Tech Tempts, But Valuations Look High

The Technology Select Sector SPDR XLK, the largest technology exchange-traded fund by assets, is up more than 22 percent year to date, underscoring the point that technology is the best performing group in the S&P 500 this year.

While technology's bullish performance through the first three quarters of 2017 tempts investors to get involved, some analysts believe the sector is at or above fair value. In a recent note, Morningstar pointed to the semiconductor industry as primary driver of technology upside this year, but also a space where current demand is unlikely to continue unabated. XLK allocates about 15 percent of its weight to semiconductor stocks, its fourth-largest industry weight. 

“Semiconductor business conditions have been downright stellar in recent months, with robust demand from the automotive and industrial sectors and optimism for a rush of new Apple Inc. AAPL iPhone sales in the fall,” said Morningstar. “Enterprise software and IT Services are still interesting growth sectors to us, and we still see a handful of undervalued names in these spaces.”

Rosy Scenarios

Some big-name tech stocks, such as NVIDIA Corporation NVDA, may be tempting investors with multiples that could prove hard to justify. Shares of NVIDIA are up 67.5 percent year to date, making it one of the best-performing semiconductor stocks.

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“In general, we still believe that valuations across tech are painting overly rosy scenarios in new and emerging technologies around artificial intelligence, for example, where NVIDIA appears significantly overvalued to us,” said Morningstar.

Investors are unlikely to find bargains with bellwether tech names, at least that is Morningstar's view. The research firm views Apple, Alphabet Inc. GOOG GOOGL, Intel Corporation INTC and Facebook Inc. FB, among others, as richly valued.

To The Cloud

A trend that is likely to prove durable in the years ahead is the transition to cloud computing. Markets are already pricing that in as highlighted by the First Trust Cloud Computing ETF SKYY, which is up 21.5 percent year to date. SKYY is the first and still only ETF dedicated to cloud computing equities.

“In our view, the single most important trend in technology remains the ongoing shift toward cloud computing, which we think is having ramifications on dozens of stocks across our coverage,” said Morningstar. “In short, both startups and enterprises, in efforts to reduce the high fixed costs associated with running on-premises IT hardware and software, are shifting more and more workloads to infrastructure-as-a-service (IaaS) vendors.”

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