Justin Lahart

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Worth Watching: How Tech Firms Come to Terms With Their Own Missteps

Justin Lahart

When John Chambers, the Cisco Systems (CSCO Quote) CEO who has lately been doing pro bono work as Silicon Valley's whiner-in-chief, began talking this winter about how the U.S. economy had entered recession, a lot of people stood up and took notice.

This was Chambers, after all, the inveterate optimist whose company was pretty much the symbol of the New Economy. Cisco was supposed to be bulletproof, the outfit that made the stuff that everybody couldn't afford not to have. If Cisco was feeling the effects of the U.S. downturn, things had to be bad.

"It makes no difference what the Federal Reserve or the latest statistics say," Chambers told the Swedish newspaper Finantidningen in February. "What we see now is absolutely not a soft landing. Ask anyone in American manufacturing industry and they will say that we are in a recession."

Earnings (or the lack thereof) season has just kicked off, and you can be pretty sure that lots of other tech companies are going to be grousing about how bad the economy has become. Motorola (MOT Quote), the cell-phone maker with a penchant for disappointing Wall Street, was a fine example. In the press release that accompanied the company's estimate-missing quarterly report, CEO Chris Galvin said: "We see a continuing downturn in the U.S. economy beginning to spill over to the rest of the world. The high-tech sector, which has been hit hard, is already in a recession. These issues, plus interest-rate policy or energy prices, cannot be controlled by Motorola." The suggestion is the same as Chambers': The U.S. is in recession and the Federal Reserve has messed up.

The U.S. is not in recession, however. It has slowed, yes, but it appears that the economy continued to grow in the first quarter, and there are signs that it may have begun to reaccelerate. Moreover, while tech companies may be laying crepe, Old Economy companies say they're seeing signs of improvement. Though sales were down for the Big Three automakers in the first quarter, they came in better than either industry analysts or the industry itself expected. Now it looks like the automakers actually will be stepping up production in the second quarter to meet demand.

The difference between tech companies and the car companies is that the car companies saw the slowdown coming, and started cutting back production and working down inventories in the fall. In contrast, tech companies appear to suffer from the same problem that people used to criticize Jackie O. for -- believing her own press -- and thought they were somehow immune to a slowdown. This left them incredibly wrongfooted for a cooling in demand, and that's hurt them badly.

At the beginning of the year, industry analysts, who take their cues from the companies they follow, forecast that tech-sector earnings would grow by 4%, according to Thomson Financial/First Call. Now the expectation is that earnings will decline by 37%. It's understandable that such a rapid deceleration has got tech CEOs and analysts bandying about the R word. And given Wall Street's continued infatuation with tech stocks -- they make up about 17% of the S&P 500 and 75% of the headlines -- it's understandable that plenty of people in the market believe the U.S. economy is in recession.

"You gasp when you see the Nasdaq down 70%," says Lehman Brothers chief economist Steve Slifer. "It distorts things."

Yet away from the stock market, Slifer says things don't seem quite so gloomy. While it's certainly true that the economy has slowed and that the Fed has some more work to do, the consumer continues to hold up remarkably well. Even after Thursday's somewhat weaker-than-expected retail sales report, Slifer reckons that consumption grew by about 3% in the first quarter -- and "that's when the stock market was getting absolutely powdered."

Or, to be more accurate, when tech stocks were getting absolutely powdered. Other areas have not suffered the same kind of declines, notes Trilogy Advisors chief investment officer Bill Sterling. "The fact that the nontech stocks have had a moderate correction but nothing approaching a nasty bear market here may be telling you something about the real economy," he says. "There was a technology boom and then a bust and the rest of the economy has just been puttering along."

It may have been that a lot of people's portfolios were so heavily invested in tech stocks that it gave them a disproportionately poor view of what's really going on in the economy. Bank One deputy chief economist Diane Swonk, who works out of Chicago, notes that she's considerably more upbeat about the economy than many of her Wall Street counterparts, and reckons a lot of this has to do with how much closer they are to the market in general and tech stocks in particular. The boom in tech stocks in the late 1990s overstated technology's importance in the overall economy, according to Swonk, and it has been hard for people to let go of that. The idea that technology companies could suffer so deeply while the rest of the economy does OK is still anathema to a lot of investors.

It will not remain anathema forever if tech companies continue to suffer as the economy rolls along, however unsteadily. Investors will eventually conclude that the trouble in tech had as much to do with the failure to appropriately react to an economic downturn as with the downturn itself.

And guys like John Chambers simply won't command the kind of respect they once did.