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9/4/2003
11:01 AM
William Schaff
William Schaff
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Taking Stock: Tech Investors May Be Too Enthusiastic

What happens if the economy doesn't recover robustly?

Summer is about over. The kids are back to school. The days get shorter, and our workweeks seem to get longer. Oh, yes--that's called increased productivity.

We all know that the productivity improvements of the past few years wouldn't be the same without technology. So it isn't surprising that investors continue to bid up share prices within the tech sector in the hopes that the economic recovery will boost technology earnings. But I fear that technology investors may be a little over-enthusiastic.

I hate labels such as "bear" and "bull." I prefer "realist." Without fundamental financial improvement, I believe large positive price moves in the underlying companies are unsustainable. So let's look at the positive trends that are getting tech investors excited.

There's no question that the economy is getting better. The most-recent gross domestic product numbers show continued improvement throughout the United States.

The most-recent quarterly tech-company earnings show improvement or stabilization. In mid-August, Intel gave an upbeat third-quarter update of its sales and a gross-margin forecast citing improved end-user demand for processors across all channels. Recently, Novellus, which supplies equipment used to fabricate semiconductor chips, stated that fabrication capacity was starting to tighten. Back-to-school demand for hardware, especially laptops, was robust. Consumer-oriented electronic products continue to do well as buyers lead the way in the recovery.

Unfortunately, large technology vendors serving businesses aren't seeing robust demand. Most companies remain leery of large IT investment before they see a recovery in their own businesses. Therefore, it wouldn't be surprising to see technology spending lag one or two quarters behind any significant improvement in the general business cycle. IT buyers realize that delaying purchase orders to the end of the quarter results in the lowest prices. In addition, as international sales become a growing portion of total revenue, tech vendors will wait to see whether European customers will step up to buy after their August holidays.

Then there's the positive impact currency translations had last quarter on tech-company earnings. With the recent increase of the dollar against other major currencies, this benefit may diminish rapidly, which makes it difficult to predict earnings.

The biggest problem is if the economy doesn't recover robustly and instead grows only modestly. In my opinion, tech-company stock prices reflect the best scenario, supported by short-term momentum trading. Many portfolio managers stuck in the middle of the quarterly performance race exacerbate the pricing momentum we've seen in the tech markets lately. Without their technology holdings, most portfolio managers and investors would probably be lagging the broader equity indices.

But this can't continue. After all, humans are one of the more intelligent life forms on this planet, and, therefore, we'll respond rationally to an emotional environment. Oh, who am I kidding?

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com. 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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