The tech bear market should have been over by now. Tech stocks, two years into a downtrend, should have bottomed and started to go up. You should have been making money by this time in semiconductors, software, and telecommunications technologies. Instead, the picture just seems to get more grim, despite eleven Federal Reserve eases, record growth in consumer confidence, and an astounding recovery in steel, chemical, paper, and automobiles. Just last week, IBM, the one tech stock that had held up fairly well during the whole onslaught, crumbled on weaker-than-expected earnings, despite having an incredibly cyclical book of business that should have been responding to the strong first-quarter growth in the domestic product.
What the heck’s going on? How can this sector, so vital to the growth of the economy for the last decade, sit out what looks to be a very strong recovery? Will we ever be able to make any money in tech stocks again? Oddly, the answer to that question comes from looking at why the stocks in those dirty smokestack industries are where all the action is, and that answer, frankly, is not very positive for those millions of holders who think the tech turn is just around the corner.
The reason why the so-called cyclical-industry stocks are hot is that there are so darned few of them left to trade. America’s manufacturing sector has been shrinking for decades, as industry after industry rationalized and consolidated. In the three decades since I began trading stocks, probably two thirds of the industrial players have disappeared, swallowed up by ever larger players or liquidated with capacity permanently crushed. The remaining players have automated and cut their costs – in some cases, like Caterpillar’s, brutally so – and they can produce far more with far less. Now that the economy is just getting back on track, these companies are able to make fortunes at moments when they used to make almost nothing or were losing money. It’s as if a natural corporate Darwinism has taken hold, with only the fittest of the smokestackers left standing.
Not so in tech, though. In fact, tech could use a dose of Darwin right now. We have the strongest tech companies being pulled down by the meek and almost no consolidation of ne’er-do-wells in the works, despite massive overcapacity in virtually every aspect of technology from desktop to mainframe and all the soft- and hardware in between. In fact, given the colossal tragedy that was the Hewlett-Packard-Compaq merger, you can bet that any hope of a rapid consolidation has simply disappeared. Who could risk another fight like that, after what Carly Fiorina’s been put through? The amount of lost business to the Dells and the Lexmarks stemming from the fallout of the battle is staggering. So we are left with the likes of Nortel and Lucent to pull down Cisco, and XO Communications, Qwest, and Global Crossing to wreck the margins of Verizon and SBC Communications for what looks to be much of the foreseeable future. The hangers-on at Motorola and Ericsson annihilate the profitability of industry leader Nokia. And Gateway keeps Dell from gaining in profitability despite the Hewlett-Compaq morass.
Making things worse, of course, is that the clients of technology, chiefly other technology companies, phone companies, and finance companies, are similarly beleaguered with massive overcapacity. The banks and brokers, unless they merge, simply can’t even afford to spend money to upgrade their systems. Yet when a Datek merges with Ameritrade, less, not more, tech spending will occur. The phone companies have so much extra capacity in the ground that it would be cheaper to buy bankrupt properties than to build new ones, except there’s no money to buy the bankrupt ones and the telephone companies can barely hold on to their clients without giving away the store. Technology companies, at one time their own best customers, have frozen their own IT budgets because business is just so bad out there.
Of course, the same vicious cycle downward from customer to vendor existed in the industrial companies at one time, and eventually they came back. That’s instructive, but not necessarily positive: It took a decade of beating everyone’s head in before the companies accepted their fates and gave up and shut down or agreed to merge. Sometimes it took two or three iterations of bankruptcy – LTV, anyone? – before the ultimate axe fell. Yet here we are, in only year two of Lucent’s downturn, and we’ve had only eighteen months of slide to Nortel. No government is going to let Ericsson go belly-up. It is inconceivable that a Qwest, the heir to U.S. West, is going to be allowed to disappear. All of these could struggle on for years before they feel the need to fold up shop or merge. The amount of money already invested in these – plus the amount of debt on the balance sheet – almost requires that they be kept alive for years just to avoid the embarrassment of the default for those who made the deals to keep them afloat. If you don’t think that’s how the game works, have you noticed that Donald Trump still owns casinos?
If I am right, and the shakeout takes years, that’s not a period investors are willing to wade through, so the selling pressure on the big-capitalization tech stocks will continue unabated. And that’s why I think that 2002 is simply year three of a tech bear market, one that won’t end until Darwin takes hold, which, as the lesson of the ever-resilient smokestack stocks shows, unfortunately, might not happen until several years go by. Sure, you might be able to wait that long in the stocks. But remember, if you waited in the cyclicals, after years and years of patience, all you ever did was get back to even and not much more. That’s not investing. That’s inertia. And no one ever got rich through inertia.
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James J. Cramer is co-founder of TheStreet. com. At the time of publication, he owned stock in Dell, Cisco, Caterpillar, and Verizon Communications. He often buys and sells securities that are the subject of his columns and articles, both before and after they are published, and the positions that he takes may change at any time. E-mail: jjcletters@thestreet.com