Cisco

(CSCO) - Get Report

is back where Wall Street doesn't want it to be -- treading water in hopes of a tech recovery.

Investors greeted the San Jose, Calif., networking gearmaker with folded arms Wednesday, sending its shares down 6% in heavy trading following Tuesday's mixed earnings report. But strip away the bulls' disappointment and ignore those who would find deep meaning in a CEO's cautious optimism, and you're left with the same old story: Like everyone else, Cisco is still waiting for the economy to turn.

That fact is bad enough for investors who had hoped to see emerging signs of a broad-based recovery. The worry that nags at some Cisco watchers, though, is that the latest quarter could have been worse.

Some observers say that if Uncle Sam hadn't tossed Cisco a line, an uninspiring but still seaworthy quarter would have sprung a serious leak. Cisco watchers who have examined the networking gearmaker's top line say an extra $140 million or more in equipment orders from the U.S. government saved the day.

So while some Cisco watchers were encouraged by CEO John Chambers' sighting a gradual economic recovery ahead, many couldn't take their eyes off the nagging signs of slippage in the financials.

Chambers' "message is exactly the same -- current environment challenging, customers beginning to evaluate opportunities, bright future ahead -- as it has been for nearly a year," says Sanford Bernstein analyst Paul Sagawa, who rates the stock sell. "Meanwhile, sales are down 2.6% year-over-year and margins have started to deteriorate."

On Wednesday, Cisco slipped $1.10 to $17.76.

Mixed Bag

On the surface, the fourth-quarter numbers and the first-quarter outlook were just as Wall Street would have wanted. Much has been made of the fact that earnings were merely in line with estimates, rather than a penny above, as has been customary. But the company's forecast of 3% sequential first-quarter revenue growth should have overcome those worries.

But astute observers noted some other unhappy clues in Tuesday's earnings numbers. CIBC World Markets analyst Steve Kamman pointed to a sharp rise in inventory, to $873 million in the latest quarter from $765 million in the fiscal third quarter. For its part, Cisco blamed the acquisition of Linksys for the increased level of parts in the channel.

Linksys also got the blame for dragging down gross margins, which slipped slightly to 70% from almost 71%. Cisco executives said that they expect Linksys' lower margin consumer products to subtract a percentage point from gross margins; they projected a 68% target for the current quarter.

The Wall Street reaction was surprisingly muted, considering Cisco's near-iconic status as a tech bellwether. While the company's shares slid Wednesday, a broad tech selloff was averted and its chief rivals -- outfits like

TheStreet Recommends

Ciena

(CIEN) - Get Report

and

Juniper

(JNPR) - Get Report

-- dropped only modestly.

Hanging In

But the glass-half-full crowd says given the sorry state of tech demand so far this century and the sluggish macro economy, Cisco's done admirably well.

"I think we're seeing Cisco make a steady recovery under very tough conditions," says Kamman, who has buy rating on the stock. "Unfortunately, the market priced in more than Cisco could deliver."

Cisco was "a crowded long," says one hedge fund manager with no positions. "When you have a lot of people set up long, and they deliver in-line results, you'll always get incremental sellers."

The fact that so much of Cisco's performance -- roughly $330 million, or 7% of sales -- came from government contracts is worrisome to a few observers. Federal contracts typically account for about 5% of sales. Cisco was fortunate to find a big increase in purchases from the U.S., and some wonder if that sort of thing can continue.

With the U.S. government's fiscal year ending this quarter, Cisco is likely to enjoy a so-called budget flush as the remaining cash in the spending plan gets put to use. In a best-case scenario, the government business should taper off just as the economy makes its long-awaited recovery.

But even the bulls have worries on that front. It seems while national security efforts and new federal communications network spending has been ramping up, fiscal troubles among states and municipalities have been putting a crimp on IT plans.

In other words, says CIBC's Kamman, "What the feds giveth, the state and local may taketh away."