Sector Spotlight: Technology As A Growth Engine In 2016?

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Includes: FTEC, FXL, IGM, IYW, MTK, QTEC, REW, ROM, RYT, TECL, TECS, VGT, XLK
by: TD Ameritrade

From driverless cars to robotic dogs to smart bracelets, technology is driving innovation, and many consumers are along for the ride. On a larger scale, businesses want higher levels of network security and efficiency that they believe only regular technology upgrades can deliver.

For investors, the range of possibilities is wide. The information technology sector includes cloud computing, anytime/anywhere connectivity, and social media. Some analysts go as far as to say the future of the global consumer and global commerce can be found within this sector. IT is home to big-name companies, including Apple (NASDAQ:AAPL), Facebook (NASDAQ:FB), and Google parent Alphabet (GOOGL, GOOG), and bullish analysts say strong earnings growth and attractive balance sheets could generate continued investor interest in 2016. Briefing.com tapped IT as one of its top sector picks for 2016.

Big Share of the Pie

Out of the 10 S&P 500 stock sectors, Information Technology is the biggest, at nearly 21% market value of the S&P 500, notes Sam Stovall, managing director at S&P Capital IQ. It is a cyclical sector, meaning it tends to fluctuate with economic ebb and flow. In 2015, the S&P 500's information technology sector beat the nearly flat returns of the broader market with a 4.3% year-end return.

For investors looking to diversify their portfolios across various stock sectors, technology may be worth a hard look. "If one were to ask, what's the poster child for growth within the overall market? Most would say technology," Stovall says.

The current fundamental backdrop for key industries has some positive features, including hardware and storage, communications equipment, and semi-conductors, Stovall says. "In a slow economic-growth environment, companies are looking for a competitive edge. Usually that competitive edge comes in the form of technology and tech spending," he says.

Earnings Lift?

Expected stronger earnings growth could be a boon to information technology in 2016, and the cash-flush sector isn't burdened by high debt levels relative to other sectors, adds Patrick O'Hare, chief market analyst at Briefing.com.

"The technology sector is trading at a discount to its 20-year average [price-to-earnings] ratio. It's not like the late 1990s, when tech was trading at 66 [times] trailing earnings and people still thought it was a great buy," Stovall says. With a current P/E at 15.6, technology stocks are trading at a 29% discount to their median P/E of 22 since 1995, he notes. Overall, technology earnings are expected to increase 7.7% in 2016, S&P Capital IQ projects.

No sector is without risks, however. IT is a very international sector that relies on foreign sales for a portion of its revenues, and that leaves it vulnerable to currency movements. "If the value of the dollar rises dramatically, it could serve as a headwind for technology," Stovall warns.

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