Rate Cut Spurs Tech, but Has the Economic Horse Left the Barn?

It's the sort of counter-intuition that could come back to haunt investors very soon. Tech stocks put together one of their biggest and broadest rallies ever after the Federal Reserve's emergency rate cut confirmed Wall Street's worst fear, that the longest-running economic expansion in U.S. history may be nearing its end.

No stocks have reacted more hotly to the Fed move than those in the Internet infrastructure sector. In recent months, fears of a slowdown in information-technology spending by big corporations have taken stocks like JNI (JNIC), Emulex (EMLX) and Network Appliance (NTAP) well off their highs. But the Fed move had those same stocks rocketing more than 20% higher -- like nearly every other infrastructure stock.

At least for one afternoon, investors are showing remarkable confidence that Fed boss Alan Greenspan is doing what it takes to engineer a so-called "soft landing" for the economy. But some remain cautious in the midst of this ebullience.

20%, Anyone? Infrastructure Stocks Get Jazzed
Stock	Percent change	Trailing price-earnings ratio
QLogic (QLGC:Nasdaq)	+32.4%	155
Veritas Software (VRTS:Nasdaq)	+30.9%	N/A
McDATA (MCDT:Nasdaq)	+30.2%	305
Sun Microsystems (SUNW:Nasdaq)	+29.7%	53
Emulex (EMLX:Nasdaq)	+27.9%	156
EMC (EMC:NYSE)	+24.5%	106
Network Appliance (NTAP:Nasdaq)	+24.4%	267
JNI Corp. (JNIC:Nasdaq)	+22.2%	69
Finisar (FNSR:Nasdaq)	+19.5%	N/A
Brocade (BRCD:Nasdaq)	+16.9%	315
Source: ILX

Saturation

"It's sad," says Fred Hickey, editor of the High Tech Strategist newsletter. "We have things completely saturated out there after years without correction of excesses, massive consumer and corporate debt, the Nasdaq at a 100 P/E and the S&P 500 trading at 25 times earnings. Oh yeah. Everybody's going to run out and buy a new PC or new cars or new houses. We've already done that for the last 10 years, Greenspan. Thank you for the collapse that's coming."

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Fed Scorecard

Things needn't collapse for investors' hopes to come crashing back to earth. A soft landing, after all, implies softening -- not the sort of thing to make people feel better about price-earnings ratios well above 100, a nosebleed level to which infrastructure stocks are not unaccustomed. At the same time, the emergency move suggests that the Fed considers the risk of recession more serious than most observers had been thinking. "It just confirms that things are looking pretty brutal out there," says Lehman Brothers analyst Dan Niles.

Niles is one of a growing number of observers who think that a slowdown in companies' spending on information technology will exert corresponding pressure on tech vendors' earnings next year. He cut his earnings estimates for both Intel (INTC) and Dell (DELL) on the premise that the recent weakening in the corporate PC market isn't going to disappear. Moreover, Niles reckons that the year-over-year growth of IT budgets in 2001 will be 3 to 5 percentage points below the current 10% International Data Corp. forecast.

Incrediburgible

It's unlikely that a Fed cut will have much of an immediate impact on corporate, much less consumer, spending. That fact could weigh heavily on infrastructure stocks of all stripes -- even stalwarts like Sun Microsystems (SUNW) and EMC (EMC), each of which have built incredible revenue growth on the phenomenon of free spending by corporations on the tech gear necessary to participate in the New Economy.

Sun's management in particular has made a forceful effort to distance itself from the troubled Internet sector, making the case to analysts that the large, traditional corporations are its most vital customers. And neither Sun nor EMC has lowered guidance for either the current quarter or longer term. But the Fed may see something coming that those firms don't.

"We've got a big Fortune 500 problem coming, not just with small companies," says Niles. "The data that's coming in is telling me that we're screwed."

Screwed and up 20%.

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