Finding Value With Technology ETFs

After starting this year in fine form and leading the market higher through the first half of 2016, defensive sectors, such as consumer staples and utilities, have been taking drubbings over the past couple of months.

Defensive Sectors: Recent Performance And Valuation Concerns

From their most recent 52-week highs, the largest consumer staples and utilities exchange-traded funds are off 6.4 percent and 8.7 percent, respectively. Part of the reason for the declines in those once scorching sectors are concerns that the Federal Reserve will soon raise interest rates, speculation that often hampers rate-sensitive groups such as staples and utilities.

Second, and perhaps equally as important, are valuations. As in, defensive sectors are viewed as richly valued and recent departures from those groups could be a sign that investors are embracing higher beta fare with perceived value.

“Utilities, consumer staples and other defensive names are still expensive relative to their history, and in many cases, their fundamentals. Large cap utilities stocks are trading at a premium to their 20-year average relative price-to-earnings (P/E) and price-to-book (P/B) ratios (source: Bloomberg). For example, over the past 20 years the S&P 500 Utilities Index has typically traded at around a 25 percent discount to the broader market. Today the discount is less than 20 percent,” said BlackRock in a recent note.

One Possibility: IYW

The iShares Dow Jones US Technology (ETF) (NYSE: IYW) could be an intriguing option for investors looking for some of the last vestiges of value in an aging bull market. IYW, an ETF famous for its largest weight to Apple Inc. (NASDAQ: AAPL), is up 7 percent over the past 90 days, easily topping the largest staples and utilities ETFs over that span.

IYW should also prove sturdy if interest rates due in part to the healthy balance sheets and large cash balances held by many big-name U.S. technology companies. Conversely, some big utilities names are saddled with large debt loads, increasing their vulnerability in the face of rising interest rates.

Apple and Microsoft Corporation (NASDAQ: MSFT) combine for 28.7 percent of IYW's weight, and those are two of the most cash-rich companies in the United States.

While there will likely be a return to defensive sectors, higher beta fare might be the better near-term bet.

“At some point we will likely see value return to this segment of the market, but we’re not there yet. High yield, low beta stocks remain vulnerable based on still elevated valuations and hypersensitivity to even small changes in interest rates. I see better value in other sectors such as technology, which are reasonably priced and better positioned to grow in a slow growth world,” added BlackRock.

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