The importance of the technology theme for the continued long-term performance of the US economy and...
The importance of the technology theme for the continued long-term performance of the US economy and stock market should not be under-estimated but neither should the risks that exist in the short term.
The euphoria that surrounded technology during 1999 was understandable: the IPO market produced some staggering performances, while the broad Nasdaq Index posted a return of 86% in local terms over the year. Performance became less and less discriminate as the year wore on, however, to the point where it seemed that investors were not even interested in a company's business model or whether the management was credible.
In 1999, with novelty value driving virtually all technology stocks sharply higher, investors were not punished for such a lax approach. But it will not be so easy to make money in technology in 2000. Many of the day trading gains from 1999 are in danger of being lost as the sector matures.
Investors should remember that technology companies are just like any other company - they need to operate a sound business, have a strong market position and a clear future strategy. Companies that can combine these qualities with the undoubtedly exciting growth prospects offered by the technology sector are very attractive investments over the long term. But it is inevitable that an industry that has become as vogue as the internet will attract mavericks. For this reason, there will be a significant number of failures as the industry consolidates over the coming years.
We therefore prefer to play the internet theme by investing in quality companies which provide the infrastructure or enable companies to employ the internet, rather than 'me too' companies that might have delivered stellar performance since their IPO, but which do not have a coherent long-term strategy. The overwhelming demand for a faster and more efficient infrastructure means that, even in the fast moving technology sphere, a head start of a few months in developing specialist proprietary products can make a big difference.
Companies such as VeriSign, whose digital certificates underpin many of the internet's e-commerce transactions, and Ciena, whose next generation optical network switches help to speed the flow of information, are both examples of 'real' technology companies with leading edge products and good business models. As the business to business (B2B) internet space expands(we think that most of the current forecasts under-estimate the potential) companies such as these will be the winners.
Our conviction in technology as a theme within the wider investment picture remains undimmed, and the beauty of the B2B internet roll-out is that it is a truly global theme that, for now, will benefit primarily US companies. The use of technology has been instrumental in protecting US companies' margins and in keeping inflation in check, and the spread of B2B internet across the globe is likely to bring these benefits to other parts of the world economy.
These drivers will provide excellent long term growth potential for quality US infrastructure and 'internet enabling' companies with established track records and existing technologies. Now that Y2K is all but forgotten, this process is getting underway in earnest, and we expect it to continue for at least the next five years. The impressive earnings announcements coming out of the technology sector for the final quarter of 1999 could therefore be the tip of the iceberg.
As the initial euphoria fades, the key to successful technology investment in 2000 and beyond will lie in separating the wheat from the chaff. As the chaff becomes apparent, the technology sector is unlikely to be a place for the faint-hearted.
Michael Mullaney is head of American Equities at Scudder Threadneedle Investments
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