With the Nasdaq up nearly 10% since the end of February, you'd think technology investors would be celebrating. But plenty of party poopers are out there. Merrill Lynch chief U.S. stock strategist Richard Bernstein recently recommended that investors focus on utilities, consumer products, health care, and defense -- anything but tech stocks. His worry, which investors might be wise to heed, is that the recent rebound in tech stocks has been premature.
Indeed, the early March rally may already be fizzling. Tech stocks sold off for the three days ended Mar. 14, after revised outlooks from chipmaker Intel and software giant Oracle prompted investors to worry that the increase in corporate spending on technology they had been anticipating in late 2002 may not materialize until early 2003.
That concern overshadowed the positive news that sent tech stocks climbing earlier in the month, including reports that a few tech sectors, such as semiconductors, had shed their excess inventory and were poised to bounce back. With the tech-laden Nasdaq down 61% from its March, 2000, high, "people were looking for any excuse to get in," says Lew Johnson, an expert on technology stocks at Queen's University in Canada.
SETBACKS COMING? In the past, though, tech recoveries usually have trailed the rest of the economy by a quarter or two -- and the signs of a pickup this time around are uneven so far. The overall industry could yet suffer setbacks in the form of bankruptcies and consolidations, warns Bernstein. And price wars are escalating in sectors such as wireless, driving down profit margins. The tech "rebound will be amazingly muted" Bernstein predicts.
Tech companies themselves have been far less bullish than much of Wall Street. While analysts polled by financial research service First Call expect these outfits to produce, on average, earnings growth of 42% this year, companies' own guidance has been more guarded. For example, Larry Carter, chief financial officer of networking giant Cisco Systems (CSCO), said in a February speech that he saw "a modest recovery under way." Disappointed that his comments weren't more optimistic, investors sold the stock.
Surveys of corporate tech buyers also produce far more moderate growth forecasts than Wall Street's. A recent poll of 931 major companies in North America by tech consultancy IDC showed that fewer than half plan to increase their spending this year. This is especially bad news considering how dismal 2001 was.
Money managers advise putting just 10% to 20% of your money in tech shares
Even if corporate spending on technology picks up sooner than companies expect, the recent market rally likely absorbed most of the upside for tech stocks for the year, says Dave Sherry, portfolio manager with EGM Communications & Technology Strategy hedge fund in San Francisco. Tech-stock valuations are already at multiples far higher than the rest of the market. Merrill Lynch's tech index is trading at 43 times 2002 earnings, while the S&P 500-stock index trades at a forward price-earnings ratio of just 22. Those high prices mean tech stocks have plenty of room to fall even if Wall Street's earnings targets are accurate.
With the sector looking so risky, portfolio managers recommend investing just 10% to 20% of assets in tech stocks over the next six months. Rather than chasing the rally, they advise picking names within tech subsectors that either have proved their resilience in the downturn or are allied with cyclical industries that are about to start ramping up.
INFLOW OF ORDERS. EGM portfolio manager Sherry thinks chipmakers will benefit from an upswing in the cyclical semiconductor market that already has begun. He likes chip-equipment makers Applied Materials (AMAT) and Novellus Systems (NVLS). He even thinks telecom equipment makers -- one of the most beaten-down sectors in the market -- should see an inflow of orders in 2003 as service providers, who've been holding back on purchases for more than a year, start buying new equipment. Sherry's favorites include Internet infrastructure maker Juniper Networks (JNPR) and optical company Ciena (CIEN).
Michael Sandifer, who's on the investment committee for the $1.5 billion Amerindo Technology Fund, thinks auctions and travel have proved to be the Internet's "killer apps," and he believes that some of the top names will benefit further as the economy recovers. He favors auction house eBay (EBAY) and online travel site Expedia (EXPE). Both companies are leaders in their fields, have strong financials, and have enjoyed double-digit annual growth even during the downturn, he says. And most analysts expect their revenue growth to accelerate as the economy improves.
Some stock-pickers will always find techs that do well. Can you?
Howard Sutton, portfolio manager for Canada's $300 million Tera Capital Global Fund, which focuses on high tech and biotech, likes software and services companies that managed to keep growing even during the recession. His fund's top holdings include IBM (IBM), Microsoft (MSFT), Electronic Data Systems (EDS), and BMC Software (BMC). BMC may be especially attractive. Its shares are trading around $18, or about 40% below their 52-week high of $31.
Some smart stock-pickers will always find technology names that will generate good returns no matter what's happening in the economy. But rather than rushing to join the tech party now, most investors probably ought to enter timidly -- until better evidence emerges that the recovery will be strong enough to move stocks higher from here. By Olga Kharif in Portland, Ore.