Steady on chaps
A few hours ago Intel announced that it brought in over $10 billion in revenue in the fourth quarter alone. This resulted in a doubling of its operating income compared with Q4 2006, a 51 per cent increase in its net income to $2.3 billion and a 46 per cent increase in its earnings per share (EPS) to 38 cents.
By most people’s standards these are pretty impressive figures and, given the poor performance of many other blue-chip companies, not to mention Intel’s main competitor, you would think that Intel’s share price would climb on the news. You certainly wouldn’t expect an initial plunge of 14 per cent, but that’s exactly what happened. It turns out that analysts were expecting an EPS of 40 cents, but surely a 14 per cent drop is an overreaction to a shortfall of five per cent. Well, not if you look at the broader context.
As I covered in my first opinion piece of the year, the spectacular misjudgement of most US banks in exposing themselves so much to the sub-prime mortgage market has led to a global credit crunch. But that’s not all it’s done – it’s also contributed to a justifiable sense of anxiety and uncertainty about the US economy. With the US government roughly $5 trillion in debt and the trade deficit topping $60 billion, the sub-prime losses have led many commentators to predict recession this year.
On top of that, today the US government announced a rise of 0.3 per cent in the Consumer Price Index – its primary measure of inflation. This follows a big jump of 0.8 per cent in November and could strengthen fears of a return to stagflation.
Stagflation is a hybrid word comprised of stagnation and inflation. It describes an economy in which both unemployment and inflation are high. High unemployment is a symptom of a struggling economy and the principal tool central banks have to boost the economy is the lowering of interest rates, which in turn lowers mortgage payments and makes it cheaper to borrow. The problem is that this also has the effect of raising inflation – a highly undesirable event if inflation is already above target – so in a period of stagflation the primary tool for stimulating the economy is unusable.
Furthermore, one of the reasons the sub-prime crisis happened in the first place was the drastic cutting of interest rates in the US, intended to stimulate the economy following the busting of the dotcom bubble – itself the product of over exuberance and poor judgement on the part of investors. To break out of this cycle of boom and bust, sometimes the only way is for everyone to be worse off for a bit while the markets and economies correct themselves.
Of course you can’t expect people like analysts and fund managers, whose job depends on them picking over performing stocks regardless of the prevailing economic climate, to stop looking for diamonds in the rough. The feeling appears to have been that the technology sector might be resistant to the market gloom and Intel, being one of the biggest, is considered a barometer of the whole sector. So when it fails to hit predicted numbers, however narrowly, already spooked investors tend to panic as their hopes of a safe haven evaporate.
There appears to be some precedent to this. Intel stock has only beaten estimates around half the time since 2001 and on the times that it has missed estimates its price has dropped an average of nearly nine per cent on the following day’s trading.
So we can probably expect to see a lot more volatility in the stock market as investors lurch from one ray of hope to another. A quick look at IBM’s share price following its better than expected results illustrates that, while Samsung’s shares also rose despite a drop in profits for the same reason.
In summary it’s probably going to be a bit of a crazy year in the world’s stock markets and short term swings should be taken with a pinch of salt. However, if a technology company can generate $10 billion in revenue in the same period that a financial giant like Citigroup is losing the same amount, to me that says technology is still one of the best sectors to be in.
