Why technology stocks are back in favor
NEW YORK (AP) – There is one constant amid the unprecedented volatility that has sent the major U.S. stock indexes seesawing up and down this year: Investors are still optimistic about technology stocks.
Indeed, investors seem to have tailored their strategies to allow for the purchase of tech stocks, notwithstanding the fact that additional interest rate hikes are a virtual certainty.
The tech-dominated Nasdaq composite index returned to record territory this past week, hitting another all-time high Thursday before shedding 137 points during Friday’s broad market selloff.
The Nasdaq index has made a sharp turnaround since early January. At that time, worried investors, fearful that Federal Reserve Board policy makers were planning big interest rate hikes in an assault on inflation, sold technology stocks on the theory that sales would slow if buyers couldn’t afford to borrow the cash needed to purchase tech products.
In fact, after hitting a new record during the first trading session of 2000, the Nasdaq index plunged about 400 points over the next three days. The rapid decline shaved off nearly 10 percent of the Nasdaq’s value, leaving the index dangerously close to what Wall Street defines as a correction.
While the correction never materialized, investors still spent most of January fretting over what the Fed might or might not do at its February meeting.
But when – as had been widely predicted – interest rates were raised by a quarter-point on Feb. 2, the modest increase apparently gave tech investors a jolt of confidence.
To justify that confidence, investors are extolling an entirely new philosophy.
The new doctrine goes something like this: The best technology companies are growing so rapidly that the Fed’s strategy of incremental interest rate hikes to offset inflationary pressure will have little or no impact on the companies’ bottom lines.
The strategy seemed in full bloom on Thursday. Even as Fed Chairman Alan Greenspan hinted of further rate hikes during a congressional hearing, tech stocks were rallying to push the Nasdaq index to a new record.
”Technology stocks remain appealing, but on a selective basis,” said Alan Ackerman, senior vice president at Fahnestock & Co. in New York.
”Some technology companies have the capacity to grow their earnings at a rate much faster than blue-chip companies. Hence the tech companies offer a type of safe haven against interest rate fears,” Ackerman said.
Many technology companies are posting annual earnings growth of 30 percent a year, Ackerman noted, while old-line blue chip companies continue to wallow in the 8 percent range.
Network equipment maker Cisco Systems is a prime example of a company that fits the new strategy. The stock has gained about $20 since Jan. 1, hitting a 52-week high of $136.25 on Feb. 10. It closed Friday down $4.69 at $125.81.
Is the optimism justified? Consider that Cisco’s earnings growth has far outpaced that of the average growth rate for companies included in the broad Standard & Poor’s 500 index over the last five years. And the pattern is expected to continue for another five years.
Mutual fund manager Art Bonnel, who runs U.S. Global Investors Bonnel Growth Fund, provided additional justification for the new strategy.
Most technology companies aren’t saddled with the same debt burdens faced by older, industrial companies, he said. Consequently, tech companies are less vulnerable to short-term interest rate hikes.
”Tech companies have made a lot of money in recent years and they’ve paid off their debts,” Bonnel explained.
In addition, many tech companies – such as computer chip and software makers – produce goods that are relatively inexpensive, Bonnel said. So neither the manufacturers nor their buyers need to go heavily into debt to keep the supply chain moving.
It’s a different story, however, for the big industrial companies whose capital-intensive operations keep them perpetually in debt and extremely vulnerable to rate fluctuations.
That dynamic has been well reflected in the recent losses sustained by the Dow Jones industrial average.
For the year, the Dow is down nearly 1,300 points, or 11 percent. On Friday, it fell 295.05 to 10,219.52, giving the Dow a loss of 205.69 for the week.
The Nasdaq ended the week with a gain of 16.29 after losing 137.18 Friday and closing at 4,411.74. But the Nasdaq, which reached a new closing high of 4,548.92 on Thursday, is up 8.5 percent for the year.
The S&P 500 ended the week down 41.03 after falling 42.17 Friday to 1,346.09. The index is down more than 8 percent in 2000.
The Russell 2000 index, reflecting the performance of smaller-company stocks, was down 8.55 for the week, falling 12.77 Friday to 545.65. So far this year, the Russell 200 is up 8 percent.
The Wilshire Associates Equity Index – which represents the combined market value of all NYSE, American and Nasdaq issues – ended the week at $13.12 trillion, off $261.23 billion from the previous week. A year ago the index was at $11.28 trillion.
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