Sectors: Looking Beyond Tech for Growth

With the Nasdaq up more than 67% since March, some fund managers are taking profits on their tech holdings and rotating into other cyclical stocks

By David Bogoslaw

While there are still reasons to be wary of how far equity prices have come since March, those who are certain the rally can be sustained are trying to position their portfolios for the biggest possible gains in the months ahead, and that may mean shifting away from technology stocks.

Technology has been the most-loved sector since the stock market hit its low in March, evidenced by the fact that the 67.4% gain in the Nasdaq composite index since then has far outpaced the 57% rise in the Standard & Poor's 500-stock index and the 49% increase in the Dow Jones industrial average. The reason that tech stocks didn't drop as sharply as financials or industrials when the broader market cratered supposedly is because businesses were expected to continue to spend on technology products to improve efficiency even as they slashed their workforces and cut other costs.

But with tech stocks having come so far, and confidence about a sustained rally wavering, some mutual fund managers have begun to trim their tech holdings to move more aggressively into other sectors they think may have more leverage to the economic recovery. Standard & Poor's Equity Research had an overweight position in tech from Mar. 24, but downgraded the sector on July 31 to market weight, says Alec Young, international equity strategist at the S&P research arm.

"We have a cyclical tilt. We think the [U.S.] economy will continue to recover," he says. "It may not be the best recovery, but it's all the market needs to keep going up." S&P is recommending an overweight position in energy, industrials, and materials.

favoring industrials and financials

Optimum Investment Advisors, the Chicago-based subadvisor to the Aston Optimum Large-Cap Opportunity Fund (AOLCX), was 30% overweight in tech stocks until July, when it began to gradually rotate into financials and industrials, which had taken a bigger beating than tech during the downturn.

Signs of a broader economic recovery in late June convinced Optimum to be less defensive. While tech isn't typically considered defensive, the fact that it didn't drop as sharply during the downturn made it seem the safest of the cyclical industries, says Steven Sherman, research director for the Large Cap Opportunity Fund and the large-cap product at Optimum.

Optimum now has a neutral position in tech and has gone from underweight to overweight in industrials and financials.

"We're trying to add to our credit sensitivity. A better economic environment will lead to faster recovery for [banks that] have made loans than most currently have had,"says Sherman. That means adding credit-card companies such as American Express (AXP) and looking for the most undervalued regional banks, those hit hardest but with the most growth potential.

engineering and construction promise

"We're trying to focus on banks that have reserved [cash for potential losses on bad loans] relatively effectively and where the market is still beating them up significantly," says Sherman. "From a recovery perspective, if we're in a better economic environment next year from today, these banks will look an awful lot better."

As for industrials, Optimum sees opportunity in engineering and construction companies such as Fluor (FLR) and Jacobs Engineering (JEC), stocks whose share prices fell later in the economic cycle and haven't participated as much in the recovery to date. "They had large backlogs of business, so they didn't dip quite as fast. They're seeing a little more deterioration now than some of the other companies," says Sherman. "Because of the shape of the boom of business, it hits their income statements a little later. We're investing based on where these businesses will be a year to a year and a half from now."

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