This Time, Tech Will Follow, Not Lead


By Amy Tsao The Nasdaq's climb to 1828 as of Nov. 9, a 28% rise from its post-September 11 low of 1423, may be trying to tell investors something about tech stocks. With earnings expectations for the sector continuing to fall, many have written off any near-term hopes for it, especially since the events of September 11 made a already bad situation even worse.

So what's behind the tech-heavy Nasdaq's upswing? Are tech stocks, which powered the stock market boom of the '90s, back -- and ready to lead the next charge? Probably not. "[Tech stocks] will be huge beneficiaries, not drivers. They will be swept up by businesses increasing capital spending," says Ed White, chief equity strategist at Gannett Welsh & Kotler.

Indeed, it has never been more clear that tech is just as cyclical as any other industry. And even when the sector does rebound, it's safe to say shares of technology companies will never lift skyward the way they did in the bubble years. Over the long term, the lack of high-octane tech stocks as fuel for the stock market will have the effect of tempering investor expectations across-the-board. Tech investing will come back to reality, and so will stock market returns.

"GET USED TO IT." "If we make 6% or 7% on the stock market for the next several years, I don't think people should be surprised," White says. "I think people should consider how reasonable that would be compared to performance now. The returns of the late '90s were not reasonable. Get used to it."

Still, a case can be made for a tech comeback, though not a flashy one. Investors can probably bank on a bounce in these shares to accompany a broader economic recovery. "Tech stocks will rise once there is a generally accepted expectation that their earnings will come up. If the economy can get back on track in 2002, it is reasonable [that tech] will participate alongside a generally recovering market," says Joe Battipaglia, chief investment officer for Gruntal.

At some point, low interest rates and more tax cuts will likely encourage companies to spend more on technology products. That spending won't be about creating new capacity, Instead, it will be to acquire products and services that improve productivity and help keep costs in check.

A LOW BAR. On the earnings front, tech companies are wrapping up a dismal earnings season -- but one that had few high-profile blowups. While third-quarter earnings were ugly -- and fourth-quarter numbers probably will be too -- these sorry results help set the bar low for 2002. More favorable earnings comparisons are in the works. "I think in general, the companies and Wall Street are finally adjusting to slower growth," says Pat Adams, portfolio manager of Choice Funds.

The nagging inventory problem that has plagued technology is showing signs of abating, according to a report by Ed Hyman, chairman of International Strategy & Investment. Inventories are being trimmed in semiconductors and computers, and have declined significantly for communication equipment. "September 11 taught us how important telecom and communications are. That's one thing pulling on the demand side," says Michelle Clayman, chief investment officer at New Amsterdam Partners. "The second thing is that we've seen an enormous amount of inventory clearout."

Solid consumer spending would lend a hand to the technology rebound, both directly through retail purchasing of technology products and indirectly through the goods and services tech companies sell to retailers, says Paul Cook, director of technology investing at Munder Capital. Though consumer confidence is way off its highs, it's still quite strong considering the uncertainties -- especially the war in Afghanistan and the anthrax scare -- weighing on shoppers. "I'm optimistic about the next several quarters," Cook says. "There's a greater likelihood of things getting better rather than worse."

"PRIME THE PUMP." Another plus for tech companies: While the terror attacks of September 11 clearly shook the economy, they're also forcing companies to pay more attention to safeguarding their operations. And that could boost interest in disaster-recovery technology and security-related software and hardware, says John Davidson, president and CEO of PartnerRe Asset Management. "These two areas will not in themselves be big enough to [boost tech stocks]," he says, "but they will prime the pump and start money coming back into technology."

Some fund managers have already started to plot their technology strategy. Dan Rivera, chief investment officer for U.S. Large Cap Growth Equities at Amex Asset Management, says his portfolio is positioned for a recovery in technology as early as fourth quarter of this year. That means holdings in software giant Microsoft and services companies like and Siebel. Among tech companies, software and services tend to rise first when economic growth starts to turn positive. Next to rebound are shares in semiconductor companies and semiconductor-equipment makers. That means companies like Intel, Applied Materials, and PMC-Sierra.

Still, many pros continue to be cautious, fearing that tech will be weak for some time -- possibly into 2003 -- and that valuations are still too high. Stocks are trading at around 22 times estimated 2002 earnings, White says. "That's awfully high when it's too early to think [the worst] is over." Phil Orlando, chief investment officer of Value Line Asset Management, says overall, technology is in worse shape than other sectors, and it will get worse yet. These folks say the excesses that built up for the past several years will take a long time to be worked off. So they expect continued low demand and pricing pressure to drag earnings still lower.

In a market desperate for performance, everyone is waiting to see what the former juggernauts of the stock market can muster. The most likely scenario: Tech stocks will get back on their feet -- but no faster than the overall economy. Tsao covers financial markets for BusinessWeek Online in New York


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