Tech Pullback Raises Worries

6/26/2017


Trading remains choppy, with strength in health care and financials countering a pullback in technology. The Dow Transports are within 3% of their March 1 all-time high of 9,593.95, and a close above that level would reconfirm the bullish primary trend. For now, our buy lists hold 92% to 95% in stocks.

Tech sector dips

Underlying the Dow Theory is the idea that the Dow Industrials and Dow Transports reflect all information available to investors. Still, nothing says you can't gain some insight by looking at the action of individual stocks and sectors. Especially now, technology is a key sector to watch.

For one thing, the tech sector is big, accounting for 22% of the market value of the S&P 500 Index. No other sector comes close to that weighting. Health care and financials each account for about 14%, while consumer discretionary accounts for about 12%.

Also, tech stocks have delivered strong year-to-date returns, with a gain of 17% for the S&P 500 tech sector. That is well above health care, which ranks second among the 11 sectors with a gain of less than 13%. With tech doing so much of the heavy lifting this year, investors worry about a lack of leadership if tech suffers a correction.

A 10% to 15% pullback in a top-performing sector is fairly typical — and something a bull market should be able to withstand. But a 20% to 30% decline would be tough for this market to overcome, as it would likely trigger broad-based selling as investors dump tech-laden index funds.

Fortunately, we see such a big decline as unlikely, for two primary reasons:

• In a slow-growth economy, tech stocks are among the few areas with robust operating momentum. Among stocks in the broader S&P 1500 Index, tech stocks delivered the best earnings growth and second-best sales growth in the most recent quarter. No sector earns a higher average Quadrix Momentum score.

• Tech-stock valuations, while high, seem reasonable relative to other sectors and to historical norms. The median S&P 1500 tech stock trades at 25 times earnings — fifth-highest among the 11 sectors after energy, health care, telecom, and real estate. But, relative to the norms since 1994, only the consumer-discretionary sector trades at a smaller premium. Also, the median tech stock's P/E is 18% higher than the median of all S&P 1500 stocks — below the average of 34% since 1994.

Conclusion

Do not let one sector dominate your portfolio, but tech stocks remain attractive. Tech stocks account for 36.6% of our Buy List and 30.6% of our Long-Term Buy List.


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