A combination of fiscal and political factors--including the pending invasion of Iraq, global concern about the stability of U.S. markets, and ballooning federal deficits--might wind up combining to trash technology stocks and further tighten the noose on venture capital.
Forget last week's modest 2.5 percent rise in the Nasdaq index. What I'm talking about is the possibility of longer-term problems over the next five years with a much gloomier outlook. For this you can blame President George W. Bush's lack of fiscal restraint--and the cravens in Congress who acquiesce to irresponsible spending programs.
Let's start with fundamentals. Homeland Security projects and a war against Iraq are expensive. The Congressional Budget Office recently estimated that the Bush administration's proposals would swell federal budget shortfalls by $2.7 trillion over the next decade, generating deficits every single year. If history holds true, the Federal Reserve will "monetize" the government's debt by devaluing the U.S. dollar while spurring inflation and higher interest rates.
That would be especially bad news for the tech sector. Much more than established firms, technology companies rely on venture funding and outside investment to expand: How many sizeable start-ups are entirely funded by their founders? Steeper interest rates will make it more expensive for entrepreneurs to seek loans. If savings accounts and government bonds start paying a lot more, they'll become more attractive places for investors to dump cash instead of shaky technology stocks and start-ups.
David Tice is something of a pessimist who runs two "Prudent Bear" funds, which most people laughed at during the tech boom. While most investors saw their 401(k) plans plummet as quickly as Rep. Jim Moran's political ambitions, Tice's funds recorded gains last year of 29.6 percent and 62.9 percent.
Tice told me one reason the second fund performed so handsomely is because he bet against stocks including Cisco, Intel, and Applied Materials (which systems for processing silicon wafers). "I think tech stocks go a lot lower no matter what happens with the war," Tice says. "We might get a little bit of a market rally if the war goes well, but overall, there's overcapacity and businesses are not going to increase their spending."
Yet Tice seems ecstatic about tech's chances compared with one hair-raising analysis of the Nasdaq composite index (which touched 5,048.62 in March 2000 and closed on Friday at 1340.33). The calculation: Based on the Nasdaq's median price-to-earnings ratio of 33, the index would have to lose over two-thirds of its value for it to be reasonably priced by historical standards. Put another way, assuming earnings growth of six percent a year, the Nasdaq index would become reasonably valued sometime around 2017.
Even billions of new government spending on IT could easily be offset by the problems that sharply higher interest rates would bring.
And what about deficit-spending, which tends to causes inflation and higher interest rates? Roberts agrees that if foreign investors favor Europe instead or if shortfalls go high enough it could be a problem. But, he adds, we're not there yet. "Athough $400 billion seems like a very large number, as a fraction of the U.S. economy and a fraction of the U.S. budget, it's relatively small," Roberts says. "If we ran a trillion-dollar deficit, interest rates would go up."
To complicate matters, there's a middle view that predicts a "sideways" trend, with technology stocks neither rebounding hugely nor falling dramatically. The justification: An infusion of federal spending on technology will artificially help the embattled industry, though perhaps at the expense of the rest of the economy.
I think there's some truth to that. Computer Sciences of El Segundo, Calif.,last month that its sales will rise by more than a quarter next year, spurred in part by its growing presence in the government market. SAP to cash in on part of the $38 billion the U.S. federal government has budgeted for homeland security spending this year, and the Bush administration has an 11 percent spending increase on information technology, up to $50 billion for the 2004 fiscal year.
At the same time, research firm IDC last weekits PC sales outlook for 2003, citing the potential impact on worldwide sales of a steeper-than-expected decline in public sector sales, and the University of Michigan's preliminary survey of consumer sentiment for March reported 75, down from 79.9 in February. That's hardly promising. Neither are budget crises and IT cutbacks among state governments.
Bradley Jansen, an adjunct scholar at the Competitive Enterprise Institute and a former staffer on the House Financial Services committee, thinks the good news and bad news will cancel each other out. "Some companies that we can't predict will develop products and do well, but the tech sector will be moving in a sideways direction for the next several years," Jansen says. "A lot of different factors are counterbalancing each other. There's a price-earnings ratio that's unattractive coupled with an influx of federal tax dollars."
For the tech sector, this isn't terribly good news. Even billions of new government spending on IT could easily be offset by the problems that sharply higher interest rates would bring. How many people or businesses will shop for new computers if their monthly payment skyrockets on an adjustable-rate mortgage? Or if credit card payments become so immense they make today's bills look positively lilliputian?
A lot of stock option wealth in Silicon Valley is riding on the answer to that question.