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Tech fever rises as no one wants to miss the rebound

"... a lot of companies are still trading on multiples of 50 times earnings and above."

Sean Murphy, an analyst at the Nomura Research Institute

It is the news that technology investors have long been waiting for: semi-conductor sales are finally rising again.

These chips are the building blocks behind all the technology we use -- from the latest mobile handset to a web-hosting service -- so demand for them is seen as a good leading indicator for the tech industry as a whole. If their sales are improving, the argument goes, then recovery in the rest of the technology market cannot be far off.

Sure enough, the news provoked a flurry of excitement among investors, led by big semiconductor makers such as Infineon and ST Microelectronics in Europe, and Intel in the US. Our own Techmark index rose 4.3 percent on one day, while NASDAQ gained 3.3 per cent.

So far, so rational.

However, technology investors have not only been expecting news like this for months, they have been gorging on stocks in anticipation of it. Nasdaq has jumped more than 40 per cent since it hit its low on Sept 21 last year, while the Techmark index has jumped more than 50 percent. Yet, while the Semiconductor Industry Association did report that November sales rose 1.6 per cent on October and is predicting a 4.7 per cent quarter-on-quarter rise, its statistics show that sales are still more than 40 per cent below the previous year. Even Infineon's chief executive, Ulrich Schumacher, warns that selling prices are still below what it costs to make the chips 'so it is too early to get excited'.

So is the current tech rally justified or is it simply a reflation of the bubble that burst so painfully 20 months ago? Much depends on how far one looks ahead.

Sean Murphy, hardware analyst at the Nomura Research Institute, says investors appear to be a lot more optimistic than technology bosses. "Chief executives are saying the recovery is not here yet and investors are saying the recovery is coming soon," he said. "Are investors right in looking further ahead?"

He believes the current rally is being driven partly by liquidity: investors have a lot of money that they are keen to put into technology stocks. Buyers are also taking comfort from the fact that, while share prices may have risen sharply over the last three months, many tech companies are still trading at less than half their peak levels.

But that does not necessarily mean they are cheap: earnings forecasts are falling as fast, if not faster, than share prices.

"Based on what we are forecasting for 2002, a lot of companies are still trading on multiples of 50 times earnings and above," said Murphy. "I feel we are at risk of repeating the mistakes of 2000."

Adrian Hopkinson, a technology analyst at WestLB Panmure, agrees that investors are looking ahead -- he believes that, at current levels, technology shares are already discounting what is going to happen in 2003.

"That is easier for technology companies than predicting the next six months," he says. "But that is also why bubbles happen -- it is a long way away and it is quite easy to make mistakes.

But he still expects the rally to continue as small and medium-sized companies, which have so far been left behind, join the party.

The performance of technology shares has previously mirrored consumer confidence: that is on the rise again, so the outlook for tech stocks should be good. But that does not mean there will not be more bad news from the sector. Nomura's Murphy believes the only companies that will see their earnings forecasts for 2002 upgraded will be those that are prepared to cut their costs.

"There may be a mild increase in revenues -- perhaps 5 percent or 10 percent," he says. "But the serious earnings growth will come from those companies who can cut 10 percent to 15 percent from their costs, possibly after having done as much in 2001."

He points to companies like Dutch chip-equipment maker ASML and Philips Electronics, which have already indicated that they will be making further cuts.

Few investors will forget the losses they suffered in the technology crash during the spring of 2000. The trouble is, they also remember the huge profits that were made, albeit briefly, in the year preceding that. No one wants to miss out on the boom this time around. That is encouraging investors to ignore high valuations in their search for the winning companies. This time around, the rally may be sustainable -- or it could fizzle out when the bad news returns.
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