Don't Hightail It Out Of High Tech

So it didn't match the S&P--it's still the fastest-growing sector of the economy

If you're thinking about investing in technology, prepare to ride a roller coaster. One of this year's highest-flying technology mutual funds, a year-old Internet fund called Munder NetNet, finished the first quarter down 20%. By mid-July, it was up 15%. On Oct. 21, it peaked for the year, up 41%. From there, it was downhill again, closing on Dec. 12 with a 27% total return.

Feel queasy? So do even the most seasoned technology investors going into 1998. Tech stocks have always been volatile, but rarely do they swing so wildly. The Pacific Stock Exchange Tech Index took three major plunges this year, falling 11% in the spring, 14% in October and November, and another 10% during the week of Dec. 8. Worries abound that more trouble lies ahead. "There's a lot more fear and anxiety built into tech stocks than there's been in years," says Kevin Landis, manager of the Technology Value Fund.

PC SLOWDOWN? Is it time to hightail it out of technology? Not a good idea, most experts say. Technology is still the fastest-growing component of the U.S. economy, with profits still expected to grow 22% next year vs. 21% in 1997, according to First Call Corp. in Boston. And technology stocks have done well over the long haul. True, after the sharp December correction, tech stocks were up only 15.3% for the year through Dec. 15, vs. a rise of 30% for the Standard & Poor's 500-stock index. But since the bull market in technology stocks began in July 1994, tech stocks are up 160% compared with 119% for the S&P 500.

Still, experts expect a lot more choppiness ahead. Their biggest fears: more fallout from Asia's economic crisis, and a slowdown in the personal computer industry. In recent years, most tech fund managers routinely predicted that tech stocks would outperform the Standard & Poor's 500 index the following year, but this year many are reluctant to do so. One still-bullish manager willing to predict that tech stocks will beat the S&P next year, Seligman Communications & Information Fund manager Paul H. Wick, thinks this autumn's corrections have pushed technology-stock prices below those of the broader market, making them ripe for big gains next year. But he cautions: "A number of high-profile companies will have big negative surprises."

Exhibit A is Oracle Corp., whose stock plummeted 29% on Dec. 9 after the company disclosed a slowdown in sales to Asia. Many pros believe more companies will reveal bad news over the next six months as Asian companies scale back investments. "Companies that don't admit they're going to be hit (by Asia) are in denial," says Adam Hetnarski, manager of Fidelity Select Technology Fund.

One uncertainty in the personal computer market is whether the popularity of $1,000 PCs will expand demand or eat into sales of more expensive PCs. Also of concern is that buyers will delay new computer purchases until late in 1998 when Microsoft Corp. is expected to introduce a major new operating system. "The problem is that there's no reason right now to upgrade PCs," Hetnarski says. Some technology consulting firms are predicting that personal-computer sales growth will slip to around 14%, only slightly below their historic 15% to 18% annual growth rate. But it could mean profit disappointments across a broad swath of the technology industry, including semiconductor companies and peripherals makers.

The good news is that high anxiety over technology stocks has brought prices of some companies down to what many experts believe are bargain levels. Top tech investors say that amid the rubble of this fall's corrections are jewels that were unjustifiably discarded. "The negative sentiment makes a great entry point to buy tech stocks," says Landis.

So where are professional tech investors placing their bets entering 1998? One favorite sector is the much-maligned semiconductor capital equipment group. Stocks in this sector are being hit hard because Asia buys a large portion of the world's semiconductor capital equipment. But one company that will avoid the carnage is KLA-Tencor Corp., a company that specializes in inspecting silicon wafers for damage, says Wick. He thinks that KLA-Tencor has a technological edge that will boost profits more than 30% in 1998. Its stock, meanwhile, has plummeted 55% from its August high of 76 7/8, resulting in a below-market price-earnings multiple of 12 times his 1998 earnings estimate.

Another underpriced chip-equipment stock is Integrated Process Equipment Corp., Landis says. Although the company will be hurt by Asia, its technology is critical to the production of advanced chips, and "the world will eventually need what they sell," Landis says. At 15 1/8 on Dec. 15, Integrated's stock is off more than 50% from its October peak of 36.

SIZE MATTERS. Communications equipment suppliers are also favorites. Although wireless telecommunications companies have been hurt by Asia, investors think that giants such as Lucent Technologies, Northern Telecom, and Cisco Systems will benefit from strong U.S. demand for equipment that integrates voice and data in networks. Richard D. Wallman, manager of Dreyfus Corp.'s Technology Growth Fund, says market leaders in this fast-paced business have a big advantage over smaller rivals, and recommends all three companies.

Bellwether IBM is due for another good year in 1998, though its stock is not likely to duplicate its 28% gain this year through Dec. 15, predicts Paul H. Saperstone, technology analyst for State Street Research & Management Co. in Boston. Saperstone thinks that earnings will grow about 13%, the company should report its first gain in pretax operating income in years, and its market multiple, now about 14 times estimated 1998 profits, could get a boost if interest rates decline. Under that scenario, he thinks IBM's stock could rise as much as 20%.

The Munder NetNet fund, a top performer despite its stumble in December, is concentrating its bets on a red-hot market: Internet stocks. The NetNet fund owns companies that are bound to benefit from the Internet's growth. The fund's top holdings include three financial-services firms that rely heavily on the Net: E-Trade Group, Ameritrade Holding, and Charles Schwab & Co.

The fund also owns shares in two popular high-tech consulting firms, Forrester Research Inc. and Gartner Group, plus telecom giant WorldCom Inc., which will become the leader in handling Internet traffic when it completes its acquisition of MCI Communications Corp.

RAPID-FIRE TRADING. Like most tech fund managers, NetNet co-managers Paul T. Cook and Alan H. Harris have no idea how long they will hold onto their current crop of stocks. Their turnover ratio is close to 200%, meaning the fund traded twice the value of its assets last year. Such rapid-fire trading is standard procedure for professional technology investors, and it creates huge market risks. Sentiment towards a technology stock or an entire sector of the industry can change in a matter of minutes, resulting in volatility rarely encountered in other industries.

If you're hoping to find safety and consistency, avoid high tech. But if you're prepared for alternating bouts of euphoria and misery, now may be a good time to pick up tech stocks on the cheap.