Call #1: Overweight Global Technology
With recent speculation regarding a new potential technology bubble, this week our attention turns toward the technology sector.
Recently, the technology sector has enjoyed a number of high profile IPOs reminiscent of the boom days of the late 1990’s. But for most technology firms, the recent past has been considerably less exciting. Large technology companies have trailed the market year-to-date and over the past year. Year-to-date, for instance, US technology stocks have been flat, versus a gain of around 3% for the broader market.
We first discussed how we liked US technology back in early January. While the sector is facing headwinds along with the rest of the economy, there are a number of encouraging signs that are leading us to now reiterate our positive view and expand it to include the global technology sector as well. If anything, the technology sector is recovering faster than the broader economy, a fact not yet evident in its valuation. In short, we believe that the recent improvement in technology sector fundamentals has not yet been reflected in the sector’s prices.
One manifestation of improving fundamentals has been the recent increase in technology sector capacity utilization. Capacity utilization measures how much of the current factory capacity is being used; higher numbers indicate a more robust environment for that segment of the economy. For the broader US economy, capacity utilization remains stuck at around 75% to 77%, well below the long-term average and yet another sign of the weak recovery.
In contrast, in the technology sector, manufacturers are now using more than 80% of their available capacity, which is above the long-term average. In parts of the technology sector, this metric is even higher. For example, in the semiconductor industry, manufacturers are using about 85%, or 5/6th, of their capacity, the highest ratio since the summer of 2008.
Capacity utilization is an important metric because higher levels generally indicate more demand and coincide with better pricing power. For this reason, technology valuations have historically been higher when capacity utilization is higher, as investors are willing to pay more for technology companies when they can command premium pricing.
Today, despite the improvements in the fundamentals, most technology stocks trade well below their historic average. US technology stocks are trading at less than 3.5 times their book value versus a long term median of around 4.15 times. The stocks look even cheaper based on where they are trading compared to their earnings and a basket of technology stocks now costs the same as a broad basket of US companies. In the past, technology has typically traded at about a 35% premium to the broader market. Nor is this just a US phenomenon. The S&P global technology sector is now trading at a discount to a world benchmark; traditionally it has traded at a 25% premium.
While technology may never reclaim the glory days of the late 1990’s, its current value seems to be ignoring improving fundamentals. This suggests to us that these stocks can potentially outperform the broader market over the next six to 12 months. As such, we are reiterating our overweight of the US technology sector and initiating an overweight on the global technology sector.
Potential iShares solutions
|Overweight US Technology||IYW – iShares Dow Jones U.S. Technology Sector Index Fund (click here for fund details)|
|Overweight Global Technology||IXN – iShares S&P Global Technology Sector Index Fund (click here for fund details)|