While the broader market has adjusted lower, technology stocks have thus far held off retesting lows. The Dow and S&P 500 are finding new footing, but until today, the Nasdaq has avoided drastic decline. Thus, Wall Street Greek recommends underweighting tech stocks ahead of a tough June quarter EPS season.
As we prepared our week ahead article this past Sunday, we noted to ourselves that the Nasdaq was a laggard in the market's broader correction. While it had declined similarly to the Dow and S&P 500 Indices, it had not overcompensated like you would expect a high-beta portfolio to.
The Nasdaq is of course a composite, and so contains significantly more equities than the indexes of the Dow and the S&P 500. For this reason, its beta is likely closer to the broader market than would be reflective of the many technology stocks it contains. Other more concentrated tech portfolios like the Morgan Stanley Technology ETF (AMEX: MTK) or the Vanguard Information Technology ETF (AMEX: VGT) would offer a beta value more reflective of tech stock risk. To give you an idea of a typical tech portfolio beta, MTK's beta is 1.56, and its relative group averages 1.5.
So, while the Dow Industrials are only 0.6% off their March low (as of the authoring of this article), and the S&P 500 just 3.8% off the floor, the Nasdaq Composite is a full 10.7% off bottom still. What's interesting to note is that the higher growth the index is, the further off it is the bottom, indicating that capitulation has yet to occur, if it will recur at all. Because, capitulation occurs when the great majority of investors give up on stocks and hope seems bleakest, higher beta and more hopeful stock portfolios will be the ones exhibiting the most pain at that time. Clearly, March 10 marked the last point this occurred, and until the Nasdaq corrects, we can't say we've capitulated again. But, the question is, are we heading toward another capitulation, and our answer is yes.
We offer even further evidence of the the technology sector's higher near-term risk. If we examine stocks within the S&P 1500 Index, the IT Sector is up 12.8% over the 13-weeks ended June 13th, while the entire S&P 1500 is up only 6.4%. This is a sign that the early cyclical sector led the recent market rise, but failed to compensate for more recent retracing. Only Energy is up more during that span, while Financials are down 2.0%. And we know what's happened since June 13th...
Tech Operations Pointing to Trouble
Technology companies are starting to realize impact from decreasing corporate investment. Oracle (Nasdaq: ORCL) and Research in Motion (Nasdaq: RIMM) offered a clear sign of this today. Yes, RIMM benefits from corporate investment, since many of those Blackberries that corporate managers are using are also corporate sponsored or subsidized tools. When times get tough and layoffs increase, there's less need for these ancillary tools. Of course, some would argue that PDAs are entrenching into the corporate toolbox similarly to PCs, but that still does not negate the impact of consolidated workforce, especially within middle management.
Oracle, of course, offers a clearer look at corporate investment since its offerings are only used by businesses, while RIMM is driven by the retail marketplace. However, both today indicated a tougher outlook ahead, and both stocks are reflecting that reality. In their follow up conference call, Oracle's CFO indicated that the current quarter should offer $0.24 to $0.27 of EPS, but this compared with analysts' expectations for $0.27. The stock is down nearly 5% today as a result. RIMM is down double-digits today on its forecast for $0.84 to $0.89, which compared to analysts' view for $0.89.
Now, one might argue that the corporate management teams at these two relatively strong performing companies are being appropriately conservative, due to tough economic times. But, what's that say about the broader technology space, where performance has been less stellar than at these two firms? It says, watch out!
Underweight Tech Stocks
So, this leads us to recommend underweighting technology stocks over the near-term, and we see little difference from corporate to retail end markets, as we are at a point in the cycle where both are cutting spending. The competitive retail space might offer an easier field to find losers within, while broad weakness should strike the corporate spend space more evenly.
You're screaming, what about valuation Greek, and I'm saying, who cares this time. We have a case where the group has strayed from the mean, and thanks to very real inflation concerns and a handcuffed Fed, we cannot look to a normal recovery. Thus, these early cyclicals have an uncertain leadership role to play. Meanwhile, they're way out there in the wilderness and we've lost contact.