It's rare to find a bull in the tech sector these days. But Jeff Bernstein, senior vice-president and portfolio manager at New York-based Pilgrim Funds, figures he's about as close to sprouting horns as anyone right now. Bernstein co-manages a number of growth mutual funds, including mid-cap, all-cap, and large-cap funds. BusinessWeek Online Correspondent Margaret Popper spoke to Bernstein recently about his bullish take on tech. Here are edited excerpts of their conversation (a longer, streaming audio version is also available):
Q: Do you think this is a good time to be buying tech stocks?
A: You're getting your second chance. If you didn't get in there like a good value investor, you're now getting your shot to come back and parse through [and find something you] can get excited about for 2002.
Q: What is your outlook for the broad-based tech sector through this year?
A: I think one of the important takeaways of this stock market cycle for technology generally is that from here on out it's going to be considered cyclical. In the past, there were elements of it that were considered to be just secular growth. [Investors believed] you were just going to grow the need for software every year forever.... People thought semiconductor cycles had more to do with the product cycles of PCs than with the economy.
What does that mean to an investor? Traditionally, investors in cyclical stocks have had to buy those stocks on high or infinite price-earnings multiples and sell them when they reached low p-e multiples on peak earnings. We're going to get that in technology investing strategy going forward. You have to buy them now -- when they have high or infinite multiples on no earnings -- because you're anticipating the turn.
Recently, stocks have had a very nice run on the general feeling that they've become cheap. We had a pretty good rally based on faith that Alan Greenspan would be cutting rates. So you have value investors, half of which have never owned technology, who are buying [tech stocks] because these things aren't going out of business, and they're selling at two times cash [value] and one times book. The numbers have come down so sharply that they probably can't come down as sharply going forward. But it's pre-reporting, and we're going to get more bad news in the near term than good news.
Q: What sectors do you like?
A: We call our investment theme, "The ubiquitous semiconductor." It captures the idea that chips will be everywhere. What makes that happen is...Moore's Law -- chips come down in cost about 20% a year. Some years they're actually flat to up in price because demand is very, very good. Those are anomalies. But during those years, investors get really excited because the costs to the [chip manufacturers] are coming down 20%, but prices [of chips] are going up. Margins are going through the roof. That was last year.
Then people get irrationally exuberant, they double-order chips. That makes the whole equation look even better. Then all of a sudden you hit the wall...[and] when you have excess, the price goes all the way down to the cost of production.
Well, what happens is the chips get really cheap, and you can put them in more things. In the early days, semiconductors were only used in digital watches. At the end of that cycle, digital watches were in cereal boxes. They gave them away. Then they were in calculators. After that cycle they put calculators in cereal boxes. So it's a distinct possibility that cell phones will be in cereal boxes. But it means everyone has one. Interesting things happen when everyone has a cell phone or everyone has a PC. And that's the magic of the ubiquitous semiconductor.
Q: Are PCs a good bet for investors these days?
A: The problem is many people have personal computers, and the industry isn't really set up to sell them at $200 apiece and make any money. PC stocks and PC-related chip stocks have done well initially in this downturn because the overexuberance around them wasn't as big on the upside. Therefore, the crushing blows haven't been as painful on the downside.
But I don't think that's a place where you're going to get a huge amount of elasticity of demand -- meaning you cut prices and you sell a lot of units. I do think that there's a lot of exciting stuff in consumer electronics, where elasticity of demand can be huge.
Q: What about telecommunications? Is that sector just going to be beaten up?
A: Telecommunications certainly had the greatest degree of overinvestment. You still have to have a lot of these nascent little carriers just go out of business. Those assets have to get redeployed and move into strong hands. Competition will not come from tiny guys chipping away at the giants. It will come from the giants finally taking off the gloves and beating the hell out of each other.
You're going to see consolidation, and it's going to be big. And in big consolidation you get big slowdowns in spending. You saw it in the energy companies, in the oil companies. They all merged, and they didn't spend anything. You're going to have some mergers and some rationalization. And just as you're not investing and you're taking capacity out of the market, you're going to realize that broadband's here, and we're behind.... It's just always the way it is.
Q: When will that be?
A: If I had to guess I would say it will be two years until the actuality of it, or maybe 18 months, and the stocks start to anticipate it six months in advance.
Q: Will enterprise spending come back?
A: I think enterprise is probably underspending. By the second half of the year when they realize the consumer isn't dead, they're going to spend some more.
Q: Will that make a big impact on 2001 tech earnings?
A: In general, we're not a lot more optimistic than the Street on 2001 numbers. We just think 2002 is going to be potentially much better. This year is a washout, and everybody knows it. That's where you get into the issue of timing. The market is saying we're investing for 2002, not for 2001. But oh gosh, in the middle of 2001, it's starting to feel like a long time.