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. We’ve seen some pullbacks over the past year, only for the group to reestablish its outperformance, something that appears to be occurring again this time around. 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 is near its highest level since 2001, 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 both the durable goods report from the Census Bureau and the Empire Index from December which both are showing upturns in capital expenditures as recent months have trended higher. Also, a recent National Federation of Independent Business survey showed small business optimism rose to 106.9, showing no impact thus far from the recent stock market volatilty. 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.
- 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.
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