In meetings with clients, I’m often asked whether there’s anything cheap left in the U.S. stock market. It’s true that after a six-year bull run, U.S. stocks will have difficulty extending their winning streak. While we don’t believe we’re in bubble territory, valuations for many sectors are high—with P/E ratios driven more by price expansion (the “P”) than by the more meaningful “E” of earnings.
Give me an “E”…
So where should investors look? As I wrote several weeks ago, we believe mature information technology (IT) companies are a potential bright spot. Unlike more defensive sectors (such as utilities), price gains for mature tech stocks have largely been led by earnings growth rather than by multiples expansion.
We’re seeing the trend continue this earnings season. Apple was the standout, of course. Last week, the company reported $18 billion in profit and $74 billion in revenue—the most profitable quarter for any company ever. Earnings per share (EPS) increased 48%, handily beating expectations. (Source: Apple.)
Microsoft and Google also reported last week. Although both came in under analysts’ estimates, Google’s EPS and revenues are both up, and Microsoft reported an uptick in sales of its mobile devices. Contrast this with disappointing results for sectors such as financials, multinationals and energy, and tech appears to be one of the few areas of the market moving in the right direction.
…And mind your “P’s”
Utilities have been among the best-performing sectors this year. I can understand why: With interest rates still at record lows, and with economic uncertainty still a factor, investors naturally favor defensives, which tend to be less sensitive to market movements. But these valuations are really stretched right now.
Meanwhile, tech stocks have risen on the strength of good earnings news, and we believe they still have significant upside potential. Investors are increasingly likely to embrace growth sectors such as tech as the economic cycle matures. And the cash-rich balance sheets of the largest tech companies could potentially help them withstand increased borrowing costs should the Fed raise rates this year.
In other words, having impressively increased their E’s, IT stocks are well positioned to see their P’s improve as well.
IYW: A way to play
One way to target the “mature tech” opportunity is with the iShares U.S. Technology ETF (IYW). The fund provides investors with dedicated but diversified exposure to IT companies. Unlike broader sector funds, it has no holdings in telecoms, IPOs, health care, or other segments that may have a different risk/return profile in this environment.
The fund’s top holdings represent true industry leaders, among them Apple, Microsoft, Intel, Facebook, Google, and Cisco. In addition to these old-line giants, IYW also has a small allocation to stocks of established small- and mid-cap IT companies, which may offer additional growth potential and diversification.
When to invest? We think U.S. tech valuations look reasonable now. That said, given our expectations for continued volatility in the year ahead, you can also look to market pullbacks for other attractive entry points.
Heidi Richardson is a Global Investment Strategist at BlackRock, working with Chief Investment Strategist Russ Koesterich. She also leads the iThinking initiative for iShares. You can find more of her posts here.