The case for technology in 2018

March 19, 2018

3 minute read

by Chris Dhanraj, Head of ETF Investment Strategy, iShares Blackrock

Can technology continue to be a star performer? Chris Dhanraj discusses why it is still one of our top sector picks.

The performance of technology stocks over the recent past has been striking: In 2017, for example, the information technology sector of the S&P 500 posted a 38% return, while the broader S&P 500 Index gained 22% (Source: Bloomberg data). Perhaps even more impressive is the fact that technology is responsible for almost 30% of the total gains of the S&P 500 Index over the last five years (Source: Bloomberg, as of 2/28/18).

In investing, however, past is not prologue. So the question is: Can the good times roll on? We may not see another year like 2017, but there are three reasons why technology continues to be one of our top sector picks.

Strong earnings momentum

The BlackRock Investment Institute recently upgraded U.S. equities from neutral to overweight on the basis of significant earnings growth expectations driven by a supportive macroeconomic environment—and potentially boosted by fiscal stimulus. This thesis equally applies to technology.

This reporting season, 88% of IT companies in the S&P 500 Index posted positive earnings surprises—the highest proportion of all the sectors—while recording 22.5% aggregate year-on-year earnings growth compared to the broad Index’s 14.3% (Source: BlackRock, Bloomberg, as of 3/5/2018). This has translated into strong equity market performance year-to-date, as depicted below. Notably, the other high-flying sector—consumer discretionary—also includes two tech-powered giants: Amazon and Netflix.

Significant cash balances

Many established technology companies are cash rich, commanding strong balance sheet positions and ample investment firepower. (Source: Bloomberg, as of 11/2/2018).

This offers a number of potential advantages. First, these companies potentially are insulated from the impact of rising interest rates, and may even benefit. As we recently noted, technology historically has been among the sectors the most insulated from yield curve shifts.

In addition, one of the consequences of the recent tax legislation is the prospect of companies repatriating cash back to the U.S. at favorable rates. This increases the potential for dividends, share buybacks or increased mergers and acquisition activity. At the same time, increasing capital expenditure or research and development (R&D) spending may be supportive of the sector in the longer term.

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Investing in long-term trends

The impacts of technological disruption extend beyond the confines of old fashioned sector classifications. As we highlighted in October, investing in technology allows investors to tap into large scale, transformational shifts in the way entire industries operate—whether it be the growth of “big data,” cloud-based enterprise and infrastructure solutions, cyber security or the intrinsic importance of semiconductors. Additionally, the growth of online shopping is displacing traditional brick-and-mortar retail and could change the face of commercial real estate markets. These forces result in the tech sector exhibiting a strong secular growth profile and in our view, help justify a premium in the form of higher valuations.

Investors can choose from a wide range of tech exposures. For example, exchange traded funds (ETFs) tracking broad technology indexes can include large cap technology stalwarts. Alternatively, ETFs tracking more focused sub-indexes allow investors to target companies with network and cyber security business lines or a software focus. Investors seeking a more economically sensitive exposure may consider a semiconductor ETF, providing access to the growth of companies that design, manufacture or distribute semiconductors—the vital components of many electronics and computer devices.

Bottom line

We believe earnings momentum, strong balance sheets and economy-wide transformational forces of innovation and disruption can help provide both cyclical and structural support for technology stocks in 2018. Investors seeking exposure to technological growth can consider taking a targeted approach to their sector definitions.