By Todd Rosenbluth, CFRA
Don’t let the 10% gain in the S&P 1500 index in the first seven months fool you into thinking investor interest in equities has lifted all boats equally. Investors overweight to the technology sector should be pleased with its 21% gain, but those overweight to the energy sector, which fell 13%, are likely disappointed. Despite such disparities, tactical equity sector ETFs pulled in only $21 billion of new money in the first seven months of 2017, a small portion of $191 billion for all equity ETFs.
In addition to being the strongest performer, the technology sector’s $5.9 billion of net ETF inflows led all others, according to Matt Bartolini, Head of SPDR Americas Research. CFRA thinks investors have sought out diversified exposure to 2017’s large-cap winners; Facebook (FB), Apple (AAPL) and Alphabet (GOOGL) have sound fundamentals and appealing valuations, and all are among the 67 CFRA buy/strong buy recommendations in the US tech sector from a universe of 193 stocks (35% of our STARS coverage).
However, according to Denise Chisholm, sector strategist at Fidelity Investments, concerns about a top-heavy market are overstated. She thinks the sector’s recent P/E was in line with its historical average, while its fundamental metrics — return on equity and operating margin – are above average. Further, history is on the side of continued success. When the tech sector has beaten the market by more than 10% in any six-month period, it has outperformed over the next nine months 58% of the time, noted Chisolm.
Fidelity MSCI Information Technology Index ETF (FTEC) launched in October 2013 into a crowded market-cap weighted sector fund universe that included diversified products from iShares, SSGA, Vanguard and others. Nonetheless, FTEC’s asset base has climbed to over $1 billion, aided in part to its miniscule 0.08% expense ratio. FTEC’s holdings include AAPL, FB and GOOGL and strong performing mid-sized stocks like CoStar Group (CSGP) and Trimble (TRMB). FTEC earns a top ranking from CFRA due to our holdings-level analysis and for its modest cost factors.
Another lesser known but worthy of consideration tech ETF is SPDR Morgan Stanley Technology ETF (MTK). Relative to S&P 500 based Technology Select Sector SPDR (XLK) (another top ranked tech ETF offered by SSGA), MTK has less securities concentration with its top-10 holdings at 34% of assets, well below the 60% for XLK. MTK’s holdings include Amazon.com (AMZN) and Alibaba (BABA) along with AAPL, FB and GOOGL. The portfolio has a stronger estimated 3-5 year EPS growth than XLK’s, according to Bartolini.
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Meanwhile, Fidelity’s Chisholm also believes the industrials sector appears uniquely positioned compared with other global cyclical sectors because the sector has restrained capital spending. As a result, the operating margins and returns on equity of the companies in the sector have been strong and could be a constructive indicator of future performance. She added that the industrials sector generates as much free cash flow as the more defensive consumer staples, and was inexpensive on an historical price-to-free-cash-flow basis.