Analysis: Old economy takes revenge on new economy

Old-fashioned factors such as politics and oil have taken a toll on tech stocks. But the Internet will prevail in the end, say analysts

Events of the last week have illustrated just how vulnerable new economy shares are to old economy events. Military action, uncertainty in the oil markets and economic slowdown all take their toll, experts say. Because of continuing uncertainty tech stocks are unlikely to see the end of their current correction for several weeks.

The correction, in which investors are taking a more realistic view of high tech companies' future prospects, has meant several months of diving market prices, lacklustre flotations, bankruptcies, and consolidation. Industry observers have been expecting a recovery, but that was delayed yet again last week by the crisis in the Middle East, which could have an ongoing effect on oil prices.

Panicky oil traders pushed benchmark Brent to $35 a barrel after a bomb blast rocked the British embassy in Yemen and players watched renewed Israeli-Palestinian violence. The price hike's effects were felt even in the rarefied world of telecoms and technology, which are seen to be squeezed out when consumers and businesses must spend more on transportation and heating. Observers said old world factors such as oil prices and the weak euro will mean continued uncertainty for tech stocks.

"The stocks are coming closer to fair value, but with the latest oil price rise, I really can't see anybody for this sector for the next couple of months," said Sharon Coombs, HSBC European strategist. "It will take that long to see when interest rates are likely to peak, to gauge how severe the slowdown will be, and to see how telecom and technology stocks react to that."

This attitude differs sharply from views of the new economy just a few months ago, when investors felt businesses and consumers would keep fuelling high-tech growth no matter what, according to Coombs. "Until now people have firmly believed techs were in a structural bull phase and would not be hit by an economic downturn," she said. "I think the market has changed its perception and now sees them more as high-growth cyclicals which could be very badly impacted."

Exercising an even more obvious influence on European tech shares is the US' Nasdaq stock market, which lists many new-economy stocks including software giant Microsoft. Last week saw wild swings in the Nasdaq, which capped a dreary week by plummeting to 3,074 Thursday and then gaining 7.87 percent Friday, its second biggest percentage point gain ever.

However, analysts said Friday and Monday's gains did not necessarily signify the return of investor confidence. "The Nasdaq bounce may be just a trading-oriented one, and institutional investors may not give it much credibility," said Dirk Ley, head of European equities sales at West LB Panmure in Duesseldorf. It was a positive that the Nasdaq has tested its lows for the year twice and recovered, he added.

Are investors likely to get their confidence in Internet and high-tech shares back soon? Not likely, say analysts, noting that the trend is for markets to emphasise every negative piece of news that comes along. "These markets are overreacting on the negative as they were overreacting on the positive earlier this year... In these situations there is a high degree of correlation between markets, and Nasdaq is the natural leader," said Hendrick Garz, European equity strategist at Germany's WestLB.

"People are worried about the risks these high valuations represent, and so we see immense volatility despite the fact that we also have relatively robust GDP, low inflation and double digit earnings growth," Garz said.

However, experts maintain, as they have all along, that strong business models will win out in the end, despite any amount of ill feeling among investors. Companies using the Internet to build unique and powerful businesses are out there, and will rise out of the rubble eventually, experts say.

"It's fairly obvious that sentiment is negative, but you've got to look past that and focus on the business. In my portfolio I'm keeping firms which I feel confident will not miss third-quarter earnings," said Gariesh Sharma, head of Merrill Lynch's Digital Europe Fund. "Price is never a good reason to buy a stock, whether it has gone down ten percent or not. I'm looking for strong earnings and fully-funded business plans."

The general picture from analysts is still that the correction is a healthy response to the lack of discrimination shown to tech stocks earlier this year and last year. Despite negative outside influences and gloom among investors, analysts do not feel the markets are about to throw the baby out with the bath water.

Reuters contributed to this report.

See ZDII for US tech investor news.

Lots of hopeless Internet startups have been funded by hapless venture capitalists in the last few years. The truth is -- Charles Cooper says -- we've arrived at a punishing phase of the Internet revolution where profits and strong revenue growth suddenly matter. Go to AnchorDesk UK for the news comment.

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