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Technical Insight

Portfolio (Portfolio)

Compound semiconductor stocks are hammered as the US markets experience their worst week since the Great Depression. But the wireless and defense industries may offer some comfort.
Taking stock of terrorism First the good news. History indicates that the US Stock Market is adept at absorbing shocks to the system. "Disasters leave but a small footprint on the markets" says Mark Hulbert, writing in the New York Times. In fact recent scholarly research shows that share prices often climb in the six months after a crisis begins. And now the bad news. The decline in the market in the week following the 11 September terrorist attack on New York and Washington is almost without precedent. The Dow Jones industrial average fell 14.3%, its worst weekly decline since the Great Depression, and the NASDAQ composite fell 16.1%. When the week was over, three years of gains had been wiped out, with most widely traded stocks having sunk back to levels not seen since 1998, as investors large and small fled the equities market and sought shelter in cash, gold, bonds and other more conservative investments (see ). To analyse how the compound semiconductor-related companies fared in this hostile environment, I ve drawn up a simple "compound semiconductor index". It consists of all of the companies I discuss here in "Portfolio" that are traded in the US (i.e. all those in the table on page 88 except for the European companies). The companies are weighted according to their market capitalization, so that changes in share price for the largest companies in the group (Agilent, JDS Uniphase, Agere, RFMD) have more impact on the index value than do movements among the smaller companies. Six other indexes were picked for comparison: the Dow Jones industrial average, the NASDAQ composite, and four sector indexes: the AMEX Networking Index, which includes 15 of the largest network equipment stocks such as Nortel, Alcatel, Lucent, 3Com, Cisco and Ciena; the Philadelphia Wireless Index, which includes equipment makers like Nokia, Ericsson and Motorola as well as service providers; the Philadelphia Semiconductor Sector Index, which comprises 16 of the most widely held semiconductor-related stocks; and the SEMIndex, which is made up of 65 global, public companies serving the semiconductor equipment and materials markets. The wireless sector The 17% decline in the compound semiconductor stocks was in line with the drop in the Dow Jones industrial average and the NASDAQ composite, as shown in the chart above. But because of the relative strength of the wireless sector, the compound semiconductor index fared somewhat better than the two broader semiconductor indexes, which are largely driven by the computer industry. Less than two weeks after the attack it is fairly evident that more cell phones are being sold in the US, although this may be a temporary blip. The "wired" networking stocks also fared somewhat better than the market as a whole, but unfortunately almost the only explanation that can be offered is that this sector was already so beaten down that it had less far to fall. The percentage of the US population who own mobile phones is one of the lowest among developed nations less than 40% (see ). Finland passed the 40% mark in 1997. The US has traditionally seen the cell phone as a business tool for some and a consumer gadget for many, but several commentators now believe that more Americans will see them as a "must have" for reasons of personal safety and private communications. The Reuters News Service is reporting that US retailers sold a month s worth of phones inthe week after 11 September. Even before the tragedy the outlook was improving in the wireless sector, with several firms on track to report solid third-quarter results. On 10 September Nokia announced that it would meet its earnings targets for the quarter, despite the fact that revenue would fall about 5% compared with the year-ago period. Analysts were cheered because this indicated that Nokia was not giving into temptation to slash handset prices in response to the global slowdown in sales. Nokia shares were rising fast in before-the-bell-trading on Wall Street before everything came to a halt on 11 September. Unfortunately, it appears that Nokia is the only major mobile-phone maker that can produce phones profitably. Its 35% market share is nearly double that of Motorola, the number-two manufacturer. In the week before Nokia s announcement both Motorola and Ericsson, the third-largest player in the handset market, gave more pessimistic assessments of their prospects for the third quarter. On the same day as the Nokia announcement RF Micro Devices went even further than its biggest customer and announced that its third-quarter results would significantly exceed previous forecasts. The company increased its estimated sequential revenue growth from 10% to 30%, and said that it would break even instead of making a loss of around $5 million. It attributed the turn-around to "increased order activity and revenue growth from multiple customers and across all major air-interface standards." Along the same lines, TriQuint reported that it would hit its third-quarter objective of 30% sequential growth,climbing to $80 million in revenue. Anadigics forecast a wider loss in the current quarter, but on revenue greater than expected: although sales are picking up, customers are buying items with lower profit margins (see ). Back to defense? Some defense contractors also did well in the aftermath of the attacks. This shows eight of the top 10 companies that received the largest dollar volume of prime defense contracts from the US Defense Department in 2000, according to Morningstar. (The two missing companies are Litton, which was acquired by Northrup Grumman, and Science Applications, which is privately held.) The table hints at how difficult it is to find a single index that provides a helpful measure of the sector s performance, because of the close ties between the defense and aerospace industries. For companies like Boeing, United Technologies and General Electric that have a foot in both camps, the sharp decline in the US airline industry may offset any benefits from increased defense spending. And TRW seems to be being dragged down by concerns about the auto parts industry (see ). Among the GaAs IC companies, TriQuint derives around 10% of its revenue from the defense industry, which is perhaps why it declined just 2%, in contrast with the other GaAs IC companies that were down 15% on average. Alpha s shares also held up fairly well. In fiscal year 2000 6.5% of its sales were defense-related. However, one of the many uncertainties about a "war on terrorism" is whether it will result in the sustained increase in military spending that so benefited the GaAs industry in its formative years. This new war may be based on more small-unit, Green Beret or even James Bond-style actions than huge outlays on jets and missiles. Bad for the industry, perhaps, but probably better for mankind. Mixed Outlook from Kopin and AXT See .
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