Tech ETFs: Fuel For The Market

The Technology Select Sector SPDR XLK — the largest technology sector exchange traded fund by assets — is up 4.7 percent, extending its year-to-date gain to 31 percent. Other, more focused ETFs have posted even more breathtaking gains. Either way, XLK is thumping the S&P 500 by a 2-to-1 margin this year.

XLK has been powered by, among others, Apple Inc. AAPL and Microsoft Corp. MSFT, two stocks that combine for over 26 percent of the ETF's weight.

Technology sector earnings are one of the primary catalysts for the largest sector weight in the S&P 500, particularly at a time when other sectors are posting solid-to-less-than-inspiring results.

“Tech to the rescue! That could be the theme of the third-quarter earnings results we’ve seen so far,” said State Street in a recent note. “While earnings growth can be considered decent, growth did drop from more than 10 percent in Q1 and Q2 to just 6 percent in Q3. Average growth notwithstanding, there was one standout sector this earnings reporting season: Technology.” 

Pricey, But More To Consider

Since the bursting of the technology bubble in 2000, outperformance by the sector is often accompanied by concerns that another bubble is lurking. Still, many investors believe today is a different environment for the technology than was seen in the late 1990s and early 2000s.

Technology stocks and ETFs such as XLK may actually be more compelling than the other sectors that are handily outperforming the S&P 500 this year. Those sectors include healthcare and materials. Whereas multiples are expanding for those sectors, technology earnings per share are rising, supporting the increasing valuations.

Materials “multiple expansion is being driven by expectations for reflationary fiscal stimulus in the U.S. as well as expectations that synchronized global economic growth should support demand for basic materials and commodities, boosting material companies’ growth,” said State Street. “However, at such high valuation levels, the sector could stumble if it can’t deliver the growth expected.”

All About Earnings Growth

If earnings are the most important data points released by public companies, and many investors believe that to be the case, then technology sector earnings bode well for ETFs like XLK.

"Tech’s earnings sentiment has been strong, and the sector had the highest percentage of companies beating earnings expectations for the 6^th consecutive quarter,” said State Street. “Within the sector, semiconductors led on earnings growth, reporting 47 percent earnings growth with all the companies beating earnings expectations.”

XLK allocates almost 16 percent of its weight to semiconductor stocks, its fourth-largest industry weight.

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Photo courtesy of Apple.