Tech Trend: Friend or Fantasy?

Too many investors -- not to mention analysts and financial journalists -- suffer from the same affliction: a short attention span. A bit of news here, a rumor there and suddenly we have a trend.

Case in point: the March quarter. No sooner had it ended than a flurry of warnings, particularly by software makers, threw many of us into a tizzy. And when IBM(IBM) sprang a surprise miss on the market on April 14, there was such consternation that it is probably a good thing windows in most offices can no longer be opened.

Remember what happened the next day? The Dow Jones Industrial Average closed down 191.24 points, or 1.86%, to 10,087.51, marking a three-day decline of more than 420 points, or 4%. The S&P 500 fell 1.67% that day, while the Nasdaq Composite fell nearly 2%, bringing its three-day loss to 4%.

But five weeks later, the "dead" technology sector is back in favor. The tech-heavy Nasdaq is once again north of 2000, closing Monday at 2,056.65 for a gain of 4.5% over two weeks, while the Dow reached 10,523.56, a gain of 1.7% over the same time period.

And the big cigars of the investment banking world are once again urging investors to buy tech stocks; in the last week two major houses have upgraded the software sector, while a third boosted the entire technology group.

Meanwhile, some sell-side analysts are now calling for an end-of-year rally in technology, which implies that investors need to buy ahead of it.

How could the sector heal itself so quickly? Actually, it didn't. Technology companies aren't much different in May than they were in April. Simply put, the first quarter was never as bad as some people thought, and the next quarter or two may not be as good as some are thinking now.

"I'm generally favorable on the tech sector," says Loomis Sayles analyst Tony Ursillo. "Valuations are attractive despite recent appreciation, companies are being more responsible in capex and spending on acquisitions and share buybacks, and companies are managing more reasonable objectives," he adds.

While not stellar, tech's first quarter of earnings was more of an average one than a stinker. In a typical quarter, 59% of the tech stocks will beat expectations, 21% will match and 20% will disappoint, according to Thomson Financial analyst John Butters. With 72 of 80 companies reporting so far, 57% did better than expected, 26% equaled expectations and 17% were subpar.

Bottom-line growth averaged a modest 15% year over year, compared with 68% growth in the first quarter of 2004. Butters points out that last year's first quarter was exceptionally strong; tech stocks grew by 21% in the first quarter of 2003.

Besides misjudging the overall strength of the quarter, some investors either watched the wrong companies or drew the wrong conclusions from the right companies.