The Technology Select Sector SPDR Fund (XLK) and other technology ETFs are often viewed as growth plays, but in recent years, the sector and its traditional ETFs have been strong sources of increasing shareholder rewards, including buybacks.
XLK tries to reflect the performance of the Technology Select Sector Index, which is comprised of technology and telecom sector of the S&P 500. The ETF includes companies from technology hardware, storage, and peripherals; software; diversified telecommunication services; communications equipment; semiconductors and semiconductor equipment; internet software and services; IT services; electronic equipment, instruments, and components; and wireless telecommunication services.
While many XLK components, including Microsoft (NASDAQ: MSFT), Apple (NASDAQ: AAPL) and Intel (NASDAQ: INTC), sport some of the strongest balance sheets in the U.S., some technology companies are reining in spending amid the COVID-19 pandemic and that includes paring buyback programs as an avenue for bolstering liquidity.
“US technology companies will shift focus away from share buybacks to maintenance of extra liquidity, given the effects of coronavirus and expectations for a resulting deep global recession,” said Fitch Ratings in a recent note. “With few exceptions, the technology sector has been slow relative to others in announcing changes to financial strategies due to the pandemic, as the result of strong cash flow generation and large cash balances.”
XLK Can Still Reward
Buybacks were only one part of the equation when it came to embracing technology and the coronavirus impact on that scenario is likely to be fleeting. Additionally, many XLK components remain compelling sources of dividend growth and the sector as a whole is looking better on valuation.
“We view the technology sector as being at medium risk to the effects of coronavirus due to weaker demand as supply chain challenges have eased,” said Fitch. “Fitch is forecasting a deep global recession as its baseline forecast for 2020. We expect world real GDP growth to fall to negative 1.9% in 2020 with the U.S. and Eurozone down by negative 3.3% and negative 4.2%, respectively. China is expected to grow by less than 2%. A full recovery to pre-virus GDP is not expected until late 2021.”
XLK seeks investment results that correspond generally to the price and yield performance of publicly traded equity securities of companies in the Technology Select Sector Index. When COVID-19 abates, it’s possible that tech buybacks will roar back.
“While we expect the technology sector share buybacks to decline substantially during the current crisis, history portends a reacceleration of buybacks upon recovery,” according to Fitch. “The potential use of net proceeds from investment-grade bond issuances intended to pre-emptively shore up liquidity to fund stock buybacks upon recovery resulting in structurally higher leverage metrics than pre-pandemic levels could be an issue.”
For more on thematic ETFs, please visit our Thematic Investing Channel.
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.