Tech ETFs: A Bullish Play

Thursday, July 16, 2009

Technology ETFs led the way up in 2006 and 2007 and led the way down in 2008. It should be no surprise that it is charging ahead of market averages during the 2009 rebound. Technology is an ideal sector to time economic growth. Unfortunately, tech ETFs are unforgiving if one times it wrong.

Many economists believe that we are in for a slow, painful crawl out of recession. The market, however, senses a good deal:

It is easy to construct scenarios from mildly bullish to mildly bearish for tech. Computer companies are nowhere near as dependent on debt financing as typical industrial firms. Unfortunately, financial firms and consumers are mainstays of technology sales, and both have curtailed discretionary spending drastically. Competition ensures that they must keep spending some amount of money on technology to avoid being leapfrogged. Delaying major purchases, however, is easy to do.

Broad US technology index ETFs with moderate fees include:

  • SPDR Technology Select Sector ETF (AMEX:XLK); 0.24% annual fees
  • iShares Dow Jones US Technology Sector ETF (NYSEArca:IYW); 0.48%
  • SPDR Morgan Stanley Technology ETF (AMEX:MTK); 0.5%
  • Vanguard Information Technology ETF (AMEX:VGT); 0.25%
  • NASDAQ 100 Tracking ETF (NasdaqGM: QQQQ); 0.20%

Growing at single digits, tech companies sport a Price/Earnings ratio in the low teens after plummeting from the low 20s in 2007. Furthermore, technology traditionally has demanded more per dollar of earnings, but it now commands about the same price per dollar of earnings as the S&P 500. At least for the foreseeable future, analysts say technology is showing all the hallmarks of a mature industry: moderate growth, unspectacular margins, etc.

In the ETF world technology is generally defined as computer hardware and software, networking and often telecom but never biotechnology. For buy-and-hold investors intent on rational asset allocation without duplication, the SPDR XLK and Vanguard's VGT are obvious choices. They lead in cost with impecable indexes and complement other ETFs well.

Perhaps the most famous tech ETF is not pure technology. PowerShares QQQ (NasdaqGM: QQQQ) gained glory and then infamy during the Dot Com Boom and Bust, but it is only an index of large NASDAQ-listed stocks which happens to contain important tech names such as Microsoft. While not suitable for accurate asset allocation, it is an excellent trading vehicle with wide analyst coverage and deep liquidity. Fees are light at 0.20%

For the hefty fee of 0.60% per annum, First Trust NASDAQ-100-Tech Index (NasdaqGM:QTEC) will filter out non-technology firms from the NASDAQ listing. The appeal of this is dubious.

Technology sub-index ETFs include First Trust Dow Jones Internet ETF (AMEX:FDN) and SPDR S&P Semiconductor ETF (AMEX:XSD) which is fairly priced at 0.35% per year.

Semiconductors are a bellwether of broad computer demand. The Gartner Group warns that the economic crisis is having a significant impact on the semiconductor industry and that worldwide semiconductor revenue growth in 2009 is expected to be nearly flat. The Internet sub-sector continues to be at once a trader's delight for its volatility and an attractive long-term industry. Needless to say it is not for the weak of heart.

In addition to plain-vanilla ETFs, Invesco PowerShares has a smallline of ETFs which use fundamental financial ratios to beat IT indexes and sub-indexes (PSI, PSJ, PNQI, PXQ and PTF). There are also leveraged ETFs from ProShares (USD, ROM, SSG, REW) and leveraged and equal weight ETFs from Rydex (RTG, RYT, and RTW). Finally, there are international technology ETFs from iShares (IXN) and WisdomTree (DBT).

Co-founder of indexfunds.com, author of two books on investing, and founder of ETFzone.com, Will has been writing on indexing issues for 8 years. He holds an MBA from the University of Texas at Austin.