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By Michael Wallace After some very trying times for technology companies, evidence is mounting that a recovery is under way in the sector, one that will match the rebound in the overall U.S. economy -- and help speed its progress. Tech, the economy's growth engine, sputtered and stalled in 2001 and has since reached bottom. Now, the sector appears to be clawing its way back to healthier and more sustainable growth rates in 2002.
Tech investors may be relieved, but what are the implications for the remainder of the financial markets? Tech's rebound will shift the balance of investor portfolio risk from stocks to bonds, and it could well play an important role in Federal Reserve policy through late 2002 -- especially if the productivity gains spawned by the tech boom continue unabated.
One key ingredient in the current economic mix is the persistent strength of U.S. productivity growth, thanks to substantial earlier business investment in technology upgrades. The big question: Is the new, steeper trajectory of productivity growth cyclical (temporary) or structural (permanent)? The answer has been provided by productivity's durable gains during the brief recession. This development, along with the rebound in several other tech leading indicators, suggests that the beleaguered sector is beginning to regain a bit of its former luster.
THE REAL THING. Some of those cheering the loudest for a tech comeback are pleasantly surprised Fed officials. Michael Moskow, president of the Chicago Federal Reserve, hailed recent productivity gains, which he said were "too large to be a statistical aberration." He said they would raise living standards, bolster corporate profit margins, and consequently increase capital spending.
Although Fed Chairman Alan Greenspan has publicly expressed some reservations about productivity continuing to race ahead at the average rate of 7% seen over the past six months (with gains of 5.5% in the fourth quarter and 8.6% in the first quarter), he conceded that the productivity trend shift in the second half of the 1990s was likely "underestimated." He also agreed that it raised the bar on potential gross domestic product growth, even after being adjusted for cyclical effects.
This recognition of the continuing strength in productivity -- which can spur growth without igniting inflation -- underlines the central bank's patient approach to possible interest rate hikes as the economy gains steam (see BW Online, 5/8/02, "Vindicating Greenspan's Patience").
BACK FROM THE DEPTHS. The latest evidence of the tech rebound is impressive. The San Francisco Fed has issued a special update for its "High-Tech Watch" indicators through March. Several key metrics for U.S. tech companies have returned to positive territory from deep deficits in 2001.
Business investment in technology products has surged after the 25% rate of contraction witnessed around mid-2001. Monthly semiconductor sales returned to positive growth from roughly a 60% pace of contraction through early 2001. Shipments of computers and related products, which reached a 50% to 60% rate of decline around mid-2001, have since sprung into positive territory. Shipments of communications equipment recovered from declines of 40% to 50% through much of 2001 (though they remain in the red). The only lagging indicator was high-tech job growth.
More signs of a tech turnaround came courtesy of the latest global sales report from the Semiconductor Industry Assn. On aggregate, member companies averaged a 7.2% month-on-month sales gain in March, and a three-month moving-average gain of 5.6% -- a better indicator of an uptrend than a one-month spurt. From depressed year-over-year losses of 25.4%, the March increase was the highest sequential gain since April, 1986.
SOX MOVES. The linchpin in the sales recovery was an 82% increase in DRAM (dynamic random access memory, a type of memory used in most PCs) chip purchases, sparked by both higher demand and price increases. One caveat: DRAM prices hit their stride late in the first quarter, peaking at just over $13 apiece in March to coincide with this bullish report. As of May 17, they were at around $8.20.
Another tech sector benchmark, the Philadelphia semiconductor index, or SOX, has mirrored the recent bullish price action on the tech-laden Nasdaq composite index. After finding support at post-September 11 lows of 344, SOX hit its first-quarter peak in March at 641, drifted off as the second quarter began, and then spurted once more in mid-May. It dropped to near 450, but is now trading back above 530.
Meanwhile, the Nasdaq's upward movement since falling below 1,600 on May 13 also suggests the balance of risks has shifted against short-sellers, who make bets that stocks will fall in price. Another tech beacon, chip toolmaker Applied Materials, announced a 51% gain in new orders, thanks to consumer-electronics demand and a significant increase in capital spending by chip manufacturers to meet this demand.
FINDING THE GRAIL. Even as the stock market struggles to reconcile the improving fundamental outlook with an unwanted legacy of its past high valuation levels and widespread accusations of accounting irregularities, it looks increasingly likely that Greenspan's Holy Grail -- a rebound in business spending -- is already well under way. In simple terms, this situation favors stocks over bonds, as an orderly and sustainable rebound in business spending on technology will inoculate the economy against a relapse into recession.
As long as the Fed waits for more traditional data to catch up to this prognosis, robust productivity gains should continue. That gives the economy room to run before the Fed is at last forced to tighten rates to rein in inflation. Wallace is a senior market strategist for Standard & Poor's/MMS International