When

Nasdaq

general

Cisco Systems

(CSCO) - Get Report

announced last week that its campaign to sell communications gear will bog down in coming months, it inadvertently threw a dirty bomb into the ranks of its smaller peers.

If the next few quarters look like a hard march for Cisco -- which has taken advantage of the telecom depression to consolidate most pieces of the networking puzzle under its command -- then you can bet there's a nuclear winter in store for the rest of the industry.

The announcement must have come as quite a shock to many speculators who had been bidding up the prices of battered telecom players as if the future held nothing but sunshine. Most of the roughly 100 technology stocks that rocketed more than 50% in the month following the lows of Oct. 10 were telecom suppliers.

Moreover, the past month's best-performing exchange-traded sector funds have all been related to networking or telecommunications. Merrill Lynch Internet Infrastructure HOLDRs rose 55% in the month through Friday, while the iShares Goldman Sachs Networking Index gained 29.6%.

The cruel probability, however, is that the October surprise may have been the last big bang for shares of many of these companies, and thus the last chance for longtime loyal investors to sell with dignity. For there is little doubt that the next chapter for most of these companies will be the 11th -- as in bankruptcy filing.

Which are the most likely to survive, and which to fail? That's not easily answered, but there are signs. To answer the question, let's first take a look at the companies that advanced the most since the market turned around on Oct. 10.

As you can see in the table above, shares of telephone-system equipment maker

Nortel Networks

(NT)

had the biggest bounce on the October trampoline, vaulting nearly 250% from its low at 44 cents to a high on Nov. 6 at $1.52. And shares of fellow equipment giant

Lucent Technologies

(LU)

had the fourth-largest move, up almost 90% from a low of around 70 cents to a high around $1.32.

There were two good reasons for these advances.

The first is technical. As shown in the last column of the table, their shares were very low-priced by the middle of October and also among the most heavily shorted names on the board. When such stocks start to move up sharply, short-sellers buy shares to cover their positions -- sending prices higher, faster than would occur from mere buying interest alone.

The second reason is fundamental. Regional Bell operating companies, also known as carriers, have said in recent weeks that they plan to cut capital expenditures by up to 30% next year from already low levels. If they really cut spending by that amount, and their comments are not just political posturing in an effort to obtain some sort of bailout from the federal government, then what few dollars they spend are likely to go into the long-delayed maintenance of old, or legacy, equipment -- not brand-new devices. In this scenario, Lucent and Nortel are likely to be among the few recipients of carrier spending in 2003.

Both Lucent and Nortel shares have been the subject of heavy buying by top management and directors in recent months -- at prices up to 50% higher than the peak of the recent move. Price-to-sales and price-to-earnings ratios for both stocks are at historical lows. Lucent has a high debt load, while Nortel's load is more modest but still substantial.

The revenue and earnings trends at both companies are terrible, and sentiment about the stocks is worse. To buy either now for the long term, you need not draw a grand scenario that paints a robust future. You must only make the bet that they are not likely to go bankrupt.

Why the Up Moves Aren't Buy Signals

Sounds enticing to the contrarian in you, doesn't it? After all, above-market returns are investors' reward for taking risk at low prices, not for avoiding it.

The problem is that between now and 2004, carriers' disinclination to spend as their earnings deteriorate is likely to put more and more pressure on these onetime titans and their prodigious workforces. They can each cut their staffs by another third and still be overcommitted. And that's not even figuring in their staggering pension obligations.

I'm afraid that 11 will ultimately be the final chapter for both, and I would take advantage of any further bounce over the remainder of this year, or the middle of 2003, to unload them. Since they are so heavily shorted, the mechanics of the marketplace could squeeze share prices up to the $3 to $6 range before they collapse.

A grim scenario? Not really. Like large trees that fall in the forest and provide mulch and habitat for younger, smaller species, the toppling of Lucent and Nortel could actually have a salutary effect -- setting the stage for a healthier industry recovery in 2003-2006. Indeed, management at both companies could do their peers a favor and bow out gracefully -- selling their few healthy divisions to competitors and removing excess capacity by closing down the rest. The U.S. steel industry, strangely enough, would be a model. So would the disk-drive industry, where there are just a handful of players left.

Four More You Don't Want, Three You May

As for the rest of the companies on the list of the big October surprisers, the most likely to meet a similar demise are

Vitesse Semiconductor

(VTSS)

and

Conexant Systems

(CNXT) - Get Report

. They may be good for a bounce, but the market already has essentially decided that their communications semiconductor technologies are unlikely to make the leap into the future. And there are so many other optical electronics players in the space that didn't even make my cut for the list; the share-price bar was set at a measly 50 cents, and market capitalization had to exceed $200 million.

Those not making the cut include the twisted twins of optical-networking gear,

Corvis

(CORV) - Get Report

and

Avici Systems

(AVCI)

, which, if you're just joining us, each had market caps larger than

General Motors

(GM) - Get Report

not long after their initial public offerings in July 2000. By the time the carriers get ready to buy from them again, most industry analysts believe the new kids on the block will have made their products obsolete.

If you believe the judgment of market forces has any value, the few October bounce companies worth owning in the network-equipment business appear to be the ones that have managed to eke out a small profit during these troubled times and sell their products primarily into large enterprises or into carriers' metropolitan, or local, loops.

These include guerilla fighters

QLogic

(QLGC)

and

Advanced Fibre Communications

(AFCI)

and

el commandante

Cisco Systems. You may have an opportunity to buy all but QLogic at their October lows over the next 10 months. Targets for initial purchases of each might be, respectively, $30 (could ultimately return to $20), $11 and $9.

At the time of publication, Markman owned the following stocks mentioned in this column: Cisco Systems.