If you have seen your technology and telecommunications portfolio sink, don't panic. According to Salomon Smith Barney (SSB) analysts, the current contraction in the equity markets is cyclical and not structural in nature and therefore the downside is limited. The primary driver of this cycle, according to SSB, is the United States interest rate environment.
SSB, in a study, looked at the two-year and ten-year United States treasury rate cycles and found a correlation with the NASDAQ and the technology component of the S&P 500. Earnings growth declined three times in the last decade, in 1997 –1998, 1994-1995 and in 1990-1991. Each time this occurred shortly before technology stocks stopped under performing the S&P. The reason why stocks have gone up when earnings have declined is interest rates. Falling interest rates as been associated with falling earnings.
"We going very close to the bottom," observes Andrew Barrett, chief technology strategist at SSB, in relation to the cycle. And "[u]pon finding the bottom we have seen a fairly substantial reversal trend," says Barrett. SSB believes that the upswing will occur should the federal reserve cut interest rates. "We believe that the Federal reserve will move to a more accommodating rate environment over the next 12 months," says Barrent. SSB concurs with the March federal futures contract rate, which indicates a 70% chance of a quarter-point rate cut sometime in the first quarter.
A further reason why an upswing can be expected soon is that SSB believes that fundamentals remain robust. "The internet has not dried up and gone away," says Barrett. The optical environment of the revolution that we have seen in terms of technology is still in full effect, the technology and telco market, albeit slowing, still outpaces that of the broader markets. "What we have seen over the last few months has been a reallocation of funds but not a reallocation of fundamentals. These companies are still churning out fantastic new innovations, and products," he continues.
But a word of caution from the investment bank. SSB expects the recovery not to be broad based. "Investors are going to have to remain very company specific," says Barrett. His picks? "Value" stocks; internet and telco infrastructure companies such as Nortel, Cisco, and AOL because of its interesting strategic fit with TimeWarner. In the mobile space Barrett expects Nokia to do well. In terms of Asian telcos, Barrett has a positive view on Hutchison Whampoa and NTT DoCoMo. However, SSB's approach to semi conductor industry is cautions, believing that supply is beginning to meet a slowing demand.
