When might IT equities lose their shine?

US IT firms have stormed ahead of the pack so far this year – but can they continue? Investment strategist Lars Skovgaard Andersen gives his views on the outlook for IT equities.

The US earnings season is in full swing and IT companies are grabbing many of the headlines. Strong financial reports have boosted share prices and helped IT equities handsomely outperform the broader market so far this year – for whereas the broad US S&P 500 index is up by around 17%, the S&P 500 Information Technology index is up roughly 27%.

The surge was perhaps best illustrated by Microsoft, whose share price jumped last week on the back of excellent earnings to push its market value past the USD 1 trillion mark for the first time – making it the world’s most valuable company at present.

“At Danske Bank we have been overweighting the IT sector for some time and continue to do so – a good decision in light of the earnings reports,” says Danske Bank’s investment strategist, Lars Skovgaard Andersen.

Other digital giants like Apple, Facebook and Amazon have surprised positively, though technically Facebook does not belong in the IT sector, but rather in communication services, while Amazon is actually included as a consumer cyclicals company.

New impetus
One question being asked of Lars Skovgaard Andersen by many investors at the moment is whether the good times can continue for IT equities. Is there further potential for investors?

“Whereas I was more cautious ahead of the earnings reports, my response now is a clear and unequivocal yes. After the pronounced increases so far this year we had reached a point where equity prices needed a new impetus and confirmation that the IT sector was still on the right track. And here I think the earnings reports have provided many with the answer they had hoped for, even though there have of course been a few disappointments,” Lars explains.

Lars Skovgaard Andersen highlights several important drivers for the IT sector at the moment:

“The sector is very much being driven by corporate investments in new technology, with a high level of investment activity in cloud solutions, big data and internet security. Microsoft’s numbers and expectations going forward strengthen our belief that IT companies will continue to benefit from a solid level of investment,” says the investment strategist.

Broad, global exposure recommended
Lars Skovgaard Andersen also notes that IT companies are experiencing attractive earnings growth overall compared to the market in general, and that they have solid cash flows and low levels of debt, which reduces their vulnerability to rising global interest rates.

“The sector’s fundamentals essentially remain strong,” he says.

That is why he expects the IT sector will continue to outperform the equity market in general. He recommends having a broad, global exposure to the sector; for example, via a fund, though he also sees a number of attractive individual companies in the market.

A potential threat to the sector – apart from a slowdown in corporate investments – is the US dollar strengthening. The US IT sector makes 67% of its sales abroad, and a stronger dollar might hit exports. Paradoxically, this could be the scenario if things go too well for the economy, as focus would once again shift to potential rate hikes from the US central bank.

A note of caution
Lars Skovgaard Andersen is more cautious about the communication services sector, which includes companies like Facebook and Alphabet (Google). Danske Bank has a neutral weighting here. However, our investment strategist stresses investors should not necessarily avoid this sector, but rather that it should have a lesser weighting in portfolios than IT.

“Companies like Facebook and Google are drawing a lot of political attention, as they are heavily exposed to consumers and could face increased regulation and digital taxes – which might be a potential drag on these companies for quite some time.

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Disclaimer: Danske Bank has prepared this material for information purposes only, and it does not constitute investment advice. Always speak to an advisor if you are considering making an investment based on this material to establish whether a particular investment suits your investment profile, including your risk appetite, investment horizon and ability to absorb a loss.

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