With semiconductor stocks down over 40% in the past couple of weeks, investors have begun to worry that the group has hit its cyclical peak. Rather than questions like "what is the upside to the quarter?" I'm hearing, "When does the cycle end?" Although there are some clouds on the horizon, we do not believe the group has peaked cyclically, and we've checked both the long-term and short- to medium-term indicators to come to that conclusion.
The long-term picture is somewhat cautionary. Cyclical tops are almost always defined by excess capacity. Front-end shipments of capital equipment are currently growing at about 75% year-over-year, compared with 34% for semiconductors. More capacity is being added than can be absorbed, and for that reason, supply should more than equal demand in some products next year.
But the short- to medium-term indicators are positive. These include pricing, lead times, and inventories. We're big believers that spot prices are an excellent marginal indicator of tension in demand and supply. Prices across the board remain firm. Our most recent indicators show that prices in even some of the most inflated segments-like passives and nonvolatile memories-continue to trend upward slightly. Another positive indicator is that order lead times are generally stretching.
Finally, inventories tend to be a good medium-term indicator of demand potential. Inventories appear to be low at most PC and cellular-handset makers. These points give us confidence that 2000 should remain a good year for semiconductors.
So what's impacting stocks? Semiconductor stocks, like many technology issues, have been inflated, trading at valuations two to three times higher than they were only a couple of years ago. Higher interest rates not only compete with high-multiple stocks for new cash, they also raise the cost of capital spending. Given higher levels of risk to growth, investors demand a lower risk or reward ratio.
Higher interest rates and weaker stock prices, however, are a major concern. Years ago, I asked a purchasing manager what his early warning signal was. He said it was the stocks. First the stocks went down, then his business went bad. This time, we hope it will be different.