It’s The Economy, Stupid

Intel’s news last night wasn’t bad, all things considered.

The problem is that this downturn may not be about technology earnings anymore.

As we said two days ago, the market has been spending the last month pricing in a decline in consumer confidence and spending. And yesterday, the market took another beating when the NAPM services index came in way under estimates. At 45.5, the broad service economy, which has been the main engine of jobs growth for 20 years, may be entering its first contraction in four decades. The market took another blow this morning with a much weaker than expected August unemployment report. The story isn’t about the recession in technology and manufacturing anymore. The market’s biggest fear has been that that weakness might spread, and that fear may well be borne out.

What does this mean for Intel and other technology stocks? Put another way, if the consumer stops spending, what does that mean for the highly-vaunted Pentium IV-Windows XP rollout that many are hoping will boost technology spending?

It’s not about technology earnings anymore. It’s about pricing in the first global recession in 50 years, and what that could mean: a slower-than-expected recovery. Expecting the debt-laden U.S. consumer to hold up the world once again is asking a little much. A period of slow growth and contraction seems inevitable at this point. At the least, it seems likely that things will get worse before they get better.

But Intel’s update last night wasn’t bad. The company could show sequential revenue growth this quarter if September turns out as expected. However, there is some evidence that back-to-school PC sales have been weaker than expected. As expected, the price war with AMD is crimping margins, and it’s anyone’s guess when pricing power will return. The one negative is that Intel declined to give guidance on 2002 CapEx spending – that uncertainty could hurt chip equipment companies.

But the problem with Intel remains its valuation. At 51 times estimates, Intel trades at about twice its long-term growth rate. And a look at Intel’s chart (see below) suggests that the stock could get cheaper, with a clear breakdown out of a 5-month trading range. That breakdown appears to give Intel downside potential to $20, with the caveat that the stock recently had a false breakout to the upside. A close above $27.50 would cast doubt on the bearish scenario.

The good news is that this market is very oversold, and could bounce as soon as today or Monday. It would be nice to see a good retest of the April lows first, at 1619-1639 on the Nasdaq, 1080-1100 on the S&P, and 9400 on the Dow. If the market doesn’t put in a good test of those levels before bouncing, the odds are that any bounce will be a weak one until that retest comes.

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