Foreign Markets Power Top Tech's Growth

Many of iShares S&P North American Technology ETF's (IGM) top holdings gained ground during the second quarter, even as the broad market slid toward bear market territory. Apple (AAPL), IGM's recent No. 3 holding, leapt nearly 19% for the three months ending June 27; No. 6 holding Google (GOOG) jumped more than 20% in the same period; No. 8 holding Oracle (ORCL) gained about 10% and No. 9 holding Qualcomm (QCOM) surged about 14%. Only three of the fund’s top ten holdings lost ground for the period, and none dropped by more than 3%. The fund itself gained about 5%.

IGM held more than half its assets in its top ten holdings during those three months—standard operating procedure for this fund—so strong performance by the largest U.S. tech stocks gave the fund's momentum a strong boost. IGM ranked 14th on the ETF Momentum Tracker Sector Table last week, up from 33rd on April 8. Whether IGM's momentum continues to build will depend largely on a few factors: how much tech spending slows in response to the turmoil in the U.S. economy, the success of the latest products released by major U.S. tech firms, and the ability of those firms to tap into overseas markets.

The technology sector usually gets hit hard when the broader economy suffers, but many tech firms proved surprisingly resilient during the adverse economic climate of the last several months. Smaller firms and companies that rely heavily on U.S. markets faced challenges, but tech giants like Microsoft (MSFT), IBM (IBM) and Apple generated healthy profits. IBM, for example, on April 17 announced a 26% increase in profits from a year earlier. Big Blue owed its strong showing largely to heavy spending from its corporate customers—many of which invested in products and services designed to boost productivity and cut costs. Google released similarly impressive first-quarter results on the same day as IBM, reporting a 30% increase in profits from a year earlier. Many analysts expected Google's revenues from its search engine advertising to drop off due to the lagging economy, but sales abroad made up for fairly weak U.S. revenues.

Small-cap tech stocks have had an edge for the past several years, but the mood of investors changed with the subprime mortgage crisis and the economic downturn. Starting last fall, investors have favored more defensive positions in stocks of diversified companies with large cash flows. IGM, which recently had an average market capitalization of about $45 billion and a portfolio that includes almost all of the biggest names in technology, has benefited greatly from that shift.

The Goliaths of the tech sector continue to thrive even as the U.S. economy weakens, largely because they generate a substantial portion of their revenues in foreign markets. The weakness of the U.S. dollar has given American firms a major advantage overseas, by making prices of their products and services more competitive. Moreover, the sales produced overseas are now worth more after they’re converted to dollars.

The technology sector in general is highly sensitive to product cycles, and IGM’s returns reflect that fact. The fate of Microsoft's Windows Vista operating system, for example, will continue to have a strong influence on IGM's performance, as will the future of Apple's iPhone. Investors responded coolly to Apple's announcement in early June that the company would slash prices on its new, faster iPhone, sending shares in the firm down 9% for the month ending June 27. But the introduction of the mobile device into new international markets later this year could help the firm maintain its recent growth and help its stock regain the intense momentum it had last fall. Shares in Apple were down more than 14% year to date through June 27.

Microsoft experienced a 2% decline in revenues from its Windows business during the first quarter, which analysts attributed largely to the lagging U.S. economy. While Microsoft has seen strong results this year from its Server and Tools segment, the firm faces a number of challenges—ranging from Google's development of Web-based applications to compete with popular Microsoft programs to the firm’s failed attempt to acquire Yahoo! (YHOO). Shares in Microsoft were down more than 22% year to date through June 27.

IGM recently had a standard deviation of 15.72 for the trailing three-year period, meaning the fund was almost twice as volatile as the S&P 500 during that period. The technology sector is always unstable, but the added risk associated with this type of fund particularly stands out during turbulent times like these. On the other hand, the firms that are most likely to eke out growth and stock gains during a market slowdown are the large companies that dominate this fund's portfolio.

Comments

[mkreisel]

This is a terrible fund.