Stick With Tech ETFs Over Energy

There's good reason to believe technology ETFs will continue to outperform their energy counterparts.

sumit
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Senior ETF Analyst
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Reviewed by: Sumit Roy
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Edited by: Sumit Roy

Google adds $60 billion to its market cap in one day; Amazon surpasses Walmart to become the world's largest retailer; Facebook hits an all-time high. Those are just a few of the glowing headlines the tech sector has seen during this earnings season, helping to fuel the Nasdaq-100 to an all-time high earlier this month.

The PowerShares QQQ (QQQ | A-65), which tracks the Nasdaq-100 and has $42 billion in assets, has handily outperformed the broader stock market with a 7.2 percent year-to-date gain. Meanwhile, the Technology Select SPDR (XLK | A-90), which holds tech companies almost exclusively, has performed more modestly, but has still outperformed the market, with a 2.4 percent gain.

The tech sector, which now contains the world's top three firms by market cap―Apple, Google and Microsoft―is seeing rapid growth and is where most of the market's earnings are coming from. In fact, profits from the industry accounted for 28 percent of the S&P 500's total earnings in the last year, according to Bloomberg. That's far and away above any other sector, including financials, which is next on the list, with 20 percent of profits.


The Tech-Energy Contrast

While technology shares and profits have been doing well, the market as a whole has been lagging. The S&P 500 is barely in the green for the year, and overall earnings growth for the latest quarter is expected to be negative on a year-over-year basis for the first time since 2012.

The market's problems stem from a few areas, but none are as salient as the energy sector, where earnings are expected to tumble 54 percent from a year ago in Q2, when oil prices were at their highs.

In fact, energy is the perfect contrast to technology. In recent days, major firms in the energy sector such as Exxon and Chevron have hit 52-week lows, just as the aforementioned tech heavyweights have rocketed to all-time highs.

Pressured by one of the biggest oil slumps in history, energy is the worst-performing sector of the year, with the Energy Select SPDR (XLE | A-95) down 12 percent so far in 2015. The industry now only accounts for 7 percent of the cap-weighted S&P 500's total market value, compared with 20 percent for tech.

S&P 500 Sector Weightings

Charts courtesy of Bloomberg

That's a big shift from last year, when energy was at 11 percent and tech was at 19 percent, or from back in 2008, where at one point, energy and tech were equal, at 16 percent.

Broad-Market Impact

As tech eats into energy's share of the pie, investors are faced with a number of questions. The first is whether the divergence between the sectors is simply a reflection of industry fundamentals or a more troubling sign.

Could weakness in energy stocks eventually push the broader stock indexes much lower, fueling the big correction in markets that many have been waiting for?

Andrew Gogerty, vice president of investment strategies at Newfound Research, doesn't believe the downturn in energy necessarily bodes ill for the broader markets. As he notes, the market as a whole has been unfazed during the past year despite the steady sell-off in energy.


"The energy sector (as measured by XLE) has fallen roughly 30 percent since its sell-off began in June 2014," said Gogerty. "Over this time, the S&P 500 is up more than 8 percent, and the other eight sectors are up almost 10 percent on average."

Indeed, as the energy sector's weighting in the S&P 500 has shrunk, so too has its impact on the index.

Portfolio Adjustments?

From a historical perspective, some investors may see parallels between the current situation and that of the late 1990s, when tech was all the rage while energy fell deeply out of favor amid a massive oil bust at the time.

The poor performance in energy was merely a footnote in a surging market that was gaga for all things technology. Of course, the late 1990s turned out to be the peak for tech and the bottom for energy, underscoring how rapidly fortunes can change.


That raises the second consideration that investors face: whether to adjust their portfolios in reaction to this sector divergence. Should investors ride the wave in tech while shunning energy, or take a contrarian view and do the opposite?

Newfound Research's Gogerty says tech is still the place to be for now.


"We are a momentum–based asset manager; so at the moment, we are firmly in the camp of remaining out of energy and in technology," he explained.

Valuationwise, tech shares also seem to be on firmer footing than they were during the last boom. The price/earnings ratio for the S&P 500 technology sector is only 17 compared with 60 during the dot-com peak.

On the other hand, even after the recent decline, the S&P 500 energy sector is historically expensive, with a P/E ratio of 25. Moreover, the outlook for oil and natural gas prices remains challenged, suggesting that the sector could continue to underperform.


As Gogerty points out, "Just because an asset class has seen a large correction does not mean that things can't get worse."

Sumit Roy is the senior ETF analyst for etf.com, where he has worked for 13 years. He creates a variety of content for the platform, including news articles, analysis pieces, videos and podcasts.

Before joining etf.com, Sumit was the managing editor and commodities analyst for Hard Assets Investor. In those roles, he was responsible for most of the operations of HAI, a website dedicated to education about commodities investing.

Though he still closely follows the commodities beat, Sumit covers a much broader assortment of topics for etf.com, with a particular focus on stock and bond exchange-traded funds.

He is the host of etf.com’s Talk ETFs, a popular video series that features weekly interviews with thought leaders in the ETF industry. Sumit is also co-host of Exchange Traded Fridays, etf.com’s weekly podcast series.

He lives in the San Francisco Bay Area, where he enjoys climbing the city’s steep hills, playing chess and snowboarding in Lake Tahoe.