Taking Stock: Don't Get Out Your Party Hats Just Yet

A funny thing happened to the stock market the last couple of weeks: It actually started to rise. From the Nasdaq 100's recent low close of 807.42 on Oct. 9 to Oct. 22's close of 963.87, there was a move of 19.4%. Not bad for nine trading days. The big question is whether the rise is for real this time.

Because crystal balls are clearly out of favor, I use company fundamentals. And since this is earnings season, I have quite a few reference points to see if technology companies' fundamentals are starting to improve. Unfortunately, the near-term outlook is still pretty bleak.

Some readers will point to the wonderful news and price improvements of technology stocks in recent days as a harbinger of better days. They'll point out the strong performance of Dell Computer, IBM, and Microsoft. But there are more bad examples than good ones.

Here are some of my concerns. First, we're still struggling with an economy that's on the brink of a double-dip recession. We might avoid the fall but, then again, we might not. A war could push us over the edge. Second, corporate profitability hasn't recovered, though it may be stabilizing. Earnings only look better because expectations have been set so low, and we're unlikely to see growing IT budgets without an across-the-board pickup in corporate profitability. Third, throughout most tech sectors, company fundamentals refuse to improve and even continue to decline near term. Shares of one of the largest semiconductor companies, Texas Instruments, declined more than 18% on the day it posted lower-than-expected earnings per share and, more important, lowered its revenue outlook for the fourth quarter. This should concern us because its products go into everything from PCs to televisions. As if Texas Instruments' news wasn't bad enough, Taiwan Semiconductors missed its third-quarter earnings call, and Intel reported weak third-quarter revenue and earnings.

With limited control over sales, the only way for semiconductor companies to increase profitability and free cash flow will be to cut expenses and capital spending. This means a sad Christmas for semiconductor equipment manufacturers such as Applied Materials and Novellus, because they need loose budgets from semiconductor companies to make their numbers.

Software and IT services haven't been immune to the downturn. Veritas Software just said its fourth quarter may come in lower than analysts' expectations. Consulting firm Accenture is forecasting revenue growth for its fiscal year ending in August of 0% to 2%--not exactly compelling numbers and just about in line with growth expectations for the gross domestic product. And let's face it: IBM's numbers weren't all that stellar. The company's revenue was flat year over year and up only 1% sequentially quarter over quarter. Backlog from services declined again, and software sales declined 3% year over year. Maybe IBM can hit its target of double-digit earnings growth rate next year, but not for too many years thereafter--not at 0% revenue growth.

As you can see, there isn't enough evidence of a turnaround yet. Yes, share prices may anticipate a turn, but I think investors can afford to wait. My advice: Be patient, go shopping, and help stimulate the economy--you never know, it may benefit IT spending.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at [email protected].

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