MARKET COMMENTARY

The Tech Sector Today: Not the Dot-Com Craze

09.25.2017 - Carin L. Pai, CFA

Q3 2017 PERSPECTIVE: EQUITIES OVERVIEW

More than 20 years after Amazon started selling books online, economists are still struggling to understand the full impact of the technological revolution. In a “knowledge economy” that is driven by entrepreneurs and enabled by rapidly-evolving technologies, is economic growth accurately captured by traditional metrics such as GDP, inflation, worker productivity and unemployment?

New algorithms might be necessary. But until they are available, we can gather a fairly reliable sense of technology’s impact on the economy by examining sector fundamentals. One might also argue that as tech goes, so goes the market, which is why we also want to take a closer look behind this sector’s recent gains.

The numbers are impressive: In the second quarter of 2017, tech accounted for 11.3% of the S&P’s total sales—but generated 21% of its profits (CHART). Tech was also the S&P’s best-performing sector in 2017 through the end of August, returning 26% versus the market’s 12%.

The Dot-Com Hangover

Investor perceptions, however, are another matter: Despite improving fundamentals and a supportive economy, investors continue to look at any run-up in tech prices with skepticism, a lingering effect of the dot-com crash in 2000. During the tech bubble of the late 1990s, start-ups with meager sales and no earnings generated strong demand in the IPO market, but valuations were based almost entirely on speculation.

Today, the world is a different place. The tech sector is well-established, profitable and highly influential, representing almost a quarter of the S&P’s total market capitalization. Tech firms are true disruptors, shaking up the status quo in a variety of industries with attractive profit margins. In many cases, the winners are companies with high-quality management, which we spend a considerable amount of time researching.

Rational Valuations

While P/E ratios in the tech sector have approached pre-2000 levels, causing some anxiety for investors, we do not believe valuations are unreasonably high under current economic and market conditions. The sector has strong fundamentals, as evidenced by its contribution to S&P earnings growth, and has some of the healthiest balance sheets in the S&P 500.

The tech sector is also enjoying secular tailwinds from cloud computing, software-as-a-service, mobile communications and the “Internet of Things.” If US firms receive a tax break to bring offshore profits back home, we could see an acceleration of share buyback activity, special dividend payments to shareholders or an increase in mergers and acquisitions in the tech industry.

What Could Go Wrong?

Of course, we also remain on guard against the possibility of something shaking the investment terrain. Market volatility has been modest this year and investors poured $9 billion into US tech stocks through the end of July. If the market corrects, the tech sector’s strong momentum and outsized contributions to S&P 500 earnings could make it susceptible to a sharper pullback than the market as a whole.

With all of these factors in mind, we re-examined our sector weightings in client portfolios in early August and took some profits, where appropriate. If the market reprices and tech stocks decline disproportionately, we would likely become buyers again, deploying cash into names that look attractive.

Signals Versus Noise

A market event as significant as the dot-com collapse can affect investors for years, sometimes decades. While it offers a valuable lesson about chasing performance, the collapse also appears to be distorting perceptions of the tech sector today.

We encourage all investors to keep in mind that the tech sector has evolved dramatically since the events of 2000. This could be especially important to remember during the final months of 2017, when we would not be surprised to see volatility return to the market. Your Fiduciary Trust portfolio manager is always available to help you separate the signals from the noise.



This analysis is provided for illustration and discussion purposes only and does not guarantee future results. Please speak to your Fiduciary Trust contact if you have questions or would like more information. This communication is intended solely to provide general information. The information and opinions stated are as of September 1, 2017, and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.
CFA® and Chartered Financial Analyst® are trademarks owned by CFA institute.

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