Why The Tech Sector Will Go Even Higher

by: Victor.


Even though Donald Trump's initial policies do not favor the tech companies, he is going to change his stance yet again.

Meanwhile, the world is undergoing a change of Industry 4.0, where leaders in the technology sector are very likely to be benefited.

In conclusion, the tech sector is very likely to go much higher, even though it will not be without ups and downs in the short run.

The technology sector has been one of the best performers since Donald Trump became the new US president. While the S&P 500 (NYSEARCA:SPY) rose about 15% in the past 12 months, the S&P IT Index (NYSEARCA:XLK) did better at 36%. In this article, I will look into the factors behind this bullishness, and I believe this sector is likely to continue outperforming the market.

^SPX Chart

Since the election, the market has been going exactly against the promises of President Trump. For example, even though Trump said he would put America first and help local manufacturers to come back to life, the industrial companies (XLI) have not substantially outperformed the general market in the last few months. On the other hand, he has vowed to smash Obamacare, but the healthcare industry (XLV) has been one of the best-performing sectors since the start of 2017.

^SPX Chart

Still, the most puzzling of all is the mysterious strength of the technology sector. Trump has declared that he would shut down the borders, start trade wars with foreign countries, and ban immigrants from other places. It will decrease opportunities for global business as well as the availability of expatriate talents, and these are certainly not what the Silicon Valley would like to see. So, despite such seemingly unfriendly policies, why do investors still pour their money into the tech companies?

My explanation is that investors simply do not believe that Trump will do what he has claimed he would do. One of the wisest things I have heard about the current US president is that, while the media takes Trump literally but not seriously, his fans take him seriously but not literally. In other words, Trump is a businessman, and his words are merely rhetoric to get him what he wants, so he is liable to change his first stance any time.

So far, Trump has indeed flipped on some of the big issues. The president said he would identify China as a currency manipulator, and then he said he would not. Trump said his government was likely to replace Janet Yellen, but then the press reporting him saying it was not true. He said he would not attack the Middle East, but then he signed an offensive against Syria. It is not hard to imagine that Trump would eventually become friendly to the Silicon Valley shortly.

In other words, the market is digesting a possible reversal of the president's stance. I expect that, once Trump openly acknowledges that the economy is not very strong and admits that it is not the best time to implement his ideas, the tech index would correct a little bit to "sell the fact". It is possible that it may happen after the June rate hike, when it becomes apparent that the underlying situation is not strong enough for higher interest rates, and the government will have no choice but to revert to the QE tricks of the past eight years.

Despite all this, it is worth noting that, even though most of the technology leaders are reaching new 52-week highs in their share price, some of them are still quite cheap with regard to their forward price-to-earnings ratios. For example, Lam Research Corp. (NASDAQ:LRCX) produces etch and cleaning systems used in water fabrication equipment for the semiconductor industry, and it has a forward P/E of 15 at the time of writing.

LRCX Chart

Also, Applied Materials Inc. (NASDAQ:AMAT) makes deposition, inspection and equipment used in integrated circuits and flat panel semiconductors, and it has a P/E of 16.

AMAT Chart

Similarly, Microchip Technology (NASDAQ:MCHP) creates digital signal micro-controllers, flash memory products and interface devices, and has a P/E of 17.

MCHP Chart

Lastly, Synopsys Inc. (NASDAQ:SNPS) provides semiconductor design, verification platforms and integrated circuit products, and it has a P/E of 23.

SNPS Chart

Of course, a low P/E ratio alone certainly does not mean the company is a bargain, but it gives you an idea how many candidates in the sector are attractive to both value and momentum investors. I believe the underlying reason for this phenomenon has something to do with the long-term prospect of the industry. In other words, investors see something valuable in the sector as a whole instead of just making a short-term speculation of policy reversal.

According to Professor Klaus Schwab, founder and executive chairman of the World Economic Forum, we are now in the Fourth Industrial Revolution consisting of ground-breaking innovations like mobile supercomputing, intelligent robots, self-driving cars, and so on. The resulting disruptions have the potential to fundamentally change the ways in which we live and dramatically improve the efficiency of organizations. Tech companies around the globe are competing to be the first to implement these changes in the real world, and the US is one of the major players in this race.

Each era has a driving theme that creates great bull markets. In the nineties, it was the World Wide Web. In the new millennium, it was China and the emerging markets. Now it has come to artificial intelligence and labour-free manufacturing. If any real growth has to come out of the US in the future, the primary driver is very likely to be technological innovation. In other words, the bullish trend in the technology sector is a possible manifestation of the global macro trend towards intelligent robots, and as long as this narrative is in place, the long-term trend in the industry is unlikely to change.

In summary, even though the short-term political stance of Donald Trump is unfriendly to the Silicon Valley, he is liable to change anytime, as he has demonstrated so far. In addition to this, the macro-narrative of the next Industrial Revolution may fuel an underlying change in the sector, causing it to go up in the long term. Even though the trend is certainly subject to short-term volatility, I maintain an overall bullish perspective on it.

Disclosure: I am/we are long SNPS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.