How to play a coming tech rally

A broad market rally is likely later this fall and, because tech shares fell further than the market for most of this year, their outperformance could be explosive. If tech shares rally -- and it's still an 'if' -- consider adding Apple (AAPL, news) and EMC (EMC, news).

As technology rallies go, the gains of the past week and month are suggestive of bigger things to come, but they're not totally convincing yet.

For the week that ended on Sept. 16, several stocks in the sector, including Nvidia (NVDA, news), Intel (INTC, news), Oracle (ORCL, news) and Marvell Technology Group (MRVL, news) convincingly beat the 5.42% gain for the Standard & Poor's 500 Index ($INX). Nvidia was up 11.38%, with Intel up 11.52%, Oracle up 12.42% and Marvell gaining 10.81%, according to Morningstar.com.

That's not especially surprising. High beta stocks, like most technology stocks, should rise faster than the general market when the broad market is climbing. Nvidia, for example, has a beta of 1.61, meaning that it is 1.61 times as volatile as the broad market. (By definition, the broad market of stocks has a beta of 1.) It's also not surprising given the way technology stocks have been pounded in 2011. Even after this rally, Marvell Technology is down 18.22% for 2011 and Oracle is down 6.07%.

A recipe for a tasty bounce?

But the recent technology rally is also a reminder of the coming seasonal sweet spot for technology shares. Technology companies see a huge positive swing in revenue every year in the third and fourth quarters.

I suspect we're going to get some kind of November/December rally in stocks this year once the global economy (and especially the eurozone), manages to survive September and October's very rough spot without falling apart. The historical seasonal pattern for technology shares -- added to the underperformance of technology stocks in 2011 -- will push the sector to the front in any rally.

Given all this, the tech sector's performance could actually be quite explosive, because the sector is underowned. For many investors, technology shares have fallen off the radar screen, and any rally strong enough to generate "believers" will have a very strong bandwagon effect.

In most years, sometime around Oct. 20 or so is a good time for checking the technology weighting in your portfolio. Last week's rally says that you ought to start that checkup -- and start adding to your technology weighting -- a little early this year.

Choose with care

To be completely clear, I'm not saying that the U.S. stock market is about to launch another big nine-month rally or that any end-of-the-year rally in U.S. stocks is sustainable. I think we're all too aware of the big problems that are still lurking out there. All I'm looking for is a relief rally if, as I continue to think likely, European governments get their act together enough to kick the Greek and Italian debt crises down the road into 2012 or 2013. In other words, don't fall in love with anything you might buy now, and look to take profits when the flow of not-quite-as-bad-as-expected news starts to diminish in January or so.

A technology rally would lift all boats, but not equally. Microsoft (MSFT, news) was up only 5.36% last week, actually trailing the S&P 500. Cisco Systems (CSCO, news)was up just 5.06%. On the other hand, Broadcom (BRCM, news) rose 6.67% and EMC 6.9% -- both more than the S&P 500. (Microsoft owns and publishes MSN Money.)

I think this boost in tech shares -- even if it doesn't hold long enough to roll right into an end-of-the-year rally -- provides a pretty good template for where to put your money this year. So what did last week's technology rally tell us about where to place our bets for the last quarter of 2011?

Tech prospects in 3 parts

1. The old technology giants are due for a bounce, but that's about all. I think you could get a bounce out of these stocks just because they've been so beaten up and investors are so familiar with the names, but the challenges facing these companies are enough to make them laggards in the sector. In addition, their size makes finding new growth opportunities big enough to move the scale a difficult task.

I'd put PC companies such as Hewlett-Packard (HPQ, news) and Microsoft in this group. PC sales aren't exactly setting speed records. On Sept. 17, analysts at Gartner cut their projections for semiconductor revenue in 2011 to a 0.1% drop from 2010. Just in June, Gartner had predicted that semiconductor revenue would climb by 5.1% for 2011. Also in September, Gartner cut its projections for unit growth in PC production to 3.4% for the year, down from 9.5% in its earlier forecast. Add in the drop in prices for much of what goes into a PC -- memory chip prices, for example are falling -- and you've got falling revenue despite a slight uptick in unit sales.

Big networking companies are seeing a similar slowdown. On Sept. 13, Cisco reduced its forecast for long-term revenue growth to 5% to 7% from a previous estimate of 12% to 17%.

You can get a sense of how big any bounce might be by looking at the performance of Hewlett-Packard, up 4.42%, and Cisco, up 5.06%, in this rally. Both trailed the market, but both stocks had been beaten up so badly in 2011 that they climbed with the sector. Even after last week's rally, HP is still down 43.35% for 2011 and Cisco is down 17.25%.