times the total worldwide estimate of DRAM sales.

Historically, Micron has traded at two times its own sales, not the total industry’s. Micron has a little more than 20% market share. Today, Micron is valued at $26 billion – nearly two times the total worldwide estimate of DRAM sales. I guess that’s why Merrill Lynch made Micron one of its dozen semiconductor stock upgrades [recently]. Ha!

As for the overall semiconductor forecast, Maria, Dan and Boris couldn’t have been more wrong. Research houses now admit that the semiconductor sales decline in 2001 will be the worst since 1985’s debacle, and I believe that when the final results are in, the collapse will exceed 1985’s. Cell phone sales in 2001 – approximately 400 million – are 200 million units short of the forecasts from last year.

In 2000, cell phone vendors put about 100 million extra units into inventory due to a sharp sales shortfall from forecasts. Palm Pilot sales last quarter were one-fourth of what Palm had originally forecast, leading to a massive inventory bulge and brutal price war, which continues today.

As for the Internet as a driver of the semiconductor industry in 2001, what can I say? Online spending in June was 20% lower – $3.2 billion vs. $4 billion in June 2000, according to Forrester Online Research. According to Nielsen/NetRatings, the number of U.S. users of the Internet has stagnated at 100 million since January. The average number of minutes spent online per month is down from the beginning of the year.

According to Webmergers.com, through June of this year, at least 555 dot.com companies shut down, with 60% of all dot.com failures since January 2000 having come in just the first six months of this year. More than nine times as many dot.com companies have shut down this year than in the first half of 2000. The failed companies are spewing enormous amounts of computing, storage and networking equipment into the used-equipment market.

Because some may argue that even 2002 earnings estimates are temporarily depressed due to price wars and the like – highly unlikely – I made some comparisons using price/sales ratios using analysts’ ‘optimistic’ forecasts. Those comparisons show semiconductor stocks as more than two times overvalued vs. historical valuations.

As always, I suggest that individual investors not sell short. While most of my money is tied up in cash and cash equivalents, I continue to play the downside through a combination of longer-term put options, LEAPS and shorts. With stock prices still egregiously too high – total market valuation at 140%-plus of GDP vs. its 55% historical long-term average – I remain in the bear camp.

When we finally get capitulation from investors, we will have cash at the ready to buy great tech stocks dirt- cheap.

I have short/put positions in Micron, IBM, Intel, Applied Materials, KLA-Tencor, Altera, Linear Tech, Maxim Integrated Products, Nvidia, Celestica and CDW Computer Centers…

While it’s been frustrating to watch stocks like this rise for no good reason, Mark Twain provides some solace: “Let us be thankful for the fools; but for them the rest of us could not succeed.”

Fred Hickey,

for The Daily Reckoning

Fred Hickey is editor of The High-Tech Strategist. This story is adapted from the August issue and a version of it appeared on the grantsinvestor.com website.

Readers of the Daily Reckoning are cordially invited to try grantsinvestor.com for 30 days. Simply, follow this link:

Try Grant’s Investor” and follow the menu provided for you there. Thank you

*** Americans are woefully ignorant of the “financial facts of life.” At least that’s what a touchy-feely article in the Detroit Free Press tells me, suggesting that a non-profit organization get involved with educating America’s youngsters.

*** And with good reason, I suspect. “Personal debt in the U.S. has reached an all-time high,” the article relates. “The amount of their incomes Americans are dedicating to paying down that debt is at levels unseen in 15 years.” Moreover, “mortgage delinquencies and writeoffs by credit-card companies are rising, and personal bankruptcy filings could hit a record this year.”

*** Many are still feverishly gripping the last great savior of the American family balance sheet: the home. “Today your home isn’t your castle, it’s your margin account,” says Scott Burns, of the Dallas Morning News.

*** For now, real estate markets around the country are still rising…average homes in…

Boston: up 13.9% to $345,000

Denver: up 14.9% to $210,000

Fort Myers: up 14.4% to $111,100

Los Angeles: up 11.5% to $225,000

Sacramento: up 22.9% to $163,000

*** Will it be long before layoffs and the illusory corporate profit mirage of the late ’90s takes its toll on the real estate bubble, too?

*** Greenspan before the Senate two weeks ago: “I think one of the things that’s occurring in this country is the evolution of housing into a very sophisticated, complex industry, in the fact that…as the market value of homes continues to rise, even in a period when stock prices are falling, we’re observing a rather remarkable employment of that so-called ‘home equity wealth’ in all sorts of household decisions.”

*** “The bothersome fact is that home mortgage borrowing is becoming a handy finance tool,” writes Burns, “the equivalent of your own personal IPO.”

*** Eric, what happened yesterday on the Street?


Eric Fry reporting from New York:

– Booorring! The Dow fell one point yesterday. The Nasdaq offered only slightly more thrills by posting its first positive close in seven days – up 25 points. The Nasdaq owed much of its advance to the on-again, off- again semiconductor index (SOX), which gained almost 2% on the day.

– It seems Goldman Sachs analyst Terry Ragsdale woke up Monday morning and decided semiconductor stocks aren’t so bad after all. He placed Intel on the firm’s oh-so- prestigious “Recommended List” and upgraded a slew of chipmakers on the belief (read: hope) that fundamentals will improve in the fourth quarter.

– “We think the stocks are headed up for now,” Ragsdale opined. “The recovery writing is on the wall, and we don’t see how investors will be able to resist.” Yeah Terry, we can see how it’ll be pretty tough to resist shares selling for 60 times collapsing earnings.

– What inspired Ragsdale’s call, I wonder… A prophetic vision during the night? An uncontrollable urge to be bullish on something…anything? Perhaps a plump new underwriting deal from Intel? Who knows. One thing’s for sure. It wasn’t tangible evidence of recovering semiconductor demand. There isn’t any.

– “Don’t be suckered by the Street’s latest tech-stock hype,” warns Fred Hickey’s High-Tech Strategist. The semiconductor industry is still in the midst of the worst downturn in its history and semiconductor stocks remain grossly overvalued.

– “Virtually all its major-end customers – Compaq, H-P, Sun, EMC, Nokia, Ericsson, Cisco, Nortel, Lucent, etc. – are in turmoil,” says Hickey. “[And yet] the average P/E ratio for the semiconductor stocks in the SOX index, based on analysts’ estimates of 2002 earnings…is 84. The absolute lowest P/E ratio for any of the stocks is 44!”

– “Before you act on Merrill’s – or Goldman’s – latest urging,” Hickey cautions, “I ask you to think about this Chinese proverb, ‘Fool me once, shame on you; fool me twice, shame on me.'” (More in a Daily Reckoning Guest Essay below…)

– Gold keeps on edging higher as it tries to muster another of its infamous mini-rallies. One of these days, the mini-rally will blossom into a full-fledged maxi- rally. Given the dollar’s recent weakness, we shouldn’t rule out the possibility. The AMEX Gold Bugs Index climbed nearly 3% yesterday – not too shabby for a financial relic.

– But the relics that really “rocked” yesterday were the coal stocks. Peabody Energy soared an eye-popping 13% after announcing that its earnings could rise briskly on the back of surging Appalachian coal prices. Shares in Massey Energy, another leading U.S. coal company, also jumped about 13% on the day.

– “Coal prices for Appalachian coal on the spot market, where 20 percent of coal is sold, doubled this spring and have held onto those gains through the summer,” Reuters reports.

– John Myers of Outstanding Investments suggests coal is still at historical lows. Myers: “Coal has been a crucial source of energy since the time of the Pharaohs… and used extensively for fuel since the Industrial Revolution. But since 1975 or so, the greens have beaten the coal industry silly.

– “At the height of the energy crisis, the price of coal hit $100 a ton,” Myers continues. “In constant 2001 terms that would put the price of coal close to $300 a ton. By 1999 the price of coal had fallen to just $20 a ton. That was just one-tenth of its price during its heyday. Even after a revival, the price of coal is selling for only $40 a ton, a fraction of what it wasfetching 25 years ago.”

– Pret-A-Manger, the all-natural sandwich shop I frequent down on Broad Street, did a cool $1 million in sales last year. Maybe my eyes were bigger than my stomach…

– Emboldened by its initial success in the hyper- competitive Manhattan restaurant market, the Britain- based operation is “ready to blitz New York with 40 stores selling cheap gourmet eats to lunchtime crowds,” says Crain’s.

– Ironically, the unnatural McDonald’s owns one-third of the company and an option to acquire all of Pret A Manger over time. Maybe we should keep our eyes on Ronald & Co… First McCafe coffee bars…then gourmet sandwiches. The innovations seem to be working. What’s next, McHedge Funds?


Back to Addison Wiggin, in Paris…

*** Yesterday evening I went down to the Franprix, my local grocery store here in Paris, and I noticed that there’s a disturbing trend afoot. The liter of wine I’ve grown accustomed to sipping with my sup has grown noticeably more expensive. Once less than $2… it’s now closer to $3. (okay, so it’s not the finest issuance from the vine…)

*** Still, “the market seems to be ignoring poor euro data and focusing more on the not-so-good U.S. data,” a UBS Warburg currency strategist told the IHT. The euro traded briefly over 90 cents yesterday. The franc, pegged loosely to the euro, has been trending towards 7.

*** Uncle Harry Schultz, curiously following the Russian press, points out: “Outspoken economist Tatyana Koryagina said in testimony to Sergei Glazyev’s State Duma hearings on June 29 that ‘holders of dollars will soon be able to use them for wallpapering their toilet stalls.’ She also forecasts a world financial system blow out in mid-Aug.” Maybe so… more below.