Early Tech Earnings Bode Well for Sector

But clearly they overdid it.

Google's just one buoyant data point in this very young earnings season. Fortunately there have been others. International Business Machines (IBM), Intel (INTC) and Infosys Technologies (INFY) all had strong reports this week, while BlackBerry-maker Research in Motion (RIMM) looked recession-proof when it posted a couple of weeks back. And though it was by no means a perfect string — Nokia's (NOK) cautious outlook and eBay's (EBAY) slowing core auction business saw to that — it does instill confidence.

Consider that on Monday the tech-heavy Nasdaq Composite Index was back down in bear territory, off 20% from its October high. Never mind that it was trading at the fire-sale price of 20 times forward earnings — the market has had no faith in Street estimates. But if these early earnings indications hold, if we have more Googles and fewer Nokias, tech stocks (dare we say it?) could finally come back.

"I'm pretty encouraged by earnings season so far," says Robert Stimpson, portfolio manager with Oak Associates Mutual Funds. "Tech stocks do look cheap. And when you look at numbers from IBM, Intel and RIM, they haven't been really affected by this slowdown that we're supposedly heading into."

The results out of Google, IBM and Intel are encouraging for another important reason. The mantra for tech investors this year has been to hold big-cap companies with solid fundamentals and lots of revenue coming from overseas. International operations not only help shield the company from U.S. weakness, but those revenues get a boost from the declining value of the dollar. It's a sound strategy, but with the exception of IBM it hasn't really helped anyone's share price. This week's results, however, proved the wisdom of that thesis. Intel and IBM derive a good two-thirds of their sales from overseas, while Google, for the first time in its history, generated more than half its revenue from international operations.

That certainly bodes well for next week, when Microsoft (MSFT) reports. Indeed, with the market distracted by its bid for Yahoo (YHOO), Citigroup analyst Brent Thill advised clients to buy Microsoft ahead of earnings. "Investors appear to be ignoring the strength of Microsoft's underlying fundamentals," Thill wrote Wednesday. "We suggest investors take advantage of this temporary [Yahoo-induced] dislocation between stock valuation and fundamentals and buy Microsoft before investor attention returns to the strength of its core business."

Of course strong fundamentals and international revenue streams are meaningless if investors have no taste for tech or stocks in general. Happily, that appears to be changing, too, says Kenny Landgraf, president of Kenjol Capital Management. "Tech was just indiscriminately sold off, but now the sentiment has improved," he says. "We're seeing the market trade in a range of higher highs and higher lows. It looks like institutional managers are going in and buying some of these bargains that have been just smashed."

If the mood has indeed improved for techs, that doesn't mean it's going to be an easy ascent. Remember, we're still very early in this earnings season. There's still ample opportunity for some disappointments. In addition to Microsoft, next week we'll hear from Apple (AAPL), Amazon.com (AMZN) and chip makers Texas Instruments (TXN), Qualcomm (QCOM) and Broadcom (BRCM). If Google's 20% post-earnings pop is any indication, the market will trade strongly on individual news, both good and bad.

Still, that is preferable to last quarter when positive news went unrewarded and anything neutral or negative was slammed. But it should make for some rocky sessions. "Good news appears to be good news again, and that's a good thing for the market," Stimpson says. "But we're going to have a lot of volatility. Once we get through earnings season, I think the market's going to be set for a nice little run."

Don't expect every company to eclipse estimates by as much as Google did. That beat was preposterous. But if enough of the bellwethers exceed expectations and give at least in-line guidance, the market should regain its confidence in forward earnings. Once that happens, it'll be hard to argue that tech stocks are no bargain.