This article was written by Invesco PowerShares Senior Equity Product Strategist Nick Kalivas.
Investors looking to increase the risk-return potential in their portfolio may want to talk to their advisors about the Internet sector, which has four merits worth considering:
1) Price trends that appear favorable
2) Active merger and acquisition activity
3) Strong revenue and cash flow growth relative to the broad market
4) A positive correlation to interest rates
Let’s explore these factors in more detail:
Price charts argue for a renewed uptrend
For followers of technical analysis, the PowerShares NASDAQ Internet Portfolio (PNQI) shows signs of breaking out of a one-year consolidation to the upside. Internet stocks were strong in in 2012 and 2013, but took a rest in 2014 to catch their breath. The fund’s recent move over the $68 level may suggest the start of a new leg higher and attract buyers who invest based on price charts. The chart below illustrates the price strength of PNQI during 2012 and 2013 and its consolidation in 2014, with signs of a potential upturn in 2015 on a budding rally above trend line resistance. (Investors may want to consult with their advisor before embracing the merits of technical analysis.)
M&A in the sector is hot
The Internet sector has made headlines recently with Expedia’s announced purchase of Orbitz at an approximate 24.5% premium to Orbitz’s closing stock price prior to the announcement (PNQI holds both Orbitz and Expedia — 0.22% and 2.30% of assets, respectively, as of Dec. 31, 2014). The all-cash transaction pointed to industry consolidation in the online travel sector, and the price offered suggested that stocks were not overly expensive in the sector. Unlike in other areas of the market, M&A in the Internet sector is vibrant. Bloomberg reports that M&A in the Internet sector is up 244.6% year-over-year. By comparison, M&A across all sectors is down 44.4% year-over-year.1
We see growth on the horizon
The constituents of PNQI are expected to see average and median year-over-year cash flow growth of 28% and 11% respectively.1 This is much stronger than the S&P 500 Index, which is forecast to see average and median cash flow growth of 13% and 8% respectively.1
Furthermore, the Internet sector is seeing robust sales growth. Constituents of PNQI are projected to see average and median sales growth of 31% and 19% respectively over the next year.1 In contrast, stocks in the S&P 500 Index are projected to see average and median sales growth of 7.2% and 4.9% respectively.1
A negative correlation to interest rates
For investors who are worried that interest rates will increase, PNQI may be able to benefit from higher interest rates. Over the past five years, the correlation between PNQI and the 10-year Treasury yield has been +0.42.1 The positive correlation could enable PNQI to be on a list of ETFs to consider in a rising rate environment.