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Tech Earnings Have Investors on Edge

For technology stocks, there may be more damage to come—in the form of quarterly earnings reports. Still, analysts see some buying opportunities

Amid a rout in tech stocks that has accelerated since the turn of the New Year, investors are nervously awaiting the opening barrage of fourth-quarter earnings reports from industry bellwethers including Intel, IBM, Wipro, and Seagate (STX). IBM's surprise pre-announcement of strong fourth-quarter results offered some hope that fears may be exaggerated about a U.S. recession gutting technology spending. But even a hint of managerial concern could send investors fleeing, as shown by the panicked response given some mildly cautious remarks by AT&T's CEO in early January.

A quick recap: The technology-heavy Nasdaq composite index is down more than 13% since late October. That includes a 5% plunge since the start of 2008, even after buying spurts driven by hints the Federal Reserve may stoke the economy with more interest rate cuts, as well as IBM's news. Market research firms have cut their forecasts for both U.S. and global tech spending. And chip stocks, long considered the canary in the tech-stock mine, are giving off an unappetizing scent that could be taken as a signal to evacuate. On Jan. 4, JPMorgan (JPM) downgraded chipmaker Intel (INTC) to a neutral rating, citing concerns over slackening orders. Two days earlier, Banc of America Securities (BAC) downgraded Texas Instruments (TXN) and AMD (AMD). Not surprisingly, chip stocks have suffered even more damage than the rest of the sector: Since the start of 2008, Intel has plunged 11%, and the Standard & Poor's Semiconductor Index is down 10.7%.

Healthy Fundamentals

Experts say it's likely the tech sector will fall further, given the difficult economic outlook. Predicting a 50% chance of a recession, S&P on Jan. 9 cut its portfolio recommendation (, 1/9/08) for tech stocks from overweight to underweight. "Chances of a severe correction have increased," explains Sam Stovall, chief investment strategist at S&P, which like BusinessWeek is a subsidiary of The McGraw-Hill Companies (MHP). Stovall believes the overall stock market may continue to decline for as long as another six months.

Despite the grim outlook, there are some encouraging words to be heard. During the past 10 recessions, the Nasdaq composite has dropped an average of 19%, according to S&P. "We are already halfway there," says Scott Kessler, an S&P analyst. Michael Mahoney, managing director at Falcon Point Capital, says tech stocks could hit bottom within three to six months—and be among the fastest sectors to recover.

No one can predict with certainty whether, if there is a recession, the Nasdaq will decline more or less than the 19% average. But analysts are confident the industry isn't headed anywhere near the implosion of 2001, when the index plummeted 78% during an eight-month recession. (For that matter, analysts also aren't expecting to see a repeat of two other anomalies: the recessions of 1957 and 1960, when tech stocks actually gained value.)

Another hopeful sign is that the tech industry's fundamentals appear to remain healthy on the whole. Sure, in December, IDC cut its forecast for growth in U.S. tech spending in 2008 to between 3% and 4%, down from 6.6% in 2007. But at least it's still growing. Earlier this decade, U.S. tech spending fell 6% in 2001 and another 5% in 2002.

Belt-Tightening Factor

And, as evidenced by IBM's update on Jan. 14, U.S. tech companies with substantial foreign sales may suffer even less of a jolt from a domestic recession. Worldwide, tech spending is still projected to grow almost as much as in 2007, driven by strong demand for smartphones, storage devices, and software. "Large bellwethers with international exposure would probably fare better in this type of an environment," Kessler says. IBM (IBM), seemingly tired of seeing its shares pounded, preempted its quarterly report by just three days to say it posted a better-than-expected 24% jump in fourth-quarter earnings per share. The gain was fueled by overseas sales and the dollar's weakness, which made that revenue more valuable in dollars. Overall, quarterly revenues rose 10%, to $28.9 billion, exceeding analyst forecasts of $27.8 billion.

It's also encouraging that, so far, few companies have issued early warnings about their quarterly results. "As of now, there are no indications of a massive slowdown," Kessler says.

Still, as the technology industry has a way of evolving more rapidly than other sectors, the slowdown might not produce the same winners and losers as in the past. Consider the telecommunications sector. Back in 2001, AT&T (T) and Verizon (VZ) were considered defensive plays—still stodgy utilities collecting monthly phone bills like clockwork. Indeed, during the 2001 recession, Verizon's stock only fell 3%. After all, even consumers in deep financial trouble weren't likely to abandon their home phones to cut corners. But seven years later, consumers rely so heavily on cell phones that many might be more apt to cut off their home phones first, says Craig Moffett, an analyst with Sanford C. Bernstein.

While Verizon and AT&T can ease that pain as the nation's two biggest cellular-phone carriers, both may also see wireless subscriber growth slow in a tougher economy. Recession belt-tightening might also lead some consumers to downsize their cable TV service, a business Verizon and AT&T have entered over the past several years. And, as suggested by AT&T CEO Randall Stephenson on Jan. 8 to analysts, recession-leery consumers may be growing hesitant about paying for speedier broadband Internet services. "We are really seeing some softness," he said. A day later, Verizon President Dennis Strigl told analysts that his company has not been impacted by the economic downturn.

No Sure Thing

Software is another example of a sector that's changed dramatically since the last recession. Take Oracle (ORCL). Until a few years ago, its earnings were dominated by sales of corporate database software, a prime target for cost-cutting by businesses grappling with hard times. But today, recurring, predictable revenues from Oracle customers that want to keep their software in tip-top shape account for nearly half of the company's sales. "Oracle is much more stable," says Andy Miedler, senior technology analyst at Edward Jones.

Elsewhere in the technology sector, alternative energy stocks may post gains even in a recession if oil prices remain high. And outsourcers providing back-office services for other companies may, once again, prove to be an effective defensive play. On Jan. 8, Lehman Brothers (LEH) upgraded Wipro (WIT) to overweight, predicting the Indian company will post strong third-quarter results on Jan. 18. Analysts polled by Thomson Financial expect the outsourcer to roughly double its quarterly revenues, to $1.2 billion, year over year. Miedler believes that Accenture (ACN) would benefit from further outsourcing and consulting during a downturn as well.

But, at the end of the day, technology will never be a sector for those without stronger stomachs. "Technology is in much better shape than it was before," Miedler says. "But it's certainly not health care or a utility that's needed in good times and bad."

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