High Tech Stocks: A World Of Hurt

Foreign markets mirror U.S. concern about profits

Misery loves company--especially when it comes to technology and telecom stocks these days. Not only is the Nasdaq down 14% since the middle of July, tech stocks are wreaking havoc from Japan to Helsinki. Japan's version of the Nasdaq, the Jasdaq, is down 13%, Frankfurt's high-tech Nemax 50 index has fallen 10%, and the Euro.NM growth index is off 8%. Leading the downward charge are such international heavyweights as Nokia, Lucent, China Mobile, and WorldCom.

But don't despair, especially if you're a long-term investor. This global tech swoon is most likely temporary, due to the double-whammy of profit warnings and the fear that the U.S. economy isn't slowing enough. What's more, it's providing much needed relief by bringing valuations down to more reasonable levels and deflating rampant speculation. "Expectations in these stocks got well out of control through the course of last year--not just in the U.S. We're seeing a necessary unbundling of euphoria," says David Bowers, chief global strategist at Merrill Lynch & Co.

TAKING A BREAK. It also doesn't mean that tech will cease being the global market leader. Worldwide demand for high-speed Internet access, wireless, and broadband communications will only increase, say analysts. But for now, tech stocks are taking a break. "The Nasdaq is in the rehab center, and we can't let it out because it will try to sneak a drink at Harry's Bar," says Charles Pradilla, chief investment strategist at S.G. Cowen Securities Corp. Pradilla thinks the tech downdraft will continue through the year's end, with the Nasdaq remaining in a trading range from 3,200 to 4,400.

Not all global tech stocks are in the doldrums. Canadian optical networking company Nortel Networks Corp., for instance, is faring well. And EMC Corp., the top corporate data-storage company in the U.S., Europe, and Asia, recently reported a 50% jump in earnings, and its revenue should accelerate for the rest of the year. Tech stocks that are performing the best have real earnings and strong growth momentum. "You've got to be much more specific and talk about individual companies rather than sectors," says Achim Ferhrenbacher, an analyst at M.M. Warburg & Co.

By and large, however, tech stocks are suffering globally. The biggest reason is that the world's stock markets still closely track the U.S. And in the U.S., third- and fourth-quarter profit warnings from tech companies are mounting. In the past two weeks, WorldCom Inc. and Lucent Technologies Inc. have said that earnings for the second half of the year would be lackluster due to slower sales.

Overhanging the market is the interest-rate/inflation scenario, which could last longer than a bad summer cold. And that's especially affecting richly valued tech stocks. While it's unlikely that the Federal Reserve will raise rates when it next meets on Aug. 22, many strategists and some economists say that another hike before the end of the year is likely, especially if short-term economic data aren't tame enough.

OUT OF FAVOR. Then there are problems within the tech sector. Investors are increasingly questioning Internet business models, especially those of companies that have yet to turn a profit. On July 27, Amazon.com, which already was down 70% from its 52-week high, plunged to its lowest level since December, 1998, as investors lost patience after a second-quarter revenue shortfall. "Investors are finally asking, `Can this company make money?"' says Pradilla. Softbank, the Japanese company that invests in Internet companies, is down more than 70% this year.

Software stocks, too, are out of favor because companies are increasingly selling Internet applications rather than prepackaged, shrink-wrapped programs. BMC Software and SAP, for instance, have turned in dismal performances in the past year.

Global wireless companies such as Nokia, Motorola, and Ericsson have lost their luster in recent weeks. The reason: They predict slower cell phone sales in the second half of this year. Investors are also concerned about the huge fees these companies must pay for the licenses that will allow them to offer mobile data-communications services. Europe already has started to auction off these licenses, and the U.S. will start soon. Yet another issue is the race to see which companies will dominate the third generation of wireless. Even so, analysts say that wireless stocks should start to pick up again when new cell-phone models come out next year.

HARD HIT. And semiconductor companies have been hit hard recently on concerns that the chip boom has peaked and will start to drop off. In an attention-grabbing report issued last month, Salomon Smith Barney analyst Jonathan J. Joseph warned that hard-to-find chips were becoming easier and cheaper to buy, while chipmakers continued to ramp up capacity. The report sent U.S. stocks such as National Semiconductor Corp. and Texas Instruments Inc. downward. It also hit such chipmakers as South Korea's Samsung Electronics, which has fallen some 15% since July 24, and Hyundai Electronics Industries Co., which has dropped 16%.

There's good semiconductor news, however. Analysts say that sales will likely pick up next year as global PC demand increases. Also, companies that manufacture chips for computers are increasingly making them for a variety of New Age communications devices. A rebound in cell-phone sales should also help the sector.

One area that's getting attention: stocks of Old Economy companies that are using technology to their advantage. For instance, Grupo Televisa, the Mexican media company, is using the Net for content distribution. And energy company Enron Corp. uses the Internet as a marketplace and is moving into broadband.

Despite the recent sell-off, investors remain sanguine when it comes to tech. According to a recent study, 46% of investors surveyed by Charles Schwab & Co. say they plan to invest in a tech-focused mutual fund within the next six months, more than double last year's 21%. And with small investors besting gurus in tech forecasting in recent years, that could mean this sell-off is just a bull-market hiccup.