Beware of the second Tech bubble

Investors who have lost their shirt in the technology sector should beware of losing the rest of their clothing in the coming months.

For since the technology sector touched bottom on September 20, the NASDAQ has bounced upwards by almost 40 per cent. Anyone joining the party at this stage has not merely missed the best part, but is in danger of joining in just as reality intrudes to spoil things again.

The problem is that the high growth, high profit days are over for the foreseeable future as the technology market is oversupplied and likely to remain sluggish for some time. That means that Tech share prices at these levels are a nonsense. And make no mistake, share price ratings are now back to the levels seen in March 2000, just before the last tech bubble burst.

Semiconductors, for example, presently trade at five times forward sales compared with two times in 1998. This is ridiculous in a market slump, with plenty of chip capacity to supply demand for the next couple of years.

Likewise the communications equipment makers are over priced. There is huge surplus capacity at the Telcos particularly in the long-haul backbone networks.

Software houses may have a better outlook because they are not burdened with excess inventory. But all this is well known and stock prices are anticipating a recovery in the market that is probably some way off.

So what is reality in the Tech sector? First, even if Tech sales volumes pick up, prices will remain depressed by over capacity. It will take a wave of bankruptcies and mergers to consolidate the industry before it can move forward again in terms of profitability. That will clearly take years rather than months to occur, even in a dynamic place like the United States.

Indeed, the Tech sector may never regain its previous abnormally high profit growth, and become more of a mature industry with steady profits. That may not be such a bad thing, but it does not justify share valuations at current levels.

The logical action for anyone holding Tech shares right now is to sell them, and wait for a second Tech crash. Then, and only then, will valuations be attractive. At that point most investors will have been burnt for a second time by technology and nobody will want these shares. Of course, that will be the best time to buy. For technology is the future, but not at any price.