“Unsustainably Low”

A new phrase entered the lexicon of tech investors on Friday: “unsustainably low.” Wit SoundView used that phrase to say that the optical equipment business is so bad it has to get better.

Wit said that overcapacity combined with an economic downturn has precipitated “an unsustainably low level of equipment investment. That should trigger a sharper rebound for revenues and profits than analyst estimates or investors expectations now anticipate.” However, the firm went on to say, “2003 is where we expect real improvement, and we expect results to go lower in the coming year.”

Wit’s upgrades of JDS Uniphase and Optical Communications sent optical equipment stocks surging on Friday.

That’s not a bad argument on Wit’s part. Buying when things seem darkest, when “blood is running in The Street,” as they say, is a time-tested strategy. Picking the right beaten-down dot-coms, like Priceline.com or 1-800-Flowers.com , back in December would have yielded gains of 200%-600%.

Also on Friday, Robertson Stephens recommended several “orphans” in the telecom equipment sector based on strong cash positions, among them Sycamore , Corvis , Clarent and Cosine . And value manager Bill Miller of Legg Mason Value Trust has been buying shares of Tellabs recently.

The problem is that most optical and telecom equipment companies are now losing money, so they’re tough to value. A few exceptions are Digital Lightwave , which trades at 29 times this year’s estimates, Optical Communications, which trades at 32 times this year’s estimates, and Ciena , which trades at 56 times estimates. Of course, one earnings warning could change the outlook for any of these companies. All three of those stocks have made higher lows than they did in April (Ciena barely so), so in that sense they are technically healthier than stocks like JDSU, Nortel , Lucent and Tellabs, all of which have made lower lows recently. Tellabs is also profitable, trading at 23 times this year’s estimates, but warned last week that the next few quarters will be difficult.

The other cautionary note is one that almost every stock in the sector shares: sharp gaps marking recent breakdowns. And they are all running into resistance at the start of those gaps. Until they are filled, those gaps remain the dominant technical feature on the charts. In the chart of Digital Lightwave (see below), note that the chart remains below the recent gap from 35.91-31.61. The stock turned back Friday at 32.84 to close below that gap, in the process creating a black candlestick, meaning the close was lower than the open. At least a few traders took advantage of the good news to dump shares of DIGL. The stock must hold its recent low of 26.29. A gap up to the 36 level would be bullish, creating an “island reversal.”

This is a risky market, however, and the Nasdaq is trading in a high-energy pivot area between 1973 and 2125 (2077 is first resistance). A sharp break of either end of that range should let investors know which way tech stocks in general, and optical equipment stocks in particular, are headed.

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