Updated from 6:57 a.m. EST
investors are probably reaching for the Dramamine right about now.
After surging 7.5% in the first few weeks of January, the index has proceeded to give up that gain and then some, recently moving below its Dec. 31 close of 2003.37 to touch 1993.24 in early Tuesday trading. Meanwhile, the Nasdaq tracking stock known as the
Nasdaq 100 Trust
is slightly down for the year after being up almost 6% in mid-January.
This kind of volatility isn't altogether surprising. Last year, the Nasdaq was on fire, soaring almost 50% as many companies rebounded sharply after hitting a low in 2002. As 2004 began, the momentum was still buzzing and a stellar fourth-quarter reporting season helped propel the Nasdaq to levels not seen in 30 months.
But with all the good news priced in and valuations growing excessively, tech stocks began to decline. The question investors are now asking is whether the correction has run its course or whether there's more heartache to come.
Paul Nolte, director of investments at Hinsdale Associates, thinks the Nasdaq is in a precarious position. If the index falls below 2000, he believes that could pave the way for a deeper correction to the 1700 or 1800 area. The Nasdaq is currently sitting at 2007.
"The market internals are confirming that the high in the
Nasdaq market in mid-January is likely the high for
the first half of the year," he said.
Total advancing volume compared to declining volume has fallen to its lowest level of the year, and advancing volume as a percentage of total volume is at its lowest percentage in more than 12 months, he noted.
Although Nolte expects both the broader market and the Nasdaq to correct going forward, he "fully expects" the Nasdaq and technology names to underperform.
Jeffrey Saut, chief investment strategist at Raymond James, advises investors to underweight high-beta names, specifically tech and telecom stocks. Even though
reported good news last week, Saut said both companies saw their share prices fall, indicating that the rally is over.
Applied Materials beat analysts' expectations last Wednesday and forecast higher orders for the current quarter. Meanwhile, Broadcom raised its first-quarter revenue outlook, citing strong demand. Broadcom slid 3% over the next two days while Applied Materials fell 2.5%.
Some analysts are concerned because capital spending has recently started to slow down overall. In the fourth quarter, business investment rose at a 6.9% rate after a 12.8% gain in the third quarter. Investments in equipment and software increased 10% after a 17.6% rise in the prior quarter, according to the Commerce Department.
In addition, technology earnings, like
earnings as a whole, are expected to decelerate this year. After climbing 54% in the fourth quarter, tech earnings are seen rising 50% in the first quarter, 47% in the second, 31% in the third and 16% in the fourth, according to Thomson First Call.
While these numbers still sound impressive, many tech companies are trading at extreme valuations and there's little room for disappointment. Both Broadcom and Applied Materials sport price-to-sales ratios of more than 7.
"The great earnings performance that the technology world is anticipated to deliver this year is already pretty well reflected in the stocks, and that's what investors are cashing in on right now," said Charles Crane, a strategist at Scotsman Capital Management.
Crane said the gap between high- and low-beta stocks became so wide last year that the market is in a natural correction process. While the Nasdaq was up about 50% last year, the S&P gained about 26%. "I wouldn't be surprised if in 2004 the returns on the Nasdaq are less than those on the S&P 500 or other more conservatively constituted indices," he said.
Don Hays, president of Hays Advisory, is looking for all stocks to consolidate over the near term, but is optimistic about the duration of the downturn.
"We suspected that the downside damage for the S&P 500 and Dow Industrials would not be all that great," he said. "Even for the Nasdaq and Russell 2000 types, we doubt the damage will be more than a nominal 8% to 10% zone of ebbing and flows."
Hays said growing skepticism should be balanced out by strong earnings and economic growth. "The bottom line is, of course, that this is nothing more than a short pause, and a prelude to what we suspect will be the last nice rally into Election Day."