Is The Technology Sector Headed For Another Q2 Breakout?

Summary

• The Technology sector is one of the hottest market sectors heading into 2018, led by Electronic Equipment, Telecommunications and Software stocks.
• My quantitative and technical models indicate unusual cyclical patterns that look very positive for Tech stocks into April and beyond.
• This article considers several of the top Technology ETFs and the top holdings that are delivering the highest returns.
• Additionally, individual breakout stocks are selected for significant gains.
• I fully anticipate that the stocks and funds mentioned in this article will outperform this year due to changes in tax law and the strong increase of investments evidenced in this sector.

From the Big Picture to Individual Stock Breakouts

This analysis starts with a 14-year chart of the Dow Jones US Computer Services Index shown below. This sub-sector of technology is one of many industries showing strong growth and a recent surge in volume over the past year. The technical indicators illustrated below also correspond to a potential breakout move in the coming month that could sustain through 2018.

(Source: StockCharts.com)

The technical aspects of the multi-year chart show a number of strongly positive indicators:

• Relative Strength of the Index is positive and increasing with an RSI of 70.
• The ADX 14 measure of higher highs growing larger than lower lows confirms a positive uptrend at a relatively low level for significant upside growth potential.
• The average volume in this sector from 2017 to today is significantly higher than, if not more than double that of, previous levels shown in the Computer Services Index.

The Technology Select Sector SPDR ETF (XLK) tracks an index of S&P 500 technology stocks and can be viewed as a good proxy for the technology sector. With $20.58 billion under management, this is the largest ETFs concentrated on the technology sector. A seasonality performance chart of XLK for the past five years from 2013 shows a strong pattern of consistent performance from March through May of each year. Since 2013, the fund has gained in April 4 out of 5 years (80%), for an average +0.4%, and gained in every year in May (100%) by an average of 3.4% as shown below:

(Source: User generated from StockCharts.com)

The first half of the year performance shows particularly strong growth between February and May, usually with underperformance in June of each year since 2013. Compared to the S&P 500 over the past five years, XLK has performed extremely well each year in May, with an average of +1.6% better than the SPY ETF proxy for the S&P 500 as shown below:

(Source: User generated from StockCharts.com)

While this unusual seasonality pattern is no guarantee of future results, it does show where the most positive monthly results have trended over the past 5 years and which months to avoid. The technical chart above may also support the strong move again into April and May, where XLK has gained 80% and 100% of the time since 2013, with a sharp decline in June technology performance.

Further, the technical analysis of the underlying stocks in the technology ETF which follows below also supports the seasonality timing depicted in the bar charts above over the past five years. We certainly could see a repeat of strong growth that outpaces the S&P 500 again this year over the next few months. Some ideas on how to capture this unusual seasonality effect in the technology sector are listed below.

Exchange-Traded Funds to Capture Technology Sector Value

Seven selected exchange-traded funds that seek to index, and in some cases, leverage the composite of the S&P 500 Technology Index or key firms in the Nasdaq or NYSE Technology Sector are shown with their respective returns in the list below. A brief description of each of the seven ETFs will give you some perspective on the differences and strengths of each.

1. Technology Select Sector SPDR ETF - This is the largest of the ETFs that focus on the technology sector with $20.67 billion in assets. The 1-year performance is 31.86%

2. Vanguard Information Technology ETF (VGT) - This ETF has $19.58 billion in assets, and the 1-year return of 35.14%. This is another of the largest funds that tracks the technology sector indexes.

3. Direxion Technology Bull 3X Shares ETF (NYSEARCA:TECL) - This is an approximately 3x leveraged ETF with $647 million in assets and a 1-year return of 106.50%. Like all levered funds, it tends to underperform in volatile markets if held for longer than its reset period, and is only suitable for short-term trading positions.

4. ProShares UltraPro QQQ ETF (TQQQ) - This is another aggressive 3x leveraged ETF with $3.4 billion in assets and a 1-year return of 100.50%.

As a levered product, TQQQ is not a buy-and-hold ETF; it’s a very short-term tactical instrument. Like many levered funds, it delivers 3x exposure only over a one-day holding period. Technology companies dominate TQQQ’s underlying index - the Nasdaq-100 - so TQQQ’s future performance is tied closely to the performance of the tech industry.

- ETF.com

5. First Trust NASDAQ-100-Tech Index ETF (QTEC) - This is a technology sector fund tied to the Nasdaq 100 technology sector index with $2.4 billion in assets under management and annual return of 35.75%.

6. SPDR NYSE Technology ETF (XNTK) - This smaller fund has $966 million in assets under management and is focused on NYSE technology stocks. The 1-year return was 41.83%.

7. ProShares Ultra Technology ETF (ROM) - This fund concentrates daily 2 times exposure to the Dow Jones US Technology Index. The fund has $319.7 million assets under management and annual return of 72.42%.

Many more funds are available to examine on ETF.com, but these seven selected funds comprise a wide range from the largest to the smallest funds, all among the very top-performing Technology sector funds for different applications and risk tolerances.

A Deeper Look at a Top-Performing Technology ETF for 2018

For purposes of analysis, and to continue this dive into more granular data, I have selected TECL as a top-performing Technology ETF fund with a return of 106.50% over the past year.

Again briefly, TECL is an approximately 3 times leveraged ETF with $647 million in assets. An 18-month performance chart below of TECL illustrates the upward-trending price of this high-performing fund.

(Source: Finviz.com)

We can see a number of strong technical indicators and price patterns on both the weekly TECL chart above and the daily TECL chart shown below:

• The Relative Strength on both charts shows strong positive momentum with values in the 60s, with plenty of upside potential.
• The weekly chart shows a breakout of the ADX 14 indicator to positive price momentum, and that is not as clear in the daily chart ADX 14.
• In both charts, the price is tracking at the lower range of the positive trending price channel, with upside potential to the 150 price range and higher.
• The money flow index on the weekly chart has moved significantly more positive, denoting higher inflows, which tend to drive higher prices.

(Source: Finviz.com)

Diving into the Top 10 Holdings of a Top Technology ETF

The top 10 holdings of TECL as of December 31, 2017, are listed below from publicly available fact sheets. In total, these 10 positions represent 61.09% of the fund's assets.

Next, I will examine how these 9 largest stock positions (combining Alphabet stock classes) look individually and analyze whether we see positive potential price performance in the coming year for these top picks in the Technology sector. The technical and fundamental parameters assessed are based on the criteria I use for evaluating strong momentum characteristics from my doctoral research. We will start with the largest holdings and work down to the smallest of the nine stock positions.

1. Apple (AAPL)

(Source: Finviz.com)

The positive RSI trend and SMA 20 crossover confirm some initial momentum in the short term, but it is not particularly strong as a breakout yet. Similar technical conditions of ADX and MFI are showing some weakness, with money flow currently flat.

Additional highlights for Apple include:

• Analyst consensus price target at $192.43
• EPS Q/Q growth +30.90%
• Forward P/E of 13.38
• Sales Q/Q growth +12.70%
• Analyst recommendation - 2.10 Buy

2. Microsoft (MSFT)

(Source: Finviz.com)

The positive trending trade channel is bullish, as well as the positive conditions of the RSI. ADX 14 may be setting up for another positive price move; however, money flow is trending downward, indicative of increasing net outflow. Conditions show a consolidation period that may be headed for stronger Q2 price performance but not an immediate breakout.

The highlights for Microsoft include:

• An initial price target of $104.24
• EPS Q/Q growth +21.50%
• Forward P/E of 23.78
• Sales Q/Q growth +12%
• Analyst recommendation - 1.80 Strong Buy

3. Facebook (FB)

(Source: Finviz.com)

Facebook is showing strong positive technical conditions with RSI breaking positive and the price moving above the negative trending price channel. This move with the increasing money flow index looks to be a very positive indicator of increasing price performance.

The highlights for Facebook include:

• An initial price target of $222.81
• EPS Q/Q growth +54.80%
• Forward P/E of 20.33
• Sales Q/Q growth +47.30%
• Analyst Recommendation - 1.80 Strong Buy

4. Alphabet (GOOGL)

(Source: Finviz.com)

The technical pattern for Alphabet looks very positive with RSI increasing and moving above 50. The price is trending toward a retest of the top of the current price channel around $1140. Money flow is weak and indicates a current net outflow, but this is a lagging indicator, and price performance looks strong here.

The highlights for Alphabet include:

• An initial price target of $1280
• EPS Q/Q growth 27.00%
• Forward P/E of 22.69
• Sales Q/Q growth 24.00%
• Analyst Recommendation - 1.80 Strong Buy

5. AT&T (T)

(Source: Finviz.com)

AT&T is coming up off a retest of the bottom of a positive price channel with increasing RSI and money flow. The technical indicators are mixed but beginning to show more positive price movement ahead.

The highlights for AT&T include:

• An initial price target of $40.65
• EPS Q/Q growth -150.40%
• Forward P/E of 10.71
• Sales Q/Q growth -0.40%
• Analyst Recommendation - 2.50 Buy/Hold

6. Intel (INTC)

(Source: Finviz.com)

The technical indicators for Intel look very positive. RSI is a strong 66 and rising on a positive trend. The ADX 14 line has shifted positive and looks poised to increase along with prices in the near future. The current price is at the higher end of the positive price channel and could break out for significant gains in the near term.

The highlights for Intel include:

• An initial price target of $52.69
• EPS this year up 37.90%
• Forward P/E of 13.36
• Sales Q/Q growth 4.10%
• Analyst Recommendation - 2.30 Buy

7. Visa, Inc. (V)

(Source: Finviz.com)

The technical indicators for Visa are relatively flat, but the price performance is maintained in the current positive trending price channel. The RSI is showing some early signs of strength, and the price may retest the upper levels of the channel around $135.

The highlights for Visa include:

• An initial price target of $140.23
• EPS Q/Q growth -29.30%
• Forward P/E of 23.32
• Sales Q/Q growth 9%
• Analyst Recommendation - 1.80 Strong Buy

8. Cisco (CSCO)

(Source: Finviz.com)

The technical indicators for Cisco are in positive territory but declining. RSI of 58 is good but showing a downward trend. The ADX 14 line is in positive territory and indicates some price consolidation at these levels between 43 and 46 in the short term. The money flow has crossed into net outflow and indicates price weakness.

The highlights for Cisco include:

• An initial price target of $48.38
• EPS Q/Q -482.2%
• Forward P/E of 15
• Sales Q/Q growth 2.70%
• Analyst Recommendation - 2.00 Buy

9. Verizon Communications (VZ)

(Source: Finviz.com)

The technical indicators for Verizon show early signs of positive price reversal that require broader confirmation over time. RSI is low at 43 but trending positively toward strength above the 50 line. Money flow shows negative outflow and has not yet reversed the overall trend. Momentum is turning positive and will test resistance first at the $50 price line.

The highlights for Verizon include:

• An initial price target of $55.88
• EPS Q/Q growth -58.50%
• Forward P/E of 10.49
• Sales Q/Q growth 5%
• Analyst Recommendation - 2.60 Buy/Hold

Putting the Pieces Into Perspective

When we examine all nine stocks collectively that currently make up approximately 61% of the TECL 3x leveraged technology top holdings, the outlook seems very promising.

(Source: Finviz.com)

Each of these 9 stocks has a Buy or Strong Buy rating from analysts. Most have strong fundamentals and are trending well in positive price channels, all with substantially higher consensus price targets from analysts. Each of these top firms has a market cap at or above $200 billion, with Apple the highest market cap at $903.3 billion. The 3 times leverage factor of the TECL ETF greatly increases risk and potential returns from the very positive technology sector going into 2018. While these stocks look to perform very well again soon, smaller technology firms may also deliver very good results into 2018.

What do the Small-Cap Technology firms have to offer?

So, after a look at 7 technology ETFs, and a brief technical decomposition of 9 of the top holdings of the TECL ETF, there are some of you who might still be curious about what opportunities the small- and micro-cap technology stocks have to offer. Well, I'm glad you asked!

My Weekly Breakout Forecast articles published throughout 2017, and now into 2018, have identified a number of technology stocks that may continue with strong momentum in the year ahead. While the forecast selects from among the best stocks at that time across all sectors, I have highlighted some strong technology performers from prior weeks this year on the list below, with a link to each original article for your further consideration.

• FireEye (FEYE) +19.66% from Week 7 Breakout
• eGain Communications Corporation (EGAN) +39.23% (for subscribers) from Week 7 Breakout
• QuinStreet (QNST) +39.39% from Week 5 Breakout
• KEMET Corporation (KEM) +10.56% from Week 2 Breakout

This small sample of stocks still shows the momentum characteristics for growth in a Technology sector that is ready for more price appreciation. Often, the small-cap stocks lead the way and signal a larger, more broader move to come. This article serves to give you many different ways to participate in what I believe will be a significantly strong move in a recurring Q2 pattern for the Technology sector.

You may also want to take a look at other articles and portfolios I offer, like the Breakout Portfolio that is up +55.80% through last week.

Latest stock selections here: Week 10 Breakout Forecast: Short-Term Picks To Give You An Edge

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As always, I wish you the very best in all your investments!

JD Henning, PhD, MBA, CFE, CAMS

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.