Information Technology Sector Rating: Neutral

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. The impact of stay-at-home behavior during the COVID-19 pandemic and increased consumer demand for personal computers, gaming hardware, software, and personal devices may slow as the positive impact from fiscal stimulus fades. And the ongoing supply chain issues continue to be a problem for sourcing semiconductors, resulting in high order backlogs for business and consumer electronics.

Business investment in information processing, software, and industrial equipment in the U.S. has increased significantly. The Technology sector continues to play a pivotal role in advances in robotics and automation, the transformation toward big data and cloud computing, the software and artificial intelligence that make it work, and smartphones, tablets, and network interfaces to enable us to use it. In the wake of the COVID-19 pandemic, higher wages, labor shortages and input inflation has resulted in an acceleration in investment in productivity- and labor-enhancing technologies.

Counterbalancing the strong fundamentals, investor optimism about future growth potential has pushed many valuation measures to well above their historical averages, and higher interest rates may weigh on investors’ perceived value of future earnings—though there is little evidence of a direct relationship between Technology relative performance and interest rates. Additionally, there are rising legislative and antitrust risks for some of the largest companies in the sector.

The Russian invasion of Ukraine in late February, and the ongoing political response, has clouded our outlook on equity sectors. Due to the unprecedented and volatile series of events, the economic and market landscape has become highly uncertain.

Until there is more clarity on how the sharp rise in commodity prices, tightening of financial conditions, and likely Federal Reserve interest rate hikes might impact the economy and underlying fundamentals that drive relative sector performance, we think it’s prudent to maintain sector allocations that are in line with the overall market.

Positives for the sector:

• Fifth-generation (5G) cellular network 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 are likely as businesses enhance productivity with tech investment
• Capital expenditures have an improving outlook—particularly with the prospects of higher technology infrastructure spending

Negatives for the sector:

• Valuations are very stretched relative to the historical average, making expectedly higher interest rates a significant headwind due to investor perception.
• Semiconductors are in short supply amid very low inventories and strong demand—though the chip industry is seeing strong revenue growth
• The sector is highly concentrated in a few stocks

Risks for the sector:

• Potential antitrust lawsuits in the U.S. and Europe.