Despite New Yorkers’ fondness for irony, nobody needed a neon reminder of the obvious. In 1999, there were 493 VC deals raising $4.9 billion for New York-area companies. Chase Capital partners, one of the biggest players, had private equity gains of $2.52 billion for that year, and it was estimated that there were 250,000 new media jobs in the region – more than the advertising industry. The following year, there were some 861 VC deals in the New York region, totaling $11.2 billion.

By 2001, the fun was over. Chase had merged with JP Morgan, whose private equity group lost $1.2 billion that year. Flatiron Partners, the star and spiritual leader of the bubble in New York, had given up its Silicon Alley digs to slink into a couple of desks at JP Morgan Partners. Quite a come-down for the joint venture between Chase Capital and Softbank, whose buzz equaled that of rival west coast legends like Kleiner Perkins. Opportunistic and forward-thinking as ever, the once-thriving capital of new media had nothing else to do but move on to the next big thing, something that New York truly could understand…pickles. JP Morgan’s most recent investment was the $485 million purchase of Pinnacle Foods, makers of Vlasic pickles and Swanson frozen dinners. Indeed, the company is not quite the high-profile player it was during the heydey of the 1990s. Like its peer investors in New York, it has done a considerable amount of sobering up – and has made a major shift in focus.

JPMP trimmed its investment in technology and telecom from $2.7 billion at year-end 2001 to less than $2 billion a year later. By this summer, the firm’s top technology investments were hardly sexy Seagate Technology, a 24-year-old maker of disk drives, and The Nasdaq.

Post-bust and post-9/11 New York venture capital is characterized by fewer deals and fewer players. VC continues to be a viable mode of raising capital, but the terms are more painful for the entrepreneur. Gun-shy VCs have made it clear: They do not want to repeat their own mistakes.

In 2002, Silicon Valley veteran VC dealmaker Draper Fisher Jurvetson topped the charts in the New York region with nine deals. To be sure, JP Morgan had seven in its own right – but that is a far cry from the outfit’s 44 investments in 2000, double the closest competitor, Goldman Sachs, which had 22.

Recent moves by the region’s VCs echo their brethren nationwide. They are looking for later-stage investments with shorter paths to profitability. (You could probably fit all of New York’s seed stage VCs into a single taxi if you wanted to.) VCs are also looking for tried-and-true technologies like enterprise software – long a mainstay of private equity investment due to the economies of scale – as well as wireless technologies and healthcare. Software companies received $58.8 million in 10 deals in the first quarter of 2003, and telecommunications a healthy $26.8 million in five – both an improvement from the previous quarter.

Surprisingly, media and entertainment deals are near the top of the charts again, with six deals totaling $48.3 million in investment in the first quarter. That said, while the precipitous decline in venture capital investment that began in late 2000 has largely come to and end, venture investments in the region are still only at 1996-1997 levels.

Will the winter of New York venture capital last a long time? Doubtful. While some VCs, notably Flatiron, have largely folded up shop, the boom brought both the intellectual capital and the infrastructure needed to support a vibrant VC industry to the region. DFJ’s recent activity shows that the West Coast firms have not left yet, and many maintain that they are more optimistic now than they have been in the past, given the sharp drop in valuations that accompanied the bursting of the bubble.

We hope not. We do think that the market got a little ahead of itself, and said as much last month. And there's nothing wrong with a little "consolidation" to close out the year. Unless, of course, you're an investor in something like the British telecom player Cable & Wireless. First, Moody's Investors Service downgraded the company's debt to junk status on December 6. Then word leaked out the next week that the company was planning to cut 65 percent of its European staff. And Merrill Lynch downgraded the stock to Sell in the midst of it all. Result: a 42.1 percent decline. (For more on the havoc-wreaking New York investment bank, see "Taste Test,".)

No single industry showed positive gains leading up to year-end, with semiconductors and communications equipment showing the others the fastest way down. Even single-stock advances were few and far between, with just 64 stocks in the index notching increases. Interestingly, just 14 were the stocks of U.S.-based companies, a clear sign that stateside equity markets are still not offering global leadership. Rational Software, mind you, did climb a solid 13.4 percent as a result of its agreement to be acquired by IBM (NYSE: IBM). But Big Blue can't buy everything. Or can it?

Revenue growth for the sector hit its nadir in late 2001. That's encouraging. The same goes for both profit margins and returns on invested capital. The excitement over the increasingly institutionalized build-out of wi-fi, or wireless networking, has shown that the faithful are still capable of technological flights of fancy, regardless of what the underlying economic model might be. A trail of both useful and useless gadgetry will follow in its wake.

Clearly, innovation is not dead. Much of it has, however, moved to a new address on the corporate income statement. Like many of Silicon Valley's erstwhile superstars, innovation has left its regal digs (on the revenue line) for a decidedly more downscale neighborhood (cost controls).

One result is that the journalist's search for innovation has become a little more boring. You've heard it in the pages of Red Herring and elsewhere--companies are no longer in search of whiz-bang technology and communications products that cost a lot and offer no guarantee of an enhanced bottom line. Customers want increased productivity--and at a lower price. (I, for one, want Apple Computer to drop its prices on the iPod.)

As our columnist Pip Coburn writes this month, if one company can't help its customers meet reduced cost expectations, another will be glad to do so. And the odds are getting better that said company will be located in China (see "Tactics"). An increasing shift of hardware manufacturing to China no doubt contributed to the fact that producer prices for computers and related equipment fell 20.5 percent for the 12 months ended September.

This new cost-obsessed world is difficult to face, given all the fun we had with the likes of Ariba, JDS Uniphase, Kozmo.com, and Softbank. But those days are over. Heck, even Jeff Bezos got some religion. Of course, optimists will point to the growing investment in wi-fi from diverse players like AT&T, IBM, Intel, T-Mobile, and startup Boingo Wireless. But such spending is relatively minor in the grand scheme of things. Others will point to Google, and the delicious mystery of its oft-speculated profit margins. But as Michael Copeland points out (see "Google Goes Public"), Google is also an exception to the rule.

The grand scheme, rather, is about something else entirely, a philosophical shift on the part of buyers that has huge companies changing their entire vision in order to stay relevant. In the simple sense, Hewlett-Packard's Adaptive Infrastructure, IBM's Computing on Demand, and Sun Microsystems' N1 are all aimed at helping customers use their IT resources more efficiently. They're all part of the so-called virtualization movement--treating the network as a computer and provisioning processing and storage resources on the fly. But there's a Pyrrhic quality to them as well. The success of the strategies will cannibalize sales of the core products (i.e., hardware) that got them where they are today. Forget war with the competition. Try the guy down the hallway in software.

Small companies can find their place in the scheme by pinpointing opportunities that help companies keep a lid on costs. Startups like Candera, FalconStor Software, Inkara Networks, and Z-force are all fledgling players in virtualization. Egenera is following in Dell Computer's footsteps as a provider of commodity hardware. And on the telecommunications front, companies like Vonage--an IP telephony player--are busy hacking away at legacy pricing structures.

Michael Malone's essay, "Forget Moore's Law", hints at the magnitude of the change with which we're confronted. Increased processing power--regardless of the cost of achieving it--is no longer the primary concern of technology buyers. It's price. And only those suppliers that can prosper without too much reliance on price increases will emerge victorious.

Like the Donner party's infamous 19th-century trek to California, many companies--and many divisions within companies--won't be able to survive the IT spending winter. But many will pull through, even if they have to resort to grim tactics. What's more, the market environment isn't likely to get much colder than it is already. Of course, when it does warm up, we'll be keeping an eye out for the Googles of the future. In the meantime, we'll be pulling out our calculators to run the numbers along with the rest of the bean counters.

Duff McDonald is the executive editor of Red Herring magazine.

We're surprised that anyone in New York made it into the office to trade in the second half of the month, when the East Coast was being treated to a dose of Jack Frost's strongest medicine. But that's when all the selling hit the tape: the MSCI-Red Herring Index actually fell 11.6 percent from January 14 through 31, with the other indexes close behind.

The most notable decliner in the index was AT&T, which disappointed analysts with weak fourth-quarter results and a downbeat outlook for 2003. The stock slid 25.2 percent. Silver lining? AT&T announced that, forthwith, it would abstain from forecasting quarterly or annual earnings for Wall Street, thereby limiting the frequency of opportunities for the struggling company to inflict pain on investors.

Telecom equipment makers continue to confound with their upward charge (see "Half Full," below). And in a blast from the past, Internet software and services led our industry gainers. Strong moves from Softbank (remember them?) and Yahoo pushed the group up 9.6 percent (Hong Kong: 0648; Nasdaq: YHOO).

But that's all noise when you consider the mounting pressure in the Middle East. George W. Bush's State of the Union address didn't leave a whole lot to the imagination. The sabers are rattling and the soldiers are shipping out, and stock market conditions are likely to get a whole lot colder before they warm up again.

I gave up on the book almost as quickly. My memory is imperfect here, but I recall Mr. Martin's autobiographical work to be a meditation on the process of building a rowing "shell," or training boat. A retired naval officer of some sort, he was living on the East Coast, in life's "slow lane," and enjoying every minute of it. For me, though, it was 1999, and I didn't have time for such meandering reflections. There were stories to write and Internet events to attend. If Mr. Martin and I shared anything, a desire to ponder boatbuilding wasn't one of them.

Fast forward to the 2002 holiday season, and I noticed the book sitting on my parents' shelf. I'd given it to them--they'd recently retired--because I thought it might be more suited to the speed of their lives than mine. While I left it there on the shelf (I don't have anywhere to store a boat), it did occur to me that it might be time to give the book another shot. I returned to New York, only to find waiting for me an SG Cowen Securities report on technology investing in 2003. It advises investors to "get used to life in the slow lane." Boatbuilding, anyone?

Seriously, the months ahead look poised to be less frenetic for technology and telecom circles than the last several quarters were. We're not in free fall anymore, but we're not exactly getting ready to take off again, either. In other words, we're in the midst of a recovery, but not a robust one. "The strength and slope of the recovery are likely to be quite modest," write the analysts at SG Cowen, "and long-term prospects remain moderate." Such projections would have seemed anathema three years ago, but a moderate upward slope sure looks inviting these days.

Why so slow? Because while the sector has stabilized, and many industries might even show single-digit growth in 2003, there's not much more to report. Pricing power, particularly for software vendors, remains elusive. Profits are recovering but are still low by historical standards. And while a degree of certainty has crept back into the IT-spending decision, it's the same damn thing we've heard for two years running: the first half of the year looks anemic, but there could be recovery in the second half.

The venture capital community also shows signs of cruise control. According to a survey conducted by the research firm Venture One and the professional services firm Ernst & Young, VC funding of IT companies in third quarter 2002 was $2.50 billion, a shade shy of the second quarter's total of $2.54 billion. Another down quarter, to be sure, but for fans of the second derivative out there, the slope of the decline is the shallowest since third quarter 2000.

There even seems a "slowness" to good news. At a time when IT spending has pretty much vaporized in sectors like finance, many are coming to see new government initiatives on homeland security and defense as life preservers for many technology companies, particularly in IT services and software. That said, it's the U.S. government, my friends, a.k.a. the most laborious decision maker on the planet, and historically a low-growth, low-margin business partner. So far, it hasn't even been able to officially appropriate the $37 billion put aside for homeland defense in fiscal 2003.

Another purported opportunity, so-called Web services, also remains in low gear. The concept of Web services is all about speed, in that it aims to remove humans--the slowest part of any IT process--from the equation, and have computers initiate communications on their own. But Microsoft, as big a proponent as any in Web services with its .Net initiative, recently decided to eliminate the .Net brand from future product names. The company's products weren't able to keep up with the hype that preceded them.

We're happy to report that there does seem to be a pickup (albeit a slow one) in interest in the tattered telecom industry. As Om Malik points out in this month's cover story (see "The Operators," page 28), some new players are sniffing around distressed telecom assets in hopes of building sustainable businesses in a recovery. They're not scooping up assets at a Bernie Ebbers-like rate, but the increasing pace of transactions is encouraging.

When making her continually optimistic predictions during the boom, Goldman Sachs chief market strategist Abby Joseph Cohen used to speak of "Supertanker America." Given what we've been through in the past three years, that seems a quaint anachronism today. Still, the long-awaited shakeout of the tech sector--and the economy at large--is gaining purchase. And we might just have enough time to build that boat before all hell breaks loose again.

Duff McDonald is the executive editor of Red Herring magazine. Write to duff.mcdonald@redherring.com.

His recommendation was based less on the company's financial prospects (although they were dubious) than on an uncomfortable feeling brought on by the cast of shady characters that seemed to be floating in its orbit. The lineup included Adnan Khashoggi (a fugitive arms dealer), two convicted drug dealers (one dead), a Colombian cocaine hit squad, and others with ties to the Iran-Contra scandal.

Amazingly, a recent lawsuit suggests that he hadn't even uncovered all the malefactors. The case, which was filed last fall on behalf of MJK Clearing, a subsidiary of Minnesota brokerage StockWalk Group, points a finger directly at the Toronto branch of Deutsche Bank and a recently fired broker named Wayne Breedon. Other colorful defendants: Mr. Khashoggi; Ramy El-Batrawi, the former CEO of GenesisIntermedia; Bradford Keiller, the owner of a Las Vegas strip club; and ten people referred to as "John Does 1-10."

According to the suit, Mr. Breedon and his co-conspirators engaged in fraudulent stock loans using Genesis shares, bringing down StockWalk in the process. The firm's collapse last year was the largest of a brokerage in 30 years.

Their original plan, like many hatched in the halcyon days of the late '90s, was to take the stock market public in a splashy IPO. But the plan hit a snag: the bubble burst, and with stocks going down, it wasn't exactly the best time to try and sell the idea of investing in the stock of the stock market itself.

Because of a series of sales to private investors in 2000 and 2001, however, some 33.2 million shares were eligible to be sold beginning on June 28, 2002--splashy IPO or not. On July 1, they began selling over-the-counter for $15 a share (OTC: NDAQ.OB).

Nasdaq officials weren't too excited about the stock's prospects. In a letter dated June 20, Nasdaq's chairman, Hardwick Simmons, wrote, "it is not clear that a market will develop for our common stock or whether that market will reflect the true market value of Nasdaq's common stock." He was right about the market. Daily trading volume of the shares has averaged a mere 12,550. By contrast, so-called QQQ shares, which track the Nasdaq 100 Trust, and which many investors use as a proxy for Nasdaq Composite performance, average more than 94 million shares a day (AMEX: QQQ).

That said, a share is a share, and the market value that's been determined in the absence of the buzz created by an IPO--whether it's "true" or not--is plain to see. As of mid-December, the shares sold for $10.50--30 percent below their debut price. Meanwhile, the Nasdaq Composite had edged up half a percent.

Investors are clearly concerned about Nasdaq's ever-declining market share, both in number of trades and volume--share that's being siphoned off by competing electronic networks like Instinet. In third quarter 2002, Nasdaq's share of trades was just 28.6 percent, down from 39.3 percent for the same period a year ago; share of volume was 23.2 percent, down from 29.2 percent. The recently launched SuperMontage, a new trading platform, is intended to help bring some of that market share back. To date, it hasn't done so. Nasdaq has also been back-pedaling on its ambitious international expansion plans, leaving investors to rightly wonder just where any future growth might come from.

In the meantime, Nasdaq stock is trading for just 14 times 2003 earnings estimates. If SuperMontage is a success, that will look like a bargain in hindsight. If not, they might as well not bother with the IPO anyway.

In mid-November, Corning announced that it had agreed to sell its precision lens unit to manufacturing conglomerate 3M for $850 million in cash. Salomon Smith Barney analyst Timothy Anderson upgraded the stock, citing decreased insolvency risk. Investors were of like mind, and drove Corning shares up 56 percent in just three days.

Others were not so kind. CIBC World Markets analyst James Jungjohann, for example, asked investors whether they'd ever cut a worm in half to see if it would grow.

While we will neither confirm nor deny having done so in the past, isn't half a worm better than a bankrupt worm?

The most recent IT spending survey by Goldman Sachs, consisting of 100 executives from Fortune 1,000 companies, shows that most companies expect to underspend IT budgets in fourth quarter 2002 and to keep spending growth in the low single-digits for most of 2003, with a spending recovery in the second half at the earliest. If cost-cutting has indeed come close to running its course at many companies, they'll need more juice than that to meet double-digit earnings-growth expectations for the year.

Still, it's hard to knock across-the-board gains. The MSCI-Red Herring Index jumped 12.9 percent for November, more than double the increase of the major indexes. Communications equipment firms continued their tear, with Corning taking the mantle from Nortel Networks (NYSE: NT; see "Glass Houses"). Even JDS Uniphase gained more than 50 percent (Nasdaq: JDSU).

It's clear that investors have decided the bottom has passed. According to Merrill Lynch, year-over-year tech shipment growth went positive in October for the first time in 19 months. Order and shipment moving averages were also positive for the first time in more than a year. Yes, that's good news, but maybe not 12.9 percent worth of good news. Hold on to those reins.

Apparently uninterested in history's fondness for October market crashes, investors bid the MSCI-Red Herring Index up 18.8 percent, trouncing the major indexes. Seven of our constituent industries gained more than 20 percent.

Investors may not be entirely out of their minds. As analysts' earnings estimates have finally started to come down to earth for the remainder of 2002 and for 2003, we hope the market has begun to find firmer footing than it had when forecasts were still out of whack.

Some industries are even approaching their long-awaited shakeouts. Take wireless telecom services: in the third quarter, AT&T Wireless, Nextel Communications, and Verizon Wireless posted unexpectedly strong results (NYSE: AWE; Nasdaq: NXTL). The industry's much-discussed consolidation should take shape in the months ahead.

But back to things we can only hope to understand. Four of our five top performers are makers of telecom equipment (see 'Hotter than hades')--even as the industry defies predictions that it couldn't get any worse. But it can, and it probably will. Watch out for those anvils.

Some have postulated that investors are excited because both Lucent Technologies (NYSE: LU) and Nortel are preparing reverse stock splits. We don't buy it. Nor do we think the $280 million contract Nortel secured from China Unicom merits the more than doubling of its stock.

Merrill Lynch analyst and Red Herring columnist Steven Milunovich suggests one plausible explanation: short covering. In a November 1 report, he points out that countertrend moves like we saw in October are usually led by so-called fallen angels. As short-sellers panic and start covering their positions in beaten-down stocks, it makes sense that telecom equipment stocks get a little more juice--even as analysts continue to downgrade the sector.

Founded in March 2000, and self-funded by its founder, David Tilkin, Protegent has developed Web-based compliance technologies that automate the supervision of stock brokers and their dealings with customers. Instead of relying on hindsight and the tedious examination of order tickets and foot-thick printouts, the company's software allows compliance professionals to spot "exceptions" in customer accounts in real time--stuff like account churning, over-concentration, and suitability violations.

While it's difficult to pin a precise number on the annual cost of compliance to brokerage firms, that hasn't stopped Protegent from trying to ballpark it. After taking into consideration the 5,450 broker-dealers nationwide, 92,000 branch offices, 675,000 registered representatives, and 150,000 dedicated compliance professionals, Mr. Tilkin's team has come up with a price tag of $2 billion a year for the industry's compliance efforts.

With eight customers at present, including Wells Fargo and Wachovia Securities, Protegent is looking at 2002 revenue approaching $5.5 million and profitability late in the fourth quarter. Given that the brokerage community urgently needs to find ways to stop hurting itself, there's clearly a lot more for the taking.

The first leg down came when the company dropped this shocker: EDS would report earnings per share of 12 to 15 cents for the quarter, instead of the expected 74 cents. Boom! The stock fell 52.8 percent in a single day, from $36.46 to $17.20.

The second snafu involved a strategy that would have been considered prudent in different circumstances. Starting late last year, EDS set up hedges against employee exercise of stock options by buying calls and selling puts on EDS stock, both with exercise prices in the low $60s. Had the stock stayed at or above those levels, the strategy would have worked. But it didn't, and news of a $225 million settlement of the put options sent EDS stock down another 29 percent, to $11.68.

Despite the group's middle-of-the-road showing in the industry rankings, individual telecommunications companies continue to experience an exquisite kind of pain. Both Nortel Networks and Lucent Technologies made our list of decliners, as Nortel delivered another earnings warning, and both companies continue to watch customer orders disappear. Alcatel, despite a late charge, was only the sixth-worst performer in our index (NYSE: ALA). It was edged out by Sprint PCS, whose executives did the unmentionable and told Wall Street that the company would actually lose wireless customers in the quarter--a sacrilegious announcement by any standard.

Most of the good news was to be found outside of North America, where all five of our top gainers are based. Modern Times Group, a Swedish media company, felt the need to tell the world not once, but twice, that its film Grabben i Graven Bredvid, or The Guy in the Grave Next Door, was knockin' 'em dead at the Swedish box office. Investors, perhaps feeling a little funereal themselves, took note and bid the stock up 10.3 percent during the month.

By the end of August, though, things were back to their usual depressing state. Iraq-related high oil prices were threatening the burgeoning recovery, tepid forecasts by Intel and Sun Microsystems sent technology stocks into a tailspin (Nasdaq: INTC, SUNW), and baseball owners and players were setting new standards for greed. In the last week of August, our index fell 5.8 percent, although it did manage to hang on to a shred of its earlier gains.

Broadcasting and cable television stocks led the market on the way up, with a particularly strong performance from Comcast (Nasdaq: CMCSK). That stock rose nearly 25 percent on the backs of AOL Time Warner shareholders, as the entertainment giant paid billions to AT&T and Comcast to extricate itself from a complex deal involving its Time Warner Entertainment unit. Communications-equipment stocks also surged ahead, led by Avaya, which popped after it negotiated a new credit facility with its lenders.

Notably, after a three-month hiatus, Vitesse Semiconductor returned to our top-gainers-and-decliners list--this time on the wrong side of the equation. It marks the fourth time in seven months that Vitesse has made the scene, earning it an award as the most volatile chip stock we've ever encountered. How's that for putting a positive spin on a difficult time?