The U.S. tech sector has clearly recovered from its recession but is poised to suffer some ups and downs until the next wave of innovation arrives in 2008.

Those were the conclusions of a new sector index created by Forrester Research and the Information Technology Association of America, which claim they've invented the most comprehensive view of the health of the tech sector.

"We expect the index to follow a saw-tooth pattern in 2006 and see a mild downturn in 2007," Forrester predicts. "Don't weep for the U.S. tech sector, but don't break out the champagne either."

The quarterly index, unveiled Monday, was created from 11 measures of tech-economy health, organized by demand, supply and firm strength. Using 2002 as a baseline with a measure of 100, the index reached 121.6 in the third quarter of 2005, approaching a three-year high of 122.3 set in the fourth quarter of 2004 and 3.9 points higher than this year's second quarter.

But Forrester also found indicators of a future weakening in the U.S. tech sector, with its outlook for fourth-quarter business investment falling. Forrester also said early fourth-quarter readouts show a drop in CIO confidence, while U.S. enterprises are projecting smaller budget increases for 2006.

The latest indication of a potential slowdown came from Forrester's November 2005 North American and European Enterprise IT budgets and Spending Survey, which found that U.S. enterprises project IT budgets to increase only 3.1% in 2006 vs. 3.4% heading into 2005.

Forrester expects some measures, such as employment and IT spending, to continue to grow, but at slower rates. Other measures such as IT vendor profits, stock prices and CIO confidence are expected to fluctuate.

Such weakening comes on the heels of a strong third quarter. Forrester found that CIO confidence on the health of budgets and future spending prospects shot up in the third quarter, contributing to an overall increase in the index. Revenue increases at U.S. tech firms and a rise in the iShares Dow Jones U.S. Technology Sector Index Fund ( IYW) also contributed to the third-quarter improvement. And IT employment climbed to its highest level since the first quarter of 2003, with the addition of 15,500 new tech jobs.

But despite the increase in IT employment, supply measures have hovered around the baseline 100 mark since late 2003. Demand of IT in the U.S. is stronger than supply, with imports and offshoring accounting for the gap. One measure of supply, venture-capital investment, was down in the third quarter, but that may be simply seasonal as similar drops occurred in the third quarter for the past three years.

The index hit a low point of 89.2 in the first quarter of 2003 and then recovered to its high in the first quarter of 2003. The index then slipped in the first quarter of 2005 as CIO IT spending outlooks, VC funding and U.S. vendor performance dipped. That was followed by a small recovery in the second quarter continued in the latest third quarter.

Forrester is projecting U.S. IT spending will rise 7% in both 2005 and 2006, slowing to 2% in 2007.

The firm then expects the next wave of tech innovation and heavy IT investment to commence in 2008, driven by the launch of Microsoft's ( MSFT) new Windows Vista operating system, followed by enterprises purchasing new servers and storage.

That conclusion comes after studying tech spending in the past 50 years and finding that the sector typically goes through eight-year periods of tech digestion between each boom, which is driven by a whole new generation of technology, explains Forrester research analyst Andrew Bartels, who covers IT spending for the firm.

Bartels believes that the next new technology shift -- what he calls ubiquitous computing -- will hit in 2008, leading to a 9% compound annual growth rate in IT spending from 2008 to 2010. The new wave will include data centers that are able to be more self-monitoring, ubiquitous wireless Internet access and software as Web services, he says. Call it "organic IT" or "computing everywhere."

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