The market has been mired in low-volume, range bound muck for most of the year, and as we approach ‘summer channel’ resistance at the 1130 level in the S&P, it begs the question, are things going to be different this time around? Despite a stuttering recovery and the incessant chirping of doom and gloomers, we are starting to get some indications that a new bull market could be on the horizon.
The technology sector typically leads the charge during bull markets, but that has not been the case since March 2009 lows. Since the broader market bottomed in March 2009, the technology sector has performed in-line with the S&P 500. At a time when money market markets returns are paltry and treasury are yields are extremely low, it seems natural that income-driven investors would be even more inclined to look at tech stocks. So, where is the disconnect? The answer is that tech companies, up to this point, have chosen to hoard cash rather than find creative ways to enhance shareholder value. In the process, they are doing themselves a disservice.
One problem lies in the fact that many tech companies generate significant cash flows abroad, and all things equal, the associated costs with repatriating those cash flows discourage companies from routinely paying dividends. These large cash hoards have harbored an auction environment for tech start-ups in which acquisitions occur at inflated premiums. Investors are getting sick of seeing the H-P’s and Dell’s of the world engage in a bidding war for 3-Par (which was at $9/share before takeover rumors, and was sold for $33/share) instead of looking for ways to reward and attract shareholders. It’s like watching your sugar momma girlfriend go out and pay exorbitant prices for the latest designer handbags while she won’t take you to one freakin’ Yankees game. At some point, it just becomes downright offensive!
MSFT: Beacon of Light, and trend-setter?
Bloomberg reported late Monday afternoon that Microsoft (NASDAQ:MSFT) will be issuing debt to boost dividends and repurchase shares. Microsoft, while not directly tapping into large cash reserves, is taking advantage of the its sparkling balance sheet and AAA credit to (God forbid!) reward shareholders and actually let some money leave the tech sector. Microsoft is satisfying investors’ thirst for income from their investments a time of uncertainty in the equities market, especially baby boomers who are looking for income for retirement (after watching their equity investments stagnate for the last decade). And although Microsoft has lagged on the innovation front over the last decade (I don’t see many people walking around with Zune mp3 players these), they are poised to become at least a modest player in the battle for cloud computing market share.
The question now becomes whether Microsoft is an isolated case, or whether other tech names will follow suit. These tech companies need to stop living in the 1990s, when their central focus was to drive up the stock price by attracting growth-stock managers. It’s ok, guys, we won’t take it as a sign that you can’t cut the mustard anymore in terms of growth. In the current low-cost-of-borrowing environment, it’s only smart to take advantage of the opportunity.
What It Means for the Broader Market
A renewed focus on shareholder value, and the strategic exploitation of low borrowing costs could allow the tech sector to lead a new, sustained market rally. Microsoft shareholders immediately responded positively to the company’s move Monday because it makes sense, as opposed to the company’s ill-conceived attempt at appeasing shareholders in 2004 with the $3/share special payout which resulted in an almost equal decrease in the stock price. Morgan Keegan Analyst Travis McCourt believes a 4.7% dividend yield for tech—in line with utilities—would lead tech stocks to trade at higher prices, and some dramatically higher.
Even if a philosophical shift does not take place, it seems investors are already disproportionately discounting shares of tech companies. A recent research note from Bernstein tech analysis Toni Sacconaghi suggests investors appear to be punishing tech bell-wethers too harshly for decelerating growth, because relative to the S&P revenue and profits have been stronger in the tech sector since March 2009.
Investors are fleeing the stock market in droves, evidenced by the shockingly low real volume we have experienced this summer. Fed up with the elevated risk posed by equities, investors are choosing instead to buy treasury bonds yielding 2%. The tech sector has an opportunity to deliver both income and growth prospects to investors, and I will be watching how this develops very closely.
