3 Good Ways to Play a Coming Tech Rally

09/20/2011 8:00 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

After a difficult summer, expect a profitable late autumn, as a season that’s already very good to technology gets an additional boost from a broad market upswing. Here are the names worth watching.

A broad market rally is likely later this fall and, because tech shares fell further than the market for most of this year, their outperformance could be explosive.

If tech shares rally—and it’s still an "if"—consider adding Apple (AAPL) and EMC (EMC).

As technology rallies go, the gains of the past week and month are suggestive of bigger things to come, but they’re not totally convincing yet.

For the week that ended on September 16, several stocks in the sector, including Nvidia (NVDA), Intel (INTC), Oracle (ORCL), and Marvell Technology Group (MRVL) convincingly beat the 5.42% gain for the S&P 500.

Nvidia was up 11.38%, with Intel up 11.52%, Oracle up 12.42% and Marvell gaining 10.81%, according to Morningstar.com.

That’s not especially surprising. High-beta stocks, like most technology stocks, should rise faster than the general market when the broad market is climbing. Nvidia, for example, has a beta of 1.61, meaning that it is 1.61 times as volatile as the broad market. (By definition, the broad market of stocks has a beta of 1.)

It’s also not surprising given the way technology stocks have been pounded in 2011. Even after this rally, Marvell Technology is down 18.22% for 2011 and Oracle is down 6.07%.

A Recipe for a Tasty Bounce?
But the recent technology rally is also a reminder of the coming seasonal sweet spot for technology shares. Technology companies see a huge positive swing in revenue every year in the third and fourth quarters.

I suspect we’re going to get some kind of November/December rally in stocks this year, once the global economy (and especially the Eurozone) manages to survive September and October’s very rough spot without falling apart. The historical seasonal pattern for technology shares—added to the underperformance of technology stocks in 2011—will push the sector to the front in any rally.

Given all this, the tech sector’s performance could actually be quite explosive, because the sector is underowned. For many investors, technology shares have fallen off the radar screen, and any rally strong enough to generate “believers” will have a very strong bandwagon effect.

In most years, sometime around October 20 or so is a good time for checking the technology weighting in your portfolio. Last week’s rally says that you ought to start that checkup—and start adding to your technology weighting—a little early this year.

Choose with Care
To be completely clear, I’m not saying that the US stock market is about to launch another big nine-month rally or that any end-of-the-year rally in US stocks is sustainable. I think we’re all too aware of the big problems that are still lurking out there.

All I’m looking for is a relief rally if, as I continue to think likely, European governments get their act together enough to kick the Greek and Italian debt crises down the road into 2012 or 2013.

In other words, don’t fall in love with anything you might buy now, and look to take profits when the flow of not-quite-as-bad-as-expected news starts to diminish in January or so.

A technology rally would lift all boats, but not equally. Microsoft (MSFT) was up only 5.36% last week, actually trailing the S&P 500. Cisco Systems (CSCO) was up just 5.06%. On the other hand, Broadcom (BRCM) rose 6.67% and EMC 6.9%—both more than the S&P 500.

I think this boost in tech shares—even if it doesn’t hold long enough to roll right into an end-of-the-year rally—provides a pretty good template for where to put your money this year. So what did last week’s technology rally tell us about where to place our bets for the last quarter of 2011?

NEXT: Tech Prospects in 3 Parts

|pagebreak|

Tech Prospects in 3 Parts

  1. The old technology giants are due for a bounce, but that’s about all.

I think you could get a bounce out of these stocks just because they’ve been so beaten up and investors are so familiar with the names, but the challenges facing these companies are enough to make them laggards in the sector.

In addition, their size makes finding new growth opportunities big enough to move the scale a difficult task. I’d put PC companies such as Hewlett-Packard (HPQ) and Microsoft in this group.

PC sales aren’t exactly setting speed records. On September 17, analysts at Gartner cut their projections for semiconductor revenue in 2011 to a 0.1% drop from 2010. Just in June, Gartner had predicted that semiconductor revenue would climb by 5.1% for 2011.

Also in September, Gartner cut its projections for unit growth in PC production to 3.4% for the year, down from 9.5% in its earlier forecast. Add in the drop in prices for much of what goes into a PC—memory-chip prices, for example, are falling—and you’ve got falling revenue despite a slight uptick in unit sales.

Big networking companies are seeing a similar slowdown. On September 13, Cisco reduced its forecast for long-term revenue growth to 5% to 7%, from a previous estimate of 12% to 17%.

You can get a sense of how big any bounce might be by looking at the performance of Hewlett-Packard, up 4.42%, and Cisco, up 5.06%, in this rally. Both trailed the market, but both stocks had been beaten up so badly in 2011 that they climbed with the sector. (Even after last week’s rally, HP is still down 43.35% for 2011 and Cisco is down 17.25%.)

  1. Anything Apple has a chance to significantly beat the marketalthough suppliers to Apple might do better than Apple itself.

In the recent rally, shares of Apple climbed 6.1%, while shares of supplier Broadcom were up 6.6%.

In contrast to the PC market, the tablet market is experiencing solid growth, and Apple’s iPad shows no sign of losing market share. For the company’s fiscal third quarter, Apple reported 183% unit growth (with 179% revenue growth for the iPad).

Apple’s market share in the tablet market was a huge 68.3% in the quarter, even as market share for its biggest competitor—tablets based on Google’s Android operating system—actually lost share. The piece of the market owned by Android tablets fell to 26.8% from 34%.

And rather than seeing new competitors dent its dominance, competitors are:

Leaving the market—Hewlett-Packard and Sharp (SHCAF), for example, have stepped away from tablets.
Crashing on disappointing sales—sales of the BlackBerry PlayBook from Research In Motion (RIMM) have plunged to just 200,000.
Receiving lukewarm reviews even before launch—as Sony (SNEJF) as discovered.

No wonder that Apple, rather than rushing an iPad 3 to market to fend off competition, is sticking to its schedule for a 2012 update of the line.
The rest of Apple’s business isn’t doing badly either, with iPhone sales climbing 142% in units, and sales of desktops and notebooks increasing by 15% and 13%, respectively.

What’s truly amazing, however, is that while Apple the company has been scoring numbers like this, Apple the stock still sells at just 16 times trailing 12-month earnings per share. I think investors can’t quite believe that someone isn’t about to kill Apple’s golden geese sometime soon.

Nonetheless, with Apple shares up 24.16% for 2011 as of September 16, investors might do better in an end-of-2011 rally with shares of a supplier such as Broadcom, which is down 17.47% for 2011.

Broadcom looks especially interesting because of a report last week from Taiwan Semiconductor Manufacturing (TSM), the world’s biggest contract maker of chips for other companies. It reported that third-quarter sales would exceed forecasts because of rush orders from an unnamed customer.

Some of Taiwan Semiconductor’s customers have already preannounced disappointing sales for the period and analysts have pegged Broadcom, the largest Apple supplier among Taiwan Semiconductor’s customers, as the most likely rush-order candidate.

Broadcom provides the Wi-Fi/Bluetooth chip for the iPhone. And Broadcom looks like it’s the supplier for the WAN cards in the newest version of Apple’s Airport router (replacing a Marvell Technology card.)

Taiwan Semiconductor itself has a strong Apple connection; the foundry looks like it will pick up substantial chip orders from Apple for the next-generation A6 processor that will be used in the iPad 3. Samsung (SSNLF) is Apple’s major current supplier for this central processing unit (CPU), but Apple is engaged in a bitter patent fight with Samsung over that company’s own Galaxy tablet.

  1. Storage, storage, storage—and making it more efficient.

The names I’d watch here are EMC and VMware (VMW)—although, since EMC owns 80% of VMware, you can cover both bases with just EMC.

Digital data, which needs to be stored somewhere, is growing at roughly a 40% annual rate. The key to this game isn’t the hardware, but instead the software that manages data, de-duplicates them, allocates machines to data, schedules data tasks, and the like.

EMC trades at 22 times trailing 12-month earnings per share, and the consensus Wall Street estimate pegs its earnings growth at 17.4% for 2011.

I have some worries about VMware’s ability to defend its turf against companies like Microsoft (which is building more virtualization software into existing products, enabling storage systems to set up virtual machines that more efficiently allocate tasks among systems), but remember that this is all about a relatively short-term rally in the technology sector.

This is how I currently handicap an end-of-the-year technology rally. The next few weeks should tell investors how likely that rally might be, and whether investors will have to suffer through another dip in the sector before getting a move higher.

Full disclosure: I don’t own shares or units of any of the companies or partnerships mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of June, see the fund’s portfolio here.

Related Articles on STOCKS