Worst may not be over for tech stocks

Jonathan Davis: The bear necessities of business are proving problematic for stock market debutantes

Several things convinced me a year ago that we would soon be heading for a nasty bear market in technology stocks. One was the absurd lengths that respectable City analysts were prepared to go to justify valuations for new technology issues that could not be justified by traditional means. Many assumed that businesses without profits or experienced managements could continue growing at explosive rates for years ahead, untroubled by recessions, competition or any other real-world phenomenon.

Several things convinced me a year ago that we would soon be heading for a nasty bear market in technology stocks. One was the absurd lengths that respectable City analysts were prepared to go to justify valuations for new technology issues that could not be justified by traditional means. Many assumed that businesses without profits or experienced managements could continue growing at explosive rates for years ahead, untroubled by recessions, competition or any other real-world phenomenon.

A second personal turning point came at the annual meeting of the Fidelity Special Values investment trust last December when Anthony Bolton, the trust's longstanding manager, was repeatedly pressed by the handful of shareholders present to abandon the investment principles that had stood him in good stead for 20 years and go chasing after overhyped stocks in the technology sector instead. He wisely but politely refused, pointing out that he had seen many fads come and go in his time. The only question in his mind, even then, was when, not if, the hype that surrounded all dot.com stocks would burst. He preferred to stick to his contrarian style of investing in small and medium company shares; not least because for much of 1999 this sector of the stock market was trading at as great a discount as he could remember, and therefore appeared to offer exceptional value.

Events have amply borne him out. Bolton's two special-situations funds have enjoyed another excellent year, with the investment trust up nearly 40 per cent according to its latest annual report. I trust that the shareholders are suitably grateful for his stubbornness. What was particularly telling, I thought, was that investors who were smart enough to have found one of the few actively managed funds that has repeatedly earned its fees over many years, could still not help themselves from trying to persuade a highly respected professional to go chasing after the latest hot thing in the market - for no other reason, apparently, than the fact that it was going up very rapidly.

Suddenly, so they seemed to be saying, they were the experts and Anthony Bolton was the dunce. It was another indication that what had started as an interesting new trend in the market - there being no doubt that the internet and the parallel changes in telecommunications technology are going to change the way that business is conducted - had developed into a genuine investment craze of the kind that one normally only reads about in market histories.

A key distinctive feature of all such crazes is that even sensible people find themselves being tempted to do reckless things that they would never contemplate in other spheres of their lives. Another is that suddenly everyone you meet, from the proverbial taxi driver to your friends at the golf club, are given to holding forth on subjects about which they know little.

Psychologists and behavioural finance theorists have long known that many people attach more significance to recent news than they do to deeper trends that stretch further back in time. There is also the psychological comfort of knowing that lots of other well-regarded people are going down a similar path, which lends a spurious confidence to their decision to get involved. As Keynes observed more than 60 years ago, most people would rather fail conventionally than succeed by unconventional means, and investment is no exception.

In stock-market terms, what happened last autumn was that there was a huge flow of cash towards one corner of the market, telecoms, media and technology, with little differentiation made between the three of them. As most people knew that these would be the sectors most affected by the arrival of the internet and, just as important, new mobile phone technology, there seemed little need to distinguish between them. All rose accordingly, though it was striking how the media sector went from being the chief perceived victim of the new technologies one month to one of the main beneficiaries just a few months later. (It is true, if rather ironic, that a large chunk of the money raised by new internet companies has gone on advertising in traditional media, such as television, press and poster campaigns.) Now the whole process has gone into reverse and all three sectors are suffering.

The broking community, never at a loss to turn adversity into a positive, has discovered some new arguments to drum up business - for example, "just look at how well the market excluding TMT stocks is doing" (a standard salesman's trick is, if in doubt, discard the inconvenient) and "stand by for the traditional rally in technology stocks between November and March each year" (a spurious and meaningless historical trend). Nasdaq, the main US market for technology stocks, has now fallen 37 per cent in three months, but it is still only 20 per cent off its levels of a year ago.

I could well be wrong, but I am not yet convinced that the worst is over. It is true that the speed and ferocity with which the frothiest dot.com stocks have declined has exceeded even my expectations. That is good, in one sense, since it implies greater realism, but it also suggests that what we are now living through in technology is a whole-hearted bear market, when reason has given way to a stampede. This process will not end until the last marginal buyer has been squeezed out of the market. One small pointer may be that the most popular stocks on E*Trade's buy list are still technology issues, which hardly implies that online punters have yet given up on the game.

Meanwhile, of course, the lingering clouds over the economic outlook in both the United States and the UK remain. All of which is hardening a growing feeling that it may be time to start thinking about putting a heavier Euro-slant into your investment portfolios. There must be a good chance that a euro-denominated investment in a diversified European fund will yield a double pay-off over the next three to five years - with respectable market returns reinforced by an appreciating currency.

Of course, predicting when the bottom in the euro will finally be reached is impossible. On both sentiment and value grounds, however, the turning point is probably not that far away, if indeed it has not already arrived. The hypothesis will be tested one way or another next year, and is certainly worth bearing in mind as a strategy for the New Year.

* Davisbiz@aol.com

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