High tech: Where’s the bottom?

Zoomer | January 1st, 2006

There’s a strong temptation to believe that NASDAQ has fallen about as far as it can. But remember, many people said the same thing last spring and thought they had been proven right in the summer rally. As it turned out, it was a dead cat bounce – the plunge resumed in the fall and continued right into the holiday season.

Some money managers believe that, despite the sharp drop, there is still quite a bit of overvaluation in the NASDAQ Composite and that we could see further declines before we hit bottom. The slowdown in computer sales, which was reflected in profit warnings from Dell and Gateway among others, could intensify, especially if the economy slips into recession in 2001.

The telecoms are vulnerable. Fierce competition has slashed profits in traditional money-spinners such as long distance service, while the new revenue producers like wireless and data transmission are not growing quickly enough to pick up the slack.

Bottom in first quarter


It’s difficult to predict where the bottom might be, but some pessimists are saying the NASDAQ Composite could drop below 2,000. We have yet to experience what is known as the "capitulaon" phase, in which investors throw in the towel in a massive sell-off. Until that happens, the index could continue to drift lower, buoyed by the occasional rally as bargain hunters move in.

But, and this is important, at this stage there is no doubt that we are getting close to the floor. The shares in the great technology companies are not going to fall to zero. Even if there is another 20 per cent downside remaining, the fact is that we are already down more than 50 per cent from NASDAQ’s high. Just as no market goes up forever, so no market goes down forever. When irrational exuberance gives way to irrational despair, the end is in sight.

I expect that we will see the NASDAQ bottom in the first quarter of 2001. The real question for investors is what happens after that.

Once bitten…
I believe the answer will be a slow recovery, which will gradually accelerate over the next two years. There will be no sudden explosion in tech prices. We are going to see a "once-bitten, twice-shy" attitude on the part of investors, especially those who came late to the party and had their fingers burned.

Earnings will watched much more closely than in the past. Revenue growth will be important, of course, but it alone will never again be enough to drive stock prices to absurd levels. The companies that will do best initially once the recovery begins will be industry leaders that are trading at reasonable levels and that combine solid profits with good growth prospects. As always in meltdowns of this kind, it will take the juniors longer to come back.

Hold or fold?


The action you take now will depend on what’s in your portfolio. If you own shares in some of the industry leaders like Nortel, Intel, Cisco Systems, Microsoft, Oracle, Sun Microsystems, etc., you may wish to hold on to them for the long term. They may decline further in the next few months, but two years from now I believe they will look like good value at current levels. If you own junior tech companies, review each independently and decide what action is in order.

For tech-based mutual funds, I suggest you hold at this point. They’ve already been beaten up so badly that selling now would mean abandoning the ship after it has sunk. Have patience, wait it out, and gradually add to your holdings once it appears the market has stabilized.

It may take time, but high tech will eventually rise again. The 21st century is not about to revert to the Dark Ages.

Happy New Year.

Adapted from a column that originally appeared in The MoneyLetter, published by Hume Publishing. For subscription information, call 1-800-733-4863.