uploads/2015/05/Housing-starts31111.png

Tech Stocks Would Benefit as the Economy Improves

By

Updated

Another reason we like mature US tech is that it’s a cyclical industry. In other words, when the economy gets stronger, cyclical sectors like tech have tended to generate higher revenues through increased consumer spending. Companies with higher revenues have a greater opportunity to increase shareholder-friendly policies compared to industries that are “defensive” in nature.

Due to the resilience in US economic growth and anticipation that the Federal Reserve will likely raise interest rates this year, we’re starting to see investor sentiment transitioning from defensive to cyclical stocks.

Article continues below advertisement

Market Realist – Tech stocks would benefit as the economy is showing signs of improvement.

While the US GDP (gross domestic product) growth slumped in 1Q15 due to temporary factors, recent data suggest that the economy is recovering. The economy created 213,000 new non-farm jobs in April, rebounding from 94,000 jobs created in March. The only areas of concern are the tepid growth in consumption and the weakness in manufacturing. Retail sales were flat in April. However, recent housing (VNQ) (IYR) numbers are encouraging.

The graph above shows the monthly housing starts in the US. Housing starts rose from 944,000 in March to 1,135,000 in April. This exceeded analysts’ estimates of around 1 million.

An improving economy means that people have more money to spend on discretionary (XLY) items like high-end electronics, fancy restaurants, luxury cars, and so on. This is why cyclical sectors like technology (IYW) tend to perform well when the economy is improving.

The graph above compares the correlation of quarterly returns technology stocks and the utilities (IDU) with the annualized quarter-over-quarter (or QoQ) GDP growth, over the last 20 years. As you can clearly see, technology stocks are more linked to GDP growth than the utilities.

Hence, technology, along with other cyclical sectors, would outperform utilities and other defensive sectors when the economy improves. We will discuss this in detail in the next part.

Advertisement

More From Market Realist