Meet the Street: Support for the V-Shaped Recovery Makes a Comeback

What a difference a week makes.

Allan House Technology Analyst, Federated Investors

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With stocks rallying sharply last week following several encouraging earnings reports, support for a V-shaped recovery for the economy has undergone a revival. One of its supporters is Allan House, a software and telecom analyst at mutual fund company Federated Investors. House believes low inventories and President Bush's economic stimulus package are likely to prompt businesses to invest in technology once again.

Not every tech stock is going to move up, though. House is concentrating on those that are coming out with earnings that don't fall too short of expectations and that have solid fundamentals.

Read on to find out the tech stocks House is recommending to Federated's portfolio managers, and why he's cautiously bullish about the technology sector and the stock market overall.

TSC: What's your outlook for capital spending for technology?

House: [Oct. 10] was when, I believe, sentiment began changing for a lot of these names: Ariba(ARBA), Commerce One(CMRC), i2(ITWO), Lucent(LU), Nortel(NTL), Cisco(CSCO), Microsoft(MSFT), PeopleSoft(PSFT), Oracle(ORCL). It goes across the gamut.

The sell side had brought down a lot of their estimates after Sept. 11, and some of them [did so] almost indiscriminately. As a result, we had very wide estimates out there for companies. To give you an example, Siebel Systems(SEBL), which makes customer relationship management software -- this quarter, their estimates were anywhere from 5 cents to 14 cents, and for next quarter, it was anywhere from 9 cents to 18 cents.

Being on the buy side, we look at these estimates and we know that there obviously were a lot of problems out there. We wanted to see what worst-case scenarios were out there, so a lot of times we'll take the lowest number, discount a little bit and then create our prices there.

[The week of Sept. 30] really did not have any major preannouncements for really huge software companies such as Microsoft, Siebel and PeopleSoft. The announcements that did come out were companies like Mercury Interactive(MERQ), which is more of a tier-two software company. And even though they didn't meet the estimate number, they came in above the lowest number. As a result, the stocks started to rally.

TSC: Just coming in under the wire, is what you are saying?

House: They are coming in just above the wire. A lot of us were expecting the worst-case scenario. Stocks had sold off on worst-case scenarios. So then what happened is that we started bidding them up based on the [idea] that maybe the worst case was too [extreme].

Prices tend to move before the fundamentals improve. So what was happening was, the stock prices started to move, and this started [Oct. 10] and if we hadn't had the FBI come out mentioning a possible terrorist attack, and if we hadn't had the anthrax [case at NBC] up in New York City, I think the market would probably have continued to rally [Friday] into the middle of [this week]. Now it will be a waiting game because we have gone from very low valuations back to the high end of historical valuations. Some stocks are likely to continue to rise through the middle of [this week] simply because they have not reached price parity with their peers.

We had Juniper Networks(JNPR) come out [Thursday night] with great results. In a bad market, they still went up 20% on Friday. You had Network Associates(NETA), which was supposed to have zero cents per share in earnings. They came out with five cents and raised guidance going forward. Those types of companies are continuing to incrementally bring in good news and people are starting to feel a little bit more confident going forward.

We are looking past the valley. A lot of these economists on Wall Street are saying we're in a V-shaped recovery.

TSC: That's interesting, because by the middle of this year, a lot of them gave up on the V because it was looking foolish to support such a rebound.

House: Back in April, stocks sold off in anticipation of very, very bad numbers coming out -- very, very bad guidance. At the same time, back in April, many of the Wall Street economists were talking about a V-shaped recovery.

Well, the first day of April, we sold off. The second day, we were flat. The third day, the stocks started to move up [for] the same reason as this time -- because we didn't have any true, large, big-name technology companies come out and preannounce. So what happened [last week] was stocks took off before the fundamentals.

Going into the second quarter, stocks started selling off all the way until last Wednesday [Oct. 10] on the fact we were heading into a recession, [thinking] maybe this was a U-shaped recovery, maybe it was going to last longer. Then all of a sudden we have the terrorist bombing. That throws another wrench into everything.

Then, all of a sudden, no more preannouncements. Economists are starting to talk about a V-shaped recovery. Government is talking about stimulus packages. We have the Fed continuing to cut rates. People are feeling better about the V-shaped recovery. Earnings preannouncements coming out aren't as bad as we had thought, and some aren't even coming out.

Maybe the world isn't coming to an end. The best companies are going to survive. And, in fact, they are going to thrive next year. So we started bidding them up, starting with the hedge funds covering their shorts, [which] started artificially moving the stocks up. Then the institutional buyers and momentum players saw that this was happening, feeling a little better about what was happening geopolitically and then started to jump in.

And that's where you saw a lot of excitement.

TSC: What does this mean for capital spending? Can it possibly improve, given the recessionary state we seem to be in?

House: To say technology in general is going to improve is difficult, because there are some areas in technology, such as carriers like AT&T(T), SBC(SBC) and Verizon(VZ) that have talked about reducing their capital expenditure. So that area is having problems.

Until two weeks ago, I would have said the same for technology in general. But now what we are starting to see is that the government is trying to create some incentive for companies to spend. We are talking about reducing the time for depreciation, giving some incentives for companies to actually go out there and spend money.

So what my thoughts are now -- and I think the Street is beginning to see some of that, too -- is that these companies that were going to defer these purchases because of the economy, the Sept. 11 attack and the uncertainty, may, in fact, decide, "If the government is going to give me an incentive to buy some of this, why not go out and buy some of this?" So that's why you are starting to see some of these areas starting to move, too.

A lot of those stocks have run. A lot of the sell-side analysts missed it, and now what we are going to have to do is wait and see if the fundamentals improve. The companies that show fundamental improvement, in sales or whatever, may rally by the end of the year.

TSC: You advise a couple of the Federated funds. Could you mention a couple of the big ones, and could you also tell us what stocks you are telling those portfolio managers to buy?

House: We have the (FGSAX)Federated Growth Strategies fund, (FCTAX)Federated Communications Technology fund, (LEIFX)Federated Equity-Income fund, and some value funds.

For many of the funds, I have been recommending Microsoft and Oracle. Right after Sept. 11, I picked six software names that I feel very comfortable with going forward and I have since added four more. The 10 are: Microsoft, Oracle, Computer Associates, Siebel, Checkpoint(CKP), Veritas(VRTS), BEA Systems(BEAS), PeopleSoft, Mercury Interactive and Citrix(CTXS).

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