Computer hardware manufacturers are members of the FTSE Information Technology - Hardware sector. It is a volatile group of companies. The sector played a key role in both the rise and fall of the infamous internet bubble.
As our first graph reveals, when things go well for this sector, they go extremely well. On the other hand, sector shares fell 98.3% from their all-time high in 2000 to their most recent low in October 2002. The decline was one of the worst-ever drops in history ... from any sector, from any country and from any century.
The rebound from October 2002 to January 2004 was equally exciting. Sector shares more than tripled, significantly out-performing the rest of the stock market. But the sector has limped ever since, falling in each of the last three calendar quarters. Prices fell by 20 per cent alone in July to September. To put this drop into perspective, the FTSE-All Shares index gained about two per cent in the same period.
Price swings of this magnitude reinforce the fact that this sector is not appropriate for the faint-hearted. Investors should not forget that some sector companies continue to be loss-making. Their sole claim to fame is that they are among the survivors.
So what lies ahead for this volatile sector? History provides us with some useful perspectives.
Our first graph reveals that sector prices had fallen to 1995 levels when they finally reached their low in October 2002. 1995 was well-before the dot com bubble took off. It seems reasonable to conclude that many late-1990s excesses were finally washed away when the sector index bottomed out at 153 in October 2002, 60 per cent below current levels. It is only an educated guess but this figure provides us with an estimate of where sector prices could slip to if everyone's rosy predictions for the future are completely wrong.
On the other side of the coin, our second graph (just below) provides us with a more positive perspective.
Experience teaches the 75-day trend line is an important diagnostic tool for this sector. Throughout the last decade, the line frequently served as a solid level of support during upturns, and an important resistance line during downturns.
It was frequently a difficult barrier for sector prices to break through. And if a penetration did occur, it was typically followed by a solid continuation move.
Note that sector prices rose throughout 2003, solidly supported by the 75-day trend line. But prices fell below the trend in early in 2004 and have been disappointing ever since.
The 75-day indicator is not a perfect tool. When it comes to the stock market, no such indicator exists. But the frequency with which the 75-day trend line provides support or resistance is striking. And if a penetration does occur, there are high odds of a solid continuation rally/decline.
Shares now sit nine per cent below the 75-day moving average a small gap for this volatile sector. If the past is any guide, a decisive breakout above this line could be the start of a major continuation move.
Which brings us to the £64,000 question. Will a breakout occur or are shares destined to retest the 2002 low?
No one knows the answer with certainty of course but history suggests a breakout to the upside will soon occur. The reason is linked to the calendar.
The IT-Hardware sector is quite new. Sector records exist for little more than one decade. Even so, an interesting seasonal pattern has already emerged. Since 1991, this sector rose 11 times in October to January versus two declines. Both exceptions to the rule occurred in the bear market of 2000-2002 that marked the bursting of the speculative bubble.
On balance, a decisive penetration of 75-day trend line in the next few months is likely. If the breakout occurs, it could be the start of a very healthy continuation rally.
If you are considering a sector investment, keep in mind that this analysis is light on firm conclusions and heavy on "might", "could be" and "perhaps". The best course of action for the moment is to keep to the sidelines until the underlying trend tips its hand. The key first step is for sector shares to decisively break out above their 75-day trend line.
While waiting for the underlying trend to reveal itself, use the time to do research on various sector companies.
Go to www: londonstockexchange.com/engb/pricesnews/statistics/listcompanies/
for a full list of sector companies.