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With so much attention being paid to growth-to-value rotation and the corresponding laggard status of technology stocks, it's almost easy to be dismissive of the once beloved sector.
Of course, seasoned advisors know that would be foolhardy. Although the tech-heavy Nasdaq-100 Index (NDX) is up barely more than 6% year-to-date – a showing that far trails the performances of an array of value benchmarks – now isn't the time to ignore tech stocks. It could very well be time to revisit the group and weigh the long-term benefits of disruptive growth and innovation in client portfolios.
Here's the deal. Betting on a substantial near-term tech rebound is difficult. Such a scenario may not materialize next week, next month or in three or four months. However, the issues plaguing the sector aren't likely to prove sticky. Those include inflation (likely transitory) and rising 10-year Treasury yields, which crimp the longer duration cash flow found in the tech sector.
Obviously, those situations are drags on tech. Who would have thought the previously moribund energy and financial services sectors would be the places to be this year and that tech was going to languish? No, sector leadership isn't permanent, but tech has some favorable traits other sectors simply don't have, making it ideal for a wide array of client portfolios.
As advisors well know, tech is classified as a growth sector, meaning its constituents must have the earnings growth to support that status. The first quarter of this year proves tech is meeting that challenge with aplomb.
“Tech was one of two sectors that had the highest percentage of companies that reported earnings above estimates — a whopping 94%,” writes Invesco Chief Global Market Strategist Kristina Hooper. “And it’s not just earnings — tech had the highest percentage of companies reporting revenue above estimates as well at 94% (followed by communication services, which includes a number of stocks formerly classified as part of the tech sector at 88%).”
Hooper's point about tech being a revenue story as much as it is an earnings story is well taken. It's important because the sector is a voracious repurchaser of its own shares, meaning it can affect earnings per share for the better, but after awhile, analysts and investors will rightfully demand revenue growth. If top line growth isn't delivered, tech companies that buy back large amounts of stock in the name of boosting the bottom line risk being painted with the ominous IBM brush. Good news: the broader sector has impressive revenue credentials at the moment.
“And the tech sector is reporting the highest year-over-year revenue growth of all 11 sectors at 21.5%, with four of the six industries in tech having reported growth above 15%,” adds Hooper. “These results certainly help to justify current valuations, which are on the rich side but remain well below valuations during the tech bubble.”
Bright Outlook
As advisors, particularly those that have been in the businesses since around the time of the 2000 tech bubble, well know, investing in this sector is often as much or more about what the group can do for portfolios in the future over its near-term potency.
Should the aforementioned rates of earnings and sales growth be maintained or exceeded, obviously the longer-ranging view of tech is appealing for clients. There are reasons to believe that will happen.
“Companies in general have higher levels of cash that they can deploy on tech spending. They reduced their tech spending in 2020, and therefore need to spend more in 2021 in order to keep up,” notes Invesco's Hooper. “Global information technology spending is expected to rise 8.4% in 2021, and it’s projected that the IT spending focus for 2021 will be on revenue growth.”
Amid ongoing cyber attacks and some employees opting to continue working from home, cybersecurity and cloud computing spending, as just two examples, will continue soaring, underscoring the long-term potential of tech sector allocations.
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