Tech Fund Managers Put on Brave Face
For technology investors, 2000 will go down in history as the year Nasdaq became a punch line. Only nobody was laughing.
The tech-dominated Nasdaq composite index tumbled 39% during the year and more than 50% from its March 10 all-time high.
Hopes that the new year would bring relief have been dashed in the first five trading days of 2001: Despite a record one-day Nasdaq surge Wednesday after the Federal Reserve cut interest rates, the Nasdaq index slid 2.5% for the week. It eased an additional 0.5% on Monday.
For investors in technology stock mutual funds, the losses in most funds last week added insult to 2000’s injury.
The accompanying chart shows how most tech-sector mutual funds fared last week, as well as their performance data for 2000 and annualized returns for the last three years (for funds that have been around for that long).
When will the tech sector hit bottom? To answer that, investors probably need to have an answer to a much bigger question: Will the economy continue to slow sharply this year--or even fall into recession--or is the current slowdown likely to run its course in a quarter or two?
So far, the problem for many tech companies isn’t that sales are declining--just that they are slowing from extraordinary growth in recent years. But given the high prices the stocks reached relative to earnings, investors weren’t prepared for even a mild slowdown in growth.
Because of the risk of a deeper economic slowdown that could slash tech companies’ sales and earnings across the board, many portfolio managers concede they can’t say that the stocks are finished falling.
“This will be a tough year, particularly in the first half,” warns Deb Koch, co-manager of the Strong Advisor Technology fund in Milwaukee.
But looking out a year or more, she said, investors still have to view tech as the premier growth sector in the economy.
“Compared to any other sector, I think this is the best place to be in the long-term,” she said.
Here’s a look at how a number of tech-fund managers view the sector’s prospects, and how they’re focusing their portfolios:
* Kevin Landis, manager of San Jose-based Firsthand Technology Value fund (2000 return: -10%) and Firsthand Technology Leaders fund (-24.2%). Long-term, Landis is bullish--not surprising for a tech-fund manager, of course.
The sector’s crash has resulted from a variety of factors, he said, including overly optimistic investor expectations, the economy’s slowdown and the wave of company profit “confessions” that the slowdown has generated in recent months.
“These things tend to feed on themselves,” he said.
But Landis, like other tech fund managers, is trying to get investors to focus on the idea that market plunges like the current one ultimately produce great investment opportunities--the chance to buy good companies at a discount.
Still, he cautioned, investors need to be selective.
Landis never jumped into “dot-com” stocks and doesn’t anticipate doing so now, he said. Moreover, he believes that many companies dependent on the personal computer industry aren’t going to come back strong, because PC sales won’t be a driver of tech-sector growth in the future.
“My fear is that everybody is going to go back and buy Microsoft, Intel and Dell,” he said. “I think that’s a mistake. I have a hard time seeing eye-popping growth out of those companies in the future.”
He sees much better opportunities in companies that produce the optical networking equipment that is tying computers and other devices together worldwide--companies such as Ciena (ticker symbol: CIEN), PMC-Sierra (PMCS) and Corning (GLW).
He also likes e-commerce companies that focus on serving big business, such as Siebel Systems (SEBL) and BEA Systems (BEAS).
It’s true, Landis says, that many tech stocks still have relatively high price-to-earnings ratios, even after last year’s losses. But that is typical of fast-growing companies, he notes.
“Nobody likes to overpay, but sometimes you do have to pay up for the better names,” he said.
* Dennis McKechnie, managing director of PIMCO Equity Advisors in New York and portfolio manager of the PIMCO Innovation fund (-28.8%) and the PIMCO Global Innovation fund (-41.4%). “The prospects for this year are certainly better than last year,” McKechnie deadpans.
Nonetheless, some sectors of the tech market are unlikely to see their previous highs soon, if ever again, he said.
For example, consumer-oriented Internet companies will sell at valuations more in line with brick-and-mortar companies in their respective industries--far lower than the valuations investors put on the stocks last year, McKechnie said.
In other words, Amazon.com (AMZN) may trade like a retailer; America Online (AOL) like a media company; and Yahoo (YHOO) like an advertising and retail conglomerate.
But opportunities exist in two developing themes, McKechnie believes. One is the emergence of the wireless Internet.
“We think this will increase the penetration of cell phones and cause current cell phone users to purchase new phones,” he said.
The major beneficiaries of this trend: Nokia (NOK), Qualcomm (QCOM), Texas Instruments (TXN) and Openwave Systems (OPWV), all of which are involved in some facet of wireless communications.
The second major trend McKechnie sees in 2001 is the accelerating effort by big companies to automate their businesses to control inventory, information flow and paperwork more effectively.
The beneficiaries of that trend are likely to include BEA Systems, Check Point Software (CHKP), I2 Technologies (ITWO) and some old favorites, such as Oracle (ORCL) and Cisco Systems (CSCO), which help companies manage information.
* Deb Koch, co-manager of the Strong Advisor Technology fund (started in November; December return: -7.3%) in Milwaukee. Some investors may think that a stock that sells for half of what it was going for a year ago is a relative bargain. But that’s not necessarily the case, Koch says.
“No one knows how slow the economy is going to get or how bad it is going to be,” she said. “These [stocks] are so driven by growth that you have to get that part of the equation right.”
Still, Koch thinks it’s a great time to assemble a shopping list of tech names that you may want to buy as prices get more reasonable. She said she’s concentrating on two sectors: software companies that sell applications to Internet firms, and networking companies, such as Cisco and Juniper Networks (JNPR).
Koch is convinced that, over the long run, tech stocks will outperform the overall market. So even though she doesn’t advocate buying right now, she also doesn’t suggest that investors sell.
As the accompanying chart shows, there have been many deep sell-offs in tech since 1987. But even investors who bought at peak levels before those sell-offs have earned stellar returns in the long run.
“The only thing you can do is ride out the rough spots,” she said. “The worst thing you can do is capitulate when you are right at the bottom.”
* Bill Keithler, portfolio manager of the Invesco Technology fund (-22.8%). Keithler is another one who thinks that many tech stocks--at least the ones he wants to buy--are still too pricey.
Price-to-earnings ratios remain above 100 for many tech stocks, he notes. “We think there is more bad news to come,” he said. “Investors need to view tech stocks as mere mortals, as opposed to something special.”
Though he doesn’t question the tech sector’s strong long-term growth prospects, he said investors still may not be realistic enough about the companies’ vulnerability to economic swings.
Still, as prices continue to ebb, Keithler anticipates stocking up on a few select data storage and semiconductor names. He won’t say what he’s buying, but top data storage companies include EMC (EMC), Brocade Communications (BRCD), Veritas Software (VRTS) , Network Appliance (NTAP) and McData (MCDT).
“If I wanted to be glib about it, I’d say that it’s too late to sell, but too early to buy,” he said.
* Craig Callahan, chief investment officer at Meridian Investment Management, investment advisor for the ICON Information Technology fund (+14.1%). Callahan, whose fund managed a gain last year because he lightened up on tech shares early in the year, now is looking around the fringes of the tech universe for value.
Among the stocks he likes are Concord EFS (CEFT), which provides electronic funds transfer services; Barra (BARZ), a company that provides investment management software; and Tellabs (TLAB), which sells telephones and telecommunications products.
Still, he says, in many ways “technology was 1999’s story,” and he’s focusing on other sectors. Buying tech stocks now risks missing the boat in other areas of the market, such as health care and finance, he says.
* Bob Smith, manager of the T. Rowe Price Growth Stock fund (+0.3%). Smith, whose fund typically holds a third of its assets in tech stocks, remembers a year ago when nobody wanted to own Philip Morris. The stock went on to lead the Dow industrials in performance last year.
“You don’t want to be blindly contrarian,” he says, “but your best stock purchases tend to be the ones that give you a sick feeling when you’re buying them because you’re going against the crowd and are afraid you’re going to look really stupid.”
Does that reasoning apply to tech stocks now? Maybe.
“On current [earnings] estimates, Cisco is selling at a lower [P/E] multiple than Pfizer,” Smith said. While Pfizer may be a leading drug company, it’s likely to grow at a slower rate than better technology companies, he said.
“The market is discounting revenue and growth [with tech stocks],” he said. “The question is whether it’s got the proper discount” yet.
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Taking the Long View
Short-term pain in tech stocks can lead to long-term gains for investors who can stand the volatility. This chart shows the Pacific Stock Exchange technology index’s declines during tech sell-offs and the returns for those who rode them out.
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Annualized return Selloff period PSE decline through 12/31/00* 10/5/87--12/4/87 --42.2% 18.4% 7/5/88--11/21/88 --22.0 22.1 7/16/90--10/16/90 --34.0 25.7 1/17/92--10/5/92 --17.6 26.8 3/13/94--4/20/94 --15.2 31.3 9/20/95--1/15/96 --13.4 29.2 5/20/96--7/23/96 --21.9 31.6 10/13/97--12/24/97 --20.5 30.3 7/20/98--10/8/98 --25.2 37.8 3/27/00--present --36.2 NA
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* Measured from the index’s peak during the specified sellloff period
NA = Not applicable
Source: T. Rowe Price Associates
