Technology To Take The Lead

Technology has been one of the poorest performing sectors in 2013 and over the past 12 months. The S&P 500 has returned 13.98% over the past 12 months while the S&P 500 Information Technology sector has returned -2.93%, lagging by nearly 17%. The two main drivers of the market rally have been a chase for yield and the float shrinkage that has been occurring through cash M&A and share repurchases. Technology has not been one of the main beneficiaries of these trends but I believe the record cash return by Apple will mark a turning point.

The stock market has been shrinking. In February there was over $100 billion in share repurchases & cash M&A announced. This float shrinkage has helped propel the overall market higher but has been less prevalent in the technology sector. For the most part technology companies have continued to stockpile cash, with the Dell LBO having been an exception. That all changed this week when Apple announced the largest cash return in history.  Apple has pledged to return $100 billion to shareholders before the end of 2015. That works out to over $33 billion a year, a little over 8.6% of its current market cap. With this announcement technology has joined the float shrinkage party and the sector is likely to play catch up. Its also possible that Apple's technology peers will follow its example.

The poor performance in the technology sector does have some fundamental justification. There is a large amount of disruption occurring in technology. The PC related companies have been disrupted by tablets. The tablet and mobile device markets are becoming more competitive. The enterprise software companies are feeling the slowdown in global GDP as well as the move to open source and cheaper alternatives. However, there has always been disruption in technology and the lower valuations already account for this. Its not like everything is perfect in consumer staples, one of the best performing sectors. Companies like Coca Cola and Procter & Gamble have barely seen any revenue growth yet the stocks are flying.  The same can be said for pharmaceutical companies like Pfizer.

I believe that technology will be the best performing sector between now and year end and have positioned myself that way. Technology is by far my highest allocation with Check Point Software, Amdocs and Apple being my largest tech positions. All trade at greater than 10% free cash flow yields (to enterprise value) and all are returning cash to shareholders.