Technology: The return of tech

In early April, Bob McWhirter finally got the sign he was waiting for. As president of Selective Asset Management Inc. in Toronto, McWhirter manages the top-ranked Northwest Specialty Innovations Fund, and is arguably Canada's foremost authority on investing in the technology sector. Although he has an eye for great bottom-up fundamental stories, he primarily uses a strict quantitative stock-screening model that ranks the market universe on 12 metrics. These incorporate measures of value, growth and especially momentum. That's led him to focus on smaller companies for the past several years, such as Wi-Lan Inc. (TSX: WIN) and WebTech Wireless Inc. (TSX: WEW).

But on the morning of April 9, the quantitative research team at RBC Dominion Securities, headed by top-ranked technical analyst Ray Hanson, published a report that identified a new intermediate momentum Buy signal. a moving price average that sometimes indicates an upward trend. for the Nasdaq Composite, Nasdaq 100 and the Merrill Lynch 100 Technology indexes. And in a notable break with past tactics, McWhirter invested “a significant amount of money” in a basket of large-cap U.S. tech stocks, including Microsoft Corp. (Nasdaq: MSFT), Cisco Systems Inc. (Nasdaq: CSCO) and Oracle Corp. (Nasdaq: ORCL). bellwethers that have traded in relatively narrow ranges for years. The bold move was soon affirmed by conversations he had in the last week of April with two other highly regarded independent technical analysts, Ian Notley and Leon Tuey, the latter of whom told McWhirter, “Somebody rang the bell” on tech stocks. McWhirter's conclusion: “Now's the time to be looking long and hard about seriously increasing the weight in tech.”

If your eyebrows just arched high on your forehead, you're probably in good company. It's been so long since anyone dared suggest a broad-based improvement in the tech sector. But the sentiment toward technology's prospects is changing, and the new-found optimism is not based just on technical analysis. There are also macroeconomic and cyclical trends at work that may indicate a resurgence in high-tech over the next couple of years.

The TSX, of course, lacks large bellwether technology stocks, especially since Nortel Networks Ltd. (TSX: NT) and Celestica Inc. (TSX: CLS) are in the midst of long-standing restructuring efforts. That means you need to look stateside for clues, and the technical analysis of large U.S. tech stocks is showing that a significant number of them are breaking out of classic long bases. where shares trade within a distinct range over multiple years. For example, Oracle broke out of one such long base last summer, and the stock is now supported at levels not seen since mid-2001. EMC Corp. (NYSE: EMC) only recently broke out, with share prices finally topping the last high-water mark in January 2004. But the list of stocks that Hanson identified as exhibiting similar patterns is 15 names deep, and includes Sun Microsystems Inc. (Nasdaq: SUNW), IBM Corp. (NYSE: IBM), Texas Instruments Inc. (NYSE: TXN), Intel Corp. (Nasdaq: INTC) and Agilent Technologies Inc. (NYSE: A), as well as a lone Canadian stock, CGI Group Inc. (TSX: GIB.A). Hanson, who has studied the pattern back to the 1930s, figures the sector is starting an uptrend that will persist for the next 18 to 24 months.

“When stocks trade off these big bottoms, ultimately, they break out on the upside and they go like hell,” agrees Tuey, who is officially retired in Vancouver but actively tracks the market. “Not just for a year or two, they go for many years, to heights that would dazzle any investor. Be prepared to hold these stocks for two years or longer.”

There are other encouraging signs, too. A U.S. GDP report in late March showed corporate profits declined by 0.3% in Q4 2006, which should renew spending on technology to boost productivity, according to a market commentary released April 1 by David Kotok, chief investment officer of Cumberland Advisors, a New Jersey wealth management firm. By Kotok's analysis, such a scenario has happened three times in the past 25 years, with each boom lasting three to four years. The likelihood of another boom is bolstered by the piles of cash companies currently have available to spend. New orders and backlogs at high-tech companies are holding up better than other industries, noted Stewart Pillette of San Francisco's Pillette Investment Management in a recent research report, while inventories remain controlled, thus improving margins.

For the first time in years, beleaguered managers of Canadian technology mutual funds are feeling a bit more upbeat. “There are a lot of things that are going to put the wind at the back of the sector,” says Dan McClure, who manages the country's larest technology mutual funds, the underperforming $254-million Investors Global Science & Tech A. One of the most important factors is a new product cycle for many consumer products (including Microsoft's Vista operating system, which fuelled a positive surprise in the company's Q1 results announced April 26). “The real money is going to come when corporations start upgrading and all the spinoff effects from that,” says McClure.

Ben Rogoff, the London, Ont.-based co-manager of the Mackenzie Universal World Science & Technology Class, is another believer. He says technology's fortunes will be driven by new services and applications that make use of third-generation mobile networks and the glut in broadband capacity. But he sees greater opportunities in smaller and mid-cap stocks. “I don't have Microsoft, Oracle or Sybase. none of those companies that we frankly think are yesterday's stories,” he says. But Rogoff is excited by companies such as Inc. (NYSE: CRM) and its software-as-a-service model. “Because there are no upfront costs associated with software anymore, it allows people to buy software that they couldn't before.”

Not everyone is convinced. Duncan Stewart, who has worked both as an investment manager and a sell-side tech analyst, but now holds court as Deloitte Canada's director of research for its technology division, notes that the industry's revenue boom during the pre-bubble 1990s may not repeat itself. What drove interest then was spectacular revenue growth, but that's not the case now. “There's not actually as much out-and-out growth in technology as there would have been 10 years ago,” says Stewart. “It's a maturing industry.” Unit volumes are doing OK, he says, but there is still pricing pressure, and he's not hearing many CIOs planning huge increases in IT capital expenditures. On the flip side, he also argues that the M&A activity in the sector makes it one to watch. “Just because technology isn't growing the way that it used to doesn't mean you can safely ignore it as an investment area.”

The success of McWhirter, who “ground out” five-year annualized returns of about 18%, proves tech never had to be completely ignored, but his performance was overlooked in a Canadian market riding a resource boom. Perhaps investors will wake up this year. “Our guess is that from a technical analysis perspective, we should have some very interesting times ahead,” says McWhirter. “Just as the mines and oils in Canada have had their opportunity over the last three to five years, it appears to be tech's time to shine once again.” And how does that make him feel? “It's nice to be loved.”