Is Tech Ready to Rumble?
It's been nearly seven years since the Internet bubble burst, and most sectors of the stock market have recovered-except technology. In fact, the tech-heavy Nasdaq composite index remains more than 50 percent below its all-time peak, while the Dow Jones industrial average is trading at new record highs.
But "tech stocks have tended to flourish once the Federal Reserve stops its series of interest-rate hikes," according to a recent study by Turner Investment Partners. The asset management firm notes that tech was a market leader in the three months following the end of Fed rate-hike cycles in the '80s and '90s. And it appears as if the Fed is done hiking rates-at least for now.
A growing number of money managers think tech's time has come again. Even value-oriented investors who have historically avoided the sector are starting to increase their holdings in tech.
Take John Linehan. Over the past 18 months, the manager of the $5.5 billion T. Rowe Price Value fund has been building his stake in companies like Cisco Systems and Microsoft, which is now the second-largest holding in his arsenal. Earlier this year, he also beefed up his IBM and Intel holdings. As a result, his fund's concentration in tech has jumped from just 4.5 percent two years ago to nearly 9 percent recently.
Cheap. "The catalyst that's getting tech stocks off the bottom is valuation," says Linehan. In other words, after more than half a decade of being out of favor, many tech stocks are trading at attractive prices.
But investors aren't looking solely at price. "Many tech companies don't have a lot of debt, they have very strong balance sheets, and they are generating a significant amount of cash flow," says Linehan. Moreover, some tech companies have even begun paying dividends recently.
This strategy of bargain shopping seems to be paying off. Over the past three months, shares of Cisco, Microsoft, and Intel have jumped 33.6 percent, 22.1 percent, and 17.5 percent, respectively.
This has certainly gotten fund managers' attention. According to a recent survey of money managers by the Russell Investment Group, 56 percent are now "bullish" on tech, versus just 18 percent who say they are "bearish" on the sector. This means Wall Street is more optimistic about tech than about any other sector except healthcare.
To be sure, tech still has been the worst-performing stock category over the past three years. Tech, after all, is a highly cyclical sector, so it tends to do well when the economy is firing on all cylinders. Yet the economy is now slowing down, not speeding up.
"Tech is on deck to do well, and tech's time will come eventually," says Jack Ablin, chief investment officer for Harris Private Bank. "But the economy may need to get past its bottom, and growth rates may need to be on the upswing before tech makes its move."
This is certainly true of tech companies that are dependent on consumers for revenue growth. But firms that sell to businesses may be a safer play, market watchers say. According to a recent survey by Merrill Lynch, corporate information-technology budgets are expected to climb 4.4 percent this year. That's twice the growth rate of 2003.
Linehan notes that after years of cost cutting and improved efficiencies, many companies are sitting on piles of cash. "And technology is one way for these firms to invest their cash while increasing their productivity," he says.
Another thing: Don't forget the impact of globalization. Even if the U.S. economy slows considerably, tech firms with global reach, such as IBM and Cisco, could see their continued profit and sales growth from activity overseas.
This story appears in the October 23, 2006 print edition of U.S. News & World Report.