A Dismal Day on the Nasdaq: There Is Change in the Wind

Techs have hit a rough patch, and the underpinnings are shaky. Be cautious when they tell you to look over the valley.
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Today was a fine mess on the

Nasdaq

. The Comp tried to rally, floundered and then flopped to its lows at the end. Leading tech companies like

Cisco Systems

(CSCO) - Get Report

and

Corning

(GLW) - Get Report

were drilled.

Cisco's stock broke down below its 200-day moving average for the first time since late May, when it touched that level before rebounding. There was no rebound today. Most disturbing to me was that the Comp's reversal took place without a lot of bad news. Nor was there a spike in volatility. And that suggests to me that the tech sector could go lower. Bottoms don't get built amid complacency.

Meanwhile, the Dow held up. It was driven significantly by the accurate rumors that

Chase Manhattan

(CMB)

will

buy

J.P. Morgan &Co.

(JPM) - Get Report

But less-expensive, higher-dividend stocks, both big-cap and small, also hung in there. What names?

Johnson & Johnson

(JNJ) - Get Report

,

Coca-Cola

(KO) - Get Report

and

McDonald's

(MCD) - Get Report

. The small-cap

Russell 2000

was only a bit in the red.

What do I make of all this? The post-Labor Day Nasdaq is in trouble, and relief may not come any time soon. Are we looking at a bear market in tech? I don't know.

You can make the case that many tech stocks will recover at the end of the preannouncement season, when companies with problems confess. (That takes us pretty much to the end of September.) The notion here is that the absence of accurate information is causing the problem, and that when these companies report great numbers, the market will take off again.

The problem with that analysis, for most investors, is that if the companies do disappoint, the outcome will be horrible. The stocks will be pulverized. And if you are not a hedge fund manager who can protect your longs with equally aggressive short positions, you will be dead meat in the event of bad news in your highfliers. Whatever pain you have already experienced in your portfolio, you will see more.

Let's say the U.S. economic "soft" landing turns "hard" because of an oil-induced snag in consumption here and abroad? Let's say the U.S. productivity growth rate slows a bit? You will see missed earnings. And you will see cracks in stocks already priced for perfection, which I would say includes any stock selling for more than 100 times trailing earnings.

Here is

Morgan Stanley Dean Witter

U.S. strategist Byron Wien, in a report released Tuesday: "Despite the abundance of good news

in the technology sector, I believe it is pretty much priced in. You can make a case that stocks are fairly valued, but I continue to think they are overvalued. I believe there are two markets, with technology still richly priced. Moreover, if anything goes wrong from here, I don't think the markets are prepared to handle it."

Byron's takeaway: "I don't look for a significant decline, but I expect the market to struggle through year-end.

Byron's colleague, strategist Peter Canelo, is more bullish in the same report. He thinks technology earnings will be a knockout and that tech's current difficulties are "typical overreactions by investors going into the pre-announcement season."

Canelo also expects the slowing economy to pick up by the second half of next year. "We expect investors to look over the intervening valley of slower growth, toward the pattern of stronger earnings that should lie ahead."

Canelo is a smart guy. But in my experience, when you hear guys on Wall Street tell you to look over a valley, you should proceed cautiously. Typically, the valley is deeper and longer than they anticipate. And you can be sure that most other investors are not going to wait around to hit the canyon floor.

So the question remains, "Has something changed in the market to make tech stocks more risky than is generally appreciated? I don't know. But I am sure that something has changed in the dynamics of the market. Demand for tech stocks is not what it was before the correction earlier this year. Yes, some stocks have recovered to their prior highs, but most tech stocks remain closer to their lows. This price action has some meaning.

One of the wisest analysts on Wall Street,

Merrill Lynch's

senior investment adviser, Robert J. Farrell, expressed my worries in a report last week called "Wringing Out the New and Ringing In the Old." Farrell wrote: "Now that investors are heavily overweighted in New Economy, IT-related stocks and have priced them to perfection, they are realizing that even great beauties can grow warts. We think an extended sorting-out process has gotten under way that will separate the core leaders from the many losers."

Tomorrow, I will talk more about where Farrell would put money.

Brett Fromson writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

bfromson@thestreet.com.