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Information Technology Sector Rating: Marketperform

By

Brad Sorensen

photo
CFA, Managing Director of Market & Sector Analysis, Schwab Center for Financial Research

Brad Sorensen heads market and sector analysis for the Schwab Center for Financial Research and writes for several Schwab publications. He is a member of Schwab's Investment Strategy Council.

Before joining Schwab in 2004, he was a senior analyst at AMG Guaranty Trust, where he designed portfolio strategies for high-net-worth individuals. Sorensen graduated from the University of Colorado with a bachelor's degree in finance and master's degrees in business administration and finance. He is a Chartered Financial Analyst charterholder.

October 11, 2018
Submitted by satya.billa on October 11, 2018
Information Technology Sector

Information technology sector overview

The tech sector has suffered a bit following the announcement of new tariffs to be imposed on China. The globally exposed group could continue to struggle as the trade dispute drags on, but could rebound quickly should tensions thaw.

Market outlook for the information technology sector

The tech sector has reversed course and has struggled since the threat of rising tariffs from the U.S on China. The tech sector gets more than half of its revenue from foreign sources, according to Strategas, making it seem more vulnerable to trade disputes. For now, we are keeping our marketperform rating on the group, and we still think businesses largely need to upgrade tech resources, which should help support the group.

We still like technology, but remain a bit concerned in the near term about some negative factors facing the sector—resulting in us suggesting investors not look to “load the boat” on this recent pullback. Concerns about slowing global growth, as mentioned, appear to be ramping up and could negatively affect the group, while further trade dispute escalation with China could continue to weigh on the sector, as we saw recently. Additionally, although we still believe in the need for companies to expand their spending on capital improvements, especially in the technology area, we are concerned that trade concerns may delay some of that spending.

However, the U.S. consumer now seems to us to be willing to spend more on technology and consumer confidence remains strong, apparently largely ignoring trade concerns, with the Conference Board's Consumer Confidence Index® rising to 135.7. This still-elevated confidence should help support the tech sector and leaves us still positive on the group, but with a bit more caution from our point of view.

Although we’ve been waiting for a move higher in capital spending for some time, we are encouraged by the July National Federation of Independent Business (NFIB) survey that showed capital spending plans for small business remain elevated and gained despite trade issues, while overall capex plans have declined some according to data compiled by Strategas Research.

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 but those may be delayed by uncertainty surrounding trade. 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.

So we aren’t overly negative or positive on the group as we think that, for now, the risks are balanced with the return potential and believe that a neutral rating is appropriate for the time being.

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 affect revenues and increase costs in certain areas of the tech sector.
  • Trade disputes: If trade conflicts continue to escalate, it could raise costs for American producers and prices for consumers.
  • Capital spending delays: If those same trade disputes lead to companies again delaying capital spending plans, it would likely be detrimental to portions of the tech sector. 

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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