Publish date:

Scorched Tech Stocks Now Comeback Candidates

If the past holds true, the worst losers could soon turn into big winners.

For investors pathologically in love with Nasdaq 100 stocks, the past six months have seemed like one of those science fiction movies where the monster gets so ugly and snarly you can't help but avert your eyes.

Before I explain why it's probably time to pry open those peepers again, let me be the bearer of a little bad news.

Since the market peaked this very week in March, the roll call of failure at the top of the tech ticket has had virtually no parallel in bull market history.

Qualcomm

(QCOM) - Get Report

is down 52% through Monday,

Yahoo!

(YHOO)

is down 45%,

Dell

(DELL) - Get Report

is down 39%,

Microsoft

(MSFT) - Get Report

is down 43%,

WorldCom

(WCOM)

is down 32%,

Applied Materials

(AMAT) - Get Report

is also down 32%,

JDS Uniphase

(JDSU)

is down 26% and

Cisco Systems

(CSCO) - Get Report

is down 24%.

Even in the worst years of the past decade, no rout of the big-cap techs has been as complete as the one over this six-month period. In 1994, for instance, Cisco was the worst of the tech titans -- down 34% from March 20 to Sept. 20. But

Sun Microsystems

(SUNW) - Get Report

was down just 8% in the period, Applied Materials was actually up 1% and

3Com

(COMS)

rallied from a 20% deficit to a 21% advance. No other year compares; even the Persian Gulf War year of 1990 and the Asian financial crisis year of 1998 were kinder to Nasdaq stocks than 2000 has been.

What Goes Down Must Go Up

But note what happened next in 1994 and those other bad years -- anything but a further decline. After Cisco's 1994 collapse amid an interest-rate and inflation environment much like the one we have experienced in 2000, the stock rallied 37% over the next six months -- and was up 181% 12 months later. 3Com went on to rally another 45% over the next six months and 135% over 12 months. All of the Nasdaq 100's top 10 stocks were up at least 9% from October 1994 to October 1995, with

America Online

(AOL)

the leader at a gain of 296%.

A fluke? Maybe not. I tested this hypothesis against historical market data from 1985 to 1997:

Start with a universe of the top 15 stocks in the

Nasdaq. Focus on the five with the worst six-month return through Oct. 1. What happens over the next 12 months?

The answer, according to back-testing software from

Q-Analytics

: On average, they gained 21% over the next 12 months -- 5.7 percentage points better than the

S&P 500

index. The best of the years was actually 1994, when the top five rebounding stocks were Applied Materials, Cisco,

Costco

(COST) - Get Report

,

Intel

(INTC) - Get Report

and

Novell

(NOVL)

. They were up 81% in aggregate, about 55 percentage points better than the broad market.

The five worst six-month performers among the biggest 15 Nasdaq stocks when I ran this screen on Monday were Qualcomm, Yahoo!, Dell, Microsoft and WorldCom. If you're inclined to follow this contrarian route to potential success over the next six months but want more stocks, take the next two from the list of infamy as well: Applied Materials and JDS Uniphase.

Now, before you value investors start feeling too smug, it's well worth noting that the five Nasdaq biggies that performed

best

over the same six-month period from 1985 to 1997 did much better than their delinquent brethren over the next 12 months: 36.7% on average, or 21.5 percentage points better than the broad market. This year, that fabulous five as of the end of last week were

Juniper Networks

(JNPR) - Get Report

, Sun Microsystems,

Broadcom

TheStreet Recommends

,

Oracle

(ORCL) - Get Report

and

Amgen

(AMGN) - Get Report

.

Search for Strong Saplings

As we light a candle on the six-month anniversary of Nasdaq 5000 and find ourselves sooty but unsullied, let's consider that the rout may have been a good thing -- much like a fire that burns through a forest of old growth, leaving room for saplings to grow and prosper.

A screen of the market's very best stocks of any size or exchange in the past six months reveals that cash has flowed to a new generation of potential blue-chips as smart money managers have reallocated risk capital from companies that were maybe a tad overvalued to ones that were not.

Who are the lovely young things that have emerged fresh and fearsome on the fallow ground? They are a ravishing list of no-names -- many from the wrong side of the tracks, which is to say, not tech and not biotech. Four are from the diversified electronics group, led by

Power-One

(PWER)

; five are from the scientific instruments group, led by

Newport

(NEWP)

; and four are semiconductors, led by

IXYS

(SYXI)

. But the biggest cohorts are the oil and gas drillers, led by

Swift Energy

(SFY) - Get Report

, and the obscure medical laboratories and research group, led by

Laboratory Corp.

(LH) - Get Report

, as well as asset management, led by

Nvest

(NEW) - Get Report

.

The biggest two names in the group were

Integrated Device Technology

(IDTI) - Get Report

, up 132% since the Nasdaq high in March, and

CDW Computer Centers

(CDWC)

, up 148%. The leading biotech name in the bunch was

Vertex Pharmaceuticals

(VRTX) - Get Report

, up 155% in the past six months.

So what happens next? Bert Dohmen, a veteran trader and newsletter publisher based in Honolulu, says he thinks the big story over the remainder of the year will be a sharp revival of interest in biotechnology. He says that the

Amex Biotech

index hit a record high in March, then collapsed before staging a surprise rebound to within a mitochondrion's length of the old high in July. It then retreated before bouncing back again in August. Amid the technology weakness in September, it has held firm and exceeded the July high.

"I think we're going to see a powerful breakout to the upside in biotech," he said. "The intraday action in the big names has been very strong; every time they have a pullback we see new buying and multipoint spurts. That's very bullish." His favorites to play the idea are big-cap

PE Biosystems

(PEB) - Get Report

, mid-cap

Celera Genomics

(CRA)

and small-cap

Cell Genesys

(CEGE)

.

Looking at the big picture, Dohmen says he believes that while technology will perform fairly well over the next six to 12 months, the market will broaden out. His thesis: Rising interest rates from mid-1998 through early 2000 led professional money managers to overweight technology in their portfolios because they're the companies least dependent on debt. But as interest rates decline, starting next year, he believes managers will trim tech to a market weighting, and the beneficiaries will be such forgotten sectors as the utilities, regional banks and real estate investment trusts. His picks in the latter are

Spieker Properties

(SPK)

and

BRE Properties

. Even though the utilities have already staged an electrifying run, he believes that they're just starting a two- to three-year emergence as growth stocks. Power on.

At the time of publication, Jon Markman owned or controlled shares in the following equities named in this column or listed in the SuperModels portfolios: ADC Telecommunications, Amdocs, America Online, CDW Computer Centers, Cisco Systems, EMC, JDS Uniphase, Kopin, Maxygen, Microsoft, Nokia, Nortel Networks, Oracle, Qualcomm, Siebel Systems, Superconductor Technologies and Xcelera.com. He welcomes your feedback at

mctsc@microsoft.com.

More from

MSN MoneyCentral

Markman's SuperModels

Jubak's Picks

Rowland's Watch Portfolio