Outlook for Technology Stocks

For many investment managers, sector positioning is a key driver of performance. During the long bull market of the 1990s, technology was the place to be, as investors were willing to overlook the sector's ever-richer valuation and focus instead on the promise of the Internet. That gave way to a more sober view, leading to the Internet bust and an extended period of sector underperformance.

Tech's Comeback

Yes, tech is back, but this time it's leading the market higher because of its rising profits and solid fundamentals. Year-to-date through Nov. 30, the Goldman Sachs Composite Technology Index was up 15.51%, as compared to 6.23% for the S&P 500 Index.

While tech moves to the fore, the subprime loan mess has punished financial companies, a group that had been among the market's leaders throughout this decade. Year-to-date through Nov. 30, the Lipper Financial Services Funds Index lost money, with a return of -10.86%.

This pro-tech, anti-financials market has been a boon to investors in the Nasdaq-100 Index, which is made up of 100 of the largest domestic and international non-financial stocks listed on the exchange based on market capitalization. With close to 60% of its market cap in technology, the Index has gained 19.43% this year, but is still trading at less than half its all time high of roughly 4587, which it reached in Mar. 2000.

Why Tech is No. 1 Indicator to Index Performance

In addition to the big U.S. tech names such as Microsoft, Apple and Google, the Nasdaq-100 has exposure to overseas companies (Canada's Research in Motion, India’s Infosys and Ireland’s Ryanair) and a number of big retailers (Bed Bath & Beyond, Costco and Whole Foods). The Index's ability to stretch its run of outperformance into 2008 depends on whether technology can keep outperforming and, to a lesser extent, the financials keep lagging.

So far, technology issues have escaped the worst of market's subprime-related declines, but in a recent earnings report, Cisco Chairman John Chambers surprised investors by saying his firm's falling sales to financial companies could have an impact on the bottom line. Even though Cisco’s earnings were solid, his statement caused the market to question the sector’s vulnerability to an overall economic slowdown and caused a sharp selloff in the big tech names.

But, according to Wellington Management Company’s Scott Simpson, fundamentals in many tech sub-sectors remains quite positive. "While U.S. enterprise spending is soft, worldwide enterprise spending remains strong," he says. "IT spending in the Asia-Pacific region is growing at around 9% a year and China is already the third-largest purchaser of technology products."

On the consumer side, Simpson says demand for feature-rich phones, including music phones and smart phones, as well as the continued transition to 3G wireless technology, remains strong and should drive revenue higher for select handset and component manufacturers.