SET Monthly Issue July 2016
RUNNING WITH THE BIG DIGITAL DOGS
No corner of our sprawling economy is as disruptive, dynamic, and innovative as the technology sector.
Tech is also the single largest part of the economy, even larger than the financial or industrial sector. No company in the technology sector can take anything for granted, not in a business where yesterday’s dazzling breakthrough can so quickly become yesterday’s news and crumble into irrelevance.
Investing in tech is the classic exercise in risk and reward. Too many investors have been lured into trouble by tales of “The Next Microsoft”… only to find that better products don’t always sell.
Some of you will remember the war between Betamax and VHS in the now ancient days of video tapes. Betamax from Sony was technically superior. It produced a better image. But VHS from JVC won out over Betamax for two other reasons… the machines were cheaper, and you could record longer on a single tape.
This priceless lesson from the history of tech investing is to watch the consumer, not the product. Because of this, large and established tech companies like Apple and Microsoft give investors an edge.
Big companies may be bloated when it comes to bureaucracy. That’s par for the course for a mature organization. But there’s a different behavior demonstrated by large, well-established tech companies that more than compensates for this.
Because they have been competing for decades, they have learned the lesson of listening to the market.
And while the big dogs listen, they’re waging a constant competitive battle against upstarts. Mid-size and smaller tech firms are scrambling to innovate, capture market share, and deliver profits.
We think this is a good time to invest in technology, and why this month’s recommendation is the Vanguard Information Technology ETF (NYSE: VGT).
WHY NOW
Global uncertainties mean this is a particularly good time to invest in companies with solid financial foundations.
Traditionally, investors flock to the financials and financial services for this kind of strength, but right now, there’s a one-two economic punch that makes this difficult.
There’s the combination of low interest rates and the uncertainties of the regulatory environment. Regulators could force banks to put more money into reserves and other safety nets, which could further slam the brakes on the financial sector.
Technology offers what retail banks, investment banks, and financial services firms don’t… financial strength.
When we look at tech, we’re looking at organizations with incredible cash flow and fairly low capital expenses.
We’re also looking at a sector where demand for products and services is strong.
On the consumer side, the appetite for mobile services (and the software that makes it possible) isn’t about to vanish. Neither is the thirst for social platforms.
On the corporate side, there’s even more upside. Companies are still shifting to remote servers and cloud computing. There’s significant growth in software as a service (SaaS), where software applications are collected online.
Because the cloud and SaaS give companies a way to reduce IT expense, we see strong continued growth.
There is also big data, real-time analytics to help businesses develop a better understanding of their processes, their customers, and their performance.
So it’s not as if the big tech companies have run out of gas and don’t have anything left to sell. Innovation is alive and well. The only question is, what’s the smart way to invest to capture the upside?
We like the three-pronged approach of the Vanguard Information Technology ETF.
Actually, the fund takes two different three-pronged approaches. The ETF tracks the performance of the MSCI US Investable Market Index that offers two different diversification benefits.
DIVERSIFICATION BENEFIT #1
The fund is invested in large, medium, and small companies. The diversification by market cap gives investors a simple way to benefit from the market’s preference for different sized stocks. When small-caps fall out of favor, you have exposure to mid-caps and large caps.
DIVERSIFICATION BENEFIT #2
The fund covers three tech sectors…
Software and services… firms that focus on developing software for applications, systems, databases, management, the internet, and entertainment.
IT Services… data processing, outsourced services, and general information technology consulting.
Hardware and equipment… manufacturers and distributors of computers and peripherals, electronic equipment, semiconductors, semiconductor equipment manufacturers, and communications equipment.
There’s just about everything collected under the massive tech umbrella, and this diversification within the sector is what draws us to Vanguard’s Information Technology ETF.
We can insulate ourselves from some of the expected volatility of tech stock prices.
When hardware sales are sluggish, we can offset the slowdown with strength elsewhere in the sector, such as services and consulting.
As you can see from the two-year chart, this ETF is prone to some swings, but there is a pattern of recovery from the dips.
THE ETF’S OBJECTIVES
The First Vanguard Information Technology ETF (NYSE: VGT) tracks the performance of the MSCI US Investable Market Index (IMI)/Information Technology 25/50. It’s made up of stocks of large, mid-size, and small U.S. companies in the IT business.
The top five holdings and percentage weight for VGT:
| Company Name | Ticker | % Weight | ||||
| Apple Inc. | AAPL | 12.65 | ||||
| Microsoft Corp | MSFT | 9.10 | ||||
| Facebook Inc. A | FB | 6.23 | ||||
| Alphabet Inc. C | GOOG | 5.23 | ||||
| Alphabet Inc. A | GOOGL | 5.01 | ||||
| 07/03/16 | ||||||
A Closer Look At The Top 5 Holdings
They’re not just familiar names – they’re usually front-page news.
Apple Inc.
One remarkable achievement after another, and one common question as investors ask, “What’s next?”
We’ll leave the forecasts to others. Apple watching has grown from obsession and intrigue to cottage industry. Great company, great stock.
Microsoft Corp.
Other tech companies might capture the lion’s share of headlines, but Microsoft is doing just fine.
Fiscal year 2015 revenue was $93.6 billion. Expenses were $33.0 billion and gross profit was $60.5 billion for a gross margin of 64.7%.
Microsoft revenue flows in from software products, including operating systems, server applications, software development tools, online advertising, hardware products including PCs and tablets, cloud-based solutions, consulting, product support, and training and certification services.
A few months ago, Microsoft stirred up some intrigue after announcing plans to stop selling its video game console, the Xbox 360. Industry analysts figure there’s a next-gen product in the works.
Facebook Inc.
The money keeps pouring in – more than $1 billion a quarter in ad revenues. Earnings expectations are always high, and a soft quarter or a missed analyst’s consensus target could put the brakes on the stock price.
But if and when this happens, we expect the impact to be short-lived. Facebook isn’t going away anytime soon.
Alphabet Inc.
From advertising services to Google search, and YouTube to the Chrome browser, Alphabet (formerly known as Google) continues to stake its online claim.
(The difference between Alphabet A stock and C stock… not much. Google stock split in April 2014 and went into two different classes of shares. After the one-for-one split, the number of shares doubled and the price dropped in half. The only distinction: A shares get one vote and C shares get none.)
Other top holdings include Oracle, Intel, Cisco, and IBM.
Trade Alert
Buy: Vanguard Information Technology ETF (NYSE: VGT) up to $110.00
Recent Price: $106.29
Price Target: $127.00
Stop Loss: $97.50
SECTOR SPOTLIGHT
YEAR TO DATE SECTOR PERFORMANCE
| Consumer Discretionary | XLY | +0.91% | ||||
| Consumer Staples | XLP | +8.71% | ||||
| Energy | XLE | +13.73% | ||||
| Financial Services | XLFS | -7.57% | ||||
| Financials | XLF | -4.57% | ||||
| Health Care | XLV | +0.18% | ||||
| Industrials | XLI | +6.00% | ||||
| Materials | XLB | +6.77% | ||||
| Real Estate | XLRE | +7.65% | ||||
| Technology | XLK | +1.49% | ||||
| Utilities | XLU | +21.26% | ||||
PORTFOLIO UPDATES
. . . . First Trust ISE-Revere Natural Gas Index Fund $FCG – HOLD
Natural gas prices are slumping again, largely driven by warm weather.
The price target is $37.00. Continue holding.
. . . . PowerShares S&P SmallCap Energy ETF $PSCE – BUY
There’s been a pullback in energy prices, a reflection of overall Brexit fallout.
The price target is $27.00.
. . . . First Trust NASDAQ Community Bank Index Fund $QABA – BUY
The difficult stretch for the financials and financial services firms remains with us. We continue to expect community banks to weather the storm better than larger banks with global exposure.
The price target is $46.00.
. . . . Aberdeen Chile Fund $CH – BUY
Another one of our ETFs throttled by Brexit fallout. We expect copper prices to strengthen, which will bolster Chilean exports.
The price target is $11.00.
. . . . SPDR S&P Homebuilders $XHB – HOLD
It’s been a good spring for new home sales. 2016 is outperforming 2015 by 8%.
The price target is $50.00.
. . . . Utilities Select Sector SPD $XLU – HOLD
We seem to pass along the same news each time we update you. Utilities are a safe harbor in a stormy market. Noteworthy for this briefing: one of the underperformers in the sector, Southern Company (SO), has been gaining steam after a sluggish spring.
. . . . iShares Medical Devices ETF $IHI – HOLD
Business in the sector continues to be strong. The sweet spots: electromedical equipment, such as scopes, defibrillators, EKGs, MRIs, pacemakers, ultrasounds, CT scanners, and X-ray machines.
The price target is $140.00.
Portfolio Changes
- This month we’re buying Vanguard Information Technology ETF (NYSE: VGT) up to $110.00
Category: SET Monthly Issues
