Sector Rotation for 2013 - What about Technology?

by Wayne Ferbert on December 19th, 2012

In our 5 part series on sector rotation for 2013, we identified Energy and Financials as the two sectors we like the most – and expect to out-perform in 2013. We’ll re-visit those picks in mid-2013 or sooner if the market dictates it.
Energy and Financials have been on our sector bias list for most of 2012 already – so our bias carries over in to 2013. But Technology has been in our sector rotation for all of 2012 also. Yet it did not show up as an under-valued sector going in to 2013.
You might ask: what gives?
As a sector, we have liked it mostly for fundamental reasons. We think technology is just scratching the surface on how it changes our lives. The companies in the technology sector will realize significant value in the next decade by bringing those changes to the market.
However, the companies that will make that happen are not necessarily the companies that make up the majority of the Technology Large Cap ETF that we invest in: the XLK from State Street Sector SPDR ETFs.
Remember, the actual investments that make up over 80% of the market cap of the XLK were the ones we examined to determine whether the Technology landscape was under-valued. What we found was that it did not appear, based on current valuation multiples that enough of these top companies were under-valued.
Technology is even a special case given that among all 9 of the Sector ETFs we examined, it has the largest SINGLE STOCK CONCENTRATION. Apple (AAPL) is almost 20% of the total market cap of the Technology sector ETF.  Plain and simple: Apple is the straw that stirs the Technology drink.
We have seen that so far in 2012. The Technology ETF is up 15.8% Year-to-Date. Meanwhile, Apple is up 32%+. In other words, with Apple representing such a large portion of the XLK, Apple represents almost a full 6 points of the 15% gain in the XLK year-to-date. Without Apple’s move up, this sector would be lagging nearly ever other sector.
Let’s also forget that at one point, Apple traded at $700 – not the $530+ handle it trades at today. IN other words, Apple was up over 70% at one point this year. So, Apple has been a big part of the run up in Technology and the move back down from its highs when Apple was at $700 per share.
So, if you like the Technology sector, you probably really need to ask yourself: Do I like Apple? Apple as 20% of the sector ETF will continue to play a significant role in the performance of the Tech sector in 2013.
When you look at the other top Tech players in this Index, there is not a preponderance of under-valued Tech names. So, really your hypothesis on Tech Large Caps needs to be based on what you think Apple will do in 2013.
If you think Apple will go back up to $700, then you should be in Tech. If you think it will re-trace to $405 (its Dec 30, 2011 price), then you should avoid Tech. The Technology ETF is a safer way to play Apple because it is broadly diversified, cheaper to own per share, and has options on it.
However, if you really think that Apple is headed to $700 again – then you should just own Apple. The Tech sector ETF, because it is diversified is safer. However, a move back to $700 would be a 30%+ move up from the $530+ level. That is better performance than you will ever get from the sector ETF.

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