04/14/97 COMMENTARY: IT'S ALL HANGING ON HIGH TECH NOW

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COMMENTARY: IT'S ALL HANGING ON HIGH TECH NOW

Can the bull market survive? The spectacular stock boom of the last two years has been driven by low interest rates plus rising profits in two key sectors: high tech and financial services. From the end of 1994 to the end of 1996, these two sectors accounted for almost three-quarters of all the profit gains among the stocks in the S&P 500 index (table).
Now the Federal Reserve has chopped off two of the bull market's three main supports. It has boosted interest rates to prevent inflation and slow the economy. By so doing, it has made stocks overall a less attractive investment, while at the same time undermining the financial-services sector. Banks, Wall Street firms, and other financial-services companies typically do poorly when rates are rising. Indeed, the stocks of money-center bank stocks have dropped by 15% since Mar. 10.
DECIDEDLY DOWNBEAT. That leaves computer, software, networking, and other high-tech stocks as the last support for the bull market. The early signs from that sector are not good, either: The Morgan Stanley High-Tech index has plummeted by 18% since mid-January, and the latest earnings reports are decidedly downbeat. Unless high tech can recover--as it still well might--the bull market is not likely to last much longer.
Certainly, there is little chance that a sudden surge in profitability in another part of the economy will bail out investors. Even before the Fed's latest rate rise, economic forecaster DRI/McGraw-Hill was predicting that earnings per share among companies in the Standard & Poor's 500-stock index would rise by only an average 4.7% in 1997, compared with an average annual rise of 12.6% over the previous two years. Such a meager rise, combined with higher interest rates, bodes poorly for the market.
To be sure, forecasters have made such dire predictions before, only to be surprised by the strength of the high-tech sector. In early 1996, for example, DRI/McGraw-Hill predicted that profits would slump by the end of the year, holding down the stock market. Instead, fourth-quarter 1996 profits were more than 30% higher than expected. Intel, Microsoft, and IBM together saw their quarterly profits rise by 59% from the second quarter of 1996 to the fourth quarter. That made up for weakness outside the high-tech sector, where profits fell over the same period.
However, it's looking less likely that high tech can repeat its rescue act. Many tech companies are warning that the sales they expected at the end of the first quarter did not materialize, leading to forecasts of slowing revenue growth. The carnage has been greatest in the high-flying networking stocks, with the plummet downward led by 3Com Corp.'s 57% drop in share price since the beginning of the year.
The slowdown is spreading beyond networking. Computer makers Silicon Graphics Inc. and Digital Equipment Corp. have taken a pounding. And on Apr. 1, Informix Corp., a database software company that recorded nearly $1 billion in sales in 1996, predicted a sharp sales decline for the first quarter in 1997.
Does this mean that the market is softening for all high-tech companies? Hardly. Informix competitor Oracle Corp. turned in a strong earnings report on Mar. 13, even after warning of slowing sales in Europe. Results from the strongest performers in last year's market--Intel, IBM, and Microsoft--won't be in for a couple of weeks. And it may well turn out that the weakness in the networking market is temporary.
If the high-tech sector does falter, however, there won't be much left to keep the economy growing. Especially with the Fed ready to raise rates again at any sign of overheating, no other sector looks ready to pick up the slack. For investors who once worshiped Alan Greenspan, it's time to start praying to Andy Grove and Bill Gates instead.
By Michael J. Mandel

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