Fund Junkie: Weigh Your Tech Exposure and Consider a Diet
David Gaffen:Tech Stocks Not Cheap Yet
Justin Lahart: Margin Debt at Worrisome Levels
Jim Cramer: Get Liquid
Brett Fromson: Get Ready For Fourth-Quarter Pre-Announcements
Technical View: A Lesson in Tops for a Market Ready to Bottom
Metrics View: A Dozen Stocks Still Defy Gravity
Taskmaster Chat: Take a Defensive Posture
Fund Junkie: Climate Is Changing for Net Bellwether Stocks
It's like clockwork. The
Nasdaq Composite Index falls through another arbitrary support level, and an army of analysts proclaims we've hit bottom. But several measures suggest otherwise, and a number of observers expect tech's slide to steepen before any rebound materializes.
The Comp proved indestructible through the spring, as investors eagerly bought stocks whenever the market dipped. But the Nasdaq has dropped 31% since Sept. 1, and 42% since reaching its March 10 closing high. Now, with capital drying up, lending standards tightening and technology spending declining, tech stocks face a far tougher environment than they have in years.
The decline of the past six months represents a rethinking of
technology-stock growth expectations, from unlimited growth to something more modest. This process started with the recognition that most technology stocks are subject to some earnings cyclicality. That is, when the economy slows, demand doesn't fall only for steel and auto companies -- tech outfits get hurt, too.
That's been witnessed during the last several months, as the economy has slowed. The high price of stocks reflected the assumption that technology growth would continue infinitely. But companies were unable to match those expectations: Bellwethers like
all have either warned of slowing earnings, slowing spending or simply sounded less optimistic in recent months. It's taken a bite out of those stocks; Nortel is down 56% since July 25.
Those issues hit investors hard at a time when they were getting used to earnings growth rates of 20% or more, year in and year out. Even now, price-to-earnings ratios for technology stocks, compared with other stocks, show investors are expecting growth that's a bit faster than what's likely to happen.
How Low Can You Go?
John Maack, director of equity investment at
in Portland, Ore., says a tech to nontech comparison of P/E ratios shows tech growth stocks are far less overvalued than they were in the spring. Even so, they're far from a screaming buy, he says.
As of Friday,
Salomon Smith Barney's
index of emerging growth stocks showed an average P/E ratio for tech stocks of 31.8, compared with the average nontech stock P/E of 23.4. Despite what one might expect, those tend to track pretty closely, meaning tech stocks are still a bit overvalued.
"A bear market is the process of restoring reasonably priced stocks to their rightful owners," says Maack. "I'm afraid we're still in the process of doing that, and it will probably go on into early next year. It's not going to go straight down, but it's going to be a choppy downward move."
Why are they still overvalued? Because the current investment climate, while recognizing a bit of cyclicality in the tech world, isn't considering the possibility that technology earnings growth may fall back in line with a more modest rate of growth.
"People think this is still a great investment for the long term," says Richard Bernstein, chief quantitative strategist at
. "But the long-term trend in earnings in the tech sector is high single digits. People are not prepared for that."
Since 1997, tech earnings growth has been around 20%, according to Merrill Lynch. Since 1995, however, it's more like 7%. Sure, productivity has picked up, and that's enhanced technology earnings growth by offsetting costs, but some of the surge owes to the easy availability of capital. Money was already readily available when the
Federal Reserve started easing in late 1998. Those three rate cuts added liquidity to an economy that wasn't in need, giving companies more discretionary income to invest. It's money they don't have now, with capital tightening and banks becoming stingier.
When people start doubting tech's long-term growth prospects, Bernstein says, the situation could worsen. "Everyone forgets
S&P tech earnings were down 34% in 1998," Bernstein says. "What you've seen since 1998 is a tremendous surge in the cyclical rebound in earnings. Everybody saw this and said, it's the New Economy."
Short of a financial crisis, the Fed is unlikely to be of much assistance any time soon. Though it is likely to shift its stance in coming months, what would ultimately force the Fed to move to a neutral bias and then cut interest rates, such as declining pricing power, a hard landing for earnings and more restrictive financial conditions -- conditions that are emerging -- are first going to hurt investors.
"Equity investors looking for
Alan Greenspan to be their savior shouldn't celebrate such a shift prematurely," wrote Richard Berner, economist at
Morgan Stanley Dean Witter
, late last week. He said that a period of slow growth won't automatically move the Fed to cut rates.
Barry Hyman, chief investment strategist at
, also believes technology is in for more selling for a few more months. By the middle of the first quarter, he expects the Fed will be ready to respond to diminished inflation expectations and a slowing economy. By then, the market could begin to rebound.
"Clearly, we overdid it on the upside and we're going to get to a point where it overdoes it on the downside," says Hyman. "Then, we're going to start all this over again."