3 reasons to stick with tech stocks

Russ explains why it’s not yet time to sell those tech shares.

Technology shares are once again leaving everything else in the dust. Year-to-date, the MSCI Information Technology sector, led by U.S. tech, is beating the broader market by over 5% and is ahead of laggards, notably energy, by nearly 20% (see Chart 1).

Given the magnitude of the gains, many are understandably wondering if it’s time to sell. My simple answer: no.

I last wrote about technology and growth stocks in September. At the time I suggested that growth should continue to outperform.  Today, while the broader style and tech sector are vulnerable near-term, I would cite three reasons why outperformance should continue.

1. It’s all about the cash flow.

Based on traditional metrics, technology shares look expensive. The S&P 500 Technology Sector trades at approximately 23 times this year’s earnings (P/E). Looking at relative value – the P/E of the sector versus the broader market – the sector is trading at roughly a 22% premium, a level we have not seen in more than a decade. That said, the sector remains extraordinary profitable.  The return-on-equity is roughly 30%, seven percentage points above the 10-year average. Exceptional profitability has led to exceptional cash-flow generation, much of which is returned to shareholders in the form of buybacks. As a result, using price-to-cash flow (P/C), tech’s premium looks right in-line with the 10-year average.

2. Easy financial conditions help.

Another factor favoring technology is liquidity. Technology stocks are much more likely to outperform when liquidity is improving. Using the Goldman Sachs Financial Conditions Index as a proxy, rising liquidity has been associated with average monthly outperformance of about 1.5%. Conversely, the sector underperformed by an average of nearly 1% in months when financial conditions deteriorated. Perversely, the current environment of soft growth and hard-to-quantify growth shocks, i.e. the coronavirus, supports liquidity and by extension tech shares.

3. In a slow growth world, tech can be defensive.

Finally, and most surprisingly, tech is not the same “high beta” play it was in the 1990s. Between 1995 and the end of the financial crisis, tech typically underperformed by roughly 0.10% for every 1% rise in market volatility, measured by the VIX Index. That pattern no longer holds. Today, when rising volatility is met with a policy response, as it tends to be, technology is more likely to outperform. Since 2010, in months when volatility rose and financial conditions eased, the median relative return for technology was + 0.38%. This change in fortune is arguably a function of big, long-term trends. Regardless of the quarter-to-quarter shifts in the economy, investors have confidence that secular themes –cloud computing, AI or internet retail – support tech earnings.

None of the above means that technology is not vulnerable to a short-term correction. That said, looking out over the next year technology stocks are still likely to have the wind at their back, even if things get a bit rougher.

Russ Koesterich, CFA, is a Portfolio Manager for BlackRock’s Global Allocation Fund and is a regular contributor to The Blog.

Investing involves risks, including possible loss of principal.

Funds that concentrate investments in specific industries, sectors, markets or asset classes may under-perform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of February 2020 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

2020 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.