U.S. tech stocks experienced a bit of a wobble earlier this month. This raised some concerns, as the information technology sector had entered June as the year’s best-performer on the S&P 500® Index—only to fall nearly 4% over the course of about a week.
One of the big concerns may have been that after a more than 20% march higher so far this year, tech stocks were simply overvalued. Some investors may even have wondered if we were set for another rout like the kind we suffered back in 2000. The bursting of the tech bubble back then wrought real damage: The S&P 500 Information Technology Index only recently regained the level it touched before the bubble popped.
Is it as bad as all that? Probably not. First of all, tech’s mid-June wobble could prove short-lived. The S&P 500 IT Index had already recovered roughly half its losses as of Friday. This probably shouldn’t be taken as a delay in the reckoning that must soon arrive, either, as there are reasons to think tech actually has more room to grow.
There’s no denying that tech accounts for a pretty large share of the stock market. As a sector, tech stocks now account for about 23% of the value of the S&P 500 Index—marking their heaviest weighting on the benchmark index since it topped out at about 33% at the height of the bubble. (Tech fell to about 14% just three years later.)
Does it make sense for tech to account for such a large percentage of the S&P 500? Investors may be thinking in particular of the heft of the so-called FAANG stocks—Facebook, Amazon, Apple, Netflix and Google (now Alphabet)—though Amazon and Netflix are actually considered part of the consumer discretionary sector.
“While those companies are big, it’s not clear that tech’s share of the S&P 500 index is inappropriate,” says Brad Sorensen, managing director of Market and Sector Analysis for the Schwab Center for Financial Research. “Indexes ideally should reflect what is going on in the overall economy, and at this point it’s tough to argue that technology-related products and services don’t make up at least a quarter of the U.S. economy. Even areas that don’t readily come to mind as being tech-related, such as energy or health care, are increasingly appearing to turn to tech to enhance their business operations.”
According to Yardeni Research, the tech sector’s share of S&P 500 earnings—at 22%—isn’t much below its 23% index weighting. Compare that with the bubble, when tech’s share of earnings was just 15%, less than half its index weighting.
And in terms of valuations, Ned Davis Research data show that the tech sector has a forward price-to-earnings ratio of between 18 and 19. That’s slightly below the sector’s 30-year average of 19.9.
“Of course, that period includes the tech bubble, when high valuations skewed the average higher,” Brad says. “But all things considered, valuations are roughly in line with historical averages.”
Sources of support
Overall, the environment generally still looks pretty positive—and much different than the bubble period of the ’90’s. Debt within the sector is low, dividend payouts are rising and buybacks continue. And with a tight labor market, companies are looking toward technology to boost productivity.
Evercore ISI data shows 53% of the companies surveyed are planning to increase tech spending—up from 38% as recently as November. Meanwhile, consumers may be increasingly willing to spend more on technology, and consumer confidence is now at its highest level since 2001, according to the Conference Board. That means businesses and consumers could both start pulling in the same direction.
“We think the recent pullback in tech was healthy and may have helped check some of the excessive enthusiasm out there,” Brad says. “But that doesn’t mean the sector will necessarily rebound sharply higher.”
If we look more broadly, the solid economy and strong corporate earnings should help stocks continue to grind higher, but investors should be prepared for turbulence from sources such as changes in interest rates. And they should stay diversified.
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.
What you can do next
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