Terrible Techs

My name is Tony Sagami, and I used to love technology.

Years ago, I spearheaded a publication that focused on the benefits of what I called the Supernet the new, high speed networks that are now so popular.

Heck, even back in grade school, I had the same fascination.

Remember that little kid who always sat in the front row in math class?

That was me.

I was devoted to math because I knew it would help me unlock the secrets of advanced technology.

But believing in technology is one thing. Believing it will make you money when companies have lousy business models … when their competitors are trying to gain market share with cut-throat pricing … or when their costs are surging … well … thats another thing entirely.

In fact, thats why I turned so bearish on the tech-heavy Nasdaq years ago and why I have been mostly bearish on techs ever since.

No, I didnt catch the top of the great boom. And no, I wasnt smart enough to catch the bottom in 2002, either. But I helped a lot of people save their butt and I want to make sure they dont lose it now.

Regardless of your own experience with the Nasdaq, step back from the trees for a moment and take a look at the big-picture facts:

1. From its extreme intraday high in March 2000, the Nasdaq plunged 78% to its extreme low in October 2002.

2. Then, despite all the huffing and puffing by Washington and Wall Street in the last three years, it recovered only 28% of that decline through this past August.

3. And now, just in the past few weeks, it has lost 15% of its recovery so far.

This is not very reassuring to tech fans like me. It tells me that, despite the recovery in the economy, theres still something seriously wrong with the business models of most technology companies.

It also tells me that if the economic recovery falters under the weight of higher interest rates and energy costs, a lot of these companies are going to get killed.

Let me give you a real-live example from this week …

Apple Surprise Is
Not So Surprising

After the market closed on Tuesday, Apple blew past Q3 profit expectations, reporting profits of 50 cents per share, far more than the 37 cents Wall Street was expecting.

But to produce that big upside surprise, Apple resorted to some smoke-and-mirrors devices that would make Houdini proud.

If you exclude non-operating, non-recurring adjustments especially unexpected tax benefits and a lower corporate tax rate Apple would not have earned 50 cents. It would have made only 38 cents, barely beating the 37-cent forecast.

More importantly, sales of iPods were nowhere near the gangbuster numbers Wall Street was expecting.

In Q3, Apple shipped 6.45 million iPods. However, the Jack-and-the-beanstalk crowd was expecting Apple to ship at least 7 million and some of the most giddy analysts had forecast as high as 9 million.

Even the disappointing 6.45 million is misleading because of the early launch of their new mini music player, the Nano. Apple shipped more than a 1 million Nanos in the last 17 days of Q3.

Without the benefit of the Nano, Apples sales numbers would have been downright horrible!

For the markets, this came as a big disappointment Tuesday night. So as Martin told you, Apples stock plunged by over 10% in after-hours trading.

Now, the stock has bounced back somewhat, but the real story is still untold.

The iPod Food Chain

The iPod food chain companies supplying critical components to the music player has been warning about trouble in their ranks for weeks, implying similar troubles for Apple. Here are just a few:

Warning #1: SigmaTel (Nasdaq:SGTL) makes chips that convert digital signals into music on portable music players. No surprise SigmaTel is one of Apples major component suppliers for the iPod and iPod Shuffle.

Despite the avalanche of business from Apple, business isnt so hot at SigmaTel. I say that because SigmaTel warned that its Q3 sales and profits would be below expectations.

• Instead of $78.6 million of sales, SigmaTel expects to pull in only $74.4 million.

• Instead of 30 cents per share of profits, the company now expects to make only 20 cents.

Warning #2: Portal Player (Nasdaq:PLAY) makes the master controller chip for iPod players.

Portal Player, in turn, relies on two different chip production foundries in Taiwan to make the chips it designs: Taiwan Semiconductor and United Microelectronics. Last week, United Micro reported that it sold $8.5 billion (Taiwan dollars) of chips in September a 28% drop from the same period last year.

Since Portal Player gets 90% of its revenues from Apple, it is especially vulnerable to the same flu that hit Apple on Wednesday. Well know more on Monday when Portal Player releases its Q3 results but the falling sales at United Micro arent very encouraging.

Warning #3: After production, the chips used in iPods are shipped off for coating, testing, and preparation for final assembly by chip finish companies, such as Amkor in Korea (Nasdaq:AMKR).

On July 27, Amkor warned that it would not only lose money, its loss would be bigger than expected as sales fell from $492 million last year to $489 million. What happened to all the iPod business?

Warning #4: Cypress Semiconductor makes the touch-sensitive technology used in iPods click wheel for navigating between songs. Despite that boom of business, Cypress Semiconductor reported a Q2 loss in July its third consecutive quarterly loss.

What that told me was that Apple was cutting back on its orders in response to its slowing sales. See how you can identify the canary in the coalmine when the component manufacturers start sliding?

Warning #5: SanDisk (Nasdaq:SNDK) supplies the flash memory chips that hold all those songs in iPods. If business is so great, why are insiders selling like crazy? In the last six months, 21 insiders have dumped 15.5% of their stock for a total of 736,938 shares. At the same time, they have bought ZERO shares. Thats right ZERO!

These insiders arent dumb. Prices for flash memory chips have been falling and SanDisks competitor, Hynix Semiconductor, has warned that it expects prices to continue falling. In their own words: The double-digit decline in average selling prices seen in the third quarter should continue in the fourth quarter.

Sure enough, in Q3, the average selling prices of a Hynix flash chip fell 18% from Q2. Thats not exactly good for companies in the flash business.

Important Heads-Up: Inventec Appliances Corp., which is dependent on iPod orders for more than 50% of its revenues, will be floating an IPO at the end of October, and you can bet that aggressive stockbrokers will be pushing it as a sure-fire winner. Dont bite on it. You could get a case of serious indigestion.

Big problem: If Apples faltering, imagine whats happening to the dozens upon dozens of tech stocks that have uglier fundamentals and more worrisome dots to connect?

Indeed, I see the exact same food-chain warnings in computers, corporate software, cell phones and semiconductors.

Just do your homework, and you will hear the canaries in the coalmine chirping their warning song. Then step back from the trees and look at the Nasdaq from a broad historical perspective.

No matter how much you may love technology, put distance between tech stocks and your money. There will come a time to buy them with both hands. But thats not now.

There are significant fortunes to be made in this market, but theyre primarily going to be in areas that most of Wall Street doesnt believe in or may not quite understand. Let me give you three outstanding examples.

The first example is energy. As youve just seen, its rise has been dramatic, and its still far from over.

Not surprisingly, most research analysts on Wall Street were afraid of energy. They knew that surging fuel costs were bad for nearly all of their beloved favorites. To recommend energy would have required dis-recommending industrial stocks, consumer stocks, health stocks, and yes, even tech stocks.

They didnt want to do that. So much like theyre doing today, they said the energy boom was a thing of the past. Theyre missing another major opportunity and if you follow their lead, you will too.

Another great example is gold. Gold is continually the subject of Wall Streets scorn because its seen as the antithesis of everything thats good for stocks low inflation, growing economies, confidence and stability. Its viewed as the classic anti-investment, and its return to glory is the subject of fear, not hope.

So most of Wall Street would love to see energy and gold fall, and for a short time, they may get their way: It looks like oil could stall for a while or even fall a bit further. And we think gold could recede a bit too, maybe to the $460 area.

Be ready. Because if they come down somewhat, it will give you some incredibly good buying opportunities.

My third example of new fortunes to be made is the least understood and potentially most profitable of all.

Im talking about interest rates and bonds. Most people think that a bond is just something for buying, tucking away and clipping interest coupons. They have no concept of how quickly bonds can go down or how much money you can lose on them.

Nor do they realize that there are inexpensive investments that can transform a bond market crash into a huge profit bonanza. And you can do it starting from a grubstake of as little as a few hundred dollars, without risking a penny more.

The more bonds fall, the more you stand to make. And even if bond markets dont fall, the most you can lose is the modest amount you invest.

Martin will tell you more about these unique investments tomorrow morning. In the interim, remember that long-term bonds can fall like stocks.

If you own them, the more they fall, the more you lose.

But if you own the investments Martins using right now, the more they fall the more money you make. And theyre very simple: You buy them low and sell them high.

Already, just this week, Treasury bonds have fallen below a very critical price level. That augurs for continuing sharp declines in the days and weeks ahead.

So stay clear. Then get ready to potentially make fortunes in the markets that most investors ignore or misunderstand.

Best wishes,

Tony Sagami

2005 by Weiss Research, Inc. All rights reserved.
15430 Endeavour Drive, Jupiter, FL 33478