Create a free account to continue

Is This Tech's Breakout Year?

There's also a growing global market for technology as more nations try to reduce labor costs by automating everything.

WASHINGTON (AP) β€” The stock market has had an impressive January. The staid companies that make up the Dow Jones industrial average have gained 4 percent in three weeks, and the broader market has done even better.

But the Nasdaq composite β€” a collection of technology stocks whose dot-com heyday was more than a decade ago β€” has left them both in the dust.

That's no surprise when you consider tech stocks took a licking last year. Tech companies tend to carry more risk β€” a problem for the Nasdaq during last year's market gyrations. As investors regain confidence in the economy, riskier plays are doing well.

But experts say the Nasdaq's gains reflect long-term currents that could lift tech stocks through 2012 and beyond. Many companies put off replacing worn-out technology during the recession. To compete and survive, they need to invest in tech.

There's also a growing global market for technology as more nations try to reduce labor costs by automating everything from factories to cash registers.

And the biggest tech companies face less competition these days when they try to acquire smaller companies. Many of their mid-sized rivals for those deals were weeded out after the dot-com bust and the financial crisis.

In the market for mergers and acquisitions, established players like IBM and Oracle can be picky about buying only those companies that will increase their earnings β€” and probably their stock prices.

In other words, it's not all about Microsoft-style titans and trendy social media companies like LinkedIn and Zynga. The Nasdaq contains more than 3,000 companies, many of them relative startups compared with the companies in the Standard & Poor's 500 index.

For the year β€” just 13 trading days old β€” the Nasdaq composite is up 7 percent, compared with 4.6 percent for the S&P 500 and 4.1 percent for the Dow.

"It looks like it's going to be their year, or at least their month," says Michael Vogelzang, chief investment officer at Boston Advisors LLC.

The Nasdaq sank 1.8 percent last year, while the Dow rose 5.5 percent and the S&P was flat. That left tech stocks relatively cheap, giving them more space to rise as the broader market rallied. Oracle is up 11.9 percent this year, Microsoft 14.5 percent.

Vogelzang and others say the tech rally has further to go.

"If you want to make your company more productive, you have to turn to the world of technology for that," says Kim Caughey Forrest, senior analyst with Fort Pitt Capital Group.

She expects the S&P 500's tech sector to outperform the broader market because of strong demand from U.S. companies, developing nations such as China and even cash-strapped European governments. As China's banking system exploded to serve a growing middle class, banks there spent big on IBM technology, she noted.

"Nobody questions whether they need the latest and greatest technology anymore. They know they need to keep up their technology spending," says Eric Gebaide, managing director of Innovation Advisors, a tech-focused investment bank and strategic advisory firm.

Gebaide and others mentioned many companies' efforts to move their computing and data storage off-site β€” trends known as "cloud computing" and "virtualization." Long-distance computing is cheaper, but it requires technology.

But why are tech stocks rallying now? The cloud computing transition has been under way for years, and spending by companies has driven much of the U.S. recovery since the economy emerged from recession in June 2009.

It's all about the investment cycle, says Jack Ablin, chief investment officer with Harris Private Bank. He says investors are finally willing to "flex their speculative muscles in a market that isn't falling apart in the way they feared last year."

Last year, some of the best-performing stocks were consumer staples and utilities β€” lower-risk industries where demand is consistent even the economy is slow. This year, utilities in the S&P are down 3.7 percent, while tech companies are up 6 percent.

The move out of so-called defensive stocks, the ones you want to own in a slow economy, is a sign that investors are willing to embrace risk again.

"You're getting this big market rotation," Vogelzang says. "People made money last year in the boring, stable industries, and they're saying, 'Hey, I better get on this economy train while I can.'"

Tech companies learned hard lessons from the dot-com bust of the early 2000s and the 2008 financial crisis, says Gebaide of Innovation Advisors. They hold more cash than most types of companies and carry less debt. That leaves them less vulnerable to bankruptcy or a loss of investor confidence.

Given its twice-stung discipline, tech is positioned to drive the economy β€” "perhaps the best it has been as a sector in the past 20 years," Gebaide says.

The biggest threat to the industry, Gebaide says, is a slowdown in the early investment that helps startups grow into viable companies. Those early dollars used to offer massive returns to savvy investors when a good pick went public.

Today, the upside for venture capitalists is limited because far fewer companies are going public in big stock offerings. The bar is much higher after dot-com era debacles like Before underwriting a deal or buying chunks of stock, banks and investors want to see millions in annual revenue and established customer bases. It's tough for younger tech companies to meet those standards.

Peter Falvey, managing director of Morgan Keegan Technology Group, says there's plenty of capital, entrepreneurship and good ideas to keep companies' bottom lines β€” and stock prices β€” rising.

Falvey's group specializes in tech mergers and acquisitions β€” the kinds of deals that allow IBM or Oracle to bring a small competitor's product to a wider audience and add to their own earnings. Last year was the best for M&A in his group's 11-year history, and this year's deal pipeline already is stronger than last year's was at this time, he says.

A company like IBM "has huge amounts of capital and a global customer base, plus complete hardware-software services," Falvey says. "Once you put a small company into that machine, IBM can do really well with it."

The industry's earlier downturns also helped big companies by weeding out smaller players. The number of publicly traded tech companies has decreased by a third since 2000, Gebaide says. Now the big dogs can pick and choose more carefully, acquiring only businesses that are almost certain to increase their profits.

To be sure, high-tech companies are higher-risk investments, and they could lose value quickly if the market tanks because of a debt catastrophe in Europe or something unforeseen.

"People love tech until we get an economic shock, or negative economic statistics start to come out," Vogelzang says. "Then all of a sudden, people will say, 'Whoa, I need to go buy some utilities again."

But investors should take tech's success at this stage as a promising sign, says Ryan Detrick, senior technical strategist with Schaeffer's Investment Research. He says higher-risk bets like tech stocks tend to rise as the market enters a phase of long-term growth.

Housing, tech and small-company stocks all have risen faster than broad indexes since October, Detrick says. Those sectors are sensitive to improving economic data, he says.

"When you start to see tech taking charge, that's definitely a potential step in the right direction for future gains, potentially for the whole year," Detrick says. "Those are the sectors you want to see lead a bull market."

More in Industry 4.0