Tech stocks have been on a pretty wild ride in recent weeks. After rising sharply through the first few weeks of March, the sector got hit by a flurry of bad news.
The chief concerns revolved around some of the big names in the social media world, after a series of scandals raised the possibility of a regulatory crackdown. But the sector also looked vulnerable to an apparent rise in trade tensions between the United States and China, as many tech gadgets are assembled in China. The Asian giant is also one of the largest markets for U.S. semiconductors and related equipment.
Although tech stocks have rebounded somewhat from their recent lows and the sector is still up for the year, the recent spike in volatility raised some questions about the state of the bull market. After all, the information technology sector has the biggest weighting of any sector on the S&P 500® Index, accounting for about a quarter of broad market index, so when tech wobbles, the rest of the market tends to take note.
Here we’ll take a closer look at the sector and consider some of the implications of the recent headlines.
A handful of tech-related stocks tend to get a lot of attention. In particular, the so-called FANG stocks—Facebook, Amazon, Netflix and Google (whose listed parent company is called Alphabet)—often end up in the news, in part because of how fast they’ve risen in recent years. In fact, Intercontinental Exchange, which owns the New York Stock Exchange, even launched a special index to track investments (futures, actually) related to these stocks, along with several other tech-related stars. The NYSE FANG Plus index groups the four stocks mentioned above, plus Apple, Alibaba, Baidu, Nvidia, Tesla, and Twitter.
Several of these stocks—namely, Facebook, Twitter and Alphabet—have recently found themselves in regulators’ sights because of concerns about the privacy of user data and the way these platforms are used for political purposes. Facebook, in particular, has drawn attention following reports that an outside company had improperly accessed data on millions of users, and that one of the social media company’s apps had been recording users’ calls and messages made on the platform. These revelations helped trigger an investigation by the Federal Trade Commission and requests for testimony from the Senate Judiciary Committee.
“The risk here is that issues in the social media segment could lead to more regulatory oversight in ways that affect these companies’ operations and potentially spread to other parts of the tech sector,” says Brad Sorensen, managing director of Market and Sector Analysis for the Schwab Center for Financial Research.
What’s in a sector?
Even with this risk in mind, it’s worth noting that the FANG stocks don’t necessarily represent the tech sector at large. In fact, Amazon and Netflix aren’t even considered tech companies—they’re part of the consumer discretionary sector. And Facebook and Alphabet won’t be part of the tech sector much longer anyway: They’re going to be moving over to the new communications services sector later this year (as will Netflix).
“The pullback itself isn’t even a bad thing,” Brad says. “There were signs of froth building up among the FANG stocks, so this kind of correction can help rein things in.”
Looked at more broadly, the tech sector covers an array of technology-related stocks, including makers of software, semiconductors, personal computers, communications equipment such as mobile phones, and other electronic equipment, as well as providers of consulting and information technology services.
If there are a few potential shadows over the social media segment, things look much better elsewhere in the sector.
“Fundamentals for the majority of the space look good, and capital investment plans—based on various surveys—are rising, which should benefit tech,” Brad says.
For example, the Business Roundtable Q1 2018 CEO Economic Outlook Index, which measures CEOs’ projections for spending and hiring, showed that 68% of the respondents expect to boost capital spending over the coming six months (the survey was conducted in February), compared with just 49% who said so in the Q4 2017 survey. And orders for nondefense capital goods excluding aircraft—considered a proxy for business spending plans—rose 1.8% February after shrinking the month before, according to Census Bureau data. New orders for computers and electronic products slipped slightly during the period, according to the data, but the overall rise in investment bodes well.
“Capital expenditures have been below trend for several years, and a return to more normal spending levels would boost the sector,” Brad says.
Meanwhile, consumer confidence in March was just below the 18-year high touched the month before, according to the Conference Board Consumer Confidence Index®. This should give the tech sector two major lines of support: business and the consumer.
“The economic picture looks supportive,” Brad says. “And then you have to factor in the sector’s strong balance sheets, rising dividend payments and the innovation and entrepreneurial spirit that seem to pervade the sector. That’s why we continue to rate tech ‘outperform.’”
So although some of the risks facing the social media part of the sector remain unresolved, other parts of the sector have much brighter prospects. Investors concerned about the recent headlines should keep this in mind before making any drastic changes to their portfolios.
We believe it’s important to have some exposure to each of the 11 sectors in the S&P 500 Index, and to keep it within a reasonable range—say, a few percentage points—of the market weighting. Sector returns can vary greatly from year to year—for example, tech could lead the pack one year and then lag behind another—so it could be risky to be excessively over- or underexposed to any particular sector.