Tech Stocks Subject To Economic Mood Swings

IT vendors now have a stake in consumer products ranging from MP3 players to digital TVs, so they are more vulnerable to the ups and downs of the market.

Paul McDougall, Editor At Large, InformationWeek

January 22, 2008

4 Min Read

News about the current market turmoil has centered mostly on financial stocks hit by the subprime lending crisis and retail plays suffering at the hands of overextended home owners.

The technology sector, meanwhile, was supposed to have cleaned up its act following the meltdown and become a haven for responsible investors in tough times.

It's not working out that way.

Tech stocks of late have actually performed worse than the broader markets. Over the past month, major tech barometers like the Morgan Stanley High Technology Index, the Nasdaq 100, and the Philadelphia Semiconductor Index have lagged behind the sickly Dow Jones Industrial Average by as much as 6.5%.

On Tuesday, those three indexes were down a combined average of 2.86% in afternoon trading, while the DJIA had pared earlier losses and was off just 1.08%.

All this comes at a time when IPO-bound Internet startups have to have real business plans, customer financing programs have been tightened, and bogus Wall Street research -- which helped inflate the bubble -- supposedly eliminated.

So what's behind tech's latest stock market malaise?

In the past, large-cap vendors sold mostly to businesses and therefore could withstand a little turmoil in the consumer sector. But technology in recent years has crept deeper and deeper into the home -- to the point where many vendors that used to sell primarily to commercial accounts are now highly exposed to what's happening on Main Street.

One good example is IBM. The company is known mostly for big, mainframe computers and business software that functions behind the scenes at banks, manufacturers, insurance companies, and other large enterprises.

But lately, more and more IBM technology is finding its way into consumer products. IBM processors, for instance, power the Sony Playstation 3, Microsoft's Xbox 360, and Nintendo's GameCube. IBM also holds a stake in Lenovo -- the Chinese company that bought IBM's PC business and is now trying, largely unsuccessfully, to burst onto store shelves in the U.S.

IBM recently sparked investor hope when it reported that fourth quarter and year-end earnings came in well above analysts' expectations. But literally half of the company's sales gains were due to favorable currency exchanges made possible by the anemic U.S. dollar. Without those gains, IBM's 2007 sales increased by a very modest 4%.

IBM shares on Tuesday were off 1.42% in afternoon trading. Another business technology vendor that's becoming more reliant on consumer sales is Cisco Systems. A couple of years ago, most people not employed in the Internet industry had never heard of a router -- let alone had plans to buy one. Now, with home networking and Internet telephone service a reality, Cisco is counting on individuals to drive much of its future growth. In January, Cisco revealed that it had sunk $9.5 million into a startup that makes software for mobile devices.

Cisco shares were down more than 4% Tuesday.

As for chipmaker Intel, long a stalwart in both the business and home PC markets, the company last week reported a profit forecast and earnings reported that disappointed analysts. Intel shares were down 0.63% late Tuesday.

Then there are those vendors that have always had a presence in the consumer market, but are now relying on home buyers more than ever. Apple, for instance, for years was content with owning a small share of the PC market through its Macintosh desktop line. Now, however, the company is enjoying a revival on the back of the iPhone, iPod, and other cool toys aimed squarely at the Best Buy crowd.

But the current economic uncertainty has consumers poised to reign in spending on such handy, but largely unnecessary, devices. "I'm not likely to spend much on gadgets when it appears we might be headed into a recession," says Anne Russell, who edits a women's fitness Web site and magazine in Los Angeles.

Apple shares were down more than 2.5% on Tuesday afternoon.

Beyond the stock market, the implications of all this for IT managers is troubling. Business cycles tend to ride a longer, more stable wavelength than the frenzies that occasionally roil consumer markets. But with more of their key suppliers depending on the mass market for sales, buyers of commercial IT equipment may increasingly find their vendors distracted by stock market dips and other short term events.

They might also find themselves on the short end in terms of their suppliers' management time, product roadmaps, and investment priorities. After all, why spend money developing a product you can sell to 50,000 customers when you can build something for a market of 50 million?

As a result, investors shouldn't be surprised if sub-prime mortgage and consumer spending woes continue to drag the big tech indexes lower. The upside: tech stocks could be poised for the biggest gains when the markets finally recover and consumers decide they can again splurge on the latest MP3 players, video game consoles, digital TVs and other gear powered by technology from 'business' vendors.

About the Author(s)

Paul McDougall

Editor At Large, InformationWeek

Paul McDougall is a former editor for InformationWeek.

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