The combination of expensive stocks and poor fundamentals has led to a sharp and brutal bear market ...
The combination of expensive stocks and poor fundamentals has led to a sharp and brutal bear market in technology stocks worldwide.
What has been especially concerning is that no area of technology has escaped unscathed. Signs of deterioration were first seen in the semiconductor and telecom equipment spaces last summer before spreading to PCs and servers and then most recently into areas such as storage, software and optics.
The last areas hit were considered strong secular growers, able to withstand all but a long recession. The fact they have been affected characterises the scale of the downturn. Worse still, visibility into future orders continues to worsen and is considered as bad as it has ever been.
The question is what to do from here? There are two main schools of thought. Some believe technology stocks are about to enter a Japanese-style decline that could lead to years of underperformance. The argument contends that corporations have over-invested in technology goods in pursuit of unproven productivity enhancers such as the internet or the PC. As a result, technology's proportion of total capital budgets has soared and yet the productivity benefits from this will prove elusive.
Firms will therefore cut back spending resulting in years of sub-trend growth. If this is correct, we should expect technology stocks to continue performing poorly as fundamentals deteriorate and valuations reflect an expectation of at least trend growth going forwards.
However this argument misses two key axioms of technology. First, the most important dynamic within technology is change. The internet is the latest in a string of technological revolutions that go back to the invention of electricity. The next wave of change will bring numerous opportunities allow-ing technology to resume high growth. Rapid change also has two key side effects:
* Technology products have a short lifespan, on average about one third of other capital goods. This creates the need to upgrade regularly and should avert a long Japanese-style recession.
* Change drives new entrants, which drives down price. In simple terms, this means technology will generate more demand and more revenue as prices fall.
Second, the very reason companies purchase technology goods is to drive productivity. Aside from the structural change in the US in the 1990s, there are also numerous microeconomic examples where companies have generated new revenue streams and cut costs as a result of implementing new technologies.
Therefore, although some speculative excesses certainly need to be unwound, the effect should be relatively short-lived.
Despite the gloomy near-term outlook, technology investors should start to think more constructively.
James Hand is manager of the Investec Global Technology fund
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