Let's talk about something other than the election and Iraq.

Oh, who am I kidding? How can you not talk about the two most important issues affecting the markets these days outside of Alan Greenspan's interest-rate forecast? We're clearly in a time of great uncertainty, which makes it harder for technology stocks to get any strong buying support. The uncertainty among investors has been reflected in the performance of the Nasdaq 100 during the second quarter. It started out at 1,438.41 and closed at 1,493.07 on June 28, a gain of a modest 3.8%. However, during the quarter, the index hit a low of 1,372.46 on May 17, a loss of 4.6%. That's a lot of movement for very little gain. But the index hides the fact that some big names, including EMC, IBM, and Texas Instruments, are showing negative returns for the quarter. So what should technology investors do for the rest of the year?

My ability to forecast economic events is limited indeed. All right, all right--it's miserable in many cases. Still, I do have some fundamental support for my conclusions. I believe the probability is extremely high that we're on the cusp of a long-term rising interest-rate cycle, as measured by the bond market's yield curve. But the real issue, in my opinion, is the magnitude of the change and not the change itself. If inflation is truly benign, then the impact on the equity markets may be relatively modest, allowing the economy to continue expanding without a major collapse. If, however, the economy overheats, then all bets are off.

Nevertheless, I believe the reason the change is occurring is the fact that the economy is doing well. This should bode well for those companies that are highly sensitive to an expanding economy (such as those in technology). Despite all the other global issues--and there are many--this fundamental fact should be the main consideration for investing, along with pricing. Long-term investors should always take advantage of uncertainty to attempt to gather strong companies at cheap prices. The problem is, though, that many of the technology companies aren't cheaply priced anymore and already seem to reflect an economic recovery. Little wonder that many investors are choosing to keep their heads down shortly before the calendar second quarter comes to a close.

However, very few investors make money without taking some risk. I'm still of the opinion that the economy is expanding nicely and that technology companies' second-quarter earnings will show better-than-expected results. As long as the economy expands, I believe that large business software and service companies should continue to be major beneficiaries. Maybe that explains why Microsoft is doing well recently, having risen from $26 in early June to more than $28, a gain of more than 8% compared with the Nasdaq 100 index return of slightly less than 2% for a similar time period. Good news also seems to be following Computer Sciences, a leading outsourcing company. And, in my opinion, neither company, given their solid balance sheets and growing operating cash flow, looks overly expensive, even at current price levels.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at [email protected]. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.

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