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Tech Can Still Outperform Street's Expectations

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Despite downturn, these companies remain ones to watch.

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There are 2 major parts to this economic slowdown: Credit contraction and a slowdown in consumer spending. The credit contraction part is reasonably quick and sharply painful, much like getting hit over the head with a Louisville Slugger. A sizable chunk of Wall Street's most prestigious firms have disappeared from the financial map.

Given the incredible velocity of the deleveraging process, let's assume, for the sake of conjecture, that we're halfway through this phase of the epidemic. The second part, the consumer spending slowdown, will be more prolonged here in the US and in most of Western Europe, and it's likely to emit confusing investment signals.

We've all seen or heard about the widespread hardship that US consumers are facing. Furthermore, I believe this phenomenon is probably only just beginning, as credit is increasingly scarce, unemployment is rising, and inflation is still trending up. However, it's important to remember that the middle class is growing at around 20% per year globally, largely driven by quality-of-life improvements in countries like China and India.

It's amazing how quick emerging market bulls were to point this out when valuations overseas made no sense, but now that foreign equities make reasonably attractive investments relative to their growth rates, those same advocates are now myopically focusing on how awful things are here at home. This is most certainly a herd mentality.

Now, getting back to the question: are we closer to the middle of this economic slowdown or are we closer to the beginning? Equity markets are a discounting mechanism, and one that typically begins pricing in a recovery somewhere in the middle of past economic slowdowns. The VIX has reached new all-time highs. In past crises, the markets have typically lost about 3% of total market capitalization from peak to trough, and we have now reached that level. And yet, despite a roughly 30% drop in the major indices in about a month, the conventional wisdom is that the markets are still a dangerous place to be.

Let's bring this all back to my wheelhouse - technology. I want to be leveraged to companies that sell into global enterprise, because I believe their stock prices have already largely accounted for headwinds created by the 2 parts of this economic slowdown, and thus I believe the investment is to the long side. Furthermore, as many institutional investors are seeking to reduce "exposure," they often do so by selling their most liquid names in order to raise cash.

Minyans should remember that a good "tell" is the proportion of expected revenue coming from deferred revenue (money that the company has already collected, but has yet to recognize). I think you'll find that many IT companies have a pretty incredible degree of visibility going into next year - and, though many of these companies are experiencing slower growth rates, they still have the ability to outperform the Street's expectations.

Companies that have hybrid business models -- but which are increasingly leveraged to their software practices -- include Hewlett-Packard (HPQ), EMC (EMC) and Cisco (CSCO). Pure plays in software are Symantec (SYMC), McAfee (MFE), Oracle (ORCL), Microsoft (MSFT) and SAP (SAP).

If you're an investor in this market, it's an excellent time to turn off your screens and spend your time searching for facts in this sea of wild assumptions, because at some point, this market will get back to trading on fundamentals. And watching the flicks on your screen isn't an effective way to get prepared.
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No positions in stocks mentioned.
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