Note: Professor Fleckenstein provides his commentary for educational purposes - his insights are not intended as investment advice. You can find his daily comments at www.fleckensteincapital.com
Please also note that this is Prof. Fleckenstein's Rap that was published yesterday afternoon, however given Fleck's focus / expertise in the area, we still find it helpful.
Trouble Besets Handsets
Monday night and yesterday morning saw the continuation of preannouncements in technology. In cellphone and PC world, a handful of smaller names took guidance down radically: Power Integrations (POWI:NASD), Silicon Storage Technology (SSTI:NASD), Integrated Silicon Solution (ISSI:NASD), and RF Micro Devices (RFMD:NASD). And then, CellStar Corp. (CLST:NASD), the big Asian handset distributor, slashed Q3 revenue expectations by 52% because of problems in China. They said that the combination of end-demand problems and too much inventory have resulted in an excess of 40 million phones in Asia (in a world market of roughly 450 million units sold annually). That is how you define implosion, and it will have a ripple effect on many companies here, with Texas Instruments (TXN:NYSE) being the most vulnerable.
Turning to the semiconductor-equipment arena, Teradyne (TER:NYSE) slashed its estimates from around 39-46 cents to 21-26 cents. To give you an idea of the leverage in some of these equipment companies, that prompted one of the dead-fish houses to take their 2004 estimates on this company from $1.45 to $1. But more importantly, the news caused them to lower their 2005 estimates from $1.75 to 60 cents, and this for a $14 stock.
A Buying Bacchanalia
I mention all the above to contrast with the fact that technology stocks (especially chips) were on fire again yesterday morning. These preannouncements have only succeeded in stoking such a frenzy that you would think the companies were actually chirping positively. I might be able to understand that if it was arguably the end of the bad news (because it had been going on for many months). As I have been stating, however, and as is clear from many of the preannouncements, this is not only not the end, but more likely the start of bad news. In my opinion, this is one of the most maniacal technology buying sprees that I have seen in the last six or seven years -- and I've seen a few.
Adding further fuel to the fire was the fact that housing starts were slightly better than expected (though building permits were worse), and that had the housing stocks breaking ground to the upside. So, the early going was a frenzied sea of green as folks chased after bad-news chip stocks and also housing stocks, where the bulls believe there is nary a cloud in the sky. All of this, on a day when the Fed was getting ready to raise interest rates for the third time.
Stocks Race at a "Measured Pace"
After the early-morning mini-surge, the market basically ground higher until the Fed told us that it was raising rates 25 basis points and continuing on its measured pace. And oh, by the way, damn it was good, as there was no inflation and the economy had "regained some traction." (Obviously, I was wrong yesterday in musing that the Fed might put its rate-raising on "pause.")
That verbiage appeared to be all the stock market wanted to hear, as it soon burst higher, at one point trading up nearly 0.75% on the day, as measured by the S&P, and just about that for the Nasdaq (though those gains were trimmed in the last half hour). What was hot yesterday were the oil stocks, with the oil index up about 3%. In housing land, moves of 5% to 10% were not uncommon. Tech was a bit of a piker, as most techs went out 0.5% to 2% higher, though some had been higher earlier in the day.
The amount of risk being assumed by those of a bullish persuasion is mind-boggling, relative to the potential return. Of course, I'm sure that risk/reward calculations are not actually being made. It's more of an emotional reaction to stocks going up that's causing everyone to vote the same way at the same time -- because no one wants to get left behind. The managing-other-people's-money business is really becoming an exercise in which everyone seems to check their brain at the door, just because they're so terrified to "underperform" -- not a recipe for winning in the long run, if you ask me.
Euro Feasts on a Fed Burger
Away from stocks, there were plenty of fireworks as well. In the early going, the euro exploded higher to the tune of about 0.75%, while other currencies were kind of dogging it. The dollar tried to go higher but fell out of bed, post-Fed, such that the euro closed near its highs of the day, up about 1.25%. It will be interesting to see if the euro can burst through the $1.235-$1.24 area, from which it's been turned back so many times. The euro's action is particularly noteworthy, given that the Fed did exactly what it had indicated it would do.
Away from the currencies, oil was up about 2% to $47.10. Gold and silver closed up 1%, plus or minus, before the FOMC edict, but as the Rap was being put to bed, it gained an additional $1.60 to around $411.70 in after-hours trading. Fixed income closed higher, as that market apparently believes higher short rates will hurt the economy, and therefore that's bullish for long rates. I'm just taking a stab at this, and it's the only explanation I can come up with.
For a CPA, Certifiable Pain
Now to share a couple more emails on Sarbanes-Oxley, from a handful of readers who seem intimately familiar with the problems it has created. (I have read little about this elsewhere, so their birds-eye view is especially welcome.) The first email, from a fellow involved with the financial side of the mutual fund industry, chronicles how Sarbanes-Oxley has caused grief for him and his firm:
"I work as a CPA in a top-10 mutual fund company in our tax compliance group, working alongside fund accounting and financial reporting. You can't believe the amount of additional work this is turning into after our initial estimates came in so low. Our chairman, after settling our SEC case, is certainly thanking his lucky stars we're salaried, as he can just continue to dump additional work on us without the amount of time we spend on compliance eating into his bottom line through overtime. I've easily added 15 hours a month to SOX compliance, and I'm working in a tax function.
Our Fin Reporting group doubled in size in one year. There are the certification meetings, the signing off on everything that is going near the financials, and now we have to review and project tax items for the quarterly reports as well, I am seriously afraid of how much work I see coming down the pipe as this SOX thing matures fully.
We were researching enterprise-wide paperless workflow solutions. That stopped dead in its tracks. I mean, we didn't even have a follow-up meeting to talk about it, just an email, and cumulatively, 150 hours of research between IT and accounting were flushed down the drain. We are now making due with a previously existing product that does a quarter of what we need it to do in three times the time of the forsaken project software.
Top it off with budget cuts and headcount reduction through attrition, dude, it sucks to work for public companies, much less mutual funds where we have 200+ sets of financial statements to prepare. The time and energy devoted by our IT staff, coupled with the raw costs of compliance in man-hours, leaves little time and no resources to begin a major software push of any kind. But you know, its just a blip, I mean soft patch, vbg."
Robbing IT to Pay Paul Sarbanes
In the second email, a CPA weighs in on Sarbanes-Oxley, and what it might mean for Q4: "I, too, am working on SOX issues, as a consultant (CPA). I'm a former operating executive, so I spend my time trying to manage compliance with an eye on rationality. At most turns, I'm met with other consultants' work, which is, as you might, expect heavy on documentation (e.g., a proposed four-page questionnaire to answer for every spreadsheet in use).
I keep hearing that the budgets are being seriously upward-adjusted from already staggering levels, and your previous writer is exactly right: No one knows exactly what needs to be done. He is right on the money about the IT focus in the 4th quarter; we are just now agreeing on a direction to take. Every remediation idea carries a risk of unintended (control, complexity) complications. There will be no new systems put in place in 4Q, in my opinion.
I think there will be earnings impact as well (costs/rates go higher as deadlines loom?) -- at least enough for companies to blame their other problems on SOX. And I think we're in for some true blowups, simply because the process will discover some material reporting problems. Has to happen. It's an interesting thing: The IT revolution is really so young that for many companies, this will be the first time the impact of MS Excel, et. al., will have been seriously and systematically addressed. By the way, the spreadsheet counts would blow you away!"
Obviously, many software companies will be vulnerable, as will many hardware companies. I would think that IBM (IBM:NYSE) could potentially be unusually impacted, given the problems in all their other businesses. Now we all know that IBM never preannounces because they always seem to find some way to make the number. But I can't imagine that their results are going to look very good for the next couple quarters, at a minimum.
Bile Hits the In-Box
Lastly, for those keeping score at home, I got some hate mail last night -- pretty much a rarity now, since most readers are like-minded (vs. the past, when I was writing the Rap in a public forum). Another reason why I don't get much hate mail these days is that I tend to deal rather harshly with it. Nevertheless, it is what it is.
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