Tech Industry

Mortgage meltdown: Tech stocks' gain?

The subprime scandal has sent investors looking for new homes for their money. Silicon Valley, however, may not be it.

Hey buddy, has that sagging real estate investment got you down? Could we interest you in some VMware shares?

Even if the answer to that first question is "yes"--and surely it is--don't count on too many investors answering the second in the affirmative. Securities and fund analysts say the markets will likely take a breather after the anguish over a possible credit crunch and the harsh realities of subprime mortgages going belly up.

And while those who had been plowing money into Real Estate Investment Trusts and mortgage companies are pulling back, analysts don't expect investors to suddenly switch over to technology stocks, unless they are large-cap stocks.

"During periods of heightened uncertainty, investors tend to favor large-cap stocks as a safe haven," said Jordan Rohan, managing director of RBC Capital Markets. "Sometimes the safe havens are technology stocks, but I doubt the tech sector is receiving a disproportional amount of investor attention."

Although the markets have recovered a bit in the past four days, the Dow Jones Industrial Average in Friday morning trading was off approximately 9 percent from its 52-week high of 14,121 on July 19, while the tech-heavy Nasdaq was down 6.4 percent from its high of 2,724.74 on that same date.

Meanwhile, those who put their money into mutual funds tend to stay within a general investment category, such as retail. During a market downturn, for example, investors of this ilk may seek out large-cap institutions such as retailing giant Wal-Mart Stores while foregoing the hip, cool and trendy new small-cap retail companies, say analysts.

And that hesitation about the tech sector may well be prudent. Even its so-called large-cap safe havens such as Microsoft, Intel, Cisco Systems and IBM may not be immune to wobbliness on Wall Street.

Fallout from one sector to another
Tech companies that rely on customers in the financial services industry, which includes banks, insurance providers and real estate companies, may suffer in a prolonged market downturn stemming from the subprime mortgage mess. Feeling the heat from the credit crunch, those services companies may curtail IT spending, which in turn can hit the bottom line of tech companies and, hence, their stock price.

The financial services industry comprises about 19 percent of all IT spending worldwide, according to IDC. IBM alone receives approximately 27 percent of its total sales from the financial services industry--a sector that yielded an 11 percent year-over-year gain for the company in the second quarter, noted Rick Hanna, an equity analyst for mutual fund research firm Morningstar.

Hanna isn't too worried about Big Blue, however.

"Even though IBM may have a higher percentage than the overall average (in financial services revenues), I think they are actually less at risk than average," Hanna said. "The reasoning is, its customer base is large and global and thus better equipped to weather some turbulence."

He added that IBM also receives a greater percentage of its revenue from recurring sources, such as software licenses and services contracts, compared with discretionary hardware spending.

Tech stocks may have already felt a bit of a spillover effect from the subprime market problems, said Toan Tran, equity strategist with Morningstar.

Some hedge funds that rely on computer models for trading, or quantitative funds, were caught up in the markets malaise late last week, resulting in a steep sell-off of some of their holdings. Some of those holdings, Tran said, likely included tech stocks.

On the other hand, tech IPOs have been gaining steam. To date, approximately 44 tech stocks have debuted this year, compared to roughly half that during the same time last year, according to Thomson Financial. And recent investor enthusiasm for VMware's initial public offering could propel more companies to flock to the public markets.

"If you have a very good company that wants to go public like a VMware, or has a lot of demand like a Facebook, then you could still go out. But if you're a marginal IPO, the deal may not get done at all in this market," Tran said.

Tech stocks may catch a break because of sales to foreign companies, said Matthew Wu, senior portfolio manager for Rydex Technology Fund. He noted that technology companies receive roughly half of their revenue from overseas markets, which are not affected by the domestic credit crunch in mortgages.

And keeping an optimistic outlook, Israel Hernandez, a Lehman Brothers technology analyst, noted that all is not lost in the current market environment.

"From our perspective, it's early in the quarter and if the markets settle down, this may not amount to a whole lot of (trouble)," Hernandez said.