Is Tech for Real?

Story Highlights:

• Since the mid-summer correction, Tech stocks have outperformed the broader stock market.
• Investors are asking: Is this a mere post-correction countertrend, or the onset of a sustained rally?
• Tech fundamentals and recent earnings are great this quarter (and have been in past quarters), but exercise caution—market and corporate performance are often different things in the short- and mid-term.

Since the summer's bull market correction, Tech stocks have been on a tear. And frankly, Tech currently has a lot going for it. Most Tech firms are beating expectations this quarter. Primarily, here's why:

• PC consumer demand is surging. Today, PC sales are a high volume, low margin business. Unlike ten years ago, high competition (Dell, HP, Acer/Gateway, Lenovo, Apple, etc.) and improving manufacturing efficiency have consistently driven prices down. Most major PC makers are lean, mean, and able to profit from higher than expected PC demand this year–a symptom of a robust global economy featuring consumers with ample cash.
• Big foreign spending. Globalization is fueling Tech's growth, and even the big US Tech firms (Microsoft, Oracle, Dell, Intel, and many others) are highly leveraged to international growth. Newly globalized economies require billion dollar IT infrastructure build-outs. Additionally, cheap PCs are an increasingly viable option for millions of folks in developing countries.
• Corporate IT spending is finally strong. For years, corporations needed to update their IT infrastructure but delayed due to jitters about the economy and fears shareholders would criticize for "wasting" precious cash. Firms were always "putting it off until next year." But next year never seemed to come. It could be 2007 is finally "next year." Data storage in particular is having a banner year as corporations beef up their .
• Regulatory environment remains benign. It's icing on the cake that firms predominantly involved in the internet business are still able to operate largely free of federal taxes:

Senate Passes Seven-Year Internet Tax Moratorium
Grant Gross, Network World

Beyond these factors, it's worth noting that Tech exemplifies how productivity gains and globalization help keep inflation benign in today's economy. There's no doubt technology is a leader when it comes to globalization of design, manufacturing and distribution of products. Thus, the benefits of technology products sales propagate throughout the manufacturing and end user spectrum. Advancing technology is also a key to keeping productivity high in other industries like Industrials and Financials—which in turn helps restrain aggregate prices.

Those fearing another Tech bubble are probably off the mark. Today's Tech environment is a different ballgame from six or seven years ago. The Tech shakeout burned off most speculative, non-profitable companies. True, there are still high growth areas with semi-stratospheric valuations, but gone are the days of huge market capitalizations based on purely speculative ideas.

The corporate culture has also changed. Management pays more attention to operational costs and balance sheet strength, with a healthy dose of skepticism about new product viability—indicative of a maturing industry led by results-minded, feet-on-the-ground executives. Because it's a more mature, conservative Tech landscape today, it's unlikely we'll see a truly giant run of Tech out-performance like we saw in the late 90s.

Yes, a lot folks are touting Tech's recent run, and the fundamentals do look pretty good. But this wouldn't be the first time a preponderance of analysts got high on Tech during this bull market—only to see stock prices sag. (And you can count us among those who made that mistake in years past.)

So, we'd advise caution for now—there's no need to take a big bet either way at the moment on Tech within a well diversified portfolio. There are probably still better opportunities elsewhere. There are powerful cases to be made in favor of sectors like Energy and Materials—both are likely to see even bigger benefits from high demand (due to the strong global economy) and constrained supply.

Maybe this time is different, maybe not. This could very well be a mere post-correction countertrend. Either way, Tech's strong earnings performance this year is great evidence of a strong economy.