The Information Technology industry has emerged as a big winner for the stock market investors, with global giants like Apple, Microsoft, Amazon and many others leading the stock market rally over the previous 18 months. While the sector holds a promising outlook, there are risks associated that investors need to be aware of. The Information Technology sector includes software and services, technology hardware and equipment (e.g., mobile phones, personal computers), semiconductors and semiconductor equipment.
David Kastner, Director, Senior Investment Strategist, Schwab Center for Financial Research, takes a view on 11 equity sectors, including Information Technology. Excerpts (On Information technology):
Information technology is a highly concentrated sector, with just a handful of companies representing more than 50% of the sector’s weight—including the two behemoths Apple and Microsoft.
While those are typically the primary driver of sector performance, impacts related to COVID-19 have been broad-based and positive for much of the sector, increasing consumer demand for PCs, gaming hardware, software, personal devices and online payment services (although at the expense of traditional credit card services by Visa and MasterCard)—though consumer tech demand may fade after the COVID-19-related surge.
Following a dearth in capital spending, there are signs that investment in cloud and networking equipment is picking up, which could persist if the economic expansion continues.
Also, the ongoing rollout of 5G wireless infrastructure is likely to accelerate—increasing demand for telecommunication components and semiconductors. A significant short-to-intermediate risk is the supply chain issues, which is proving to be significantly problematic for sourcing semiconductors.
Longer term, a trend away from globalization and pent-up demand for productivity-enhancing technologies are likely to improve the already solid financial position for much of the sector.
Counterbalancing the strong fundamentals, investor optimism about future growth potential has pushed many valuation measures to well above the historical average; higher interest rates can weigh on investors’ perceived value of future earnings. Additionally, there are rising legislative and antitrust risks for some of the largest companies in the sector.
Finally, strong relative price momentum earlier in the COVID-19 crisis has faltered in recent quarters.
Positives for the sector
- 5G rollout and onshoring trends are themes that support fundamentals.
- Generally strong balance sheets and earnings growth potential with low funding costs;
- Financial services technology and surging online retail sales are supporting cloud computing infrastructure and software.
- Long-term growth tailwinds, as businesses enhance productivity with tech investment;
- Capital expenditures have an improving outlook—particularly with the prospects of technology infrastructure spending.
Negatives for the sector
- Valuations are very stretched relative to the historical average, making expectedly higher interest rates a significant headwind.
- Semiconductors are in short supply amid very low inventories and strong demand.
- The sector is highly concentrated in a few stocks.
Risks for the sector
- Potential antitrust suits in the U.S. and Europe.
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