August 12, 2003

The Tip of the Whip That Is the Business Cycle

Spending on services is acyclical--it does not change over the business cycle. Spending on goods does change: it falls in recessions, and rises rapidly during expansion. Spending on durable goods is even more cyclical: you can postpone purchases of durables when cash is tight during a downturn, and accelerate durables purchases when cash is plentiful. Spending on capital goods to make durable goods is even more of a business-cycle roller coaster: businesses will buy the capital goods needed to make durables only when they find that high demand for the durable goods they make has brought them to the limit of their capacity.

And the most cyclically-sensitive sectors of all--the tip of the whip that is the business cycle--make the equipment needed to make the capital goods that firms purchase in order to produce durable goods. One firm in particular--Applied Materials--is the preeminent manufacturer of the equipment needed to make high-tech capital goods. And so today investing in Applied Materials is, as the Financial Times writes, a clean and highly leveraged bet on the strength of America's current anemic business-cycle recovery--a bet only for those with "iron nerves": Home US: For a leveraged bet on the tech rebound, they don't come much cleaner than this. Applied Materials, the biggest producer of equipment for semiconductor makers, has yet to show any bounce in sales or orders - but that hasn't prevented a 50 per cent jump in its stock since February, when it warned of a weakening order-book and more cuts. The faithful, who argued that the time to buy was in anticipation of the rebound, expect at least some vindication on Tuesday when the company reports earnings. Certainly, the latest figures should show the benefits of Applied's endless round of cost cutting. More important, most analysts expect the stirrings of expansion from Asian chipmakers to prompt Applied to forecast a 10 per cent increase in orders this quarter - though new CEO Mike Splinter is likely to maintain the cautious tone he has adopted so far. Investors in the chip equipment business, though, don't sweat the small stuff. Having slashed its cost base during the industry's nuclear winter, Applied has the potential for tremendous operating leverage. Capacity utilisation in the Asian chip foundries has rebounded from a woeful 40 per cent at the worst to nearer 80 per cent. Yet, fearful of seeing a repeat of last summer's false dawn, the chipmakers are delaying investment in new facilities. That could make any rebound even sharper. Of course, weak demand from end-customers, the source of last year's disappointment, would kill the rally in its tracks. Trading on more than 35 times 2004 forecast earnings, this is already a stock only for those with iron nerves.

Posted by DeLong at August 12, 2003 08:24 AM | TrackBack


Very interesting.

Do you believe this is a sign that this sector is about to rebound, or merely unwarranted risk taking on the part of speculators?

Posted by: James Joyner on August 12, 2003 09:26 AM

"The tip of the whip that is the business cycle." I'll have to remember that one. I supply components to companies like this so they can build their machines. No wonder I've been feeling battered and bruised lately...

Posted by: Curt Wilson on August 12, 2003 10:24 AM

Once again - the $11 trillion dollar question is: Where will we find more aggregate demand? Those who have been predicted recovery, often unintially using Herbet Hoover's infamous line, that "recovery is just around the corner," keep point to tangental issues. They also scoff at indicators such as employment because they are lagging indicators. Fair enough, but I think most workers seem to know that the job pool is shrinking, and unlikely to get better in the near term. At rock bottom, someone has to buy these wonderful things that our economy can produce, and with no rising aggregate demand either here or abroad, this means deflation. How else will companies compete? Good news for cheaper plasma screen TVs, and very good news for those with enormous wealth, but bad news for just about everyone else.

Are we returning to the depression era economics?

Posted by: SZ on August 12, 2003 11:52 AM

AMAT posts a loss....
$37 mil or 2 cents/share compared to year earlier $115 mil profit

Excluding charges for job cuts, would have been a $78 mil profit.

Net sales decline to 1.09 bil from 1.46 bil a year ago

Heres the biggie: News orders down 46% yoy,

but above target and above 2nd quarter sales of $970 mil...

Expecting revenues for current quarter to be flat to slightly up....

Posted by: section321 on August 12, 2003 03:38 PM

Why is everybody so insistant on fighting the last war(i.e. semeconductor chips)? The old leaders are never the new leaders in the stock market. Never have been never will.

Posted by: William Utley on August 12, 2003 06:01 PM

Services spending is acyclical?!?

Here are the last 16 quarters of Personal Consumption Expenditures, Services, from the NIPA, table 1 (SAAR). Recession quarters in brackets.

4.5% (3Q99), 2.8, 4.4, 3.6, 3.9, 3.3, [0.6], [1.5], [0.9], 2.1, 2.9, 2.7, 2.3, 2.2, 0.9, 1.5% (2Q03).

Sure looks cyclical to me. I agree that durable goods are more cyclical and capital deepening durable goods even more so, but be careful!

Posted by: ts on August 13, 2003 08:40 AM
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