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NOVEMBER 7, 2002 STREET WISE By Olga Kharif Are Tech Stocks Tiptoeing to an Upturn? Though the sector is far from stable, many market watchers finally see some reasons to believe, especially if you're brave
After all, they've been deceived more than once in the past two years, when the Nasdaq lost two-thirds of its value. In 2002, after a short rally in the early spring and another in August, Nasdaq stocks again moved lower. It's understandable why many investors wondered if the latest rebound -- from a five-year low of 1,114 on Oct. 9 -- was another fake rally. More than enough bad economic news, such as rising unemployment and falling consumer spending, is still around. And many tech companies just reported poor quarterly results. Yet, in October, tech stocks outperformed the others. And some good news can be found under the latest gloomy earnings reports. On Oct. 28, Michael Dell, the head of the world's largest computer maker, Dell Computer (DELL ), said he sees a pick up in demand for PCs. And on Oct. 30, IBM (IBM ) CEO Sam Palmisano announced, "Perhaps we have hit the bottom." UPBEAT BUYERS. Considering that Big Blue commands $80 billion in annual sales -- more than tech giants Cisco (CSCO ), Intel (INTC ), and Microsoft (MSFT ) combined -- it's a reliable bellwether for some analysts. "I don't care what the 20 little companies are telling me," says Daniel Niles, an analyst with Lehman Brothers who upgraded IBM to buy on Oct. 11. Corporate buyers, contributing the bulk of tech companies' revenues, are also feeling more upbeat. When Morgan Stanley surveyed 225 chief information officers (CIOs) in September, they found 40% of the respondents planned to increase their budgets for 2003, with only 22% anticipating flat or falling spending. And 95% expected a general recovery in 2003. Both numbers were drastically better than the poll results Morgan Stanley released a few months earlier. Granted, corporate spending could remain wobbly for another quarter or two, says James Glen, an economist with researcher Economy.com. But "the sharp decline in tech spending is over," he says. Already, many companies have cut their costs to the bone. That should lead to a rise in profits near-term. And because profits and info-tech spending are closely tied, that coulc result in more orders for tech companies, says Glen. As businesses start replacing their three- or four-year-old computer equipment -- already too expensive to maintain -- in late 2003, that should boost sales as well, he adds. BOTTOMS UP? Tech companies could also enjoy a mild boost in government orders. In fiscal 2003, ended Oct. 1, the feds will spend $20.5 billion on info tech, vs. $19.3 billion this year, according to consultancy Input in Chantilly, Va. Meanwhile, tech stock valuations are near their troughs, says Arnie Berman, chief technology strategist with SoundView Technology. "Most investors have given up hope on even a seasonal [fourth-quarter] improvement." For instance, contract chipmaker Taiwan Semiconductor Manufacturing (TSM ), which Berman likes, is trading at $7.82, 59% below its 52-week high of $19. Another favorite, chipmaker LSI Logic (LSI ), is trading at $6, down 70% from its high of $19.78. Of course, not everyone agrees on that point. "While [tech stocks are] cheaper than they were a couple of years ago, they're still overvalued," says Donald Luskin, chief investment officer at economics consultancy Trend Macrolytics. Based on forecast earnings and compared to bond yields, Luskin thinks tech stocks are overvalued by 13%, while nontechs are undervalued by 26%. And half of the publicly traded tech companies are teetering on the verge of bankruptcy, Luskin estimates. HISTORY REPEATS? That means tech investors have to be highly selective and bet on larger players with strong balance sheets and coffers of cash. Luskin also suggests that investors look at companies that should gobble up more market share as their rivals go under. The bottom line: Proceed with caution. Still, those who can handle some risk short-term (say, the next three months) or can stay in a position long term (at least a year) should jump in between now and mid-December, says Richard Cripps, chief market strategist with Legg Mason. He believes the latest market trends are similar to what was happening in 1974. Back then, peak-to-trough declines also reached 50%, and the stock market also dipped twice. (In 2002, the market slipped in July and October.) In 1974, stocks then quickly returned after those dips, shooting almost straight up. Cripps points out that many institutional investors sold their tech holdings before their fiscal yearend -- Oct. 31 -- so that any losses would offset any capital gains, helping to lower tax bills. That activity will continue through Dec. 31, as individual investors follow suit. "The selling pressure offers a buying opportunity," says Cripps. LONG-TERM BULLISHNESS. Some money managers, however, recommend waiting on the sidelines until more definite signs of an economic turnaround appear. Says Howard Sutton, portfolio manager for Canada's $300 million Tera Capital Global Fund: "I don't believe we've had the total flush-out yet. I still have a big caution flag waving until we see an increase in demand and revenues." He reasons that ongoing corporate cost-cutting could lead to higher margins and profits -- but only short-term. Sutton would like to see a jump in sales and further consolidation before investing. Still, "long-term, I'm bullish on technology," he says. Industry trends are looking favorable, particularly when it comes to hardware and related components. Unit shipments of processors that power computers, have grown 6% sequentially in the latest quarter, says Lehman Brothers' Niles. Prices on other chips, such as memory used for storing data, have risen in the past few weeks, although that could be due to a temporary shortage. And both the bulls and the bears in the tech sector agree that the Nasdaq likely will continue to fluctuate. "[Whether to get in] depends on your attitude toward risk," says Jerome Dodson, president of the San Francisco-based Parnassus fund, which has 40% of its $280 million in assets invested in tech shares. "[The market] is not going to go straight up. But if you don't get in soon, you could lose a lot of the upside." Dodson holds shares of semiconductor-equipment makers Applied Materials (AMAT ) and Novellus Systems (NVLS ). Clearly, this beaten-down sector comes with no money-back pledges. But the glimmer of a sustainable rebound seems to be peeking out, by some analysts' reckoning. Brave, bargain-hungry investors may want to start scouting for good tech deals.  Kharif writes for BusinessWeek Online from Portland, Ore. Edited by Beth Belton Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. 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