Stocks went on a tear after the Federal Reserve stopped raising rates in the summer of 2006, with the Dow industrials and Standard & Poor's 500 index making new highs until the subprime mortgage crisis knocked them down a notch. Leading the latest run-up? Technology stocks, with the tech sector of the S&P 500 soaring by nearly a third. It's almost enough to make investors wonder if another bubble might be forming, ready to burst.
Unlikely. This time, the tech rally is based on fundamentals rather than hype, with the industry finally emerging from years of punishment following the overindulgence of the 1990s—though the tech-heavy Nasdaq index is still about 50 percent from its all-time high of 5,048, reached back in March of 2000. "Apparently, six-plus years was enough of a hangover," says Douglas Peta, market strategist at J. & W. Seligman & Co.
Indeed, the outlook appears strong across the board for software, tech services, and pc makers as businesses finally replace aging systems. That should boost profits at software companies like Oracle and Microsoft. "The Vista party is just starting," says Kim Caughey, analyst at Fort Pitt Capital Group, referring to Microsoft's new operating system. Business orders have already accelerated pc sales in recent months, with second-quarter shipments 13 percent ahead of last year. That led Intel to raise its sales projections last week to as much as $9.8 billion for the current quarter, up from $9.6 billion. New computer orders could also help Dell recover some lost market share, Caughey predicts, because of Dell's strength selling to big companies.
Tech fortunes depend on the broader U.S. economy, of course, and it's typical Wall Street wisdom that a slowdown or recession could hurt companies throughout the sector and pummel pricey stocks.
But there are plenty of reasons to think tech might be tougher than you imagine. For instance, technology companies continue to expand internationally and derive an ever greater share of sales and earnings from abroad. And some tech sectors could particularly benefit if the Fed cuts rates this week and beyond. Shares in software and service companies, as well as chipmakers, have jumped on average more than 20 percent in the 12 months following a Fed rate cut, according to a recent report from Citigroup. The report, in fact, said those sectors were the best performers, along with retailing, after four rate cuts since 1990.
New to the equation, however, is the storm swirling around the subprime credit meltdown, with its impact on financial companies—among the biggest buyers of new technology. While pc makers do anticipate some hits from mortgage firms and others, nobody's canceling orders yet, Dell CEO Michael Dell told analysts earlier this month. "Broadly, it looks pretty good," he said.
Overweight. Tech, in fact, has become an unlikely haven amid the credit crunch and resulting market volatility. Over the past two months, the Dow Jones U.S. technology index is essentially flat, while the S&P 500 has lost about 3 percent. Despite their own reputation for wide swings, technology stocks tend to hold up well when the broader market convulses, which is likely to continue for another year or more, says Tobias Levkovich, chief U.S. equity strategist at Citigroup. Large companies like Microsoft, Intel, and Google dominate the sector, and they appeal to investors looking for size. "They also have pristine balance sheets," Levkovich points out, with lots of cash and little or no debt.
Levkovich advises investors to remain "overweight" in technology companies, although recently he suggested pulling back on hardware and equipment companies. Those shares have jumped by a third in the past year, compared with nearly 14 percent for the s&p 500, which doesn't leave much room for any upside, he says.
Widespread enthusiasm is reason to take pause, says money manager Alan Lancz. He's largely quit buying technology shares, saying investors have bid them up as high as can be justified by potential profits. But he's not selling them yet, either. Meanwhile, it seems to be getting harder to find new tech stocks to buy—leading him to contrarian picks, such as Yahoo! The online goliath missed the tech run-up of the past year, losing nearly half its market value since early 2006 while yielding online ads to Google and others. But with new management, Lancz thinks a turnaround is possible. Or the company might be a takeover target, as some analysts have speculated in recent months.