There has been a dramatic change in capital markets since the turn of the millennium, but the Technology industry in particular has undergone a metamorphosis over the last decade. At the height of the go-go nineties, the sector sold at over 50 times peak earnings and at an average free cash\ufb02 ow yield of less than 2% while the long bond offered almost 6%. Implied growth expectations were questionable at best. Since those exhilarating days the sector has been rationalized, and today\u2019s survivors offer a current free cash\ufb02 ow yield of 9%. After a long stay in growth stock purgatory, a different beast has emerged, and now the numbers are skewed in investors\u2019 favor. While the growth outlook isn\u2019t what it was in the heyday of the 90s, the fundamentals rest on a much stronger foundation.

Technology\u2019s long stay in growth stock hibernation has, in all likelihood, come to an end as the bottom in fundamentals looks to have been around the turn of the year. Considering the depth of the current cycle, margins have held up ex- traordinarily well. Following the bubble bust, businesses tightened their budgets to a point where investment dramatically undershot its long-term trend. As a result, earnings should prove less cyclical than prior cycles when investment in technol- ogy had overshot. The survivors offer strong operating leverage, global franchises and unparalleled\ufb01 nancial\ufb02 exibility. The consensus neither anticipated nor believed the underlying shift in the sector, and despite their rhetoric, current yields tell us that skepticism has yet to be extinguished. While no longer trading at depression extremes, the sector still offers a free cash

Our favorite macro theme for this year has been cyclicality. We believe government efforts to re\ufb02ate will be successful and see stocks dis- counting a brighter outlook over the course of the year (particularly those with high foreign sales expo- sure, i.e. Technology). Of course the longer-term is an entirely dif- ferent ball game as the deleveraging process which began last year looks set to last for a very, very long time; but that is a story for another time. Today, we believe the most impor- tant theme is operating leverage ver- sus\ufb01 nancial leverage. And on that front, there is no better expression of this dynamic than Technology. Technology stocks are typically a

group that trade coincident with economic prospects of the global economy. And most of the indicators we are monitor- ing today are already at or below the lows reached during the bust, in terms of both time and magnitude. As a result, U.S. tech spending in Q1-09 fell to its smallest share of GDP since Q4-94 (near the start of the bubble) and more than 20% below trend (see Chart II). We believe levels this low suggest we have seen the worst and tend to coincide with stabilization in the performance of the industry. The stocks have been rising in the face of negative news, suggesting investors have only just begun to discount a recovery. Valuations are coming off historic lows (well below the 2002 trough) and it is common for valuations to rise as economic prospects\ufb01 nd a footing.

drop is that it seems poised to do well under various economic outcomes. Traditional \u201cdefensive\u201d segments of the market present speci\ufb01c risks in the current investment landscape: healthcare faces tremendous regulatory risk; consumer staples face stiff valuation headwinds; utilities carry tremendous levels of debt. However, the Technology sector is sheltered from many of the issues facing the market today. The stocks in the group have little debt, lots of cash, and few unfunded li- abilities. With lower debt levels (median debt/equity for S&P Tech is 40 versus 70 for S&P 500) the sector is less exposed to the credit crisis, not to mention management\u2019s ongoing experience dealing with de\ufb02 ationary price levels.

After an expensive education in 2008, we expect investors will become more \u201cleverage-sensitive\u201d in their future endeavors. Technology is the least leveraged sector of the market (see Chart III), and as a result, companies in the industry are better positioned to sustain rising dividend payments. At year end, the Tech sector had $244B or 31% of the cash in the S&P

500, ex-Financials. Was it that long ago that institutional investors were throwing temper tantrums because of the cash sitting on the industry\u2019s balance sheet? $30B special dividend anyone? Turns out that a con- servative capital structure - a protective cushion against rapid product cycles, competitive shifts and technical risk - wasn\u2019t such a bad idea after all. Unfortunately, this is not part of GE\u2019s Six Sigma Black Belt curriculum.

The decline in the market cap of Tech shares combined with large cash positions makes a good deal of the sector ripe for industry consoli- dation . Large parts of the Enterprise Technol- ogy industry are maturing as growth slows, com- petition increases and core computing resources commoditize. Consolidation is the likely result. CSCO\u2019s entry into computing and ORCL-JAVA are catalysts. EMC and NTAP\u2019s battle for DDUP and BRCD\u2019s bid for ELX are evidence. We be- lieve that the industry is in the early stages of a