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Is the tech rally over?
1Q earnings have been fantastic but tech investors are worried about what lies ahead.
April 26, 2004: 1:49 PM EDT
By Paul R. La Monica, CNN/Money senior writer

NEW YORK (CNN/Money) - So what?

That pretty much sums up the attitude of technology investors following what has been a pretty spectacular first quarter earnings season.

According to Thomson First Call, S&P technology companies are now expected to post first-quarter earnings growth of 66 percent from a year ago. That's up from estimates of 55 percent back on April 1.

After a strong rally in 2003, tech stocks have struggled a bit in 2004.  
After a strong rally in 2003, tech stocks have struggled a bit in 2004.

Of the S&P techs that have reported so far, 75 percent have beaten earnings estimates -- 55 percent have done so by at least 5 percent.

What's more, the second quarter also is shaping up to be extremely strong: 41 percent of all tech companies that have given second-quarter guidance have said they will beat forecasts while only 40 percent said they will miss numbers.

Warnings are typically much more common. This time last year, just 26 percent of techs gave a positive outlook while 59 percent warned.

For the second quarter, analysts are predicting earnings growth of 52 percent from last year.

Strong earnings not a surprise

Yet, tech stocks have remained stuck in a narrow range. The Nasdaq is down slightly since April 7, when Yahoo! kicked off the first-quarter earnings parade.

What's the problem? Well, the good earnings news isn't exactly, well, news. The 50 percent rise in the Nasdaq last year was largely based on the expectation of strong company results this year.

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In other words, hale and hearty earnings growth is already baked into tech stocks.

"When earnings are great, everybody knows about it, so what's the discount?" said Barry Ritholtz, chief market strategist with Maxim Group.

With that in mind, many of the tech companies that have actually performed well after issuing strong results are ones for which there were low expectations.

That's what happened last week with Microsoft (MSFT: Research, Estimates) and Motorola (MOT: Research, Estimates), for example. It was easier for them to post numbers and guidance that were significantly ahead of expectations and that's what investors want.

"Companies have to knock the cover off the ball to get their stocks moving again. They have to surprise the Street by a ton," said Ted Parrish, co-manager of the Henssler Equity fund.

Higher rates, lower profits?

Another problem for techs is that investors are no longer convinced that the first quarter and second quarter earnings strength is sustainable. The market has a new obsession: the prospect of rising interest rates.

"There has been too much good economic news too fast and it's forcing people to think about what earnings are going to look like two, three and four quarters down the line," said Alex Vallecillo, senior portfolio manager with National City Investment Management Co.

Earnings growth for the second half of the year and 2005, while still expected to be relatively strong, does not look as good as the first half of 2004. Current estimates call for 35 percent growth in the third quarter and 21 percent in the fourth quarter.

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Next year, S&P tech earnings are expected to increase by 18 percent.

Albert Lin, director of research with American Technology Research, said many investors are also concerned that a nascent economic recovery in Japan and other parts of Asia, which have helped to fuel earnings gains so far this year, may not be for real.

"The market is intrigued by growth in Asia and but investors are divided on whether it's sustainable," Lin said. "Japan used to be a formidable economic power but it's been dormant so long that most tech investors grown accustomed to discounting it."

This doesn't necessarily mean that techs are due for a huge pullback. It's just that investors should probably start being more selective.

Both Lin and Parrish think that tech services companies are among the more reasonably valued in the sector. Parrish said he's thinking of adding to his position in two tech-services holdings: Sungard Data Systems (SDS: Research, Estimates) and Affiliated Computer Services (ACS: Research, Estimates).

But it looks like the proverbial easy money in tech has been made already.

"There's still upside in tech but it's going to be more grudging and grinding and choppy, it's not going to be this moon shot that we saw a year ago," said Ritholtz.  Top of page




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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.