Coming into Thursday, the Technology Select Sector SPDR (NYSEArca: XLK) was up just half a percent this year, a middling performance that placed the largest technology sector fifth among the nine sector SPDR exchange traded funds on a year-to-date basis.
The $12.8 billion XLK, the second-largest of the nine sector SPDRs behind only the Financial Select Sector SPDR (NYSEArca: XLF), is known for, among other things, holding one of the largest weights to Apple (NasdaqGS: AAPL) among all ETFs. With its ongoing surge, one that has taken its market value north of $726 billion, Apple is XLK’s largest holding at a weight of nearly 18%. That is more than double the 8.3% weight XLK assigns to its second-largest holding, Microsoft (NasdaqGS: MSFT). [Apple’s Ascent and its ETF Impact]
AltaVista Research has a neutral rating on XLK, but that rating is not as tepid as it sounds. The research firm’s neutral rating implies “average appreciation potential. A rating of NEUTRAL is assigned to funds with ALTAR Scores between 6.0% and 8.0%. This indicates that valuations adequately reflect the fundamentals of stocks in these funds. The majority of funds we cover fall into this category,” said AltaVista in a note out Thursday.
Investors are missing out on XLK. The ETF gained 17.8% last year, outpacing the S&P 500 by 430 basis points, while more than $1.5 billion was pulled from the fund. Another $555 million has been yanked from XLK this year, indicating that perhaps some investors are concerned about the technology sector’s valuations. However, AltaVista notes XLK has the traits of a value bet. [Tech ETFs for Growth]
“Tech seems to have become a new Value sector. Growth has slowed, but long-term growth forecasts still far exceed those for the S&P500 while margins & ROE remain impressively high. Unlike many sectors valuations have not drifted much higher since 2009. As a result, Tech trades at a P/E discount to the S&P500 whereas historically it has enjoyed a premium. We think Tech appears relatively attractive at these levels,” said the research firm.
Current valuations on some of XLK’s largest holdings, which are also among the largest holdings in the PowerShares QQQ (NasdaqGM: QQQ), the Nasdaq 100 tracking ETF, are far from the frothy levels seen at the height of the tech bubble in 2000. In 2000, the average P/E ratio for Microsoft, Cisco (NasdaqGS: CSCO) and Intel (NasdaqGS: INTC), the XLK holdings that were Nasdaq 100 members then and now, was nearly 76. Today, the combined P/E ratio for those stocks is just 43. Microsoft, Cisco and Intel combine for nearly 15% of XLK’s weight.
On the basis of price to earnings growth and price to free cash flows, XLK is also slightly less expensive the S&P 500, according to AltaVista data. [Charts Say Tech ETF Rally is Coming]
Technology Select Sector SPDR
Tom Lydon’s clients own shares of Apple and QQQ.