This summer the technology market plunged. Panic spread. Investors scrambled to sell. And few people stopped to notice that not a single end-user product showed weak sales. The demand for communications equipment remains strong - personal computer sales are up 19% this year. While the Cassandras focus on the slow 8% growth for PCs in the home market, they're missing the 30% boom in corporate business. Demand is strong for CD-ROMs, backup tapes, large colour displays, high-speed modems and network connections.
The earnings downturn in the first half of '96 was caused by a Windows 95 inventory correction combined with a glut in the DRAM market, which resulted from three years of artificially high prices.
Take a deep breath and follow these numbers. Low memory prices - they plummeted 75% - will hold total semiconductor industry growth to about 10% this year. But DRAM accounted for 35% of industry sales in 1995. If the prices of 35% of the industry fell 75% while DRAM unit volumes increased a generous 40%, then, to grow 10% overall, the rest of the industry had to grow about 50% in dollars. Since the average selling price remained flat, the number of units sold grew 50%.
The increase in sales means that excess production capacity will be used up quickly. I believe new chip construction plans that were shelved earlier this year will speed ahead. I recommend next-generation semiconductor equipment stocks like Plasma and Materials Technology Inc., Genus Inc. and Mattson Technology, which are likely to recover much faster than Wall Street expects.
Semiconductor Upswing
Semiconductor equipment companies are bedevilled by pushouts - as when a customer says, "Don't ship my order in November. I'll tell you in December if I want it."Both the June and September quarters were weak - they marked a bottom for this cycle, but the traditional spending patterns promise a stronger fourth quarter. Around half of all PCs are bought in the December period. Not only will the personal computer and communications industries grow in 1997 as the worldwide technological revolution continues, but a new generation of equipment will be needed to build the sub-0.25micron chips. This means the upturn will stretch into 1998.
Institutional money will flow first into the biggest semiconductor equipment stocks. I would buy Applied Materials, Lam Research and Novellus Systems Inc. to catch the earliest upturn.
Granted, these stocks are hated now because they've all reported disappointing earnings. At a recent brokerage firm conference, the quickest way to clear a room was to say, "The next presenting company is a small semiconductor equipment manufacturer..."
Scrambling for Supply
While some analysts estimate that the tide will turn in December, others say it'll be early summer. In a burst of candour, one exec told me: "Our DRAM customers are telling us they won't need anything until next June, but these are the same people who told us last May we should accelerate production to meet their needs in the September quarter."Because the supply pipeline is empty, a bunch of pushouts can become pullins almost simultaneously. In fact, that's almost inevitable when the technology is moving to smaller 0.25 and 0.18 micron chips. As soon as one company orders the equipment to create the next-generation chips, its competitors have to order or risk being left behind.
If the cycle swings as I expect, chip suppliers will lose market share in the second half of 1997 because they can't process enough silicon. In reaction, chip prices will tighten up. I am buying chip stocks depressed by low pricing, such as Cypress Semiconductor Corporation and Integrated Device Technology Inc. I'm still holding off on DRAM stocks such as Micron Electronics Inc and Texas Instruments, however, because overcapacity in that segment is worst.
TWIT$
The market pays you to assume risk by holding volatile stocks and virtually all technology stocks are like this, especially in the short run. I expect a strong December quarter rally lasting well into 1997. The current portfolio - with 42.3% in semiconductors and another 23.9% in PC stocks - will fly in a PC/semi upturn and I see no need to make changes now.
The Wired Interactive Technology Fund (TWIT$)
Company Primary Business Symbol Shares Price Aug 1 Since July 15 Action LSI Logic Corporation Semiconductors LSI 7,800 21 5/8 + 2 1/2 hold Applied Materials Inc. Semiconductor equip. AMAT 4,000 25 + 1 1/8 hold The Walt Disney Company Entertainment DIS 1,500 57 - 3/8 hold Apple Computer Company Hw/sw AAPL 4,800 24 1/8 + 2 7/8 hold Tele-Communications Inc. Cable television TCOMA 4,800 15 + 1/8 hold Intel Corporation Microprocessors INTC 3,000 81 5/8 + 4 5/8 hold Adobe Systems Inc. Software ADBE 5,000 35 1/4 + 4 3/8 hold Mattson Technology Semiconductor equip. MTSN 30,000 8 1/2 - 1/4 hold Euphonix Audio sw EUPH 17,000 5 1/8 - 2 5/8 hold Diamond Multimedia Multimedia hw DIMD 7,000 8 3/4 + 1 hold Seagate Technology Inc. Disk drives SEG 300 46 - 2 7/8 hold
Portfolio Value $1,381,731.25 (+ 38.17% overall) +2.04%
Pound sterling on Aug 1 was $1.54
Portfolio Value in sterling £897,228.08
The Wired Interactive Technology Fund is a portfolio of share recommendations, which began investing a virtual stake of US$1 million on December 1st 1994. Wired UK follows its fortunes monthly.
TWIT$ is a model established by Wired, not an officially traded portfolio. Michael Murphy is a professional money manager who may have a personal interest in stocks listed in TWIT$ or mentioned in this column. Wired readers who use this information for investment decisions do so at their own risk.
Michael Murphy is a money manager who publishes the California Technology Stock Letter.