The technology sector, the largest sector allocation in the S&P 500, has recently come under pressure as investors have retreated from the famous FANG stocks. In turn, some popular exchange-traded funds (ETFs) have seen outflows of capital, but investors considering tech ETFs should study the sector’s recent retrenchment before jumping in. The iShares U.S. Technology ETF (IYW), an ETF known for, among other things, a massive weight to shares of Apple Inc. (AAPL), lost more than 1 percent last week.
IYW allocates over 17 percent of its weight to Apple, one of the largest weights to the iPhone maker among all ETFs. The ETF is also one of the most credible FANG destinations, as Facebook, Inc. (FB) and Google parent Alphabet Inc. (GOOG) combine for over 21 percent of the fund’s weight. Up more than 17 percent this year, IYW also devotes more than 12 percent of its weight to shares of Microsoft Corporation (MSFT). The $3.4 billion ETF tracks the Dow Jones U.S. Technology Index and holds nearly 140 stocks, of which more than half are software and related services providers. (See also: Tech ETFs Feel the Outflows.)
Waning momentum could be one reason why the tech sector is retreating. “In a throwback to the late 1990s, tech has once again become a momentum play,” said BlackRock, Inc. (BLK) in a recent note. “The reversal in tech is part of a broader reversal in momentum stocks, a style in which tech features prominently. Using the MSCI USA Momentum Index as a reference point, it is instructive that Microsoft is the biggest name, with a 5 percent weight. At the industry level, semiconductors, software and computers represent three of the top four industries.”
Another issue weighing on investors’ minds when it comes to technology and internet stocks is valuation. While this is not 1999 or 2000, data suggest that valuations are perking up on technology stocks. For example, IYW sports a price-to-earnings ratio (P/E) of over 23, while the S&P 500’s P/E is around 19. “Multiples have been rising fast,” according to BlackRock. “The trailing price-to-earnings for the S&P 500 tech sector is up over 35 percent from last year’s low. At nearly 25x trailing earnings, the sector is the most expensive it has been since the aftermath of the financial crisis, when earnings were depressed. On a price-to-book (P/B) basis, valuations are even more extended. Large-cap U.S. technology companies are trading at the highest level since late 2007.” (See also: Tech Stocks May Be Both Cheap – and Risky.)
Investors should also consider recent price action in semiconductor stocks. A major semiconductor benchmark lost more than 2 percent last week, and IYW allocates over 18 percent of its weight to chip stocks. (See also: Technology Stocks: Do They All Deserve to Fall?)