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Information Technology Sector Rating: Outperform

Information technology sector overview

Companies likely have underinvested in technology upgrades during the past few years and may be poised to increase their investment in information technology, which could boost the sector. Also, technology companies' balance sheets are strong, which could support mergers and other activities that enhance earnings. Additionally, business confidence has improved and the potential for cash repatriation could provide a boost to the sector.

Market outlook for the information technology sector

A recent pullback in the tech sector may have unnerved some investors but we urged patience. The recent downturn appeared largely fueled by regulatory concerns regarding of the leading companied in the social media space. We admit to being concerned about such action, but given the relatively business friendly environment in Washington, we’re keeping those concerns at bay for now. Additionally, it’s important to remember that these names are only a part of the tech sector, and the fundamentals for the entire group continue to look quite strong to us. We’ve seen some pullbacks over the past year, only for the group to reestablish its outperformance, something that we’ve seen start to occur again, with the sector being one of the best-performing groups over the past month.

 

All investors should pay attention to their asset allocations and consider taking some profits in positions that may have gotten outsized, but we see no fundamental change to the majority of the tech sector and continue to hold our outperform rating. Central to our outperform rating is the evidence that appears to show companies have underinvested in technological improvements during the past several years. This can only occur for so long if companies want to remain competitive in this global environment, and we believe we are now at the point where they need to upgrade equipment.

Additionally, the cautious U.S. consumer now seems to us to be willing to spend more on technology and consumer confidence remains near its highest level since 2000, according to the Conference Board. This should give the tech sector two major lines of support: business and the consumer.

Although we’ve been waiting for a move higher in capital spending for some time, we are encouraged by the June National Federation of Independent Business survey that showed capital spending plans remained solid. Additionally, small business optimism remained elevated despite the recent trade rancor at 107.8, the highest reading since 1983, showing little impact thus far from the recent stock market volatility. We are watching developments in the business world closely, as we think it's time for business to take some of the load off of the consumer in terms of spending on technology.

Balance sheets in the information technology sector appear solid, with large cash balances and relatively low debt. In our opinion, this enables the group to pursue mergers and acquisitions that might help performance by removing competition and consolidating expenses. Additionally, we have seen tech sector companies increase their dividend payments, which may become a larger part of total equity return in the near term, while they have also increased share buybacks, which helps to reduce available shares to be purchased.

Finally, the innovation and entrepreneurial spirit that seem to pervade the technology sector make us excited about its future and support our outperform rating.

Factors that may affect the information technology sector

Positive factors for the technology sector include:

  • Increased technology spending: With productivity relatively weak, companies should look to technology upgrades to improve efficiency. Capital expenditures have been below trend for several years, and a return to more normal spending levels would boost the sector.
  • Wage increases: Increasing wages, including raising the minimum wage in various areas, could push companies to turn to technology to replace increasingly expensive human workers.

Negative factors for the technology sector include:

  • Increasing global competition: Competition, especially from areas with low labor costs, will likely continue to compress profit margins.
  • Increased regulation: There is an increased risk in our view of some potentially damaging regulation, which could impact revenues and increase costs of certain areas of the tech sector.
  • Trade disputes: If trade conflicts escalate it could raise costs for American producers and prices for consumers.
  • Capital spending delays: We continue to see signs that companies remain hesitant to increase capital investment beyond what is absolutely necessary, although there are signs that is beginning to end.

 

Clients can see our top-rated stocks in the information technology sector.

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.

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Important Disclosures

Schwab Sector Views do not represent a personalized recommendation of a particular investment strategy to you. You should not buy or sell an investment without first considering whether it is appropriate for you and your portfolio. Additionally, you should review and consider any recent market news.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is no guarantee of future results.

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.

The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of Morgan Stanley Capital International Inc. (MSCI) and Standard & Poor's. GICS is a service mark of MSCI and S&P and has been licensed for use by Charles Schwab & Co., Inc.

The National Federation of Independent Business (NFIB) Small Business Optimism Survey which is based on the responses of 740 randomly sampled small businesses in NFIB's membership, surveyed monthly.

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