Once bitten twice shy: Amid all the doom and gloom in the markets, Nick Sudbury investigates the likelihood of a recovery in the technology sector

What Investment, Nov, 2001

Amid all the doom and gloom in the markets, Nick Sudbury investigates the likelihood of a recovery in the technology sector

Rewind to March 2000 to a stock market booming behind a stratospheric surge in technology stocks, everyone wanted a piece of the action. Unfortunately, many investors are all too familiar with what happened next. The story is reflected in the August report from the SocGen Technology unit trust which, despite the troubles, is still one of the most respected in the sector. According to the report, the fund made a return of over 150 per cent in 1999, but since then had lost 20 per cent in the year 2000 and nearly 27 per cent in the first six months of this year. Needless to say, the last few weeks will have also taken their toll.

It's easy to, be wise after the event, but as the small print says, "past performance is not necessarily a guide to the future". Investors who bought this, or any other technology fund near the peak in March 2000 will be nursing heavy losses. Even before the tragic events in the US, such people would have thought twice before committing any extra funds into the tech sector, but could the panic selling on the markets be the opportunity for the brave to venture back?

What goes up...

Even before the terrorist attacks in the States, fears of a US-led worldwide recession had hit the technology sector hard. In the latest quarterly reshuffle of the FTSE 100 index, eight technology, media and telecom (TMT) stocks were relegated following sharp falls in their share prices. Their replacement by companies in the more traditional sectors was almost a mirror image of the changes in March 2000, when tech valuations were near their peak. Is this the shake out of the last remnants of the tech bubble? Some industry commentators, while still cautious, feel that the sell-off has been overdone and that once again there are opportunities within the sector.

The Nasdaq index is the most widely used proxy for the fortunes of the global tech sector and its performance certainly tells the technology story. The index peaked in March 2000 at 5132, but from there it has been downhill pretty much all of the way, with the descent being as precipitous as its rise in 1999. Prior to the terrorist attack on 11 September, the index had hit a low point of 1639 in April, a fall of nearly 70 per cent from its peak. Such a staggering fall for a market index reflects the extreme risk of the technology sector, the extent to which valuations were over stretched and also the dominance of the index by a few large US companies like Cisco and Intel, which have themselves suffered badly. In its first week of trading after the attack, the Nasdaq fell an incredible 272 points to 1423, a fall for the week of 16 per cent. The old adage of "never catch a falling knife" springs readily to mind.

The tech sector is, and was, vulnerable to fears of a US recession, fears that have increased dramatically following 11 September. Speaking soon after the attack, Jeremy Monk, head of European, Australasian and Far East (EAFE) Equities at Lombard Odier said: "It will have an affect on the US and the world economy, but we feel that it will postpone the recovery from the fourth quarter to next year. Overall, the techs in general are oversold, the interest rate reductions will feed through later this year to boost investor appetite for these type of stocks." But the repercussions from the attacks in the US are still far from clear. Despite a coordinated round of global interest rate cuts and an extra $40 billion of defence spending by the US government, the technology and wider US stock market indices fell about 15 per cent in their first week after the resumption of trading.

The outlook

Not surprisingly, the uncertainty in the markets means that there are very mixed views on the immediate prospects. According to Mikkel Bates, a director of Societe Generale Unit Trusts: "The tech sector is bouncing along the bottom waiting for a wider recovery. When business confidence recovers, companies will buy tech again." Monk echoes this sentiment when he says: "The tech replacement cycle is getting shorter and shorter, you can postpone investment but not for long." Bates also points out that: "If President Bush is of a mind to be more aggressive in terms of a loosening of policy, now is a good time because of Congress being willing to help maintain consumer confidence."

The more optimistic are looking for a sharp v-shaped recession with a recovery next year. But there may be more bad news still to come. One of the key milestones for the sector, the third quarter reporting season that is just starting, may have been severely disrupted by the events in the US. Monk comments: "The key is the outlook, rather than the figures themselves." But if IT spending is delayed still further the outlook may be pretty grim. Indeed, the result may be a raft of profit warnings over the next few weeks. One very sad measure will counteract this though, Computer Economics has estimated that the replacement cost for the IT and communications infrastructure destroyed in New York will amount to at least $15 billion.