How to avoid the trouble coming to the tech sector

CHICAGO Mon Apr 14, 2014 1:50pm EDT

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CHICAGO (Reuters) - A resounding shot across the bow has been fired at the tech sector in recent weeks. The tech-heavy Nasdaq Composite Index is down nearly 5 percent in April through Friday's close and the Nasdaq Biotechnology Index is off 21 percent from its record closing high on February 25. Many of the sector's flagships and newcomers have been in the crosshairs.

The latest tech stock falterings could be a sign of trouble ahead.

To get a clearer idea of what's roiling the tech sector, you have to look at trends within various parts of it.

One item to look at is data storage, which is offered by Amazon.com Inc and Google Inc and has been the object of a price war of late. While falling prices in this sub-sector are great for customers, they will eat into profits for competing companies.

Brian Bolan, a portfolio manager and equity strategist for Zacks Investments in Chicago, surmises that the storage price war is partially responsible for the delay of initial public offerings of companies like Dropbox and Boxee.

Tech companies' valuations, particularly those that are barely profitable, may be the object of inflated expectations of future business and earnings because they often engender irrational exuberance. Witness the dot-com bubble of more than a decade ago.

Today's valuations may not wreck as much havoc if they end up having a correction, according to a recent Citi Private Bank bulletin, which notes that current tech "speculative growth expectations are a far less profound influence on the overall U.S. stock market than was the case in 1999-2000."

That doesn't mean that the next few months won't be rocky for tech shares and the market in general. The year started with a broad-based selloff, and the current bull market may be long in the tooth in its fifth year.

"Valuations become more reasonable before investors do," Bolan adds, "But volatility is definitely something you're going to see."

CUT RISK

Although diversification is usually a good idea in any sector, it won't guarantee you protection from tech's always-skittish volatility.

One way to cut the risk of the sector is to invest in a broad-based index fund. Although you won't avoid a widespread selloff, there may be safety in numbers as most index funds give more weight to the older, more established dividend-paying companies with consistent earnings.

The Vanguard Information Technology ETF , for example, owns cash-rich Apple Inc, Google and Microsoft Corp in addition to older stalwarts like International Business Machines Corp and Intel Corp. The fund is up nearly 22 percent for the year through April 11. It charges 0.14 percent in annual management expenses.

Another option is the iShares Technology ETF , which is up 3 percent year to date and has gained about 22 percent for the prior 12 months through April 11, but charges more than the Vanguard fund at 0.46 percent in annual expenses. The fund's weighting in the top tech stocks is slightly different than Vanguard's, with more than one-third of its holdings in Apple, Google and Microsoft.

If you want to stay in tech stocks, to ratchet down exposure to the biggest names in this rambunctious sector, you should consider an equal-weighted fund that doesn't concentrate its holdings in the most popular stocks, such as the Guggenheim S&P 500 Equal-Weighted Technology ETF, which is up 26 percent for the 12 months through April 11. The fund holds less than 2 percent (each) in stocks like First Solar Inc , Seagate Technology and Teradata Corp.

While pundits have mixed opinions on whether the latest tech troubles will spill over into the broader stock market, it's likely that there's more volatility ahead and it will become even more difficult to tell when it's a good time to buy.

While tech stocks benefited from the broad-based gains of the larger U.S. stock market last year, they won't be immune from a wider selloff. They still make sense long-term in an information/technology intensive economy, although short-term they will always be volatile. You might see some bargain pricing if the sector goes into a full-blown correction. Those attempting to time the sector or leery of this ever-skittish sector might want to seek some safer harbors.

(The opinions expressed here are those of the author, a

columnist for Reuters.)

(Follow us @ReutersMoney or here;

Editing by Beth Pinsker and Jonathan Oatis)

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