Merrill Lynch recently said tech stocks should outperform, based on the following assumptions:
1. A pickup in tech industrial production
2. Firming order books
3. Improving capacity utilization
4. Global exposure
5. 70% of earnings reports beating estimates
While we don’t dispute any of the points Merrill makes, we would note that the capacity utilization is likely to drop when all of the semiconductor equipment on order starts getting installed.
However, the bearish argument goes beyond nit-picking the data Merrill chose to ignore. For example, Friday’s GDP report shows a continued slide in spending on equipment and software.
Likewise, while Thursday’s durable goods report showed a modest uptick in orders for computers and electronic products, shipments were down from a year ago.
And the decline is being led by semiconductors, as we have been predicting (and which further supports our assertion that the new equipment will hurt capacity utilization). What’s more, semiconductors are the only reported segment that does not report orders, backlog or inventory. So the overall order pickup may be misleading if semiconductor orders are tailing off.
Bulls will counter that the US GDP and durables reports do not reflect the global economy (see Merrill’s fourth point). But the counter-argument to that is that they reflect a very large portion of the global economy, and the portion that typically leads the way when it comes to the economy.
SMH 1-yr chart: