Rebounding Tech Sector Stars Could Play Key Role in U.S. Economy’s Second-Half Rebound

[Editor's Note: This tech-sector preview is the opening installment of a new Money Morning series that will make economic projections for key U.S. sectors for the last half of 2009. As part of that series, look for forecasts for housing, energy, U.S. stocks and the emerging markets.]

By Bob Blandeburgo
Associate Editor
Money Morning

If the last three months are any indication, the U.S. tech sector has shaken off its recession-heightened late-winter doldrums, and could see its fortunes soar in the year's second half as businesses and consumers open their wallets and the broader economy picks up speed.

The technology-laden Nasdaq Composite Index was at the forefront of the most-recent market rally, having soared more than 45% since hitting its 52-week low on March 10. That outpaced both the Dow Jones Industrial Average – up 30% in that time – and the Standard & Poor's 500 Index – up about 37%.

According to industry analysts, the technology sector – because it is heavily reliant on borrowing, as well as consumer demand – can serve as a harbinger of economic recovery.

"Technology tends to be a leader in the early stages of an economic turn. That's what we took for as confirmation of a sustainable rally-money rotating into a sector that historically is seen as consumer- and business-sensitive, and requiring more leverage in terms of borrowed money, because it is more sensitive to the economy," Marc Pado, U.S. market strategist at Cantor Fitzgerald told MarketWatch.com. "I expect technology to continue to lead well through this year and into February of next year."

Spearheading the Nasdaq's charge has been Redmond, Wash. software giant Microsoft Corp. (Nasdaq: MSFT).  While its fiscal third-quarter profit fell 11% from a year earlier, Microsoft beat analysts' expectations, helping the company's stock to surge more than 50% from its mid-March low. Microsoft is up about 16% in the past month.

Semiconductor manufacturer Texas Instruments Inc. (NYSE: TXN) could trade in the is up more than 45% in the past six months to its current level of about $21 per share. The company could trade up into mid-$30s within 12 months, according to Paul J. Nolte, director of investments at Hinsdale Associates Inc., an Illinois money management firm.

Earlier this month, in fact, Texas Instruments sharply raised its second-quarter financial guidance. The reason: Customers had slowed the rate at which they were reducing chip inventories – a signal that the market for semiconductors may be stabilizing.

The company now expects to report earnings per share (EPS) of 14 cents to 22 cents, up from the previous forecast of 1 cent to 15 cents per share.

Opening New Windows

The long-suffering PC market may get a shot in the arm this fall with the Oct. 22 release of Microsoft's Windows 7, which is all but guaranteed to generate better reviews than its predecessor, Windows Vista. Pre-release versions being publicly tested are already being called better than Vista, which was dogged by geeks and general end-users alike for its slow performance and questionable compatibility with legacy software and hardware.

Stopping short of admitting the goof and giving away Windows 7 to existing Vista users, Microsoft is offering cheaper upgrades to those who pre-order Windows 7 between June 26 and July 11.  The company will offer free Windows 7 upgrades to anyone who purchases a PC pre-installed with Vista after June 26.

Windows 7 is expected to be the operating system of choice for information technology (IT) managers who make purchasing decisions for corporate users.

"The upcoming introduction of Windows 7 could spur a rapid corporate PC upgrade cycle starting in late 2010/early 2011, catalyzed by the end of support for Windows XP and a recovery-based increase in IT spending," said Jeffries & Co. Inc. analyst Katherine Egbert wrote in a recent research report.

But history shows that a release of a new operating system – no matter how positive the buzz – will translate into only a slight increase in PC sales, Microsoft Senior Vice President Bill Veghte said in a webcast earlier this month. On the business side, enthusiasm is high for Windows 7, but corporations will not rush to upgrade when it is released. The release "will get drowned by the macroeconomic environment," Veghte said. "As the macro environment comes back, people will have to buy new PCs. People aren't using PCs any less."

Game On

Looking ahead, the tech sector is anticipating a slew of product releases in the year's second half – many of them in the $22 billion video-game sector, which lives and dies on new releases.

Activision Blizzard Inc. (Nasdaq: ATVI), the largest third-party game publisher in the world, will lead the way with the latest in its rock music game series with the September release of "Guitar Hero 5" on four platforms: Sony Corp.'s (NYSE ADR: SNE) PlayStation 2 and 3, Microsoft's Xbox 360 and Nintendo Co. Ltd.'s (OTC ADR: NTDOY) Wii. The third iteration of "Guitar Hero" became the first video game ever to achieve $1 billion in sales.

But the music from Activision won't stop with the last strum of a toy guitar: The company will debut "DJ Hero" in October for the same four platforms. "DJ Hero" will ship with a mock turntable and should appeal to fans that don't turn to rock for their music fix.

Activision will release new titles for proven franchises such as "Modern Warfare" and "Tony Hawk." The first "Modern Warfare" title, released in 2007, has sold 13 million copies worldwide and is one of the best-selling games on Xbox 360. The new "Tony Hawk" game represents the 12th installment in the series since it was started 10 years ago.

While sales of console games typically garner most of the attention, it is Activision's "World of Warcraft" (WoW) playing the role of its single largest sales generator. In 2008, WoW accounted for $1.1 billion in revenue, or 38% of Activision's total revenue. Sales from all of Activision's console titles were $1.2 billion. WoW has more than 11.5 million subscribers, Activision said.

Since its dropping down to its 52-week low of $8.14 in January, Activision shares have risen steadily, and are now trading in the $12 range. With a war chest stuffed with nearly $3 billion in cash and ratings of mostly "Buy" or "Strong Buy" from analysts, Activision may warrant closer study by individual investors, too.

Activision's rival, Electronic Arts Inc. (Nasdaq: ERTS) also has some potential-big-hit titles coming in the year's second half, but saw its losses more than double to $1 billion for the fiscal year that ended March 31. Like most game publishers looking to cash in on the holiday shopping season – primetime for consumer spending – EA is saving its best for the second half of 2009.

Titles such as "Madden NFL 10," "The Beatles Rock Band" and "Left 4 Dead 2" will sell well, but the outlook for EA on Wall Street is mixed, with the majority of analysts rating the company as a "Hold."

Some analysts say that EA can weather the current downturn in consumer spending, as it sits on more than $1.6 billion in cash, according to its annual regulatory filing with the Securities Exchange Commission (SEC), but the outlook for the 2009 Christmas shopping season remains uncertain.

Will iSpend?

Following a sharp drop in its stock after the revelation that its chief executive officer's health may be worse than previously thought, shares of Apple Inc. (Nasdaq: AAPL) have slowly been climbing back toward its 52-week high of $180.91. The shares are currently trading at about 21% below that peak.

The Cupertino, Calif.-based company on June 8 removed a barrier that had stopped many consumers from purchasing its popular iPhone when it lowered the price of its 8-gigabyte 3G model to $99. With wireless plans starting at around $70 per month, Apple's phone – and perhaps more importantly, its app store – will find its way into the hands of many more consumers in the second half of 2009.

Couple the 8GB iPhone 3G with the newly released, feature-rich 3GS model – and then stir in a barrage of television commercials – and the result should be a marked improvement in revenue.

It is unlikely that Palm Inc.'s (Nasdaq: PALM) Pre will put a dent in iPhone sales, partly because of sustained shortages as Apple floods the market with its phone. However, Sprint Nextel Corp. (NYSE: S) customers locked in their contracts looking to upgrade to a phone with a growing app catalog will see the Pre's similarities with the iPhone.

Sprint Chief Financial Officer Bob Brust told investors via a webcast at Wachovia Corp.'s Annual Mid-Year Equity Conference that Pre shortages still exist weeks after its launch.

"We still have a backlog of subscribers but it's not unmanageable and we get shipments every week," Brust said. Sprint is the exclusive carrier of the Pre.

Analysts estimate that 50,000 to 100,000 Pres were sold in its debut weekend earlier this month, while Apple said the new iPhone sold 1 million units in its opening weekend.

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