Shares of technology companies are rallying as investors see capital spending for their products strengthening along with the economy, consistent with the Federal Reserve’s latest growth forecasts.
Tech stocks capped their best 10 weeks of relative performance since 2009 last week, and the Guggenheim Standard & Poor’s 500 Equal-Weight Technology exchange-traded fund has outpaced the Guggenheim S&P 500 Equal-Weight ETF (RSP:US) by 4.8 percentage points since April 19. The gains show a “hand off” is starting, as investors move into industries that could outperform benchmarks later in the economic expansion, said Brian Jacobsen, who helps oversee $221.2 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin.
“If the Fed is confident enough to begin taking the training wheels off the economy, then that should benefit tech stocks,” he said. Wells Fargo maintains an overweight recommendation on the sector partly because capital spending on these products would improve with increased assurance about the durability of the expansion, he said.
The Federal Reserve Bank of San Francisco’s Tech Pulse Index, which tracks the health of the U.S. information-technology industry, is showing an improvement in investment, consumption, employment, industrial production and shipments. The index rose to 98.96 in May, the highest since 2008.
The equal-weight technology ETF began to lead the benchmark index shortly before the Fed started bracing investors for a phase-out of its unprecedented monetary-stimulus program. At the conclusion of a two-day meeting May 1, the Federal Open Market Committee said it was “prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.”
Chairman Ben S. Bernanke provided more detail on June 19 when he said the central bank may begin to taper its $85 billion in monthly bond buying later this year and halt purchases in mid-2014 as long as the world’s largest economy performs in line with its projections.
Officials project the U.S. will expand 3 percent to 3.5 percent in the fourth quarter of 2014 from the same period this year, according to their central-tendency estimate, which excludes the three highest and three lowest estimates. The March projection was a range of 2.9 percent to 3.4 percent.
Gross domestic product grew at a 1.8 percent annualized rate in the first quarter, revised from a prior reading of 2.4 percent, Commerce Department data show.
As the expansion enters its fifth year, there are signs it is “closer to being self-sustaining,” which is helping to spark interest in technology stocks because these companies’ earnings are cyclical and benefit from an improving economy, said David Katz, who oversees about $850 million as chief investment officer at New York-based Matrix Asset Advisors Inc. “Over the next six to 12 months, tech is going to be a good place to invest.”
Shares of Cisco Systems Inc. (CSCO:US), Microsoft Corp. (MSFT:US), Hewlett-Packard Co. (HPQ:US) and TE Connectivity Ltd. (TEL:US) “have done well and are poised to do better” as demand improves, Katz said. Similarly, Workday Inc. (WDAY:US), Splunk Inc. (SPLK:US) and Tableau Software Inc. (DATA:US) offer “interesting” opportunities with “revenue that’s growing like a weed,” said Erick Maronak, chief investment officer at Victory Capital Management Inc. in New York, which oversees $28 billion.
Tech stocks now are JPMorgan Chase & Co.’s “favorite” because they offer a “beta play on growth” and attractive fundamentals, said Thomas Lee, the bank’s chief U.S. equity strategist in New York. “Investors haven’t been that excited about this group,” though sentiment has been improving as the prospect of changing Fed policy encourages some repositioning, he said. A stock with a high beta tends to rise or fall more than the broader market.
The equal-weight technology ETF reduces the influence of any one “oversized” company, and while “everybody talks about the big-cap names,” small-cap companies also offer an interesting investment opportunity, Jacobsen said.
Small-cap tech stocks capped their best 10 weeks since 2011 last week, and the Russell 2000 Technology Index has outpaced the Russell 2000 Index by 6.9 percentage points since April 19. The relative performance of both the equal-weighted and small-cap groups shows that “investors have more conviction” in this industry now, said Jim Stellakis, founder and director of research at Greenwich, Connecticut-based research company Technical Alpha Inc. and a chartered market technician.
If these indexes were to trade above highs set in August 2012 relative to the market, this would be “a clear sign that investors are more comfortable overweighting this sector as their expectations for earnings are improving,” Stellakis said. Another “bullish signal” is that the equal-weight ETF “reversed all of its relative weakness and ended up outperforming the market on June 28,” he said, even as shares of Accenture Plc (ACN:US) tumbled 10 percent (ACN:US) to $71.96 that day, the biggest decline since August 2011.
The world’s second-largest technology-consulting company and a member of the equal-weight ETF said June 27 that fiscal fourth-quarter revenue will be $6.7 billion to $7 billion, falling short of the $7.36 billion average estimate of analysts, according to data compiled by Bloomberg.
Higher interest rates historically bode well for tech stocks, as they tend to lead the broader market during periods of rising short-term yields, Jacobsen said. That’s in part because these companies are less financially leveraged than peers in other industries, so they’re “not as vulnerable” to higher costs for servicing debt, Lee said.
Valuations also are compelling, Jacobsen and Lee agreed. The stocks are trading at about 13 times earnings on a forward-looking basis -- a similar level to the S&P 500 -- compared with a historical average of 17, Jacobsen said. That’s unusual because tech usually trades at a premium to the broader market, he said.
In addition, consensus analysts’ estimates suggest “subdued” earnings growth in the next five years -- about 12.5 percent versus 14.5 percent historically -- so if these companies can exceed expectations it will push their stocks higher, Jacobsen said.
Not everyone agrees the industry is poised for an increase in business demand.
“There’s plenty to be worried about in tech because it’s a tale of two economies when it comes to spending,” Maronak said. While consumers have been “unbelievably resilient,” companies still are “really gun-shy,” he said. “The economy is nowhere near where it needs to be for companies to go spending the amount of money they used to on computers and other equipment.”
Some investors remain reluctant because they worry about the industry’s global exposure, Lee said. He’s less concerned about that, though significant weakness in emerging markets would pose “the biggest risk” to stock performance, he said.
That’s not the case for Cisco, as its sales in emerging markets could expand by as much as three times total growth, Chief Executive Officer John Chambers said in a June 20 interview with Bloomberg Television. In the three months ended April 27, Cisco saw “continued improvements from a total geographic perspective,” and for the first time in six quarters, reported growth across its four customer segments, he said on a May 15 conference call.
Shares of the San Jose, California-based company have outpaced the S&P 500 Index by about 17 percentage points since May 15, when it reported fiscal third-quarter results.
“Any sense that businesses are spending more freely in capital-spending cycles helps,” Katz said. “The bull case for these stocks is enforced by a self-sustaining U.S. economy.”
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