Originally created 01/08/01

Tech investing in 2001: Some pain, lots of gain



Merrill Lynch tech strategist Steve Milunovich sees tough times ahead for 2001, but says the sector could rebound in the last half of the year.

The Federal Reserve's surprise half-point rate cut Wednesday triggered a quick stock market rally. However, the damage done to the equity market in recent months has been considerable. Milunovich warns that the difficult days for investors in the technology sector may not be over yet.

This week, Milunovich unveiled a list of 15 predictions for the tech sector for 2001. Many of the insights are highly qualified: Topping the list is the ambiguous "tech stocks should struggle in the first half but could rebound in the second." Others are more specific: Milunovich names storage and photonics as standout sectors for the future, and cautions that the IPO market, VC funds and M&A activity will likely suffer in the coming year.

First, the pain: Milunovich expects tech earnings and fundamentals to be weak in the first half of the year. While he hopes for a rebound by year's end, he says that even this is a best-case scenario. And while the Fed rate cut will help investor psychology, it will take time to affect corporate orders and earnings.

Milunovich expects both IPO underwriting proceeds and M&A deal value to decline by 30 percent or more this year. Given a prolonged economic downturn, the IPO shutdown could cause a slowdown in overall technological development, slowing the progress of some new technologies from reaching the market.

On the other hand, Milunovich notes that the decimated valuations of some tech stocks now render them more attractive buys. He notes that there may be bargains in the small-cap tech sector, which has fallen even more than its larger-cap brethren. He expects storage and optical networking to remain hot sectors, as will handheld devices. On the rise: interactive entertainment.

Milunovich expects the foremost technology winners this year to be those companies that have figured out how to cut costs or make money for their customers. Deployment has trumped development, he says, and it's no longer enough for a company to offer only cutting-edge technology. Tech investors and customers will be looking for solid, timely returns on investments, no matter what the company or sector.

For a little perspective, Milunovich recalls the PC boom of the early 1980s. In that case, too, there was a flurry of successful IPOs, followed by a painful slowdown as many companies were weeded out, leaving only the strongest ones standing. But at the end of that pain, there remained a huge creation of wealth. Milunovich expects the same to be true of the Internet sector: an unbelievable run-up, followed by a slowdown, but in the end, huge economic gains. It's just that the process may take longer than many investors would like.

"Stocks went up five times in 18 months," he says. "Taking 50 percent out of the Nasdaq in nine months doesn't necessarily correct all that. It will take longer to heal the wounds."