The technology sector has been lagging the overall market since the spring of 2012. The sluggish relative performance of the sector coupled with the movement of the relative performance chart into support suggests that the tech sector is worth exploring for investment opportunity. The graphic following shows the Technology Sector ETF (XLK) verse the S&P 500 ETF (SPY).
The macro backdrop:
Technology sector also tends to trade well in the last part of the year. The graphic shows the average monthly return of the XLK and the average level of the XLK relative to January going back to 2003. The value for January is benchmarked to 1.00 on the left axis. Monthly returns are on the right axis. On average, the technology sector seems weakest in January, February, and June, but performs strongly in the spring and firm into year end.
Although the U.S. economy is facing the headwind of higher mortgage rates and fiscal uncertainty due to the debt ceiling saga, purchasing managers surveys out of Europe and China are hinting at a revival in global economic growth. Europe and China have been areas of concern for the business community. Business spending on equipment and software could be positively impacted by the improving growth outlook.
Going into the end of the year, the technology sector may benefit from year end budget flushing and holiday spending on the consumer side. Company spending on productivity enhancing and cost savings measures will likely be in fashion, while electronics may be a strong pick the holiday season given the availability of interesting smart phones and table products.
The technology sector does not have a strong correlation to interest rates and is actually positively correlated to interest rates – it tends to rise if rates rise. The ten year correlation between the 10 year treasury yield and the price of the XLK is +0.258. As a result, the impact of Fed taper on the sector could be limited.
Screening process:
In order to look for opportunities in the technology sector, a screen was set up to find fast growing technology companies at a reasonable price. The screen consisted of three factors: 1) A PEG ratio between 0.80 and 1.20. The PEG ratio measures the price to earnings ratio relative to the growth rate in earnings. A value of 1.0 suggests the PE ratio is equal to the growth rate, while a value below 1.0 indicates that the PE ratio is below the growth rate. Stocks with low PEG ratios are usually seen as possessing value. 2) Earnings per share growth of 10% or more over the past three years. 3) Revenue growth of 10% or more over the past three years.