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Image via WikipediaBy PAUL J. LIM
THE stock market has been fighting an army of economic worries — including slowing economic growth and corporate earnings, a weakening dollar and what until last week were surging oil prices.
For the most part, investors have been so focused on the excellent performance of individual companies that they’ve been willing to overlook these threats. But with first-quarter earnings season nearing an end, “the market will refocus from the micro- to the macroeconomic picture,” says Jeffrey N. Kleintop, chief market strategist at LPL Financial. And once that happens, he contends, the view won’t be as rosy.
If economic head winds strengthen — a distinct possibility — some strategists say the market could shift in meaningful ways. For starters, stocks could suffer their first major pullback or correction since last spring, when fears over Europe’s fiscal crisis dominated the news. At the same time, technology stocks, which have been laggards this year, could become a favored sector if they benefit from some of the same forces that trouble other parts of the market.
Right now, the broad market’s performance is “approaching too-good-to-be-true status,” said Brian G. Belski, chief investment strategist at Oppenheimer. Historically, equity prices tend to move in anticipation of corporate earnings growth, which tends to recover before the broad economy does, Mr. Belski said. “Well, in the last two years, we’ve seen the market double and a huge rebound in profits,” he said. “Yet it remains to be seen if the economy will follow through and deliver on its part.”
Last month, the Commerce Department reported that gross domestic product grew at a slower-than-anticipated annual rate of 1.8 percent in the first quarter, down from 3.1 percent at the end of 2010.
David C. Wright, managing director of Sierra Investment Management, said he was particularly worried that high food and fuel costs were making it hard for consumers to spend much on anything else. He said he was also concerned that despite economic worries, stocks are more expensive than they’ve been in years, leaving little room for error. Based on 10-year average earnings, the stock market’s price-to-earnings ratio is currently more than 23, versus the long-term average of 16. The last time the ratio was this high was in late 2007, at the start of the last bear market.
By contrast, tech stocks are significantly less frothy than they’ve been in years. Historically, shares of technology companies have traded at about a 30 percent premium to the broad market, based on their P/E ratios. That’s because tech companies have traditionally enjoyed faster earnings growth than other types of businesses. Today, however, technology’s P/E is on par with that of the overall Standard & Poor’s 500-stock index.
Yet tech is still exhibiting solid earnings growth. I.B.M., Apple and Intel were among several tech giants that have recently reported better-than-expected first-quarter profits.Intel’s results — which included a 25 percent jump in revenue — were particularly embraced by Wall Street, as they were viewed as a sign that demand for hardware like PCs may be stronger than anticipated.
Over all, tech sector earnings are on track to climb 25 percent in the first quarter, while revenue is expected to jump 15 percent, according to Thomson Reuters. By comparison, profits for the S.& P. 500 are expected to grow 18 percent, while sales predicted to climb 9 percent.
Earnings aren’t the only area where some tech businesses are financially healthier than the typical S.& P. 500 company, said Robert E. Turner, chief investment officer at Turner Investment Partners, a money management firm in Berwyn, Pa. For one thing, big tech companies are sitting on billions of dollars in cash, which they are starting to use to raise dividends and make acquisitions. Recently, Texas Instruments announced plans to buy a rival, National Semiconductor, for $6.5 billion — representing more than a 70 percent premium to what the stock had been trading for.
Despite a surprising uptick in operating expenses recently reported by Google, tech companies in general are doing a better job of keeping their costs under control. In fact, according to Deutsche Bank, tech is one of only three market categories where expenses as a percentage of sales have been falling over the past five years. (The others are health care and consumer staples.)
Even if energy prices resume their rise, analysts note that technology companies aren’t likely to be hurt as much as other parts of the market because oil isn’t as large a component of expenses as it is in sectors like the industrials or transportation.
At the same time, tech spending could actually benefit if oil prices rise, because other companies and consumers are likely to look for ways to improve productivity and lower expenses. That may mean a jump in investment in technology.
Mr. Turner noted that the two biggest drivers of tech growth these days are mobile computing and — despite the recent outage at Amazon’s data centers — so-called cloud computing, where companies offload costly computer applications and data storage to servers run by third parties like Amazon and Microsoft.
Both mobile technology and cloud computing “are all about improving efficiency and cost savings,” Mr. Turner said.
Yet some of the companies that stand to benefit from this trend, like Microsoft, Intel andCisco Systems, are trading at P/E ratios of 10 or less, based on projected earnings.
“I have a bit of trouble understanding why they’re so cheap,” he said.
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