Bust begone!
The outlook for the global electronics industry is unusually tame. Industry officials expect annual growth to settle at 10 percent over the next few years, roughly half the industry's 20 percent gains through the 90s but comfortably above the 20 and 30 percent contractions suffered after the Y2K bust. But an outlook for steady growth is not in keeping with the nature of the industry, which for 40 years has swung violently from great booms to great busts.

A key negative that is containing the current outlook is an absence of breakthrough technologies or breakthrough applications. Servers, desktops, and laptops are well-established markets, benefiting only marginally from obsolescence tied to new technologies or the cutting off of support for existing technologies. Many industry officials believe a corporate replacement cycle may be underway, a plus but no revolution.

Yet there are important positives for the industry. Chip foundries in Taiwan, which have become the world leaders in production of commoditized electronics parts, are ramping up to new production technology - 300mm wafer fabrication. Production yields using 300mm fabrication are significantly higher than older technologies, though the costs of putting new equipment in place are heavy. Another positive for the industry is the centrino wireless processor from Intel, which is expected to help drive laptop sales. Nevertheless, these developments are moderate at best compared to the introduction of the mainframe in the 60s, or the PC in the 70s and 80s, or the cell phone in the 90s.

A plus for the industry that may be developing is new demand for network equipment. Over the last few weeks a group of smaller producers have reported strengthening demand from customers, especially long-suffering phone companies. For three years, makers of fiber-optic systems and fiber-optic cable have suffered the most severe contraction of perhaps any industry group in the global economy. Once giant manufacturers like Marconi or Lucent Technologies or Corning saw the bulk of their business literally vanish at the millennium. Though over-production is the tragic flaw of the electronics industry, there seems little risk that network equipment makers, given years of low production and inventory drawdown, will over-react to new demand.

Capacity, share values questioned
Industry officials keep a close eye on capacity utilization as a key barometer for the outlook. There is wide controversy on the level of capacity utilization in the industry. Estimates now center on 85 percent but range from 80 percent to 90 percent. Many believe 300mm fabrication, a technology that is still establishing itself, is running at 95 percent, a strong level but still below the absolute maximum capacity that top producers ran at during the last boom.

A lack of pricing power is a historic and significant weakness for the electronics industry. Prices for many parts, such as commoditized memory chips, routinely erode at double-digit annual rates. But more importantly, industry officials are emphasizing the lack of pricing power for leading-edge goods. More goods being sold for less money is not a recipe for financial success. Yet the stock prices of many electronics firms have risen sharply this year. Shares of Intel, by far the world's largest producer of processor chips, have risen from roughly $15 at the beginning of the year to almost $30 in recent trade. Likewise shares of Texas Instruments, a leading maker of semiconductors and handsets, started the year at $15 and are now trading over $25.

The above chart compares quarterly change in the two companies' share prices on a year-over-year basis, a smooth view that shows how closely the two companies move together. There is little doubt that investor anticipation has risen sharply since the beginning of the year. Shares in the companies have leveled over the last few weeks, triggering wide profit-taking throughout the stock market. Both companies have recently issued upbeat mid-quarter assessments, but each was greeted with disappointment - perhaps not surprising given the sharp upturn in investor expectations.

The above graph shows how sharply technology shares in general have risen this year. The Philadelphia Semiconductor Index, made up of 18 electronics manufacturers (though several of the firms outsource all of their production) is by far the most dense index available of the electronics industry. The index is well off its historic peak of 1,332 on March 2000 but is nevertheless enjoying its best run since the bust. By comparison the S&P 500, trending at just about the 1,000 level, has shown modest life this year. But note that swings in the S&P 500, which in contrast to the semiconductor index hit a modest high of 1,527 on March 24, 2000, are historically much tamer, a reflection of the relative stability of the greater market and the special volatility of the electronics market.

Boom anew?
Few industry officials expect to see a boom return to the industry. Gone forever it would seem are the days of the 'New Economy', when great output and great share gains were justified by new definitions of economic possibilities. Most believe excess capacity has been fully worked off and most see only moderate levels of new demand ahead - a recipe for sustainable growth not in keeping with the tradition of the industry.

But many industry officials suspect that a new boom could be in the making. Should the general economic pace begin to pick up significantly, they argue that many electronics manufacturers, having spent three years shutting down capacity, will be unable to meet new demand. The result? A wave of investment in new structures and equipment that would sharply increase capacity and eventually lead to industry-wide over-production.

Mark Pender, Econoday