The technology sector has long been thought of as the classic cyclical investment, with tech companies typically selling nonessential products and services to businesses and consumers and their stocks often supported by high revenue growth projections that come undone during economic downturns.
But according to some investors and analysts, market participants are beginning to re-evaluate just how cyclical the information technology sector remains, following changes last year to the widely used Global Industry Classification Standard—which removed highflying growth companies like Facebook Inc.
and Netflix Inc.
from the info tech sector — and changing business models in the software industry.
“The tech sector isn’t as cyclical as it used to be,” Dave Lafferty, chief market strategist at Natixis Investment Managers told MarketWatch. He said that while semiconductor stocks remain classic cyclical investments, the rest of the information technology sector — the software and services and technology hardware and equipment industries — have become less cyclical as a result of changes to corporate ne, business models, and maturation of companies once seen as growth names.
At the same time, some market veterans argue that the notion the tech sector is no longer cyclical smacks disturbingly of the same mentality that prevailed in the latter days of the technology bubble that burst in March 2000.
Meanwhile, the evolving perception of the information technology sector appeared to contribute to the leadership role it’s displayed since the market’s recent lows on Dec. 24. Since then, the sector has gained 20.2%, outperforming the other 10 SP 500 sectors, as measured by the Technology Select Sector SDPR ETF
has gained 19.5% over the same period.
According to Norm Conley, chief investment officer at JAG Capital Management, that outperformance can’t just be chalked up to the sector’s sharp decline in the fourth quarter of last year, as it was only the third biggest loser during that stretch.
“Even as we’ve had more questionable economic data, you see tech picking up the slack,” he noted. “These stocks are bit more immune to the economic cycle than they were 10 years ago, because many software companies have moved to a subscription-based revenue model,” he added, referring to the trend in the tech sector of providing “software as a service,” which leads to more steady revenue streams that one-off purchases.
Changing business model
“Enterprise software used to be a big-ticket deployment. If you were going to deploy Oracle or get everyone Adobe, those were big one-time investments” that would be foregone during economic downturns. The subscription model, plus American corporations’ growing dependence on enterprise software, will make a downturn less harmful for these companies, Conley said.
Brad Sorensen, managing director of sector analysis at Charles Schwab agreed that the information technology sector has become less cyclical, though he says confusion abounds as to what investors are talking about when they talk tech. “People lump Facebook, Google, and Netflix into discussion of the tech rally, but those names aren’t in the tech sector anymore,” following the September GICS shake-up that placed those companies in the communication services sector.
To be sure, this isn’t the first time that investors have claimed the end to tech’s cyclicalilty. Richard Bernstein of Richard Bernstein Advisors lamented in a Thursday research note that market participants were being lulled into a false sense of security by arguments that the info tech sector has become so ingrained in the modern economy that it is more recession resilient.
Echoes of the tech bubble
“Anyone who lived through the late-1990s tech bubble is probably cringing now,” wrote Bernstein. “The basic principals of economics and don’t have a subparagraph saying ‘this holds for every industry except for technology.’”
In an interview with CNBC, Bernstein said the notion that tech is no longer cyclical echoes tech-bubble-era arguments that it’s “something new. It’s something different. And, that’s sounding a bit like March 2000.”
In his note, Bernstein pointed to Apple Inc. as a classic example of a cyclical stock that makes up more than 15% of the Info Tech sector. He pointed out that the average price of an iPhone, at between $750 and $1,000, is higher than the average price of a dishwasher or a washer-dryer combination.
“Appliances are considered durable goods, and consumers don’t mind paying higher prices because they mentally amortize the cost over the appliance’s anticipated 15-20 year lifespan,” he wrote. “Mobile phones rarely have a lifespan of even 5 years, but consumers are expected to pay durable goods prices for a nondurable good. Such odd economics might work when employment is strengthening, but seem unlikely to work should employment cyclically weaken at some point.”
Sorensen pushes back by arguing that Apple and other info tech stocks like Microsoft Inc.
and Visa Inc.
“We have seen tech sector companies increase their dividend payments,” Sorensen said, “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.”
from the info tech sector and Amazon Inc.’s
For instance, the NYSE FANG+ Index
— which tracks shares of Facebook, Apple, Netflix, and Alphabet as well as other high-profile, high-growth tech names — rose 37% from its November 2017 inception to its peak in June of last year, while the information technology sector grew just 11%.
Todd Rosenbluth, director of ETF and mutual fund research at CFRA, told MarketWatch that “the investing community tends to blur the lines in terms of technology,” lumping in companies across different sectors. “FANG stocks were only half in the technology sector before and are now even less so with the reorganization.”
But as the market continues to adjust to the new classification and evolving business models, Rosenbluth says that info tech ETFs are a smart investment now as “the constituents offer a mix of growth prospects while having strong balance sheets and records of offering consistent dividends.”
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