Market Thoughts, Macro Themes, and Tech Sector Outlook Heading Into 2011

By Sean Udall  DEC 16, 2010 2:30 PM

Here, Sean Udall discusses his predicitions and expands on them in the new TechStrat Report. Read on to find out how to get a 14-day free trial.


I'm excited to announce the launch of the TechStrat Report in partnership with Minyanville. It's been a long winding (and turbulent market) journey to get here and I wanted to personally thank Todd Harrison and others here at Minyanville for giving me the opportunity some years back to share my themes, views, and investment ideas on the Buzz & Banter. I very much look forward to greatly expanding on my thoughts in the TechStrat Report. If you haven't already, you can sign up for a free trial here.

While my investment and trading strategies have evolved over the years, my focus has always centered around building strong fundamental investment themes and good old-fashioned stock-picking. Through the years, I've added trading techniques, options and technical analysis and one thing seems crystal clear: All those things just work better if the underlying fundamentals are supportive.

The other aspect is, I just love the hunt for the next idea. By this I mean, I have a passion for the long hours spent digging through EPS reports, screens, news flow, chart studies, and now a seemingly endless array of research reports. So I hope you enjoy the product and that it allows you to spend less time on the above toil and more time pursuing your own passions.

I hope that TechStrat will provide a one-stop shop for all things related to tech stocks, with my thoughts, your thoughts and questions via the Mailbag, and then important research and news from various places organized in the Research Tank.

As we get started with the TechStrat program, I felt it would be good to give readers an idea of my thoughts on the market and technology sector in general as well as an outlook for 2011 and beyond. Below are both my macro themes as well as tech-specific themes. Obviously, I'll be expanding upon both through TechStrat posts as we move forward.

Macro Themes:

1. Bifurcation in the market:
Broadly, I think this year will be dictated by a movement to bifurcation. From a world where stocks that have risen the most keep rising, to a world where some names finally pull a Duran and say "no mas." I see a potential for some violent down moves in certain names (and possibly some commodities as well). This list of potential ultra-violence victims is growing by the day. On the other side are slews of laggard stocks which have produced similar improvement (in revenue and EPS metrics) to the biggest stock winners. So we may finally see dynamic catch-up moves in stocks that have experienced massive valuation compression. Even though I see many stocks rising from a "catch-up" effect, I will maintain my view that "growth" outperforms "value." As previously stated, this cycle started in 2009 and my view is that it runs four to six years in total.

2. Contrarian take on government stimulus:
Just as I outlined in my themes piece last year, "Much of the media and negative pundits will continue to say that various financial government stimulus packages are the main reason that stocks and certain economic indicators/measures are rising, and until this prevailing sentiment shifts, the stock market bulls will likely be rewarded." Again as a thematic investor and trader, many of my working themes stay in place for years, and this is one of them. In time people will realize that the power of the undying capitalism in the world now is very hard to hold back. As I've written in numerous Buzz & Banter posts for a couple years now, I think many of the stimulus programs have served to delay or constrain growth, not stimulate it. I think in the fullness of time this view will be proven more correct. 2010 provided many examples of this. Car sales exploded after Cash for Clunkers was fully put in the rear-view mirror. The pent-up demand of the very old car fleet took care of itself once the market mechanisms were allowed to work. Bandwidth spending finally surged after years of being constrained by various measures (some constraints still continue). Note the moves in Akamai (AKAM), Riverbed Technology (RVBD), and F5 Networks (FFIV).

3. Sticking with variant economic view (but see that ending): I still see my highly variant economic view (of growth and the anti-going-into-the-abyss camp) continuing to work, though I now fully expect that 2011 will be a year where at least some of the economic camp changes and becomes too ebullient. Net, net GDP growth and jobs improvement should still be above consensus for at least two quarters and possibly the full year.

Interestingly, while many talk little of government stimulus programs now, there is still a sizable pile of money left to be deployed, and just like last year, more "actual" stimulus money will be infused into the economy than in 2009. The market has been very thin on the leadership front with just a few bright stars shouldering an Atlas-like load since the bull market started. My view is this changes and broadens out. If not, then I do think that might be an important tell to a very serious correction.

Tech Themes for 2011

Earlier today, I posted some of my macro themes for the coming year, and below are a number of my tech-specific themes as we head toward 2011.

1. Starting the themes just like last year:
I see extremely low rates through 2011 -- with my range being 25 bps to 75 bps of tightening and my gut feel that we see the Federal Reserve remove its 0 bps to 25 bps funds rate and replace it with either a 25 bps or 50 bps (or a 25 bps to 50 bps floating) funds rate.

The important part to this is that I've long held the unique view that the longer the Fed base rates stay very low, the stronger the ultimate growth trajectory is. This should continue to spur stronger-than-expected economic activity (not the converse, which is so often argued). Net, net, this is a core reason I've stuck with my highly variant view (since early 2009) of a stronger recovery and GDP growth than commonly expected while inflation remains benign.

2. The network keeps exploding: Web-based video is secular, bandwidth growth is secular, touchscreen proliferation is secular, mobility, data retention, business intelligence applications etc... I could go on and on with this. In my view, many technologies today are finally seeing the realization of the early days' promises of many of the advancements which we first saw over a decade ago now. This theme has essentially been in place since the end of 2008 and I just don't see a major reason to change it yet. In fact, it's now evolving given the sheer amount of traffic flowing freely with ever-increasing speeds over myriad wireless networks. Private equity is seeing this effect -- see the CommScope (CTV) deal and others. The biggest industry players are seeing this as we have seen a large increase in M&A in this group. And now the big cable and telco's are trying to find more ways to monetize their network ownership.

Cisco (CSCO) has been one of the few disappointing names. Nearly all of my other featured names have exploded -- see Broadcom (BRCM), EZchip Semiconductor (EZCH), Atheros Communications (ATHR), VMware (VMW), and others. The rub now is that fewer names are reasonably priced, and very few are the outright steal they were just six to nine months ago. However, this is a fairly large subset of players in this group and the landscape is very fluid. Given the backdrop I'll stay very focused here as I think there are still plenty of opportunities in this space to take advantage of. Interestingly, I don't see a lot of bifurcation here, save a couple key examples emerging.

3. Potential rub in the growth thesis: Gas prices rise at least 10% and have an outside chance of rising two to three times that level. If this were to occur ($3.80-4 gas or higher) some of my variant growth thesis would be at risk.

4. Alternate energy and auto transportation: This is an ever-expanding theme and I may have to break it into a couple pieces next year. So this year I'm expanding the alternate-energy thesis to include major enhancements in auto transportation. To me, the key drivers are similar. We are going to increase the proliferation in electric-car development. General Electric (GE) just announced the first major fleet deal in this space. Moreover, this feeds my research into the battery-technology space. Following this theme we still are in dire need of improved grid technology and more efficient uses of energy with increased energy production.

On the auto front I'm also seeing major enhancements or inventions regarding crash avoidance, driver assisted and connected mobility applications. I think electric/hybrid cars are here to stay, and this will be a major growth driver for various technology sub-sectors in the years to come.

5. Industrial growth fuels the old line semiconductors: This could be part of my auto-transportation thesis. However, this involves the increased spending by the whole industrial complex which requires a massive amount of new diodes, transistors, and sensors for many new production and product innovations. GE, 3M (MMM), Caterpillar (CAT), and others are all infusing more labor and safety enhancements. The sensor market in particular is something that I'm ramping my research into along with old line/traditional names such as Vishay Intertechnology (VSH), AVX Corp (AVX), Fairchild Semi (FCS), and Texas Instruments (TXN).

6. IPO's are front page news again. M&A stays strong: As I said for two years, the IPO market isn't dead, and I expect 2011 to be as strong or grow from 2010 levels. I thought Facebook would launch in 2010 and still feel it will be the deal of the year if it hits GO in 2011. One speculation I have is that it may start sacrificing value if it waits beyond 2011. We have just seen two very strong deals (YOKU and DANG) from China and I expect to see acceleration in strong foreign deals.

On the Buzz & Banter and in the article Consider a Barbell Strategy in Tech, I highlighted names such Blue Coat Systems (BCSI), CommScope, ADC Telecom, Verigy (VRGY), Electronic Arts (ERTS), Dell (DELL), MKS Instruments (MKSI), and ADTRAN (ADTN). Some of these have already been acquired or have announced deals. This should continue and possibly accelerate. I will continue to monitor many of the names I've previously highlighted as key potential targets. Again my research focuses on niche leaders across various tech sub-sectors exhibiting a unique blend of performance, growth, end-market potential, and balance-sheets characteristics. 7. The cloud keeps flying: I highlighted this area numerous times and this plays into two of my key central themes. Growth in tech investing at the enterprise and bifurcation within the Tech sector. Bifurcation is fully in play here as I see continued gains throughout the group but I'm also increasing my caution levels on certain names. I think the most promise still resides with SSD players, the Enterprise solutions vendors and plays in the Data Center space. I also think the iPad and proliferation of Droid based devices has created a fast growing need for mobile storage solutions, archive and retrieval.

8. Financial tech: Banks are the talk of many media outlets and I've weighed in a plenty on that group. However, a somewhat ignored group are stocks that service the banks and promote advances in financial tech and innovation. I see major growth in many areas in these verticals. I still favor and retain stakes in leading payment processors and plan on doing so for the foreseeable future. Visa (V) and Mastercard (MA) still seem particularly cheap to me. Banks also have much more spending capacity and need to utilize that. The strong will get more efficient and largely through enhancing core technologies.

EPS will continue to be strong, primarily led by continued record net interest margins. Helping the case will be continued strong trading, surging merger-and-acquisition growth, and improving asset management books coupled with shrinking writedowns. This should lead to solid if not very strong performance from companies involved in servicing this sector.

9. Tablets are just huge, this isn't a one-year phenomenon:
In last year's themes piece I stated, "The Apple (AAPL) Tablet will be another game-changing product and the next great extension of the iPhone platform. This product will be the first fully functional touchscreen computer and will usher in a new era of innovation (for Apple and certain chip companies). Apple will follow suit in the coming months/quarters with Macbooks using their proprietary touchscreen interface, which allows the company to further accelerate computing market share gains. I see Apple surpassing my low- to mid-$300s target and moved my target to the low $400s."

At that point last year, we still hadn't seen the product, the sales or just how functional the iPad was. At this point the iPad has crushed my early sales predictions (frankly I wasn't even close, even though I was about double most Wire House predictions). Currently, I've seen sales estimates which I do think might be hard to meet. But no matter how you slice it the iPad is the category leader and has produced a huge end market which others will eventually benefit from as well, notably Google (GOOG).

The net effect of all this is that I don't think the Apple trade is over. I'm sticking with my low- to mid-$400s area for now, though give me another quarter like last and I'll finally move my number higher. In trading/investing, many times you don't want to stay at the trough too long, and I've long ridden this name for years. But I also follow my disciplines and they are telling me that this stock still has potentially a stunning amount of relative value. Following through on my bifurcation thesis, Apple is very cheap relative to names like Amazon (AMZN), Baidu (BIDU), (PCLN), Acme Packet (APKT), and a slew of other names.

10. Revenge of (some of) the Old Guard: PEs at or below the market still exist in names like Hewlett-Packard (HPQ), Apple, Cisco, Microsoft (MSFT), and others. Furthermore, backing out these record-breaking cash balances further compresses all my key valuation ratios and puts these levels at historically depressed levels given the growth being generated. Further, some of the above have been much more active on the M&A front, and I think that should serve them well, especially Hewlett-Packard. Bottom line, I don't think the Old Guard in tech is dead yet.

11. The PC era ending? Intel (INTC) won't sit still: In my view, Apple has effectively created a dynamic new end market in mobility computing. It might follow that Pure PC-centric stocks could really get pinched (such as Dell). Tablets are simply a huge paradigm shift in mobile computing. Look for Intel to make at least one, or a series of moves, to buy into other areas that will give it growth outside of its main franchise. One such move I see as highly possible is Intel making a play for Marvell Tech (MRVL).

Years ago Intel looked at buying Broadcom, and senior management at Intel have said (numerous times) that they should have bought it. At this point, buying Broadcom would seem a difficult reach but Marvell Tech and others are still ripe for the taking.

12. Oh no, this is a Yahoo
(YHOO) prediction: I took a year off but am once again making a prediction regarding Yahoo this year. I think Yahoo does find a way to stay in the plus column and at a minimum outperforms the Nasdaq, if not by a substantial margin. However, I'm saying nothing regarding a merger!

13. Security within the technology/defense space: I like numerous names in this group such as L-3 Communications Holdings (LLL) and Nice Systems (NICE). L-3 in particular is a value for a few specific reasons. There is plenty afoot here and more on this later through the year. Suffice it to say that I will be allocating some funds to this area in the coming weeks/months.

14. Networking, part deux: I see Juniper (JNPR) making a move and buying a key player in the space. I had thought that Riverbed might possibly get taken out by Juniper this year but that didn't happen and now Riverbed is likely out of reach. However, there are still names remaining and Juniper has only played M&A small ball of late. Might Google (GOOG) make an entry in some fashion in this area as well or Microsoft? Years ago Google bought abundant amounts of dark fiber at pennies on the dollar. I would look for Google to start to find ways to monetize or commingle those assets in the future.

15. AOL (AOL) and Google: These could be two of the better-returning names as monetization of ad spend, content creation as well as deals to both divest and invest fuel superior returns of these 2010 laggards. Further, I think the pundits are vastly underestimating the potential positives/implications for Google's pipeline, particularly the Chrome OS. More to come through the year but if readers want to see how a similar technology theme played out, please view my writings on the iPhone as a platform from '07 & '08.

16. Old Guard, part deux: Both Hewlett-Packard and Cisco hit the comeback trail and produce market-beating returns in 2011. I have Hewlett-Packard hitting $55 and Cisco $29 next year.

17. Market forecast: The US stock market rises by 11% or more as measured by the S&P 500. Like last year, I forecast the tech-heavy Nasdaq to do better but with more outperformance versus 2010, though less than 2009. I did not include my regression-to-the-mean theme in the list this year but many of the tenets of that thesis still hold. Two-decades-long underperformance likely will be tempered, thus representing part of the potential for another double-digit year. I do see bifurcation and with that some of the largest winners could be supplanted and not perform well. Moreover, I see better/more shorting opportunities in certain areas.

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No positions in stocks mentioned.

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