Technology stocks demonstrate cyclicality

Investment experts continue to issue messages of calm despite some wildly fluctuating movements in the stock markets, particularly the tech-heavy NASDAQ

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By  Barnaby Chesterman Published  February 6, 2001

Volatility|~||~||~|Volatility, unpredictability, decline and disappointment may have been the words on every technology stocks investor’s lips in recent months (amid a flurry of profit warnings from many technology companies listed in the markets) but the word on the lips of some of the top industry experts is ‘cyclical.’

Once again, despite, the apparent volatility of the tech-heavy NASDAQ stock exchange, the message being delivered from the experts is keep calm and patient and wait for tech stocks to deliver, because they will. In fact, January has seen a slight change in fortunes for tech stocks resulting in renewed faith from investors.

“Momentum is favourable for tech stocks now,” says Rossen Djounov, investment director at Forsyth Partners. As long as the US Fed continues to support the markets with its favourable interest rate cuts, then fears about the future for tech stocks should prove misguided, experts believe. “The only negative thing is visibility,” adds Djounov.

Due to a drop in speed of earnings, speed of profits and speed of sales over the last two to three months, he feels it is difficult to predict what’s going to happen in the stock markets. “Short-term, these investments are good,” he insists. “People are not as worried as they were.”

This momentum that Djounov talks about began when the US Federal Reserve slashed interest rates by a half point, from 6.5% to 6%. The Federal Reserve took the action to halt fears of a nation-wide recession, and with another quarter or half point cut expected at the end of January (after this publication went to press) most stocks will be expected to surge again.

On January 3, when the Fed cut interest rates, the NASDAQ gained 325 points, more than 14%, its biggest ever one-day gain. Yet despite that, the NASDAQ still managed to lose value on the week as a whole. Another good three-day period in the middle of January, however, meant that tech stocks recovered and were up overall on the year to date.

Sung Won Sohn, chief economist for Wells Fargo & Co., said the interest rate move was needed to keep the economy from snowballing into recession. He added that the possibility, which he had put at 40%, was diminished now. “The wealth effect is so important in today’s economy, and this could have an immediate effect on consumers’ ability and willingness to spend the money,” he said.

||**||Stop the Rot|~||~||~|Gareth Watts, director of North American equities for SAMBA Capital Management International, believes the Fed had to act to halt the capitulation of the markets. “For a few weeks before the Fed acted, the whole thing was spiralling downwards,” he said. “There were several days of really bad market moves, so short-term investors were covering like mad and just getting rid of their stocks.”

Despite an avalanche of profit warnings from major technology companies, which was cited as a major reason for the continued slump in share prices at the beginning of January, stocks recovered through the middle and latter parts of the month, before this publication went to press. According to Watts, the profit warnings were merely intended to lower expectations, partly to guard against shareholder lawsuits.

As of January 4, some 108 technology companies had issued profit warnings for the quarter ending December 31. That was a huge increase of 145% from the same period the previous year. At the same time only 24 companies had announced that revenue or earnings would be better than expected, according to Chuck Hill, director of research at First Call/Thomson Financial.

Hill also added that although analysts predicted in October that tech stocks would grow 29% in Q4 of last year and 28% in Q1 of this year, those estimates had now been slashed to 3% and 4% respectively. “In addition to a slowing of consumer and capital spending, it may be that current PC products are running out of gas,” he said.

Not everyone is dismayed by the withering of tech shares, though. In fact, many on Wall Street still believe they are overvalued. “We’re in a bear cub market, or a bear market that runs fast,” says Bruce Brent, president of Reserve Funds, a New York-based money funds company. He believes that the market decline is generally good, because it leads to realistic pricing. “The lower valuations will scare away people who shouldn’t be in the markets,” he adds.

Watts isn’t too concerned about the profit warnings either. “The profit warnings come out first but then those that make their numbers come out later,” he says.

||**||Redistribution of Value|~||~||~|According to a report by Mercer Management Consulting, the ‘New Economy’ is experiencing a fundamental redistribution of value. Business-to-consumer (B2C) e-commerce companies lost 70% of their shareholder value in 2000, and some B2C portals, business-to-business (B2B) marketplaces and application service providers (ASPs) lost 80% of their value. This redistribution has seen infrastructure hardware and security software make the most headway, according to Mercer.

However, this period of losses and uncertainty has affected investors. It all came to a head in November last year according to Forsyth’s Djounov. “A lot has changed in the last two months,” he says. “By November a lot of fund managers and investors had thrown in the towel and got out at any cost. Investors became risk averse.” But that left them with cash burning a hole in their pockets.

Interest rates had to come down to halt the slide, but since then the market has woken up. Technology stocks started posting gains again. Back in March of last year, just before the famous correction in April where many dot.coms crashed spectacularly and went out of business, there was a huge disparity in evaluation of stocks in favour of technology. But now the opposite is the case, according to Djounov, and sectors such as health and energy have benefited from an upsurge in valuations.

Certainly some areas of technology were harder hit than others but Watts believes there’s going to be a soft landing now for tech stocks in general. “There could be a few more bumps along the way, but we think they’re going to have a soft landing,” he says. “Short-term there could be a lot more volatility - they’re not out the woods yet.” But in the longer term Watts still believes quality companies will grow. “Technology is an important part of the economy,” he says. “In the second half of the year things should stabilise.”

Djounov is also quick to point out that a lot of the despair surrounding tech stocks is purely relative to the astronomical prices stocks commanded a year ago. “Technology stocks still have earnings growth,” he says. “Despite the slow down they’re still the fastest growing stocks. And seeing as growth is cyclical, so technology earnings will reaccelerate again.”

In fact, viewed in relative terms, Djounov feels tech stocks are more attractively priced than 12 months ago. He says in the next 6-12 months they will still represent a good buy. “All innovation is coming from technology,” he stresses. “Nine months ago people were prepared to price them to eternity, but now there’s a more balanced view.” Investors will be hoping that is the case, so another famous correction doesn’t send everyone into turmoil again.
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