Market Overview

Don't Get Caught Up In Tech ETF Fears

Don't Get Caught Up In Tech ETF Fears

After surging 37 percent last year, the technology sector is once again leading broader U.S. equity indexes higher. Entering Thursday, the tech-heavy Nasdaq-100 Index was up 13.1 percent year-to-date compared to just 4.6 percent for the S&P 500.

A slew of tech-specific exchange traded funds are delivering impressive performance as well. For example, the iShares U.S. Technology ETF (NYSE: IYW) is higher by nearly 15 percent this year. Boffo performances by the tech sector has a way of eliciting bubble concerns, but the sector's valuations are actually more reasonable than meets the eye.

What Happened

“Since the start of 2010, the trailing price-to-earnings ratio for the S&P 500 Technology Sector Index has risen approximately 20 percent, only slightly faster than the 14 percent for the S&P 500 Index,” BlackRock said in a recent note. “A quick look at top-line valuations confirms that 2018 is not the late '90s redux.”

IYW, which turned 18 years old last month, is home to almost 140 stocks, but the ETF is known in large part for its significant weight to Apple Inc. (NASDAQ: AAPL). The fund's 16.86-percent weight to Apple is among the largest ETF weights to that stock. Microsoft Corp. (NASDAQ: MSFT) is IYW's second-largest holding at 13.53 percent.

Why It's Important

The IYW lineup is primarily allocated to large- and mega-cap, mature technology companies that offer growth prospects without the stretched valuations seen on younger and smaller companies in the sector. Interestingly, some metrics indicate tech is discounted relative to long-term averages.

“At 23 times trailing earnings, the sector is trading at a discount to the long-term average of 28. To be fair, the long-term average is distorted by the bubble years, when the sector traded as high as 70 times earnings,” according to BlackRock. “Using the median, a statistical measure less influenced by outliers, suggests that today’s valuation is right in line with the long-term norm.”

What's Next

While technology trades at a premium to the S&P 500, the sector's relative valuation to the U.S. equity benchmark is slightly below the 15-year average, indicating investors are not necessarily paying up to embrace tech. Plus, the sector remains highly profitable.

“With a return-on-equity of 20 percent, the sector remains profitable relative to both its history as well as the broader market,” according to BlackRock. “The current return on equity is six percentage points above the broader market. This compares favorably to the long-term median of around four percentage points.”

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