Tech's Dirty Little Secret: It's a Cyclical Sector
Our portfolios have had significant exposure to the Technology sector since the first quarter of 2016. Tech remains one of our biggest sector exposures both on an absolute and relative basis. Our substantial overweight in Technology surprises some of our investors because RBA generally does not make a habit of investing in overvalued or hyped sectors.
Our significant overweight in Tech stocks has been based on one fact: Technology has historically been the best performing sector when overall corporate profits accelerate. Right in step with history, Technology has been the best performing sector since the US profits cycle troughed in 4Q15 and the global profits cycle troughed in 2Q16. The Tech sector’s recent outperformance is not atypical relative to other periods during which profits accelerated.
The historical performance of the Tech sector is the sector’s dirty little secret: the Tech sector is actually a deep cyclical sector and, over multiple cycles, investors seem to habitually confuse that deep cyclicality for stable growth. They appear to be doing it again during this cycle.
Underestimating Tech’s cyclicality
The secular, long-term earnings growth rate of the Technology sector is higher than that of some other sectors, but the sector’s earnings stream is so highly cyclical that one must be careful regarding the time period used when measuring growth. Based on Tech sector valuations, history suggests that investors tend to focus on Tech’s long-term growth and ignore the sector’s deep cyclicality. That valuation strategy works fine so long as the sector’s profits are accelerating, but unravels when profits decelerate. The Tech sector’s history is riddled with disappointment.
Chart 1 compares the long-term earnings stream of the S&P 500® Information Technology sector (white line) with that of the S&P 500® Consumer Staples sector (blue line). At the peak of a cycle (like today?) the Technology sector looks to be a superior growth sector to Consumer Staples. However, the Technology sector’s growth quickly loses momentum during profits recessions. Tech looks to be a superior grower versus Consumer Staples only toward the peak of a cycle.
Trailing EPS: S&P 500® Technology vs. Consumer Staples (Sep 1990 – Sep 2017)
Source: Richard Bernstein Advisors LLC., Bloomberg Finance L.P.