After slumping last fall with the rest of the market, technology stocks have made a strong comeback.
From March 9, the equities markets' bottom, to mid-October, the technology companies that make up 18% of the S&P 500 index, for example, have risen 48.6%, compared with 21.5% for the other companies in the index. Is it too late for other investors to climb aboard?
Observers say technology stocks retain a lot of upside potential.
"You get considerable exposure to technology just by investing in an S&P index fund," said Michael Pytosh, a senior research analyst and senior vice president at ING Investment Management Inc., the asset management arm of ING Group NV of Amsterdam. "But I'd suggest you could be more aggressive" by putting 25% of an equities portfolio in tech or, for a really aggressive play, 30%. Any decision to overweight technology would depend on a client's appetite for risk, he said, but "broadly speaking, tech companies will beat expectations over the next year or so, as the economy recovers."
For one thing, tech stocks are in better shape than they were during the dot-com bubble. Companies are much healthier financially, with less leverage and overcapacity, said Ken Allen, the portfolio manager of the T. Rowe Price Science and Technology Fund. If the economy starts to recover, technology companies of all sizes are "positioned to outperform the broader market."
Allen said the sector would benefit from Microsoft's introduction of its Windows 7 operating system, which is getting good early reviews. This means all PC-related products will need an upgrade, he said. Add to that a new Microsoft Office suite that is to be released next summer, he said, and the fact that large and small businesses have been putting off replacing their computers equipment for several years.
These factors mean "the old installed base of computers will have to be replaced," Allen said, and 2010 is the year it is likely to get done.
"In the corporate world, the normal cycle has been for PCs to get upgraded every three to four years," Pytosh said. "We've kind of skipped a cycle now because of the economic downturn. The [old systems] are beginning to break, and processor speed is becoming an impediment to productivity."
Hans Mosesmann, a managing director at Raymond James Financial Inc. who specializes in the chip industry, agreed.
"This will be a huge product cycle," he said. "It's been a long time since we've had a really new operating system for the 50% to 60% of PCs that use Microsoft. Vista was no good, so that doesn't count. There's been a year of tests on Windows 7, and the reviews have been universally good, so this could be a whole ecosystem change for the PC world."
New operating systems need new applications, and other new products will be nurtured in the Windows 7 "ecosystem."
"It's been 10 years since a major industrywide upgrade," Mosesmann said. "Now is the time to jump in on this. Six months from now it will be too late."
Companies that have been stinting on information technology spending are likely to need new enterprise software. These programs run companywide platforms that support efficiencies and communications that can monitor all aspects of a company's operations, as well as automated treasury systems. The programs are offered and supported by companies like Oracle, SunGard, Adobe Systems, Sun Microsystems, IBM and SAP.
"As the economy picks up next year, capital spending will kick in, and businesses are going to have to start updating their enterprise software," Pytosh said. "That will be good news for companies like Cisco and Microsoft."
Investment strategists already see signs that companies are planning to significantly increase their technology spending. Mark Zandi, the chief economist of Moody's Economy.com, for example, is predicting that U.S. tech spending, which has fallen 10% in 2009, will grow 4% next year and 10% in 2011. Much of this spending will be to upgrade existing equipment and software, and more will be on new automation, he said.
Take Intel, for example. The chipmaker sparked a jump in global equities markets on Oct. 14 when it announced third-quarter earnings of $1.9 billion on revenues of $9.4 billion. These numbers, reminiscent of Intel's prerecession performance, pushed up the shares of PC makers Hewlett-Packard and Dell by more than 2%. Intel's CEO Paul Otellini also announced that he was buying a "fleet" of PCs for Intel employees. "I suspect a lot of other companies are coming to that same conclusion," he said.
The tech sector is also at a turning point, Zandi said, before a burst of consolidation. Thomson Financial reported more than $20 billion of tech merger and acquisition activity in September, compared with $2.5 billion in August and $11 billion a year earlier.
Fred Greene, a Raymond James financial adviser who works in the financial group at Woodforest National Bank in Woodlands, Tex., said another bullish sign for the sector is that tech companies are no longer improving earnings through cost-cutting but through revenue growth. When clients come to him looking for winning stocks, he is suggesting companies such as Intel, Harris and Digital Realty, a real estate investment trust focused on technology centers, which has had a huge run and pays 3.25%.
