Tech’s market leadership over? Not so fast

NEW YORK (Reuters) – Technology shares surrendered their leadership in the US stock market over the past month, but the fast-growing group may soon resume its outperformance and maneuver back into pole position.

Upcoming earnings reports for the technology sector , whose profits are expected to outpace the overall S&P 500 for the 11th consecutive quarter, could lure back investors who have been concerned about expensive valuations and that too many people may have piled into the big names.

The sector has slumped 4% since the first week of June, while financials have climbed more than 5% and healthcare has gained 3%. This has prompted speculation that investors may have been cashing out their tech profits to move into those groups.

“Technology has taken a rest, but it’s going to heat up again, and I see tech returning to favor the second half of the year,” said portfolio manager J. Bryant Evans of Cozad Asset Management in Champaign, Illinois.

For the first five months of 2017, tech was the talk of the stock market, far outperforming the other 10 major S&P 500 sectors and sparking the Nasdaq Composite to its strongest first half since 2009.

“I think of (tech’s recent swoon) as profit-taking rather than driven by change in the fundamental factors,” said John Praveen, managing director of Prudential International Investments Advisers in Newark, New Jersey. “The fundamentals are still positive for the sector.”

On Friday, the tech sector ended a volatile week by rising 1.3%, topping all other sectors and a 0.6% rise for the S&P 500.

Analysts estimate tech’s second-quarter earnings rose 11.2%, with semiconductor companies accounting for much of the gain, according to Thomson Reuters I/B/E/S. The increase tops the estimated 7.9% rise for the overall S&P 500 and is well above every sector except for energy, whose performance will be skewed because of negative year-earlier results.

“The tech sector has the highest growth expectations and only moderate uncertainty,” Morgan Stanley equity strategists said in a research note.

Given tech’s outsized position – 22% of the market value of the S&P 500 – the sector’s growth is critical to overall US corporate profit gains.

For the second quarter, tech profit growth alone is expected to account for nearly 28% of the S&P 500’s overall increase in earnings, or nearly half if energy were excluded.

Given tech’s outsized position – 22% of the market value of the S&P 500 – the sector’s growth is critical to overall US corporate profit gains

“In an economy that still seems to have some growing pains, consistent growth is worth paying up for,” said Peter Tuz, president of Chase Investment Counsel in Charlottesville, Virginia.

Tech’s second-quarter revenue growth is projected at 7.2%, faster than 4.6% for S&P 500 companies overall, according to Thomson Reuters I/B/E/S.

There is “growth on the top line, which is more important at this point in the cycle, than in the bottom line only,” said Kim Forrest, senior equity research analyst at Fort Pitt Capital Group in Pittsburgh. This earnings season, she will focus on companies’ comments about sales activity.

Valuations for the sector also may not be so expensive. Tech is trading at 18.1 times earnings estimates for the next 12 months, just above 17.8 times for the overall market.

That difference is even smaller when compared with the premium tech has held over the past 15 years, following the dot-com bubble. Over that time, its average P/E has been 17.2 times versus 14.7 times for the S&P 500.

Another factor in tech’s favor: The dollar’s 6.1% decline this year against a basket of major currencies.

S&P 500 tech companies generate 60% of revenue from outside the United States, compared with 40% for companies in the entire index. A stronger dollar makes foreign sales less valuable when they are translated back into the US currency for reporting purposes.

Despite these positive factors, other sectors may end up besting tech.

Healthcare’s year-to-date performance has nearly kept pace, and a resolution of the legislation moving through Congress could draw investors who have been wary about political uncertainty hovering over the sector.

A pickup in the economy and inflation could favor groups like industrials, energy and financials, which tend to perform better in such times.

Clues will come starting on July 14, when a big batch of bank reports kicks off the heart of the earnings season.

In tech, Microsoft Corp and International Business Machines Corp report the following week, while Alphabet Inc, Facebook Inc and Intel Corp are among the companies that will follow later in the month.