Don't Get Fooled...

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Remember how hard you prayed in March? Please, God, give me just one little rally in tech stocks. I'll sell what I have left, I swear, and never again commit the sins of underdiversification and speculation. Well, you can throw that pledge on the scrap heap of desperate promises never kept. Tech is torrid. Again. You want in. Again. Yet this could turn into Bubble II, a sequel with nearly as much punch as the original. That's not what anyone wants to hear after a yearlong, tech-led bust that wiped out $5.2 trillion of stock-market wealth. But the dangerous reality is that tech stocks, now on the rebound, probably have come too far too fast.

Tech was a bargain for about a nanosecond. With the tech-laden NASDAQ having surged 40% since early April, the stocks are starting to resemble an unlit cherry bomb on the Fourth of July. Consider that the average blue-chip tech stock trades at 40 times this year's earnings, up sharply from 29 just six weeks ago.

What's behind the rally? Short-term interest rates are lower, and there are modest hints that the economy has bottomed. Institutions are scrambling to get invested ahead of any recovery, ahead of the pack.

So far, individuals haven't caught the same fever. They aren't doing much buying or selling, says Bob Adler at mutual-fund tracker AMG Data. But the swift tech rebound creates vulnerability for all. It breeds that old feeling of technology not as a business but a lottery. If the rally lasts much longer, there is a good chance that individuals will start buying tech again just when they should be doing some off-loading.

Consider also that in the past 70 years, there have been 11 stock bubbles and that every one of the ensuing busts included a fake-out rally of at least 30% and lasted at least two years before fully washing out, says Barton Biggs, chief global strategist at Morgan Stanley. "This kind of bounce is what you expect," he adds. You also expect it won't last. The pullback, when it comes, will be severe if accompanied by news that suggests the economy won't rebound this year.

Perhaps the biggest problem with the rally is that it is directing capital to companies best left for dead. What really ails the tech sector is too much capacity, which won't go away until investors ration capital properly. "Anything that deters consolidation is a long-term negative for tech," says Richard Bernstein, a strategist at Merrill Lynch. He notes that telecom companies, in which overcapacity is greatest, have been sucking up 30% of proceeds from stock and bond sales this year; energy firms, just 25%--a frightful misallocation.

A solid shake-out has occurred in some quarters. With many Internet-service providers kaput, AOL Time Warner (parent company of TIME) is confident enough to have raised prices last week. Lucent is about to be sold, which will relieve some stress in telecom equipment. But consolidation has not gone nearly far enough, and with the stocks well up from their lows, the pace will surely slow. Tech earnings will suffer longer; the stocks will lag. I believe, as I said in mid-April, that we've hit bottom. But gradual recovery is what we need, not another rocket ride. If the froth gets much thicker, don't blow it again. Sell something.

E-mail Dan at See him Tuesday on cnnfn at 2:15 p.m. E.T.