COMMENTARY -- The Federal Reserve's interest rate cut may have provided a nice shot of morphine for the stock market, but the tech sector remains tricky.
After surveying a host of Wall Street research notes, tons of pundit-speak and the usual idle stock chitchat, the only thing you can conclude is that the tech sector remains dicey. Typically there's a six- to nine-month lag before an interest rate cut boosts the economy, so don't expect miracles.
"Since we don't think P/E ratios will rise much from the current level of 22-23x, and we expect very little profit growth, we can't see a way to generate extraordinary (20+%) returns in 2001," said Ed Keon, an analyst at Prudential Securities. "So let's enjoy the rally, but we caution investors not to assume it's time to 'party like it's 1999.'"
May the tug-of-war begin. In one camp you have investors that recite the "you can't fight the interest rate trend" mantra at will. On the other side, there are a lot of folks pointing out this never-ending parade of profit warnings (more than 500 in November and December).
Here's a look at the tech sector by some of the leading categories:
PCs and chips: That interest rate cut made me feel better for about an hour. But I still didn't get the urge to upgrade my PC. I didn't get the itch for Intel's latest Pentium either. And Windows 95 is still quite functional too. Consumer-oriented PC vendors such as Gateway (NYSE: GTW) and Apple (Nasdaq: AAPL) may do better if shoppers get some confidence, but corporate spending is likely to remain slow.
Chip equipment makers: Lehman Brothers analyst Edward White reckons that chip equipment stocks may be near a floor. He likes Applied Materials (Nasdaq: AMAT) and KLA-Tencor (Nasdaq: KLAC) as value stocks. However, White raises a good question in his research note. Did the world buy too much chip gear last year? If chip makers went bonkers with capital spending and there's overcapacity, no amount of interest rate cuts is going to help. The good news is that a better economic climate in the second half of 2001 might encourage chip makers to spend on new gear.
Networking stocks: Analysts said investors should look at companies that can make their quarterly numbers during two or three quarters of economic weakness. Salomon Smith Barney analyst B. Alexander Henderson said Cisco (Nasdaq: CSCO), Extreme Networks (Nasdaq: EXTR), Nortel (NYSE: NT) and Juniper (Nasdaq: JNPR) are among the companies that fit his profile. But there's a catch. Henderson said it "would be imprudent for these companies to raise guidance until the economic backdrop improves." If these companies can't raise guidance, they'll have trouble supporting those still-lofty price-to-earnings ratios.
Internet infrastructure stocks: The recent profit warning from Inktomi (Nasdaq: INKT) has a lot of folks spooked. If Inktomi, which is a well-run company, warns that means weaker infrastructure companies may really take a bath. Inktomi is one of those companies that can weather a storm better than its peers. And Inktomi still got creamed.
E-finance: Look at those online brokers go. E*Trade (Nasdaq: EGRP) and other brokerage stocks surged Thursday on the rate cut. Volume may pick up, which would boost these shares. But one day doesn't make a recovery. If the market can sustain a rally, e-brokers will look pretty good.
Dot-coms: An interest rate cut isn't going to bring back all of those easy-money companies that spent heavily on online advertising. The Fed can't curtail the creative destruction that exposed business models that won't work (see eToys' layoffs). Many online media companies are still in dire straits as advertising slows.
Merrill's GAAP rebellion
Merrill Lynch handed out its 2001 tech predictions and most of it looked like standard fare. Merrill Lynch said IPOs and mergers will be down by 30 percent or more, tech stocks will struggle in the first half and then rebound, small-cap tech stocks will do well and venture capital funding will be halved.
And then Merrill Lynch made a prediction that could make an accountant choke -- tech investors will be increasingly frustrated by GAAP (generally accepted accounting principles). I can see whiny GAAP-impaired tech companies, but an investor accounting rebellion? Puhleeze.
Merrill Lynch contends that accounting's shortcomings in describing tech companies is a huge problem. The worst offense is underestimating intangible assets. The catch is trying to put a dollar figure on intellectual property. Simply put, Merrill Lynch is saying tech companies are different -- let's capitalize research and development and marketing.
Tech firms are unique to a degree, but give me a break. The only tech investors that'll be frustrated about GAAP accounting will be those who have bought shares of companies that can't make the grade under traditional measures.TDAIN
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