"Is this the end of technology investing as we know it?" asked a plaintive post on the Market Talk with Jim Jubak Community during the worst of Tuesday's tech-stock meltdown.
Sure feels like it, doesn't it? The pasting that technology stocks have been taking lately is enough to make any investor look longingly at the gains in a staid auto supply stock like
. That long-term laggard is up 7% in the week ended April 11. Find me a technology investor who wouldn't take that gladly at the moment.
At times like these, when everything looks truly grim, I think it's useful to ask and answer a question like the one above. Taking apart this question -- and it has to be taken apart since there are really four different queries here with four different answers -- helps us understand exactly how uncertain the near term is and how solid the long term is likely to be. And that kind of mixed answer is a useful guide as we try to navigate our way between panic and complacency.
Is this the end of profitable technology investing forever? Put it that way, and I think the answer is a clear "No." The answer hasn't always seemed certain given the recent panic selling of technology stocks. But the powerful trends that are producing 30% to 50% annual growth in such areas as wireless communication and optical networking, which are producing huge new markets for semiconductors and that are revolutionizing fields from finance to retail, haven't stopped no matter what the stock market has done recently. For example, it looks like semiconductor equipment stocks still have another two to three years of growing demand ahead of them in that notoriously cyclical industry. In the long run, which I define as five years or more, the stocks of companies participating in these trends will be very profitable investments.
Is this the end of profitable technology investing for a while? I think it's likely that we won't have a strong, sustainable rally that lifts all the boats in the sector until the fall. But before then, we'll certainly have several temporary rallies. Perhaps it will be next week as earnings season heats up. Perhaps there will be a chance to make some money and rearrange a portfolio if, as is likely, the
announces a token 25-basis-point interest-rate hike in May.
Individual parts of the technology sector will move up despite the direction of the larger group. Even as
April 11 warning about the company's second quarter sent that stock down 27 points for the day, or 18%, and dragged the
down with it, stocks in such subsectors as semiconductor equipment climbed.
, for example, posted gains of 1 1/4 and 2 9/16, respectively.
Is this the end of profitable momentum investing in technology stocks? Sure feels like it at the moment. For one thing, this market has been targeting yesterday's momentum favorites for especially heavy punishment. As of the close April 11,
is down 79% from its 52-week high,
is down 68%,
55%. Drops like those make the 34% drop in
Brocade Communications Networks
or the 33% in
seem hardly worth mentioning.
Also, many of the charts of the momentum favorites now show momentum in reverse -- instead of predicting a climb toward the heavens, the indicators now point toward the netherworld. When positive momentum grips a stock, each high is succeeded by a higher high. Investors seeing a stock hit 150 buy, because they're convinced that the stock is headed to 200. Any dip becomes a buying opportunity that leads to a new high. When negative momentum grips a stock, each low is succeeded by a lower low. Investors seeing the stock hit 100 decide to sell because they're convinced the stock is headed to 50. Any rally becomes a selling opportunity that leads to a new low.
You can see this negative momentum clearly at work in the chart of a stock like VerticalNet. The stock hit a high of nearly 139 at the close on March 9. The drop to 109 on March 15 was followed by a short rally and then another drop to 91 1/2 on March 20. A quick rally, a small drop, another rally and then the stock dropped off a cliff, falling all the way to 49 on April 4. This pattern isn't finished either: The stock rallied again, almost all the way back to 60, and then resumed its decline, closing at 48 and change on April 11. I expect that there's more damage to come.
This kind of negative momentum owes very little to any good or bad fundamental news about a company's revenue or earnings. Instead, look to the price history of the stock. If VerticalNet were a stock with a long trading history and a relatively gradual pattern of price appreciation over the last year, I think the 200-day moving average would have provided massive support for the stock. That price of 56 represents the average price that investors in the public market have paid to buy VerticalNet over the last 200 days. It is now a break-even point that psychologically represents a significant reluctance to sell.
But VerticalNet sliced through that 200-day average with hardly any effort. That's because the investors who bought VerticalNet before its February 1999 initial public offering paid a whole lot less on average. According to the company's IPO prospectus, the average price paid by these prepublic venture capitalists was a split-adjusted 48.5 cents a share. For any of these private-round investors, selling at the April 11 price of 48 a share isn't a loss but a 100-fold gain. It's the existence of these investors with their incredibly low basis price on the stock that makes it so hard for a momentum stock like VerticalNet to find a bottom on the downside.
And remember, I'm using VerticalNet as an example of a class of stocks. The market is full of former momentum highfliers that went public so recently that a large portion of the company's stock is still in the hands of prepublic investors who may be very interested in selling on the next rally. Sometimes you can get a feel for that by checking the Insider Selling data on MoneyCentral. VerticalNet, again for example, has a truly long list of planned sales that include huge blocks held by prepublic investors.
Lehman Brothers MBG Venture Capital Partners
, for instance, filed on Feb. 10 to sell 1 million shares. Since the sale isn't listed among the completed transactions, it appears that this intended sale still hangs over the stock. Sometimes you just have to look at a pattern -- an initial public offering 12 to 24 months ago with a big percentage of the shares in the hands of venture capital investors at a very low average price -- and presume that this pressure hangs over a former momentum highflier.
At the least you should avoid buying shares of a stock like this until you can see that it has put in a firm base. The Wall Street adage, "Avoid trying to catch a falling knife," goes double for this class of stocks right now. Any dip is likely to be followed by a lower dip. Any rally is likely to be met by massive selling. A stock in this class needs to trend sideways for a while before it's safe to step in.
I hope that you got out of any momentum stocks of this type that you owned before the recent carnage. But if you reaped the gains of holding this kind of stock in 1999, it's unlikely that you sold off everything in your portfolio that meets this description. I know that even though I managed to sell
Metromedia Fiber Network
, I still got stuck holding the bag on Commerce One, a momentum stock that fits this description all too well. (That's one of the reasons I put a hold on the stock in Jubak's Picks: I wanted to discourage averaging down with a stock like this.) The other momentum stocks that I own in the Picks portfolio --
-- have been public long enough that they don't face a huge overhang of prepublic stock. I think that's one reason they've stayed above their 200-day moving averages (although Puma Technology is getting mighty close).
I think the road back for a momentum stocks like Commerce One is likely to be long and rocky. That's why I'm looking for a decent exit now. But that's just my opinion based on how stocks normally behave -- and stocks haven't behaved very normally lately. We'll know a little more from the market action in the next few weeks.
Is this the end of profitable fundamental investing in technology stocks? Not at all. The evidence of the last few days suggests that technology stocks with strong fundamentals will be the first to come back. And they should be at the top of your list when you're bargain hunting in this market.
I was actually encouraged by the nature of the selloffs in the first half of this week. No, I don't enjoy pain, but I do think it's a positive when the technology market goes down for a reason. On Tuesday, we had a warning from Motorola about weakness in the next quarter. On Wednesday, we got a heads-up from
might warn about slower growth when it reported, and
cut its revenue estimates for
, the parent of MSN MoneyCentral, by 3%. Under normal conditions, the technology sector should have been down on such news.
I also was encouraged that investors tried, though without a great deal of success, to discriminate between technology companies actually hurt by the news and those that might in reality be helped by the announced troubles. For example, while Motorola was sinking Tuesday on its announcement,
RF Micro Devices
climbed. Investors realized that falling handset margins at Motorola were a non-issue for these companies since they made their money on unit sales. And with Motorola reporting great unit sales ahead, these companies stood to benefit.
Now, I grant you that in the current market, most good news is simply ignored. But as we bottom in the technology sector, investors will start to take notice of news on earnings and revenue and customer growth. Stocks reporting better-than-expected numbers and forecasting stronger-than-current growth in future quarters will attract interest and investor dollars, and I'd expect them to be the first to move off the bottom. With momentum in the tank for the moment, fundamental stories will have very little competition for investor attention.
So Where Does That Leave Us?
In the long term, I think the picture is very clear. For the long-term investor with a five-year or longer time horizon, I think this is a great time to buy fundamentally solid technology leaders. I wouldn't worry about hitting the precise bottom, but I wouldn't be in a rush either. I don't think this market will rally straight off a bottom and you should have time over the next three months to do your due diligence and make long-term buys.
I think the Future Fantastic 50 portfolio is a good place to start your search. Here are my choices of the 10 best buys from that list right now:
, Applied Materials,
, JDS Uniphase,
, Qualcomm, RF Micro Devices,
Wind River Systems
The short term is a lot more uncertain. I think we'll be able to tell whether we're going to get any kind of earnings rally in technology stocks within the next few days. If we do, I still intend to take some profits then, so that I can raise some cash.
When to put any cash to work is quite a puzzle. As always, my goal will be to improve the overall quality of the Jubak's Picks portfolio so I'll be looking to sell my weakest holdings into any rally and looking to buy fundamentally sound technology stocks. I'll try to buy these at what seem to be good prices -- that is, I'll try to buy them on further dips during this period -- but I'm pretty sure that I won't get anything at the exact bottom. And I'll avoid buying momentum stocks before they've clearly put in a base.
I'll also try to play good defense. During this period, that means not getting overextended so that an unexpected dip forces me to sell a stock that I really want to hold. Margin is extremely dangerous during this kind of market. It means not buying on every dip -- averaging down only works until you run out of money. And it means being very patient. Even then, I fully expect to make mistakes, but I want them to be mistakes I can live with.
Exactly how long it takes the technology sector to recover depends on a lot of things. The strength of the earnings reports over the next few weeks and guidance about the next quarter will be enormously important. But so, too, will be the relative performance of technology stocks compared with what is being called the Old Economy. If the
Dow Jones Industrial Average
continues to perform well, that will attract some money that might otherwise have gone into technology stocks.
Jim Jubak is senior markets editor for MSN MoneyCentral. At the time of publication, he owned or controlled shares in the following equities mentioned in this column: Affymetrix, America Online, Applied Materials, Broadcom, Commerce One, E*Trade Group, JDS Uniphase, Mercury Interactive, Microsoft, Network Appliance, PMC-Sierra, Puma Technology, RF Micro Devices, SDL, Texas Instruments and Wind River Systems. Holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. He welcomes your feedback at
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