The fundamentals of the group also appeal to us. Companies that have underinvested in capital improvements during the past couple of years appear to be starting to loosen their purse strings, and will likely look to tech as a place to invest first. Such investments are typically attractive because they tend to increase companies' efficiency and productivity at all levels.
As a result, companies can produce more with fewer workers—as we're seeing with relatively high productivity numbers but still-high unemployment readings—which allows them to cut back on costs and potentially expand margins.
Additionally, balance sheets in the sector are solid, with large cash balances and relatively low debt. This enables the group to increase dividends and pursue mergers and acquisitions that might help performance. We believe this also helps provide stability to the group, which in turn gives it a certain level of defensiveness, contrary to its high-beta history.
Positive factors for information technology:
- Growth in business investment in technology is now outpacing growth in total business investment.
- Real tech investment has been below trend for several years, which could bode well for the future of the sector as spending returns to more normal levels.
- We're starting to see banks loosen lending standards, which could slowly help revive capital investments.
- New expensing rules for 2011 could move some capital expenditure forward into this year.
Negative factors for information technology:
- Increasing global competition, especially in areas with low labor costs, will likely continue to compress profit margins.
- We see signs that companies remain hesitant to increase capital spending.
- Governments are reining in spending, which could dampen investment in technology-related projects.
After a brief period of profit taking and underperformance, the materials sector has responded to the improving economic environment and has started to move higher once again, largely performing in line with the market as of late. We believe this will continue in the near future and recently upgraded the materials sector to marketperform from underperform.
Despite some tightening of monetary policy in China, spending on infrastructure projects remains relatively robust. Also, as economic growth solidifies, and companies become more confident, spending on larger projects will likely increase, potentially benefitting materials companies.
Finally, while recent dollar strength put a dent in the materials sector, we are now seeing stabilization and could see some renewed weakening, which would likely put a tailwind behind the materials group.
All is not perfect, however, and we only moved to marketperform, not outperform. We have seen wage costs increase in the materials space, while pricing power appears to be challenging. This combination is not overly positive for profit margins and causes us to remain at least somewhat cautious on the group.
Clients can see our top-rated stocks in the materials sector.
Positive factors for the materials sector:
- Scrap steel prices have started to turn higher.
- Economic growth appears to be accelerating, which should help to solidify demand in the materials space.
Negative factors for the materials sector:
- Chinese demand for processed commodities might be slowing as technological advances and a build-out of production facilities allow the country to produce more of its own materials. China recently transitioned from a net importer to a net exporter of steel.
- Global steel production is growing and Chinese steel inventories have spiked, both of which could pressure prices in the near future.
- Several governments are implementing austerity measures, which could crimp demand for materials.
- Wage costs are rising in the materials sector.
Telecommunications: Marketperform
The telecommunications sector has struggled lately as competition continues to cause concern among investors over the profitability of the wireless side of the business. Additionally, the fixed-line business continues to decrease as more people move to rid themselves of their landlines.
The telecom sector has lost some of its traditional defensive appeal, in our opinion, given that the group has moved much of its business model from the stable, regulated fixed-line business to the more variable, consumer-dependent wireless arena, while also dealing with an onslaught of competition from a variety of sources.
However, many still view telecom as more defensive, seeing the remaining fixed-line business as a cushion against variable revenues in less certain times. Additionally, dividend yields in the space remain relatively attractive to income-hungry investors.
Competition for increasingly budget-conscious consumers remains fierce, and telecom certainly hasn't been immune to bargain-hunting shoppers. We're watching developments in this area especially closely given that new products still seem to be enticing consumers to spend, but we wonder how many times the sector can draw from that well.
