An Unintended Consequence of Fiscal Austerity

An Unintended Consequence of Fiscal Austerity

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I once stood behind market makers for Cisco, the computer networking giant, whose stock was then selling at a heady 100 times earnings, and watched it surge several percentage points at the open. But that was so1990s, when Cisco was the darling of Internet-crazed investors

Yesterday, of course, the reverse has played out as Cisco’s stock dropped 15%, the most in 16 years, after Cisco CEO John Chambers announced that the company faced a “challenging economic environment” despite first-quarter profit gains of 8% year-over-year. But the real reason for the drop, according to Reuters, was the “sudden crunch in spending by debt-burdened European nations and U.S. state and local governments” that rocked global markets. The headwinds: weakening orders from cable TV operators and government agencies, and pricing pressures from competitors.

As it was back in the roaring 1990s, Cisco is considered a bellwether for the tech sector, which had been leading the stock market rebound, at least until yesterday. The technology-heavy Nasdaq Composite, which has risen in 21 of the last 25 trading days, fell 1.11% to 2,545.07 yesterday. The S&P 500 declined 0.64% to 1,209.54, with technology leading the way down.

The tech sector is considered a barometer of business confidence. Although corporate America has enjoyed robust profits, capital spending has been relatively anemic. Hopes were high that the mid-term elections and Fed’s new bout of asset purchases would create a more pro-business environment where companies were willing to open their wallets to buy equipment and hire people. Cisco’s grim guidance may be a warning sign for others.

Government spending is a major factor in the tech sector, and spending cuts in Europe and the U.S. could reduce demand for tech equipment. Ironically, slower tech growth may just be one of the unintended consequences of fiscal austerity.

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