CAUTION FLAGS: Are Dell and Hewlett-Packard Drowning in DESPERATION?

With the economy remaining weak and the sovereign insolvency crisis hitting a new gear, investors have had few sectors to hide in this year. However, technology remains a bright spot for many portfolios. Although the S&P 500 (NYSEARCA:SPY) has gained 6.78 percent year-to-date, the Technology Select SPDR Fund (NYSEARCA:XLK) has returned 11.47 percent. Shares of Apple Inc. (NASDAQ:AAPL) have led the way rising 41.76% this year, but other tech names are fading into the background.

Earlier this week, the Commerce Department announced that U.S. retail sales in May dipped 0.2 percent to $404.6 billion, marking the second consecutive month of declines. However, electronics sales managed to edge slightly higher as consumers are still willing to buy innovative and addictive devices, as long as they are mobile. Apple’s success with the iPad has accelerated the shift away from desktop computers. Morgan Stanley recently released findings from a global consumer survey that found tablet demand and PC cannibalization rates were higher than previously predicted.

In a 37-page report, the firm says 37 percent of tablet purchases last year came at the expense of possible PC shipments, higher than the 29 percent cannibalization rate initially expected. Furthermore, Katy Huberty, Morgan Stanley’s chief Apple analyst, expects the tablet market to hit 133 million shipments in 2012 and 216 million next year, representing a 40 percent and 89 percent increase from prior estimates.

Don’t Miss: Will Sleeping Giant China WAKE UP Apple’s Stock Price?

With the iPad accounting for two-thirds of tablet shipments last year, other companies such as Dell Inc. (NASDAQ:DELL) and Hewlett-Packard Co. (NYSE:HPQ) are clearly trailing behind and are desperately trying to return value to shareholders. For the first-quarter, Dell reported that its net income fell 32.8 percent to $635 million, compared to $945 million a year earlier. Revenue also declined by 4 percent to $14.42. It was a miss on the top and bottom and the company even noted the impact of competitors. On the conference call, chief financial officer Brian T. Gladden explained, “We’re seeing more consumer IT spending diverted to alternative mobile computing devices.” In other words, tablets are eating Dell’s lunch.

As the chart above shows, several old school tech companies are struggling. Shares of Dell and Hewlett-Packard have both fallen about 16 percent year-to-date. Cisco Systems Inc. (NASDAQ:CSCO) has declined 6 percent, while Intel Inc. (NASDAQ:INTC) is one of the few companies besides Apple to log positive gains on the year, generating 12.74% for shareholders. Apple recently introduced updates to its MacBook laptops that use new Ivy Bridge processors from Intel.

Aside from poor share performance, Dell and HP also share a common goal of reducing costs to enhance sluggish profits. Last month, HP announced plans to cut at least 27,000 jobs by October 2014. Meg Whitman, chief executive officer, said HP is making progress to become simpler and more efficient, but “still has a lot of work to do.” On Wednesday, Dell shares showed their first signs of life this year after announcing its first dividend and plans to trim expenses by $2 billion over the next three years. The savings will come from supply chain streamlining and reducing sales support staff.

Costs reduction and dividend plans can only do so much to provide shareholder relief. Tech companies looking to capture consumer dollars will need to create innovative products that can compete with Apple’s juggernauts. Microsoft Corp.’s (NASDAQ:MSFT) new Windows operating system is slated for release this fall, which may ignite PC sales, but there is still plenty of pain to be felt in the meantime for shareholders.

Investor Insight: Here’s Why Apple IS NOT a Hardware Company