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Tech stocks: No cruel summer?
When the temperature rises, tech stocks usually fall. Here's why that may not be the case this year.
May 31, 2005: 12:01 PM EDT
By Paul R. La Monica, CNN/Money senior writer

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The Nasdaq got off to a rough start this year but tech stocks picked up steam in May. Will the rally continue this summer?
The Nasdaq got off to a rough start this year but tech stocks picked up steam in May. Will the rally continue this summer?
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NEW YORK (CNN/Money) The summer is usually a tough time for the stock markets. And for tech stocks, the hazy, lazy days can be particularly brutal.

Remember last summer? Before Google (Research) went public in August and helped to reenergize Internet stocks, shares of many Net darlings and other tech stocks sunk due to sluggish second quarter earnings reports and tepid third quarter guidance. The Nasdaq fell 8 percent in July.

And the summer of 2002 was a scary time. That's when WorldCom blew up and investor confidence in stocks was practically non-existent. The Nasdaq plummeted nearly 20 percent between the end of May and the end of August that year.

But this summer could be different. Tech stocks have rallied sharply during the past few weeks after a poor start to the year. And this could be only the beginning.

Estimates look reasonable...

Many tech bellwethers have given solid second quarter forecasts during the past month. Despite this, some skepticism still persists.

Earnings estimates for the second quarter and remainder of the year appear to be sensible, with projections of just 10 percent annual profit growth in the second quarter and full year for the S&P technology sector, according to data from Thomson/Baseline.

Because of these relatively low expectations, the risk of companies disappointing Wall Street should be minimal. In fact, it could mean that techs have a solid chance of surprising to the upside.

"People were too negative on the sector. So now is a good time to get in since it is more of a contrarian play," said Sunil Reddy, manager of the Fifth Third Technology fund. "Estimates are stabilizing and I think the second half of the year will be a decent period for the tech sector."

And with oil prices starting to retreat from their highs of earlier this year, some say that money managers may begin to dump some of their big oil and gas winners in favor of tech.

"This is the most attractive technology has looked in some time," said Brian Nelson, an analyst with Driehaus Capital Management, a Chicago-based institutional investment firm. "The dollar is appreciating relative to the Euro and that's scaring people away from emerging markets and oil. People are moving out of energy and into tech."

Nelson adds that the increased pace of mergers in tech and telecom during the past few months could excite investors. "More money should come in to the sector in anticipation of further consolidation," he said.

As such, Nelson points to big moves in two stocks his firm owns due to takeover speculation. Defense contractor Titan (Research) has surged nearly 25 percent this month on rumors that it is in talks to sell out to L-3 Communications (Research). And SBA Communications (Research), an operator of wireless towers, has soared 33 percent this month thanks to a merger between rivals American Tower (Research) and SpectraSite (Research). Wall Street is betting that SBA could be the next tower company to be bought.

...and so do valuations

Of course, tech is always a risky bet. Stocks tend to command premium earnings multiples when compared to other sectors.

But because of the intense pessimism earlier this year, the stocks, while not cheap, still look attractive when compared to the broader market. Liz Ann Sonders, chief market strategist with Charles Schwab, said in a recent report that tech stocks have "reasonable valuations thanks to rising earnings and depressed prices."

To that end, the S&P technology sector currently trades at about 22.3 times 2005 earnings estimates, a 34 percent premium to the S&P 500's multiple of 16.6. But earnings for the tech sector are expected to increase at a 15 percent clip for the next few years, compared to a projected annual earnings growth rate of only 6 percent for the S&P 500.

Sonders added that tech stocks should benefit as corporations begin to realize that they can afford to spend more on new tech products and services. "Capital spending continues to play catch-up with what has been a strong consumer spending cycle," she said in her report.

But before investors get too excited, Sonders cautions that any rally in tech is not going to mirror what happened before the bubble burst. "We don't believe a late-1990s environment is likely for the sector," she wrote.

So as long as investors can temper their expectations, this could wind up being a profitable summer for tech stocks.

Who will be this summer's stock stars? Click here to find out.

Stock market bulls usually take a vacation during the summer. Here's why.


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