Can tech stocks spark a 2007 rally?

By Jim Jubak

That wasn't good enough. After the market closed on Jan. 16, Intel reported earnings of 26 cents a share, a penny above Wall Street expectations. But -- and this was the disappointment -- the company did not raise guidance on earnings or revenue for the first quarter of 2007.

And quite frankly stocks -- not just technology stocks, but stocks across the market -- need better earnings news than that from the technology sector right now if there's to be any hope that stocks will move higher in the first half of 2007.

It's been a long, long time since Wall Street has counted so heavily on technology stocks. But as we head into 2007, it feels like old times again, for better or worse, with hopes to keep the rally going resting squarely on that sector.

Technology shares had better cooperate. Earnings for sectors such as energy, commodity materials, financials and industrials are all projected to grow by less than the 9.9% projected for Standard & Poor's 500 Index ($INX) earnings as a whole in 2007. I don't see any other sector capable of picking up the slack, at least in the first half of 2007, if technology earnings and shares falter. Continuing the rally that started on June 13, 2006, pretty much depends on technology companies delivering the earnings goods in the first and second quarters of 2007.

Technology earnings just ahead

Investors won't have to wait long for the first test. In the three weeks starting on Jan. 16 with Intel (INTC, news, msgs), a raft of technology companies will announce fourth-quarter 2006 earnings and give guidance for first-quarter 2007 earnings:

• Motorola (MOT, news, msgs), Jan. 19
• Texas Instruments (TXN, news, msgs), Jan. 22
• Yahoo (YHOO, news, msgs), Jan. 23
• Microsoft (MSFT, news, msgs), Jan. 25
• Nokia (NOK, news, msgs), Jan. 25
• Hewlett-Packard (HPQ, news, msgs), Feb. 1
• Cisco Systems (CSCO, news, msgs), Feb. 7

That guidance will set the direction of the stock market for the next few months. (Microsoft is the publisher of MSN Money.)

Take a look at projected earnings for the S&P 500 stocks as a whole and by sector to understand why the technology sector has become so important for the market. Standard & Poor's is projecting just 9.9% earnings growth for all of 2007. That's not bad, but as I pointed out in my Jan. 12 column, "An earnings checklist for nervous investors," it is a significant decline from the 13% growth in operating earnings in 2005 and the 14.6% that was projected for 2006.

The quarter-to-quarter comparisons look even worse. Standard & Poor's is projecting just 8% earnings growth in the first quarter of 2007, compared with 15% in the first quarter of 2006.

Making those numbers, down though they are, isn't guaranteed either. With oil prices plunging toward $50 a barrel, earnings growth in the energy sector is projected to drop to just 4.5% in 2007 from 25% in 2006. Industrials, another earnings growth story in 2006 at 14.9%, are projected to drop to 9.2% in 2007. Earnings growth in the financial sector is projected to plunge to 6.4% from 17.4% and in the materials sector to 8.3% from 24.8% in 2007.

Just about the only sectors projected to show a pickup in earnings growth in 2007 from 2006 are health care, to 15.3% from 9.1%, and the technology sectors of information technology (computers and software), projected to move up to 21.6% from 1.6%, and telecommunications services, projected to move up to 27.8% earnings growth in 2007 from 14.5% in 2006.

So that modest 9.9% earnings growth rate in 2007 depends on some hefty increases in earnings from the technology sector.

And if the stock market is going to move up much from the current level, technology stocks are going to have to beat those projections. On a 2006 earnings growth rate of 14.6%, the Standard & Poor's 500 Index is reasonably valued at 16.3 times projected 2006 earnings. On next year's 9.9% projected earnings growth rate, the S&P 500's projected price-to-earnings ratio of 14.7 seems a tad expensive. Unless, of course, you know that Federal Reserve Chairman Ben Bernanke is certain to lower interest rates in 2007.

And beating those projections is also critical to the price of technology stocks, which have moved up in 2007 in anticipation of those projections. Before the slight slip in technology prices on Jan. 16, Intel was up 9.3% for the year, Yahoo rose 14%, Microsoft was up 4.5% and Hewlett-Packard rose 5.7%. Investors who have bid up stocks in the sector so quickly in 2007 are certainly hoping for more than just in-line guidance from technology companies when they report over the next couple of weeks.

Much of the rise in the sector, as well as the continued decline of energy stocks, has come as speculative money has moved out of the energy sector and into the technology sector. This isn't patient money, and it needs to see momentum on first- and second-quarter earnings growth to stay happy.

Investors looking for evidence

What these investors will be looking for -- and what technology stocks need if they are to lead the stock market in 2007 -- is evidence that these companies can grow unit sales robustly enough to offset any decline in the average selling price of a chip, wireless phone or PC. This has been the problem in the sector ever since it bounced back from the crash of 2000. Companies sell more, but they sell each unit for less and make less money on each sale. For that to produce climbing earnings, unit sales have to really get in gear.

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