Time for a correction?
With tech stocks retreating Friday despite nearly unalloyed good news from
, investors must ask themselves whether the party's close to over on the
The tech index, home to bellwethers such as
, briefly traded above the 1800 mark for the first time in over a year on Friday, making investors wistful for bubble days.
The index hit a 16-month high last week and is up more than 40% since starting its climb in October. But after being burned by an almost 80% drop in the Nasdaq Composite over less than three years, and with the index unable to hold its gains Friday, the question now is whether tech stocks are getting ready to consolidate lower.
"Judging by Friday's action, yes, the market could be ready for a pullback," said Frank Gretz, technical analyst at Shields & Co. "It seems the market got what it wanted, and as soon as the news was out, investors were already thinking: 'What do we do next?' So the market may have discounted a lot of the good news already."
One answer will come from the technology companies themselves, which must grow fast enough to justify such buoyant stock prices. Intel, for one, sounded a positive note Friday by lifting its revenue forecast and saying its gross margins will be better than expected in the third quarter.
"Intel's comments bode very well," said Ozan Akcin, chief market strategist at Puglisi & Co. "Companies won't guide upwards unless they have a real reason to do so, so this is significant."
But is one player enough to get the game going?
To be sure, many tech companies posted encouraging profits last quarter. Average earnings in the space rose 20% in the second quarter, with the average profit coming in 5% higher than analysts expected, according to Thomson First Call.
Things could improve considerably in the third quarter, with tech earnings poised to grow 75% on average. But Ken Perkins, research analyst at Thomson First Call, notes that the boost would mainly be due to
restating year-ago numbers for an accounting change. Excluding that, earnings are expected to rise by 55%.
Corporate spending in technology is growing at a subdued pace, and some analysts think that this will probably be enough to keep earnings afloat. They point to tech companies' ability to wring out favorable earnings by cutting costs drastically, and say that when the economic recovery sets in, tech firms will be poised to reap even stronger gains.
"People are ignoring that top-line growth will bleed through to the bottom line faster than expected and will translate straight into profits," said Akcin, at Puglisi & Co. "On the other hand, we understand the valuation concerns and the reasons why people are skeptical now."
Valuation indeed seems to be slowly returning to investors' consciousness, fueling Friday's 12-point pullback.
A few key names in the area have been trading at huge multiples, including Intel, now close to 40 times expected earnings, as well as
, whose stock is worth 54 times its profit in the next 12 months.
multiple is in the 200s, and
trades for more than 500 times earnings.
Akcin agrees that the fundamentals "don't totally justify the run, but tech is still one of the preferred sectors in our strategy. We're not ready to give up yet."
Others are more cautious. "I would not be a major buyer of tech right now," said Daniel Morgan, portfolio manager at Noble Financial. "Even though I am optimistic in the long term, corrections will happen along the way."
Morgan noted the "tea leaves point to an improvement in semiconductors, which is one of the bits and pieces substantiating the strength in the Nasdaq so far." But outside the chip sector, he sees very difficult times ahead for tech areas such as software, telecom, wireless and storage.
And from a technical point of view, the tech-laden index is giving some investors vertigo. "The Nasdaq has broken above its trading range, but that is not meaningful, given the low trading volume," said Gretz at Shields & Co. "I remain doubtful this is a leg up in the bull market."