Market Correction & PC Quality Could Help Apple April 19th, 1999 The Flatulent Tech Sector Last week Apple’s Q2 earnings report came in above First Call’s expectations but the stock price goes nowhere in a flatulent market. There seems to be the beginning of a massive portfolio reallocation going on by many of the biggest mutual funds. Gateway, Dell and the other usual PC suspects are all down. The shifting funds are exiting the various overvalued tech sectors to more mundane stocks that have a higher percentage of their net worth tied up in tangible capitalization like manufacturing plants or real estate. The skies-the-limit PE ratios are starting to make the wiser investors a bit queasy and they’re locking in some profit. The Wall Street Journal put it like this, "Amid recent reports of strong economic growth and weak inflation, more investors and analysts are concluding that they should be in the once out-of-favor "cyclical" stocks such as Caterpillar, Alcoa, United Technologies and DuPont, whose performance rises and falls with the economy." Everyone seems to be hunkering down for some sort of market correction that should be occurring after any nosebleed market run up. The NASDAQ’s 2.95% drop last Wednesday on record volume was kinda bearish to say the least. 1999 has been great so far for the Industrials up 13.4% and the NASDAQ up 14.35% for the year. There are no signs of any weakness in the economy. Unless you consider six months of steady decline in manufacturing and exports as a sign of something more than back wash from the global currency mess of last year. As usual, some people seem to be worried about inflation but I take this as a welcome relief to last year’s concerns about deflation. Historically, commodity prices are all near 12 year lows. A bear could make a case for generally anemic corporate profits, which last year for the S&P 500 was actually in the red due to the global currency crisis. This year analysts are predicting a more normal 8 to 14% after-tax operating earnings per share for the S&P. In fact, everything looks so peachy that many bulls see a Dow 11000 by the middle of the summer, pushed forwarded by continued strong consumer demand. Even y2k fears are subsiding as more and more companies claim to have the situation under control. The bears are going to have to think up some new arguments or it looks like 1999 is going to be the tenth year of the current economic expansion. What About Apple? A re-evaluation of the tech sector will eventually benefit Apple even though on first blush the ebbing tide of cash flow out of the tech sector lowers all ships, including the already undervalued companies like Apple and Oracle. When the money returns anew investors will be on a quest for bargains. Apple’s day in the sun will finally come. This is Apple’s sixth quarter of recovery and now with a healthy 13% of the US retail market the bite is finally getting big enough for the PC boxmaking giants to notice. Mostly they’re just shaking their heads in disbelief as they continue on in their Jurassic ways. No one seems to be learning any lessons from Apple’s dramatic new appliance paradigm. There is nothing they can do about Apple’s increasing market share. PC hardware is strapped forever to the clunky geek-friendly OS of Microsoft that perhaps has already seen its apogee, if not in profitability then certainly in market share and more importantly in mind share. Months ago I predicted that by this time there would be cheap Wintel iMac imitations bursting out on the market but there is no such thing even on the horizon. The only consumer-friendly strategy the PC boxmakers have mustered is to lower prices, quality and profit margins till they "Yugo" themselves into an earnings crisis. For instance, that Frankenstein of a corporation, Compaq, has titanic revenues of $40 billion this year. That’s 60% more than Compaq’s revenue for 1997, yet profits, estimate at a $1 per share, will come in at below 1997 levels! Thank you Compaq for screwing up investors’ perception of the whole PC market. When giants tumble we can’t expect nimble, little Apple to break it’s trading range just on a bit of happy earnings news. Free PCs? The shortsighted tactic of less for less by the PC boxmakers doesn’t seem to be having the intended results. In fact, there are those who predict that the commodification of the PC will continue till the most basic units come free with a contract for services from your ISP. E-commerce combined with increasingly negligible cost of CPUs, ram and hard drives will combine to create a situation where there is no profit in low-end computers. With nearly complete market saturation in the enterprise sector there is no room for companies like Compaq to grow except in the consumer market. As I pointed out above they have commodified much of that market into a money-losing proposition for themselves due to fierce competition. The iMac presents a (naturally) different picture of the future. In Apple’s vision, e-commerce, the information highway and AUI (Audio User Interface) creates a scenario where the personal computer becomes comparable to the American love affair with the automobile. Only far more intensely personal and thus profitable. Styles, features, and interface variety will abound as net-savvy consumers seek to express their unique identities in cyberspace. Some sort of low-end PC terminal might become the ubiquitous Internet port found in cheap motels, fast food joints, bus stations and the projects. But those that can afford it will want that gigahertz RISC CPU to run the latest 3-d multi-user applications, games and databases and to assume the most life-like avatar forms at their favorite virtual hangouts. As the Wall Street Journal pointed out, "Unit sales of Apple’s computers rose 27% compared with a year earlier, to 827,000 units, nearly twice the 14% growth estimated for the PC industry as a whole by International Data Corp." Profit margins and inventory management are the best in the industry. The future has already begun at Apple. As usual Apple’s vision far exceeds the PC boxmakers whose future gets murky beyond the bottom line of the next quarter. The multi-billion dollar question is will the new Apple be able to pull it off this time around. Your comments are welcomed.