Forgive Roland W. Gillis for sounding relieved. For the past 18 painful months, the co-manager of $6 billion at Putnam Investments Inc. has watched his technology portfolio slide down, down, down. But, says Gillis, the worst is finally over. "We're not going back to the crazy days," he says, "but we are going back to more normalized growth for technology."
No doubt about it, investors are feeling bullish about tech again, after an 18-month bear market that sliced 72% off the tech-heavy Nasdaq stock index. Since its low on Sept. 21, the index has soared 37% through Dec. 14. This powerful rally has lifted such heavyweights as Cisco Systems (CSCO) and Oracle (ORCL) by 73% and 43%, respectively, while smaller stocks such as Palm (PALM) and chipmaker Silicon Laboratories (SLAB)) have doubled or tripled.
Prospects that an improving economy--and higher defense spending--will boost tech profits are driving the renewed enthusiasm. Wall Street analysts, notorious for hyping tech stocks, are forecasting a 44% earnings rebound in 2002, after a 62% decline, according to Thomson Financial/First Call.
How realistic are they being? After all, the Federal Reserve's 11 interest-rate cuts in 2001 haven't yet fueled much capital spending. And big swaths of tech land remain in the dumps as PC makers and cell-phone, telecom, and network-infrastructure companies continue to struggle with overcapacity or market saturation. Plus, many observers think the surge is overdone and expect a sharp retreat before mid-2002. "People are closing their eyes and buying without regard to valuation," warns Paul H. Wick, manager of the $6 billion Seligman Communications & Information Fund. "They haven't learned anything from the bubble."
Gerald R. Jordan Jr., who manages more than $1 billion in hedge funds at Hellman Jordan Management Co. in Boston, thinks tech is in a new bubble that will pop at the end of March. After September 11, Jordan put 35% of his assets in software stocks because he thought they were sharply undervalued. He bought Amazon.com Inc. (AMZN) and Siebel Systems Inc. (SEBL), figuring that "they were at the bottom of their cycle and the economy will improve faster than most people think next year." Both stocks have since doubled off their Oct. 1 lows. Other favorites also have risen. Cisco, for one, was a bargain in September, at $11 a share, or 37 times estimated 2002 earnings, says Kevin M. Landis, manager of the $1 billion Firsthand Technology Value Fund. But at $19, or 65 times earnings, it's too pricey.
The pros who are buying are looking at tech sectors that remain healthy. Sales of corporate software that increases security or cuts costs continue to grow, and certain consumer categories, such as game consoles, flat-panel displays, and digital cameras, are hot--driven by new products or lower prices. So big investors are focusing on software, semiconductors, IT services, and outsourcing companies they think can sidestep tech's worst problems and produce healthy profit or revenue rebounds in the coming year.
Blue chips, such as Microsoft Corp. (MSFT) and IBM (IBM), still have their fans, of course. But the pros are mostly looking for buys among niche companies. "The market is going to increasingly focus on small- and mid-cap names, to the detriment of big names," says Gillis, because in a slow-growing economy, the math works in their favor. Simply put, smaller companies show higher percentage growth rates for every added dollar of revenue.
For example, Seligman's Wick likes Peregrine Systems Inc. (PRGN), which makes low-cost help-desk and asset-tracking software. At 30 times Wall Street's estimates for 2002 earnings, it's not dirt-cheap. But Wick expects revenues to rise at a 20% pace in the next few years. "In a period of retrenchment in corporate spending, they're less likely to be severely impacted by cutbacks than someone with more expensive software," he says.
Landis, at Firsthand, is investing defensively. He bought a big stake in Raytheon Co. (RTN) after September 11. His logic: Raytheon, the leader in defense electronics, is a likely beneficiary of increased U.S. military spending. But Landis also is focusing on niche markets where he expects decent growth next year. He thinks advanced CDMA cell-phone handsets, such as those sold by Verizon Communications (VZ), will be popular next year, so he has invested in companies that make components for them, including Anadigics (ANAD) and Legato Systems (LGTO). While both companies are expected to lose money next year, their losses will decrease, and revenues are expected to grow by 10% and 14%, respectively, according to analysts' estimates.
Other managers are trying to capitalize on the telecom bust by investing in contract manufacturers. Putnam's Gillis likes Sanmina Corp. (SANM) and Flextronics International Ltd. (FLEX), both up sharply since September because they are getting manufacturing jobs that telecom companies can no longer afford to do themselves. Sanmina's profits are expected to rise 28% next year and Flextronics' 13%.
Gillis also likes storage-software companies QLogic Corp. (QLGC) and Brocade Communications Systems Inc. (BRCD), which have both nearly tripled since September. QLogic trades at 59 times consensus estimates for 2002 earnings and Brocade at 102 times. But Gillis thinks earnings of both companies will come in higher than expected. "In the same way analysts were too slow to mark down earnings going into the recession," Gillis says, "they will be too slow to raise them coming out of it."
For now, though, the numbers don't favor short-term bulls. Tech valuations soared to 55 times trailing earnings through Dec. 7, according to Leuthold Group, a market researcher in Minneapolis. Considering that tech stocks normally trade at about 33 times earnings, there's a good chance they will dive again. Meantime, hedge-fund managers have huge short positions in tech stocks they expect to fall, such as Sun Microsystems Inc. (SUNW) and Intel Corp. (INTC)
In the fourth quarter, many investors have become more afraid of losing out on a big rebound than of overpaying for technology stocks. That lack of caution could cost them big in the coming months, if the pessimists are right.
Corrections and Clarifications
In "It could be tech time again" ("Where to invest," Cover Story, Dec. 31/Jan. 7), the final paragraph of the story was incomplete, and should have read: "In the fourth quarter, many investors have become more afraid of losing out on a big rebound than of overpaying for technology stocks. That lack of caution could cost them big in the coming months, if the pessimists are right."
In addition, the "For the record" box accompanying the story should have said that Paul H. Wick runs the $6 billion Seligman Communications & Information Fund.
Corrections and Clarifications
In the table accompanying "It could be tech time again" ("Where to invest," Cover Story, Dec. 31), the ticker symbol for Check Point Software Technologies should have been CHKP, and its stock price and p-e ratio $41 and 32, respectively.
By Geoffrey Smith