US technology sector is still going strong

July 24, 2018 15:50
Very large cap US technology companies have outperformed the Nasdaq 100 significantly since early 2017. Photo: Reuters

Investing in large US information technology companies appears to be one of the highest consensus trades among institutional investors. US technology companies seem to enjoy a perfect blend of structural and cyclical growth.

The MSCI USA information technology index trades on a P/E multiple of 18 times expected earnings, which we consider quite reasonable against the backdrop of brisk earnings’ growth. Analysts’ earnings revisions also underpin the existing uptrend in US technology companies. As the US economy continues to expand at a robust pace, equity analysts are poised to keep upgrading their sales and earnings estimates for US information technology companies.

We have recently discussed why we give US technology companies the benefit of the doubt regarding the ongoing trade war between the United States and China. China might eventually target the flows of technology goods moving across the Pacific Ocean, but it would be ill-advised to act rashly against a sector in which it generates a large net trade surplus with the US and is keen in developing its long-term expertise.

We still believe that over the next months China will refrain from using “heavy trade artillery” to directly penalize US technology firms, if only because they are usually located in “Blue States”, such as California and New York, with majority support for the Democrats.

At the industry level, we prefer software companies, which generally enjoy attractive margins and structurally elevated growth rates. Software companies have steadily outperformed the IT sector since 2017, while technology hardware is facing margin erosion and less favorable volume growth.

Semiconductors remain attractive over the long term, yet the trade war issues which plagued automobile companies recently are having second-round effects on semiconductor companies. IT services companies, which grow in line with the overall GDP, have performed in line with the IT sector since mid-2017. We consider them moderately attractive.

In summary:

- Software: Attractive margins and long-term growth, reasonable valuations.

- Internet/cloud computing: While some internet companies might be overpriced, we like the segment, especially companies offering cloud computing services (Amazon AWS, Microsoft, Google Cloud).

- Semiconductors: The industry is pausing and might lag in the short term but it remains an attractive story over the medium term, as long as global growth does not slow down materially.

- IT services: Moderately attractive at this stage of the cycle.

- Technology hardware: Structural underperformer, as IT hardware companies face stiff competition from China and fight to avoid commoditization of their products, which puts downside pressure on margins.

Investors strongly favor a concentrated list of very large cap US technology companies including Apple, Amazon, Alphabet (Google), Microsoft, Paypal, and Netflix. This group has outperformed the Nasdaq 100 significantly since early 2017 and we do not see reasons to anticipate a change of leadership.

Capital flows into technology ETFs remain supportive, while the flattening of the US yield curve drove relative outperformance. We expect this tilt toward growth companies to persist in coming months and reaffirm our overall positive outlook for the US technology sector.

– Contact us at [email protected]


Chief Economist, Head Economic Research at Bank J Safra Sarasin