Can Software Spending Hold Up?

Could software be about to follow hardware in the IT spending slowdown?

Two weeks ago, we wrote about the bearish Broadening patterns appearing in the charts of Microsoft and PeopleSoft .

Just as those patterns appeared in Juniper and Nokia last fall before the telecom sector led the market in its second leg down, could the software sector lead tech stocks in a third leg down?

Morgan Stanley economist Stephen Roach postulated last week that software could follow hardware in the IT spending slowdown. After three years of capturing a historically high share of IT spending, Roach said that software is now likely to follow hardware in the slowdown. And because the software sector has fueled so much of the IT spending growth since 1998, a downturn in the sector could have a substantial impact on the broader economy, he said.

Given that Roach has been one of the few economists to call the current downturn accurately, he’s worth listening to. And his views provide one explanation for those troubling chart patterns in Microsoft and PeopleSoft.

Economist Lawrence Kudlow displayed two charts on CNBC on Friday: One showing M2 money supply growing at double-digit rates, and the second showing M2 velocity, or the rate at which money changes hands, accelerating its decline.

Kudlow said the charts show that the Fed needs to inject more liquidity into the system. But with the Fed already pumping at record rates, an alternative explanation could be that the demand for credit is beginning to dry up. With corporate and consumer debt already running at record levels, that’s not a far-fetched scenario. At the least, it shows that economic activity continues to decline. And rather than lending to businesses, one observer claims that banks are using that liquidity from the Fed to catch spreads on safe debt instruments.

Friday’s unemployment report for July, along with last week’s NAPM survey of the service sector, show that the service sector continues to remain flat or declining, a troubling sign, because unlike the manufacturing sector, the service sector provided steady growth throughout the 1980s and 1990s. In fact, the second quarter was the first quarter in four decades in which the service sector failed to grow.

Keep an eye on tomorrow morning’s second-quarter productivity report. Analysts are expecting a 1.7% gain after being surprised by a 1.2% decline in the first quarter. The report could be as important as Cisco’s earnings report tomorrow night.

Commercial traders barely changed their short positions in the Nasdaq and S&P futures last week, an important number we mentioned on Friday. The worrisome development is that non-commercial traders increased their long positions and decreased their short positions in the big Nasdaq and S&P futures. Small investors got more bullish and big investors remained bearish; not the greatest sign for the market.

The strange thing was the wild swing in gold futures. Given that gold has been in a bear market for as long as stocks have been in a bull market, the gold futures are worth keeping an eye on to see if that trend continues.

And finally, Intel is dropping this morning on comments from analyst Dan Niles that the company will slash high-end chip prices by 50% on August 26, saying that the price war with AMD is just getting started.

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