Technology shares: "three Es" can damage your wealth

Ian Mitchell

City briefing

We know that "Es" damage your health when they come in tablet form, but the last month or so has...

Ian Mitchell

City briefing

We know that "Es" damage your health when they come in tablet form, but the last month or so has shown that they can also damage your wealth. The economy, the euro and earnings have combined to subject the Nasdaq index to a kind of water torture. The index has steadily dripped downwards in little over a month, falling by 28%. It is now below the level it reached in April when many people were talking about a collapse in technology share prices.

This latest setback is surprising for technology investors because the UK has escaped the full extent of the recent markdowns. The graph (right) shows what your returns would have been if you had tracked the Nasdaq and Techmark indices between the end of November last year and the end of this September.

While most of the time the UK follows the US lead, Techmark is now showing a 22% return compared to Nasdaq's 10%, which is the biggest gap in six months. Clearly, the UK markets are not ready to mark down tech shares as quickly as their US counterparts. But should they?

Looking at the "three Es", the UK has, potentially, the same exposure as the US. Both countries are trying to ensure that strong growth does not lead to inflation, which would undoubtedly lead to interest rate rises. Both the UK and US are seeking a "soft landing" on growth, but this is by no means certain. So the UK is exposed to this concern.

The fall in value of the euro is also a worry for UK and US software and services companies as it hits their profits. Put simply, software companies must push up their prices, which makes them less competitive, or they cut their margins in order to compete. And for services companies profits are depressed when they are translated back to the UK or US currencies. Intel, for example, warned that it would probably not meet third quarter analyst expectations for exactly this reason.

Which brings me to one final E - earnings. Nasdaq-listed companies have to report quarterly, whereas in the UK it's only twice a year. This means that there are four "confession" periods in the US during which time companies that have failed to meet analyst expectations report on their sins. We have just been through one of these periods in which such industry heavyweights as Intel, Dell, Lucent, Apple, Razorfish and Lexmark all broke bad news to the market.

In the UK we have seen nowhere near the same level of warnings, but it would be premature to start patting ourselves on the back. As the UK does not have a third-quarter confessional period, we will have to wait for another three months to see how many UK companies issue profit warnings before we can think of doing that.

I would expect the Techmark to come back into line with the Nasdaq relatively quickly. The key question investors have to ask themselves is whether the Nasdaq will rise or the Techmark fail to do so.

Ian Mitchell is an IT analyst at stockbroker Beeson Gregory. His opinions should not be construed as investment advice.

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