What is the information technology sector?
It includes makers of software, semiconductors, personal computers; communications equipment such as mobile phones; electronic equipment; and providers of consulting and IT services.
We still like the Information Technology sector’s prospects, but remain concerned about some negative near-term factors, including the trade war and the extended rally in the overall stock market. The phase-one trade deal between the U.S. and China combined with a new trade pact with Mexico and Canada to replace NAFTA have eased uncertainty. However, the Information Technology sector is vulnerable to trade disputes, as it receives significant revenue from foreign sources.¹ The sector’s fortunes are prone to fluctuation as hopes for an enduring U.S.-China trade deal are likely to rise and fall.
Additionally, the sector is the most sensitive sector to the overall market based on the relationship over the past three years. Of course you can also say that the overall market is the most sensitive to the sector, as it constitutes nearly 25% of the S&P 500 Index. In fact, it has nearly doubled the return of the second best performing sector, Utilities, over the past year. If the momentum continues, there is a good chance that the technology sector could outperform. However, investor sentiment is quite extended, so at least a mild pullback would not be surprising. That could provide an opportunity to add to the sector exposure.
While valuations of technology sector are elevated, it boasts strong fundamentals relative to the other sectors. Revenues are expected to grow 6% and 7.5% over the next two years, respectively, while earnings growth is expected to be in the about 8% and 14% over the same period.
Capital expenditures have been below trend for several years, and a return to more normal spending levels would boost the sector. Rising wages, including an increased minimum wage in some U.S. cities and states, could accelerate this trend, as companies may turn to technology to replace increasingly expensive human workers.
Meanwhile, U.S. consumers seem willing to spend more on technology. Consumer confidence generally has remained strong, despite trade concerns. Balance sheets in the Information Technology sector also appear solid, with large cash balances and relatively low debt. Meanwhile, Information Technology sector companies have increased dividend payments, which may become a larger part of total equity return in the near term, while also increasing share buybacks, which helps to reduce the supply of available shares and boost prices.
We believe that the sector’s risks currently are balanced with its return potential, and that a marketperform rating on the Information Technology sector is appropriate for the time being.
Sector Overview: Information Technology is positive on Macro, Fundamental and Relative Strength, negative on Value
Note: Each of the sector lenses shown above—Macroeconomic, Value, Fundamental and Relative Strength—is both intuitive and evidenced-based in nature. Within each, there are a varying number of factors. The Macroeconomic lens includes sector sensitivities to interest rates, stocks and the value of the U.S. dollar; the outlook for each of these is determined by the Schwab Center for Financial Research (SCFR)’s Asset Allocation Working Group, which uses a mosaic approach of quantitative and qualitative considerations. Value includes six different valuation metrics that provide a holistic perspective on current valuations relative to each of the sectors’ own historical valuations, as well as relative to the other sectors. Fundamental provides insight as to how efficiently the companies within each sector use invested capital to produce earnings; this historically has been informative as to future relative performance of the sectors. Finally, Relative Strength measures momentum of the individual sectors against all of the other sectors. We also consider the data in the context of factors outside the scope of these indicators—for example, geopolitical risk or anticipated tax legislation.
Source: Charles Schwab, as of 01/23/2020.
¹ Source: S&P Dow Jones Indices, S&P 500 Foreign Revenue Exposure Index (SPXFRUP). Information Technology had a 38.3% weighting in the index as of 12/31/2019.
What do the ratings mean?
The sectors we analyze are from the widely recognized Global Industry Classification Standard (GICS®) groupings. After a review of risks and opportunities, we give each stock sector one of the following ratings:
- Outperform: likely to perform better than the broader stock market*
- Underperform: likely to perform worse than the broader stock market
- Marketperform: likely to track the broader stock market
Want to learn more about a specific sector? Click on a link below for more information or visit Schwab Sector Views to see how they compare. Clients can log in to see our top-rated stocks in the Information Technology sector.
* As represented by the S&P 500 index
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