What's Happening to the Technology Sector?
By Dennis McKechnie
Portfolio Manager
PIMCO Innovation and Global Innovation Funds
02.23.01
The NASDAQ Composite Index has pushed to another new low this week, violating the levels set in the first week of January. The latest move effectively erases several years of progress as the NASDAQ is now at the levels it last saw more than two years ago. A short recap of what has transpired in this period may prove helpful, as there have been three key trends that have impacted stock prices.
1. Y2K has come and gone. The NASDAQ had been on a fairly linear path for the five years leading up to Y2K, then began a dramatic acceleration in the summer of 1999 when companies revealed that their preparations were complete. This acceleration was helped by the fact that U.S. money supply expanded by abnormally high amounts as the Fed left liquidity in the system to soften any potential catastrophe.
2. The U.S. economy has likely ended a ten-year expansion phase. Perhaps the excess liquidity left in the system contributed to an 'overheating' in early 2000, but, whatever the cause, most measures of business activity show the market decline in many cases heading into negative territory. With lower activity comes lower profitability, which leads to less discretionary income.
3. The impact of dotcoms have come and gone. When the dotcoms blasted out of the gate in early 1997 there was initial disbelief and dismissal as a fad. As their momentum not only continued but strengthened, investors and Fortune 500 competitors took them seriously. The stocks were bid up and corporations began spending like mad to fend off this attack, the likes of which had never been seen. Then at the end of 2000, the metrics posted by the dotcoms lost momentum due to saturated penetration, consumers’ need to sometimes physically visit store locations, and the success of the legacy companies in fighting back.
With the passing of these three trends, business at technology companies is clearly not 'tight' at the moment. In many respects they have been victims of their own success. It takes time for the economy to turn back around. It also takes time for all of the innovations that have been developed over the past few years to be 'digested' by their target audience. Companies that benefited by direct or indirect dotcom exposure must get used to the dropping off of this catalyst.
Tech stocks tend to bottom when the news flow reaches its sequentially worst point. This is typically only recognizable in retrospect. Now that the Fed has begun cutting rates, at least there is some form of a 'backstop' which leads us to believe that the situation is now at least in 'neutral' rather than 'reverse'. Visibility on an eventual economic upturn, when it comes, will likely put this sector back into 'forward' again.
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