With concerns seemingly growing by the day that the COVID-19 virus will wreck Chinese economic growth in the first half of 2020, investors are growing leery of the all-important technology sector and the related ETFs, such as the iShares U.S. Technology ETF (NYSEArca: IYW).
IYW reflects the performance of the Dow Jones U.S. Information Technology Index, which includes all tech sector picks in the Dow Jones U.S. Index. Due to the Dow Jones’ classification of information tech names, healthcare technology stocks may be included while payment technology stocks are excluded.
Heavy on the likes of Microsoft (MSFT), Apple (AAPL) and chip stocks, IYW is understandably vulnerable to investors’ coronavirus whims, particularly as more cases emerge in vital technology markets such as Japan and South Korea. However, some market observers believe that although tech is pricey, investors shouldn’t be looking to bail on the sector.
“That said, the sector remains extraordinarily profitable,” said BlackRock in a recent note. “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.”
Looking Inside IYW And Spotting Headwinds
While the sector is facing some near-term headwinds, technology remains home to some of the most prodigious free cash flow generators in the U.S. and that is a factor for long-term investors to remember.
When considering a sector pick, investors should still do their due diligence. For example, one should survey the macroeconomic environment and analyze business cycles, position according to changes in certain macroeconomic variables, identify secular industry trends, harness long-term growth rends within a particular segment, evaluate sector fundamentals, the position towards areas that show attractive valuations and overweight or underweight sectors based on recent performance.
“Another factor favoring technology is liquidity. Technology stocks are much more likely to outperform when liquidity is improving,” according to BlackRock. “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.”
Yes, tech faces near-term headwinds, but that doesn’t mean the sector won’t trade higher going forward.
“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,” according to BlackRock.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.