Tech ETFs Are Still Tempting

That was fast. Nearly as quickly as technology swooned late in the second quarter, the sector has come roaring back early in the third quarter. Over the past week, the Technology Select Sector SPDR Fund XLK, the largest technology exchange-traded fund, is higher by 3.6 percent.

While XLK and rival technology ETFs have not reclaimed the highs seen prior to the June swoon, the technology sector's recent resurgence is undoubtedly impressive when considering the late June slump for the sector was one of its worst since Election Day.

Concerns about the valuations on the FANG stocks came home to roost with XLK and other tech ETFs late in the second quarter. Although XLK does not feature exposure to Amazon.com, Inc. AMZN or Netflix Inc. NFLX — because those are consumer discretionary stocks, the ETF is heavily allocated to the other half of the FANG quartet: Facebook Inc. FB and Alphabet Inc. GOOG GOOGL.

Real Earnings Momentum

With earnings season here, revisiting the technology sector, the largest sector weight in the S&P 500, makes sense because the group has been displaying encouraging earnings momentum in recent quarters.

“The tech sector posted double-digit earnings growth in the last two quarters, and it boasts the highest percentage of firms exceeding earnings expectations in the past four quarters among the 11 Global Industry Classification Standard (GICS) sectors,” said State Street Global Advisors (SSgA) in a recent note. “Such strong earnings growth momentum is expected to continue through 2017, evidenced by the rising earnings estimates shown.”

XLK is up 16.5 percent year-to-date, an advantage of 620 basis points over the S&P 500. It helps that Apple Inc. AAPL, XLK's largest holding at a weight of 14.5 percent, is up 27.6 percent this year.

Some More Good News

A frequent concern about the technology sector, particularly this year, is that the sector is expensive on valuation. Those concerns have a way of conjuring up memories of the 2000 tech bubble, but data suggest tech is not expensive as some investors believe it to be.

Technology's “valuations are not stretched relative to the broad market and nowhere near the levels reached at the peak of the dot-com bubble,” said SSgA. “Tech sector relative valuations to the broader market based on price-to-earnings and Enterprise Value (EV)-to-EBITDA are 15 percent and 7 percent below their historical median, respectively.”

Tech's valuations are tempered somewhat because Amazon and Netflix are not part of the sector.

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