Breaking the Tech Addiction: Five Investor Delusions About the Sector

Tech investors, it's time for the analyst's couch.

Despite the fact that many big-name tech stocks have fallen 70%, 80%, even 90% in the past year, many tech die-hards can't get beyond their dependency on the battered sector. Consider the evidence: Of the 20 most commonly held stocks in Merrill Lynch accounts, 13 are tech companies. And while tech sector funds have seen redemptions this year, investors haven't been running for the exits: $3.8 billion has been pulled out through July, following net inflows of $53.6 billion in 2000.

Why the love affair with technology? For starters, some of it is warranted.

"While, clearly, the market was irrationally optimistic about the promise of the Internet and of broadband, that doesn't mean that there was nothing real about the potential for growth," says Burton Malkiel, a finance professor at Princeton University and author of A Random Walk Down Wall Street. "There is no question that technology will experience reasonably high growth in the future."

However, investors need to understand the distinction between long-term growth in the sector and the likelihood that tech stocks may not recover anytime this year -- and a recovery in 2002 or 2003 may not involve the stratospheric returns witnessed in 1999. To help investors break the cycle of tech dependency, TheStreet.com has contacted the investing world's equivalent of shrinks: behavioral finance experts. These behavioral financiers, with the help of other academics and market analysts, offer five explanations for why investors still have a fixation on tech; does any of this sound applicable to you?

1. Unreasonable Expectations for a Rebound

The first reason investors don't want to sell out of technology is because "they are holding out hope for a rebound," says Meir Statman, a finance professor at Santa Clara University.

Don't expect that to happen any time soon. The economy is not about to stage a V-shaped recovery. Increasingly, it looks as if the economy's recovery will be U- or L-shaped.

And technology isn't likely to be one of the first sectors to lead the market out of the mess.

"People are waiting for technology to bounce back with the thought that they will get even and get out," adds Terrance Odean, assistant professor of finance at the University of California at Berkeley. Don't hold your breath, the experts say.

2. Underestimating the Correction

Technology stocks had such an extreme run-up that it's likely the corrective process could drag on another year or more. But many investors don't realize this, says Woody Dorsey, president of Market Semiotics, a financial forecasting company.

Many technology companies have seen their stocks nose-dive, but are still saddled with excess inventories and high price-to-earnings ratios . For example, eBay's(EBAY Quote) forward P/E is 134, Cisco's(CSCO Quote) is 41.2 and Intel's(INTC Quote) is 55.3, according to Morningstar. And it's far from clear that these companies will notch the growth necessary to justify these lofty valuations.

Robert Shiller, an economics professor at Yale and author of Irrational Exuberance, calls this denial a continuation of the irrational exuberance that drove these stocks to their highs. "I would say that we are unwinding from irrational exuberance, but it has not gone away," Shiller says.

3. Confusing Tech With Tech Stocks

A third major reason investors are holding on to technology is because they think technology's transforming role in the economy in the next few years will automatically translate to outsize stock returns now and in the future.

Donald Cassidy, senior research analyst at Lipper, says it's not entirely irrational for investors to hope for a technology rebound "since technology has been recognized as one of the economic megatrends of our lifetime."

However, no one knows for sure when technology will stage its comeback, how strong it will be or what subsectors of technology will lead the way. There's a difference between liking an investment sector and being foolhardy about it. That's why it's important for investors to remain diversified, so that as investment sectors rotate in strength, at least part of their portfolio can reap the gains.

4. Haven't Got Time for the Pain

Some investors rationalize that as long as their losses are paper losses, they are not real. They are real, and they may get worse.

"People think a paper loss isn't a real loss and that when you realize it, that's when you kiss the money goodbye," Statman says. "Holding on to these stocks is a way to postpone the pain."

Cassidy calls the relative lack of technology-fund redemptions "remarkable." He figures a main reason technology investors are still holding on is because they don't want to experience "the ego blow of accepting a loss."

5. Waiting for the Bargain Hunters

Finally, some investors may be hoping that because technology stocks have fallen so drastically, this will attract bargain hunters, says Richard Zeckhauser, professor of political economy at Harvard University.

While a few value-fund managers have dipped a toe in a few select tech stocks, it is far from a feeding frenzy. Given the relatively high P/E levels, it's doubtful that there will be a large-scale shopping spree among the bargain-hunting lot.

"There's really no reason to assume that a stock that has gone down 90% in value is a bad stock to own. In fact, they may think that technology stocks have fallen enough and are at reasonable prices," Zeckhauser says.