This Citywire Switzerland article was written by Julien Serbit, portfolio manager at Geneva-based Prime Partners.
Information technology has been the biggest outperformer of the year and the sector has surprised many investors, with its main constituents – Apple, Google and Facebook – delivering strong earnings quarter after quarter.
But is the MSCI Information Technology index still the same investment that it used to be? Betting on a continuing tech rally in 2018 certainly sounds risky, but what can we expect to see in the coming year?
Five main segments make up around 70% of the index: internet software and services, technology hardware, storage and peripherals, systems software, semiconductors, and data processing and outsourced services. This segment diversification is not to be underestimated.
What's more, the variety to be found in the index's current top ten stocks underlines the appeal of investing through an ETF. For example, Apple, Google, Facebook and Visa are nowhere near as alike in their activities as Exxon, Chevron and Schlumberger in the energy sector.
A market consolidation scenario resulting in the dilution of this diversification among the big tech names would certainly be unappealing. However, other sectors could feel the impact of that sort of consolidation even more keenly than tech, due to stronger correlations in their top 10 components.
Big IT players tend to become diversified companies, offering more than their initial pure technological solutions to clients. Unfortunately, these firms are necessary investments if you're looking to access the digitisation trend for a wide base of consumers.
After an exuberant year and the arrival of many new competitors bringing continuous innovation (mainly from China), it seems wise to take note of the recent profit-taking and 'window dressing' on IT stocks. This is likely to be one of the catalysts for an equity market setback in 2018, and that's why we're not diving in head-first right now.
IT stocks are certainly far from cheap. But does that constitute dangerous exuberance? No, not at all.
The situation undoubtedly differs from the dotcom mania of the early 2000s: for one, the global environment is different, with negative rates in many developed countries. What's more, the IT sector’s price-to-earnings ratio is close to those seen on the S&P 500. The internet, with all its related products and services, has developed considerably over the past 15 years and is now used as a key tool in almost all industries. These elements remain broadly supportive for IT stocks against the overall markets in 2018, even if a slight setback is possible.
Two non-financial elements may shake up the information technology sector in the coming months: first, a regulatory trend could emerge to prevent tech giants from becoming too diversified and to curb their oligopolistic tendencies. Second, a new 'communication services' sub-sector in the MSCI classification is on its way and will reshuffle the cards in terms of index concentration.
A measured approach
From our point of view, ignoring the continuation of the digitisation trend by avoiding investments in the tech sector is not wise for 2018.
However, betting aggressively on a new series of successful earnings results next year would also be a risky move.
As usual, it's a question of balance and timing when it comes to successfully navigating the exciting world of information technology next year. Taking some profits can be justified after a strong year, but don’t abandon a positive stance on IT for 2018.