Taking Stock: Summer Doldrums Are About To Set In For Technology Investors

Tech equities should be only a small part of a portfolio.
It's almost summer, but for technology investors, it's the dead of winter when spring is only a distant dream.

Returns from the stock market are directly related to the supply and demand of stock by investors--and right now, demand is declining. The result has been that prices have had to move sharply lower for demand to meet the supply of technology equities. Some of the supply-demand trends are seasonal, while others are truly fundamental to the technology equity market.

First, the fundamentals. We still have about a month to go before the quarter ends. Software vendors are working overtime to meet their quarterly numbers. My sources tell me the first two months were depressing. Most of us know that about 50% of software sales hit in the last month of the quarter. Maybe a few sales incentives kick in or a few discounts are promoted--whatever it takes to close the deal. Too many companies are still talking about deals in the pipeline, and not enough of them are talking about ones they've closed.

This is a troubling trend and continues to reinforce the fact that business IT spending hasn't recovered along with the consumer-driven economy. Software vendors will be hard-pressed to make their numbers this quarter, despite the strengthening economy.

What's worse is the fact that as we get deeper into the summer, we'll have the weakest quarter of all, the one ending Sept. 30. It's often said that if you don't get the deal done by the end of the second quarter, you'll have to wait until the fourth to have another chance.

I don't expect to see the bottom in software sales until the third quarter of this year. This might not be so bad if we could at least see some improvement in other areas of technology.

There was some relief in semiconductor equipment stocks in advance of new product upgrades at overseas wafer-fabrication plants, but even their valuations have gotten too lofty. The group now sells for more than 30 times analysts' 2003 earnings-per-share estimates. That's not exactly cheap, because this sales multiple assumes a recovering earnings forecast into next year. Semiconductor stocks also are trading at more than 31 times analysts' 2003 forecasts. This doesn't bode well for a strong price recovery.

Second, we have the seasonality factor in investing. Schools are starting to let out for the summer, meaning that a lot of families will be going on vacation. Most parents I know are either in the IT business or in the investment-management business, and there are a lot of them. Interestingly enough, the effect on supply and demand in IT or the stock market is roughly the same. Once these people go on vacation, they tend to leave their business affairs behind. In the stock market, that means there are fewer buyers and sellers of stock. The lower the number of participants, the lower the volume of stock trading on the exchanges.

The same is true with IT spending. As decision makers and analysts go on vacation, decisions get deferred, meetings get cancelled, and purchase orders don't go out. No wonder few salespeople like the third quarter of the calendar year.

Is there any place for a poor technology investor to hide these days? There a few niches, but they tend to be company-specific. There's one general theme, and that's international technology companies. They may do better, relatively speaking, than U.S.-based IT companies. The real reason doesn't have as much to do with business fundamentals as it does with the potential decline of the dollar vis-à-vis overseas currencies.

Sales and profits of international technology companies, once converted to U.S. dollars, would be higher. However, this assumes that the company has most of its sales overseas, which may leave out some major international technology companies that have a large U.S. sales base.

It's tough being a technology investor, as the market seems to go from hot to cold in a hurry. Once again, it proves why many investors should hold technology equities as only a small portion of a diversified portfolio.

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