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Jon Markman's Speculations
Jan. 18, 2011, 12:45 p.m. EST
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By Jon Markman, MarketWatch
SEATTLE (MarketWatch) "” Plus-sized chip makers, banks, brokers and agri-businesses have started the year with a bang, rising 4% to 11% as a group while heroes of last year, like gold, silver and retail, have tarnished.
The connection among leaders: Large-cap semis, financials and ag all suffered from underdog status for much of the past year, but execs at these companies are bound and determined to show skeptics and smaller rivals that they are back in business in a big way and ready to blast past their old highs.
And I mean their fundamental business highs of earnings and revenue growth, and not just their stock values. Recent data from the trade deficit, inventory reports, earnings reports, purchasing managers indexes and the Weekly Leading Index of the Economic Cycle Research Institute suggest that the broad U.S. economy may have perked back up to 4% annualized growth in the fourth quarter of 2010, and is on track to sustain that level here in the first quarter of 2011.
Latest evidence is in the full report by chip goliath Intel /quotes/comstock/15*!intc/quotes/nls/intc (INTC 21.09, +0.01, +0.05%) on Friday, as detailed in the conference call transcript. Chief exec Paul Otellini reported the company recorded its third consecutive record quarter and the best year in history. Revenue was up 24% for the year, and revenue topped $40 billion for the first time. The company exceeded previous records for gross margin, operating income, and earnings per share as well. as the personal computer market "” long rumored to be dead and buried "” grew 17% worldwide in 2010.
Investors, myself included, have told Intel to sit in the corner with a dunce cap despite these amazing results because until recently it missed the boat on creating low-power chips for mobile devices and ceded the incredibly important handheld market to ARM Holdings /quotes/comstock/15*!armh/quotes/nls/armh (ARMH 25.95, -0.02, -0.08%) and Qualcomm /quotes/comstock/15*!qcom/quotes/nls/qcom (QCOM 52.90, +0.86, +1.65%) . Yet we need to focus on Intel's accomplishments and what they mean.
Close your eyes and extrapolate for a moment, and you'll see the report suggests the United States is headed toward a normal level of growth for this stage of an economic cycle, not the subpar 2.5% to 3% growth that most economists expected. It has been bought by quantitative easing, loosened tax policy and juiced-up fiscal spending, to be sure, but at least we appear to be getting what we paid for. Although employment has not improved at the same pace, data suggests we can expect it to ramp up slowly and unevenly over the rest of the year.
It's a drag if you're out of work, but don't forget that lower levels of employment are conducive to improved earnings as companies use technology and outsourcing to replace expensive workers. Lower employment is not just good for earnings but also for bonds as it keeps wage demands down, which in turn keeps inflation down. Since inflation is the arch enemy of bonds, weak employment underpins a stronger Treasury bond market. Bonus: This also helps America finance at lower rates.
In keeping with the slow, steady and under-appreciated improvement in the economy and earnings, the major U.S. stock indexes are not going crazy with upside. They are determined but not flashy. This will help make the move sustainable, and allow more under-invested private citizens and fund managers to feel comfortable about coming in from the cold during the inevitable 3% to 7% corrections that emerge over the next 12 months.
To understand why they should focus on tech stocks, let me share with you some of the highlights of Intel's conference call that point directly at the big opportunity ahead in mobile Internet "” one of my big themes for 2011, as it was for 2010.
See Stocks to capitalize on the smartphone boom.
See The best technology stock on the board.
Leveraging notes on the call from industry veteran Paul McWilliams at Next Inning Research, with permission, here are some of the key points:
"” Intel said the world's 2 billion Internet users would be joined by another 1 billion over the next five years. That's a huge number all by itself, but it's probably at least 50% low. Figure the number could be 4 billon in five years.
"” Intel said the world will add 15 billion new network connections over the next five years, including smart TVs, embedded devices, PCs and tablets. Again, this is a huge number that is an understatement. As wireless broadband speeds improve, people in every country will want their equivalent of Netflix, Hulu, MLB Network and Youtube when and where they want. That means on the road, on their handhelds, everywhere and always. Expect video and data ubiquity.
"” In 2010, the company said roughly 245 exabytes crossed the Internet, a number greater than all previous years combined. (An exabyte equals 1 billion gigabytes.) In 15 years, Intel figures that more than four times that number will cross the Internet. Yet again, as high-definition and 3D video use grows, figure that estimate proves to be low.
"” In the mid-1990s, the price of a PC was equal to 175 weeks of income for the average Chinese worker. Today that metric is down to seven weeks. As affluence spreads and prices plunge, the rise of demand for computers and Internet access among 1.4 billion Chinese and 1 billion Indians alone is ramping fast. Add industrializing Southeast Asia and South America, as well as in mineral-rich exporting nations of Africa, and stir. Intel said it believes emerging market growth will be twice as high as in mature markets and that consumer growth will be twice enterprise growth.
"” The world will need much more bandwidth, server capability, switching, load-balancing, routing, and of course, processing power in the cloud and at the data centers. This is why I will continue to be recommending so many networking and chip stocks during the next year, including old favorites like F5 Networks /quotes/comstock/15*!ffiv/quotes/nls/ffiv (FFIV 141.13, -3.04, -2.11%) , ARM Holdings /quotes/comstock/15*!armh/quotes/nls/armh (ARMH 25.95, -0.02, -0.08%) , Amazon.com /quotes/comstock/15*!amzn/quotes/nls/amzn (AMZN 190.30, +1.55, +0.82%) , NetApp /quotes/comstock/15*!ntap/quotes/nls/ntap (NTAP 58.96, -0.52, -0.87%) and Cavium Networks /quotes/comstock/15*!cavm/quotes/nls/cavm (CAVM 45.46, -0.54, -1.17%) , as well as "cloud" integrators like Cognizant Tech /quotes/comstock/15*!ctsh/quotes/nls/ctsh (CTSH 75.76, +0.75, +1.00%) .
While these high-growth companies have not been overlooked, their valuations today "” at 25x to 35x forward earnings "” are nothing like the levels witnessed back in the late 1990s when all of this was just a hope and a dream. The forward P/E multiples of industry leaders Apple and Google are 15x and 18x, which is downright tame.
Disappointing earnings from Citigroup and Delta could back up the bear's case for the stock market, while all eyes are back on Apple as Steve Jobs takes medical leave again. Michael Casey, Anna Raff and Jonathan Cheng report.
For a group to consider that has not enjoyed as much upside yet, analyst Eric Suppiger of Signal Hill Group recommends the co-location companies that house the cloud. Top picks are Rackspace /quotes/comstock/13*!rax/quotes/nls/rax (RAX 34.25, -0.38, -1.10%) , Savvis /quotes/comstock/15*!svvs/quotes/nls/svvs (SVVS 28.44, -0.12, -0.42%) and, most beaten-down, Equinix /quotes/comstock/15*!eqix/quotes/nls/eqix (EQIX 88.37, +0.66, +0.75%) . With speed of the essence in customer satisfaction, companies need their servers close together more than ever at carrier-neutral sites. Latency measured in nanoseconds, once the province of high-frequency traders, is now expected for downloads of Angry Birds from iTunes or a Pomplamoose video from Youtube.
Bottom line: Big companies are storming back and have a decent shot at surprising with upside this year even if employment remains muted. And growth investors not averse to volatility should continue to focus on positions in mobile Internet and cloud stocks: The biggest play of our generation.
Jon Markman is a MarketWatch columnist. He runs a money-management and investment-advisory firm in Seattle.
Jon Markman is a money manager and investment adviser in Seattle. For more ideas like these, try a two-week trial to Markman's daily investment newsletter, Strategic Advantage, published in partnership with MarketWatch, or his daily trading newsletter, Trader's Advantage. His Twitter feed is @jdmarkman.
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