Sentiment is also always an important factor in determining the outlook for stocks.  No matter how you cut it, stocks are still an ‘unloved asset class’ right now.  The BAML Sell Side Indicator rose for the seventh time in nine months since it bottomed in July of last year.  History suggests that strong equity returns can last for years after the indicator troughs and investor’s bearishness towards equities remains at an extreme level from a historical perspective.  Historically when the indicator is below 50 the 12-month total return for the S&P500 is positive.  Using historical returns from the SSI, the current level of around 47 suggests stock prices could rise over 20% for the 12-month period ending April 2014.  While none of these types of indicators are infallible, the track record for this ‘contrarian measure’ has been quite good.  Maybe it’s not too late to get into this market after all!  One of the classic stock market adages says to ‘be greedy when all others are fearful.’  There seems to be no doubt from the chart below that investors are definitely ‘fearful’ right now.

Sell Side Consensus Points to 20% Stock Gains

As the past two years have shown us though, saying that stocks are cheap is not enough to generate superior returns in the market.  You also have to be able to identify the stronger sectors as well as the names in those sectors that will generate excess returns to be able to beat the averages.  Defensive sectors have been the biggest gainers over the past two years while economic growth was subdued and the most important support for stock prices was low interest rates.  That is in the process of changing though as interest rates will not fall further.  Earnings growth and valuation will be more important determinants of stock price movements.

On both of those counts, the Technology sector sticks out as a beneficiary.  The companies generally have growth characteristics, a global sales footprint, high gross margins and strong cash generation capabilities.  Most of the major players in the industry have substantial cash balances as well, even though most of this cash is parked offshore from the U.S., as recent news around Apple Inc.’s US$140 billion cash hoard and its tax status has pointed out.  But, as shown in the chart below, technology stocks, with or without their cash component included, now trade at a discount to the average global stock.

Technology Stocks Cheap - with or without cash

This is a reversal from the period prior to the 2008 bear market when technology stocks traded at a premium valuation to the rest of the market, and is hugely different from the 1996-2001 period of the ‘technology bubble’ when the tech stocks traded at valuations far in excess of the rest of the market.  While not expecting any return to the glory days of the 1990’s, technology stocks should trade at a premium to the overall market given their superior growth profile, high margins and global diversity.  The biggest difference in the technology sector is the greater difference between the ‘haves’ and the ‘have-nots.’  In other words, stock picking is more important in the technology sector.  The most important trends in technology recently have been;

  1. The shift from locally-based storage to cloud services.
  2. The movement away from laptop and desktop computers to tablets and smartphones.

On the first point, the winners have been newer names such as Dropbox, whose services are completely server-based as well as the traditional players, such as Apple, which have adapted to a ‘server’ or ‘cloud-based’ storage and processing system.  This also impacts semi-conductor companies too since cloud-based services are usually processed by the memory on your computer, rather than the hard drive, making them more efficient.  Losers on both counts have been some of the traditional manufacturers such as Dell and HP, which have not migrated to the new model quickly enough.  Our favourites in the tech sector include Qualcomm and Broadcomm for their communications chips, Apple and Blackberry for their mobile computing platforms, Cisco and Microsoft on pure valuation as well as some resurgence in growth, and Google and Facebook for their search and social networking platforms.

1 2 3 4 5