NEW YORK (CNN/Money) -
Tech investors are starting to have delusions of grandeur again.
The sweeping tech rally of the past two months has been fueled by several factors, including the idea that tech stocks had been oversold and buying by short-sellers who feared getting stuck with bearish bets.
But the biggest reason for the surge is that investors believe there soon will be a recovery in IT spending and that earnings estimates may be too low.
As such, investors might once again be setting themselves up for disappointment.
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| Tech stocks have been on fire for the past two months. |
Dell Computer is a perfect example of what can happen when great expectations run amok. The stock gained 25 percent between March 11 (the Nasdaq's low point of the year) and Thursday, when Dell announced its fiscal first-quarter earnings.
The company reported fantastic numbers: 31 percent earnings growth on an 18 percent sales increase. And the guidance was also strong: expectations of 15 percent sales growth.
But it wasn't enough. Investors were hoping Dell would beat expectations (it simply met them) and raise guidance (it did not). As a result, shares of Dell (DELL: down $0.99 to $31.19, Research, Estimates) fell nearly 2.5 percent Friday morning.
"A lot of investors have been conditioned to expect surprises on the upside from tech companies so when they see companies just meet expectations they get nervous," said Adam Adelman, senior analyst with Philippe Investment Management, a New York-based money management firm.
No more promises that techs can't keep
That could be a problem going forward. Until there is a clearer indication of a pickup in IT spending, tech firms are going to be reluctant to express an abundance of exuberance.
Plus, rules are tougher now in the wake of the Enron and WorldCom accounting fiascoes. CEOs now have to certify their numbers with the Securities and Exchange Commission. That makes it less likely for companies to give overly upbeat guidance.
"Investors have lost sight of what these companies have to do now to comply with SEC regulations. There is no reason for anybody to give optimistic forecasts since you may put yourself in legal jeopardy," said Stephen Mergler, portfolio manager with Northstar Capital Management, which subadvises the Fremont Large Cap Growth fund.
For Dell, Friday's selloff may be temporary. After all, the company still has much stronger fundamentals than its competitors in hardware. But for scores of smaller companies that have experienced massive runups, unreasonable expectations could wind up being a huge bane.
"Smaller tech stocks would concern me. Their valuations are almost back to 1999 and 2000 levels," said Mergler.
Selloff to end second quarter?
Another possible reason for worry is that earnings season is now pretty much over for tech companies. Hewlett-Packard (HPQ: up $0.32 to $17.95, Research, Estimates) and Ciena (CIEN: down $0.07 to $5.45, Research, Estimates) report results next week and after that, the market will have little news until preannouncement season for the second quarter kicks up in mid-June.
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So with tech stocks rallying in such a spectacular fashion, some fund managers might look to lock in gains before the end of the second quarter.
Wendell Perkins, manager of the JohnsonFamily Large Cap Value fund, said that he recently sold off his entire position in Apple Computer (AAPL: up $0.07 to $18.80, Research, Estimates) since the stock had run up dramatically on hype surrounding its new iTunes music store. Shares of Apple are up 38 percent since April 28, the day Apple starting selling music online.
And this selling trend could accelerate in June if there still isn't any compelling evidence of a second-half upturn to keep tech stocks moving higher.
"Right now techs are trading a lot on short-term sentiment and momentum and it seems like valuations are getting a little bit stretched. We're probably approaching a short-term top," said Adelman.
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