We see two compelling drivers of strong growth for tech stocks ahead, even if the economy weakens, as my colleague Scott Wallace explains.
Are technology stocks cyclical?
Technology has traditionally been classified as a cyclical sector, whose relative performance tends to rise and fall with the strength of the economy. Given the widespread concerns about the global and US economic outlook, it may seem like a terrible time to invest in technology companies. Won’t corporate spending on information technology dry up if corporate managements remain wary about the economy?
Not necessarily. While there is considerable cyclicality to technology spending (because businesses are less inclined to spend on new systems in hard times), other factors at work today should propel technology stock leadership even if the economy weakens further.
First, technology spending has already been deferred for so long that companies have no choice but to replace outdated systems. At 4.4 years, the average age of information technology equipment and software is higher than at any point since 1952, the inception of such records, according to the US Bureau of Economic Analysis. On average, communications equipment is now 6.8 years old, two years older than its long-term average.
Companies can’t afford the loss of productivity that comes from old equipment—and they can afford to replace it. The US Federal Reserve Board shows that cash on the balance sheets of nonfarm and nonfinancial companies in the US passed $2 trillion in 2010 for the first time ever.
Second, a number of innovations—from cloud computing to mobile connectivity—are spurring migration to new technologies. That migration will continue regardless of the overall economic condition, in our view.
Mobile connectivity allows users to access any application, anytime, anywhere. And the number of access points is expanding rapidly. For example, the number of certified Wi-Fi products grew by nearly 50% in 2010 alone; the number of 3G devices shipped annually is expected to nearly double over the next five years (Display
The explosive growth in mobile connectivity should benefit tech companies in a variety of businesses, from those supplying the connections and equipping the networks that carry the increased traffic to those that manufacture the chips that help coordinate and direct it all. Other potential beneficiaries include makers of smartphones and other sophisticated devices that can exploit expanding connectivity.
Investors seem to understand this to some degree. The technology sector did better than the overall market—and far better than cyclical sectors such as energy, materials, industrials and financials—in the third-quarter market rout.
But technology stock valuations, in aggregate, don’t properly reflect the strong boost to revenues and earnings ahead from overdue equipment upgrades and the secular shift to new technologies. In my book, that spells opportunity.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
This article first appeared on Institutional Investor.com as part of its Global Market Thought Leaders section.