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Commentary—Don’t be scared off by floundering tech sector

The past few months have been particularly difficult for the stock market and in particular the technology stocks.

Earnings disappointments from some high-profile companies and, more recently, a revenue warning from Dell Computer have contributed to the volatility surrounding technology. After the parabolic performance of the technology sector last year and early this year, expectations had gotten clearly ahead of fundamentals. Changes in expectations for growth in technology, due to the slowing economy, have been occurring since March. As a result, stock prices have come down to very depressed levels.

While this has been painful, it is positive because it alleviates a lot of the speculation that was built into the technology sector. It will allow investors to purchase technology stocks based on sound fundamentals, key trends, and from companies favorably positioned to benefit from the adoption of new technologies.

Areas such as optical, networking, storage and infrastructure should continue to attract investors due to significant demand, which should remain very healthy for years to come.

The tremendous growth in the technology sector in the 1990s vaulted the market to unimaginable highs. Many investors grew increasingly uneasy as the bull market rampaged, giving rise to fears that a day of reckoning must surely be approaching for the tech sector. These fears seemed to find confirmation in 2000 with the collapse of the business-to-consumer portion of the market. Suddenly, the worst fears of the tech-investor seemed to be realized. The death of the dot-com companies has not been exaggerated. They are dead. Most of these stocks are 90 percent off their highs or have gone out of business completely.


Don’t Give Up Yet

However, it would be imprudent to extrapolate that e-commerce is dead simply because business-to-consumer e-commerce is dead. Technology is far more pervasive in an emerging global society that is growing increasingly dependent upon computerization. Business-to-business and business-to-enterprise e-commerce is very much alive and flourishing. Furthermore, as the technology-media-telecommunications convergence continues to surge, there will be a corresponding demand for technology to support the growth in these very lucrative fields.

A recent study by RHK, a firm specializing in the analysis of advanced technologies for the telecommunications industry, indicates that the demand for bandwidth could soar 300-fold in the next decade.

Bandwidth is simply defined as “the rate of speed that voice and data can travel to the end user.” Bandwidth demand will continue to be driven by heightened appetite for high-speed Internet access in homes and businesses worldwide.

More importantly, according to our research, the level of investment by the telecom companies will continue to grow to meet the insatiable demand for the new optical Internet and wireless telecommunications.

With the Internet becoming more prevalent in everyone’s life, both personally and in the corporate environment, telecom companies will be required to upgrade services and systems. In the near future, the bandwidth capacity required to keep up with the current explosive rates of growth will be far and above existing standards.

In North America alone, the Internet gains 400,000 new subscribers per month. An even more intriguing and important part of this growth scenario is the fact that much of the growth will be occurring in Asia.

China is adding approximately 2 million Internet subscribers per month. South Korea already has 2 million high-speed connections hooked up. India has recently relaxed the barriers to entry into its technology-media-telecommunications markets.


Finding The Right Path

From our standpoint, there are many vehicles to invest in this growth. In the past, many investors took the wrong path.

Many invested in the companies that provided content and benefited from business-to-consumer sales instead of companies that provided infrastructure, and more precisely, companies that facilitate the continued buildout of the network.

The days of these companies being valuated on cash flow as a means for investment justification are over. For the past several months, technology stocks have been hurt by a projected slowdown in capital spending due in part to the slowdown in the economy.

Many economists have asserted that the growth rate in technology capital spending is slowing due to the slowdown in economic growth. This may be true in a broader sense, however, looking from a micro-view there are some areas that will actually see accelerated spending.


Getting Back To Fundamentals

The correction in technology has been brutal on investors and portfolio managers alike. This correction has been emotional and recently, a correction driven by uncertainty.

There has been plenty of uncertainty surrounding the election and earnings growth. When there is uncertainty, investors often become emotional and sell stocks just because they are declining. Our research suggests the fundamentals for many technology stocks have not changed.

The fundamentals remain strong and intact. During these times an investor must take a positive approach. Currently, there are many things to be positive about.

First, the Federal Reserve has probably concluded its interest rate-tightening cycle. If history gives investors any indication of future trends, technology stocks should start to significantly outperform assuming the Fed actually cuts rates. (It is important to keep in mind that past performance is not always indicative of future results.)

In 1994 and in early 1995 when the Fed concluded the last major tightening cycle the S & P; 500 rose more than 25 percent the following 12 months. More importantly, many technology groups advanced over triple the rate of the S & P; 500.

Secondly, earnings for technology should continue to be very strong. Selected sectors in technology like the optical component and equipment, networking, storage and other infrastructure stocks should continue to show strong growth.

Lastly, many quality companies in these sectors are currently on sale. While some still appear expensive on a multiple basis they are well off their highs and their earnings growth should dwarf that of the S & P.; If you factor in lower interest rates in the upcoming months these stocks look even cheaper.

One must view the investment landscape pragmatically and take a three- to five-year horizon approach focusing on a company’s earning potential. Looking out just a quarter or two is just too short a time to fully capitalize on a company’s earning potential.

It is wise to remain very open to technology stocks for the long run. In these economic times, technology will continue to be the key driver in productivity and, consequently, economic growth for the foreseeable future.

Savvy investors believe that now is the time to buy and buy aggressively.

Valentine is the founder and president of Valentine Capital Retirement Planning Group.

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