Taking Stock: Declining Prices Could Mean Opportunity

Patience is the best course of action until spending picks up.
Declining markets are always a mixed blessing: The stocks become cheaper (which I definitely like), but losing money is never pleasant. This hasn't been the year for technology stocks so far. The Nasdaq Composite extended its 2003 rally through most of January, but since then it has mostly been downhill. As of the end of July, the Nasdaq Composite had declined 5.8% for the year. However, various sectors have posted quite different returns. Let's take a brief tour through the gloomy techscape as it stood at the end of July.

Starting at the brighter end, two categories of tech stocks posted excellent results. Internet software and service and home-entertainment stocks rose 20.4% and 12.5%, respectively. (All the data is market-cap weighted and includes tech stocks with a market cap greater than $100 million). Names such as Yahoo and Ask Jeeves drove Internet software and services stocks. Home-entertainment stocks saw large contributions from Midway Games and Electronic Arts. Sumner Redstone owns the majority of the outstanding shares of Midway Games, and he has expressed interest in either taking the company private or acquiring more than 80% of its shares.

Quite a few sectors have returned little to investors this year. Communications equipment as a category rose only 1.4%, but this masks strong performances posted by Juniper Networks (up 22.9%), Qualcomm (28.3%), and Research in Motion (84.6%). On the flip side, Cisco Systems (-13.7%), Nortel Networks, (-13.5%), QLogic (-52.6%), and UTStarcom (-50.8%) offset the positives.

The picture was a bit worse for application software, a sector always near and dear to my heart. This group of stocks experienced a decline of 11.4%. CIOs have put the brakes on spending on enterprise apps, and the list of decliners certainly reflects that: BEA Systems (-47.2%), Mercury Interactive (-24.8%), PeopleSoft (-20.9%), and Siebel Systems (-41.8%).

The worst performers were semiconductor stocks and semiconductor capital-equipment stocks, dropping 20.6% and 28.1%, respectively. The commonly held belief on Wall Street is that the semiconductor cycle has peaked or is close to peaking, and the only way from here is down. Intel's unexpected increase in inventory only fueled this theory, despite management claims that the third quarter looks "seasonally normal." The list of semiconductor stocks that declined is long and includes large companies such as Intel (-23.9%), Texas Instruments (-27.4%), and STMicroelectronics (-30.9%). The performance of the semiconductor capital- equipment stocks has been downright dismal, with leading companies down, including Applied Materials (-24.4), KLA-Tencor (-29.6), and Novellus (-35.8%).

It's easy to get discouraged, but my contrarian half smells opportunity. At some point, I believe companies will start spending on software, which will benefit the software vendors. The cycle will turn and, in my view, semiconductor and semiconductor capital-equipment stocks will once again be in the limelight. But for now, patience is a virtue.

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 shouldn't 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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To find out more about William Schaff, please visit his page on the Listening Post.

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